Dear Money & Crisis Reader,
Last week, President Trump sent his top economic advisors to Beijing to try and negotiate an end to the ongoing U.S.-China trade war.
After two days of trade talks, it’s clear that we’re a long way from a concrete resolution… and things may get a lot worse before they get better.
So today, I’ve asked economist and financial expert Jim Rickards to give us a breakdown of the trade war and shed a little light on what this means for us in the long run.
All the best,
Editor, Money & Crisis
P.S. Jim Rickards is the best-selling author of Currency Wars and one of the few people who predicted the 2008 financial crisis.
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Calling China’s Bluff
By Jim Rickards
A global trade war is now in full swing. Many nations are involved, but the chief antagonists are the U.S. and China.
China set up the conditions for a trade war by unfair dumping of steel on world markets and the theft of over $1 trillion of U.S. intellectual property.
President Trump fired the first shots with tariffs on steel, aluminum, solar panels and dishwashers. China retaliated with its own tariffs.
Trump answered back with further tariffs on $50 billion of Chinese imports. China then imposed more tariffs on U.S. goods to match Trump’s $50 billion.
Trump raised the ante another $100 billion like a poker player with a good hand and lots of chips.
China’s “Nuclear Option”
At this stage, China can’t keep going with tariffs.
They only import about $150 billion of U.S. exports. At the rate they’re going, they’ll run out of goods to impose tariffs on. But Trump can keep going because the U.S. imports so much more from China than they buy from us.
But the Chinese are obsessed with not losing face.
Chinese President Xi has just been named in effect dictator for life. He doesn’t want to start out his new dictatorial regime by backing down from a staring contest with Donald Trump. So he needs another option.
For China to keep fighting, they need an asymmetric response; they need to fight the trade war with something other than tariffs.
China holds over $1.2 trillion of U.S. Treasury securities. Some analysts say China can dump those Treasuries on world markets and drive up U.S. interest rates.
This will also drive up mortgage rates, damage the U.S. housing market, and possibly drive the U.S. economy into a recession.
Analysts call this China’s “nuclear option” when it comes to fighting a financial war with Trump.
There’s only one problem.
The nuclear option is a dud.
If China did sell some of their Treasuries, they would hurt themselves because any increase in interest rates would reduce the market value of what they have left.
Also, there are plenty of buyers around if China became a seller. Those Treasuries would be bought up by U.S. banks, or even the Fed itself. If China pursued an extreme version of this Treasury dumping, the U.S. President could stop it with a single phone call to the Treasury.
That’s because the U.S. controls the digital ledger that records ownership of all Treasury securities.
We could simply freeze the Chinese bond accounts in place and that would be the end of that.
So don’t worry when you hear about China dumping U.S. Treasuries. China is stuck with them. It has no nuclear option in the Treasury market.
That said, China isn’t out of bullets in a financial war.
If Trump imposes 25% tariffs on Chinese goods, China could simply devalue their currency by 25%.
That would make Chinese goods cheaper for U.S. buyers by the same amount as the tariff. The net effect on price would be unchanged and Americans could keep buying Chinese goods at the same price in dollars.
The impact of such a massive devaluation would not be limited to the trade war.
The last two times China tried to devalue its currency, August 2015 and December 2015, U.S. stock markets crashed by over 11% in a matter of a few weeks.
So if the trade war escalates as I expect, don’t worry about China dumping Treasuries or imposing tariffs.
Watch the currency.
That’s where China will strike back. When they do, U.S. stock markets will be the first victims.
China doesn’t have a trade war nuclear option. But it does have one very powerful weapon in its currency.
Editor’s Note: Click here if you’d like to hear more from Jim. He’s one of the world’s leading experts on money and crisis. And right now he’s giving away FREE hardback copies of his new book to Money & Crisis readers. Click here to claim yours.