US President Donald Trump has now made Huawei the biggest story in technology by forbidding it to do business with US companies. Huawei, China & # 39; s technical champion, no longer has access to Google & # 39; s Android and Intel chips, and there are even other international partners such as ARM and Panasonic bending to American influence and stopping trade. Having previously been en route to becoming the world's # 1 largest smartphone manufacturer, Huawei is now in such a difficult situation that the best metaphor the founder can come up with to remove fear is that the company like an airplane with a hole in its side: not great, but still in the air.
Bludgeoning Huawei with the forbidden hammer is, according to Trump himself, a negotiating tactic to focus China's attention on American dissatisfaction with the existing trade relationship between the two countries. It lands on top of a pile of punitive 25 percent rates that it has imposed on many Chinese imports in the US, and a promised further round of such rates on practically every conceivable Chinese export.
Two Chinese observers from experts tell The edge that China attaches great importance to these restrictions on its main overseas market, and it has every reason to respond, whether it is to relieve the sanctions or to show its own economic strength. But both agree that China has few or no good options available.
Veteran diplomat Hosuk Lee-Makiyama asks emphatically: "What is left of China to deal with reprisals?" It has already imposed rates on the few classes of goods for which it wants to protect its internal market, and it excludes American internet giants such as Google and Facebook, so what can China realistically threaten to do as a countermeasure? Some observers, such as Ben Thompson Stratechery, note that "China took the first shots" in the current trade war when it eliminated many American technology companies, and it is now the US that finally responds.
I have two thoughts.
On the one hand, I am rather concerned about the direction in which the not-so-cold war between the US and China is being led.
On the other hand, after dealing with the Great Firewall for a decade …..
Part of me just wants to say …
Cry a river, China. pic.twitter.com/CeQ0PZz6jn
– Elliott Zaagman (@ElliottZaagman) May 22, 2019
Lowy Institute & # 39; s Elliott Zaagman has lived in China for the past 10 years and looked at it, and he claims that the country's economic prosperity is brittle than it first seems. China & # 39; s "already at a point where the growth rate is not an output, it is an input," which means that the government sets the goal of reaching quarterly and borrowing banks to reach that number. Beijing has done more monetary expansion, he says, than the US Fed, the Bank of Japan and the EU combined. This has led to a number of toxic soap bubbles – for example, in homes, which have dismissed the effects of having over-priced real estate debt. Talking to him and Lee-Makiyama, you get the realization that the Chinese economy is closer to a pyramid system than a truly thriving and thriving giant.
Retaliation is particularly risky because the Chinese economy depends on the ever-increasing trade with the world, as evidenced by the massive Belt and Road Initiative to develop land and sea routes for faster freight transport. And Huawei, although an unlisted entity, was very helpful in acquiring high-quality overseas companies with its leading position in network infrastructure, 5G equipment and, most recently, premium smartphones. Lee-Makiyama notes that since the country has no social safety net, it cannot afford to ever take its foot off the gas, which inevitably represents Huawei's setback. Economists, he says, have long cherished 6.5 percent economic growth as the threshold below which China cannot drop if it wants to support its growing debt, and China reported 6.4 percent growth in the first quarter of 2019, in front of Trump's toughest rates had come into effect.
It is in this context that we must look at China's apparently formidable arsenal of weapons that it could use against the US.
There are also more advanced types of financial warfare. China has a trillion dollars in American debt, which it could dump on world markets and thus cause an interest rate step for the American economy. The Washington Post& # 39; S Robert J. Samuelson explains how this works brief and concise, but he claims that China would cause almost as much damage to itself in the process. A slowdown in the US economy would lead to even less appetite for Chinese exports, the US dollar would also fall in value and make Chinese goods less attractive, and what US treasury products left by China would also be worth less. This illustrates the inherent symbiosis between Chinese production and American consumption, which together formed the backbone of the global economy for the past 20 years.
The most threatening response since Huawei was turned into a trade pioneer by Trump a visit by President Xi Jinping to a facility for rare earths. This was a wordless reminder of China & # 39; s dominance in collecting and processing the rare earth minerals that are essential for any smartphone, laptop, hybrid car, and practically anything more advanced than a gas oven. Tell the CEO & # 39; s of two American headphones manufacturers The edge that China is the only place to buy the neodymium magnets needed for their products: one said China is the only source, the other said it controls 95 percent of the market. If you're struggling to wait a few weeks before that sweet new Powerbeats Pro goes on sale, try to wait months and months for an alternative source of magnets.
And yet, as my colleague James Vincent has already explained, rare earths are not the secret weapon that China imagines. They are not so rare, the reaction to potting Beijing is that production will become economically viable and will increase elsewhere. The final result is fewer jobs and less export for China. Lee-Makiyama sees this as an untenable scenario and points to China's ill-fated attempts to use rare earths as a trade knuckle in its relations with Japan and the US in the past.
Finally, and most obvious, the Chinese government could just do the & # 39; tit-for-tat & # 39; reaction by imposing sanctions on American companies operating within its borders. Even with an iPhone assembly of an older model in India, the vast majority of Apple's smartphone companies are built on Chinese land. Chipmakers are even more dependent, as one analysis of HSBC notes that Apple countryman Qualcomm makes 65 percent of its income vulnerable to trade disruption with China. Other US technology companies with similar exposure include Broadcom at 54 percent, Micron at 51 percent and AMD, Intel, and Texas Instruments that derive at least a quarter of their income from continuing trade with China.
American consumers can also be affected by imposed restrictions on physical retailers. Chinese imports represent 26 percent of Walmart & # 39; s merchandise, which is on the low side compared to a more typical number such as 34 percent of Target. according to UBS. Additional investigation by UBS says the Trump government's tariffs imposed on Chinese imports "could jeopardize sales of $ 40 billion and 12,000 stores." The American Apparel & Footwear Association calls the next round of rates "A self-inflicted wound that will be catastrophic for the nation's economy." If rates are catastrophic, what does a total ban on China look like? This is perhaps the most effective weapon that Beijing could use in its negotiations with Washington, but the corresponding hit on Chinese trade would be just as disastrous.
According to estimates by Lee-Makiyama, no scenario involving China in cutting off or restricting business with the outside world will be economically justified for the country. Even with its fast-growing national consumer market, China still needs more consumers for its goods and services. And with Apple and his countrymen like Nike, General Motors and Walmart with millions of Chinese employees, Trump has the leverage he needs to play hardball. That situation won't last long, the diplomat warns, and now it could be the last good chance for the US to lean on the interdependence it has with China. If the trade relationship remains as it is, China will eventually become colossal, both as producer and consumer, and the American influence would be zero.
For the US, corporate income and profits are at risk. The country's broader economy could suffer, but Lee-Makiyama says that few people would notice if GDP growth would fall from 3 to 2 percent. The same contraction for the Chinese economy, he claims and Zaagman agrees, would be disastrous. This asymmetry is at the heart of why the Trump government can afford to be self-destructive in its tariff regime, while China cannot yield to similar costs to score points for trade negotiations.
The Chinese government was "absolutely overwhelmed" by the brutality of Trump's actions, says Zaagman, who was "not expected at all." That could explain why Beijing did not make more complete or better contingency plans for a situation like today. On the other hand, Xi can be comforted by the fact that the same surprise should be heard in the offices of American tech giants, such as the economic observer in Asia, Tony Nash, formerly of the Economist Intelligence Group, asked questions why American companies had not diversified their production before. Their lack of readiness can reassure China that hostilities will not escalate beyond their current point without China falling back.
Without having a clear and coherent plan for his response, which neither Lee-Mikayama nor Zaagman believe Beijing is close to right now, the best strategy for China is to do nothing and a & # 39; strong and quiet & # 39 ; to maintain an attitude – what exactly is the country doing, just comment to say it "will not shrink back. "
The damage, "the stuff that drops out on one percent of GDP growth every year," has already been done, says Zaagman. Silicon Valley investors are now looking for startups with reduced exposure to China; major US tech manufacturers explore Vietnam, Mexico and other possible production units; and China has found its prejudices that the US cannot confirm. Now that Trump has pulled the big red Huawei handle, it's wise to avoid hurrying to mirror the movement. But again, it is not that it has much choice.