China just waved a $1.6 trillion red rag at Trump

China’s announcement of a record trade surplus on Monday, a week ahead of Donald Trump’s inauguration, is inadvertently, but unavoidably, provocative.

With Trump having vowed to impose tariffs of up to 60 per cent on China’s exports to the US (and 20 per cent on everyone else’s) on day one of his second term as president, the $US992.2 billion ($1.6 trillion) surplus will be like a red rag to a bull.

Donald Trump has vowed to increase tariffs on Xi Jinping’s China as soon as he returns to the White House. Credit: AP

More particularly, while the growth in exports to the US of 4.9 per cent in 2024 might be relatively modest, a 15.6 per cent surge in December as Chinese companies and US importers scramble to complete orders ahead of next week’s inauguration will only intensify the already strong anti-China and pro-tariff sentiments of the incoming administration. China’s trade surplus with the US grew 6.9 per cent to $US361 billion last year.

While some front-loading of its exports might have helped boost the value of the exports to a record $US3.6 trillion, the massive trade surplus is the outcome of an unbalanced economy, with weak domestic demand forcing policymakers to increasingly rely on exports for growth.

The imbalances within the economy have been exacerbated by Xi Jinping’s focus on “new quality productive forces” – heavily subsidised investment in advanced technologies such as electric vehicles, solar panels and semiconductors – that has contributed to substantial overcapacity in many industries.

The combination of weak domestic demand and over-capacity has seen factory gate prices and corporate profits falling for more than two years, nearly a quarter of China’s larger companies losing money, and China being accused of dumping its excess stocks of products into its export markets. The volume of its exports has been growing significantly faster than their value.

The weak domestic demand, despite incentives for Chinese consumers to trade in an ever-expanding range of products, from smartphones to electric vehicles, was reflected in the meagre 1.1 per cent increase in China’s imports from the rest of the world, which is another incitement for trade tensions and retaliation.

China’s over-reliance on exports for growth has made it more vulnerable to a new and more punitive trade war than the last tariffs Trump imposed (and Joe Biden retained) in his first term, even if Beijing is better prepared for a new outbreak of trade hostilities today than it was then.

The threat of what Trump and his hawkish cabinet might do has forced Xi to do what he had previously resisted (because he thinks it is wasteful) and take steps to boost domestic consumption.

To date, starting more seriously in the latter months of last year, the efforts have been focused on the trade-in policy, with the range of products and sectors targeted continually being expanded.

Fears of deflation in China have prompted calls for Beijing to do more to stimulate consumption. Credit: Bloomberg

China has been running a more expansive monetary policy, has taken steps to shore up the finances of its local governments and banks and has tried, with mixed success, to stabilise its property and sharemarkets.

While those efforts have had some positive effects, China remains on the verge of deflation, with consumer prices rising only 0.1 per cent in December and the GDP deflator, which measures the value of all goods and services after taking inflation into account, flatlining at zero.

The prospect of China falling into a deflationary trap – the “Japanification” of its economy – has led to calls from economists outside China to do a lot more to boost consumption. That may well happen at the National People’s Congress in March, where the country’s most senior leaders will set out their economic objectives and strategies for this year.

No one wins in a trade war, but China’s severely unbalanced economy makes it vulnerable to being the biggest loser if Trump does do what he has pledged to do.

China’s central bank’s governor, Pan Gongsheng, gave a speech in Hong Kong on Monday in which he said the priority of macroeconomic policy should shift from promoting more investment to promoting both consumption and investment, with more importance attached to consumption.

China would look to increase its citizens’ income, increase subsidies for consumers and improve social security, he said. The most obvious and least wasteful measures that might lift consumption would be to target low-income households by expanding and strengthening the social security system.

China’s middle class is hoarding its savings and is more likely to save more than spend any fiscal largesse after being battered by the three-year implosion of the property sector.

A boost to domestic demand would have been necessary even without the prospect of another trade war, one that could slice somewhere between 0.5 percentage points to 2.5 percentage points of China’s GDP growth, according to a range of external economists.

The impact of that trade war, if Trump follows through with his threat, could be even worse if China responds by diverting its exports to other countries.

The export surge to the US will only intensify the already strong anti-China and pro-tariff sentiments of the incoming administration.Credit: AP

It’s already experiencing pushback, with the European Union imposing tariffs on its electric vehicle exports and considering whether it should similarly target other products and countries such as Brazil, which has been flooded with cheap Chinese imports, also introducing protectionist measures.

Mexico’s President Claudia Sheinbaum said on Monday that she too would act to reduce her country’s trade deficit with China. Mexico recently imposed tariffs on Chinese clothing, textiles and small parcels.

If the US does build the promised wall against Chinese imports and China redirects its increased surplus industrial capacity to other markets, it is almost inevitable that those economies will move to protect their domestic industries and jobs, exacerbating the impact of the trade war on China.

One of the responses of Chinese companies to the first round of Trump tariffs was to reroute exports to the US via third countries within South-East Asia, notably Vietnam, where Chinese components are assembled and then on-sold as Vietnamese exports to circumvent the tariffs.

In December, the biggest growth in China’s exports was to ASEAN countries, which grew 18.9 per cent. For the year, exports to the ASEAN region grew 12 per cent – about twice the overall rate of export growth.

It is unlikely that the new Trump administration will allow what’s effectively a backdoor entry to its economy to continue. Even before taking office, Trump threatened Mexico if Chinese companies were able to use it as a base from which to sell into the US and take advantage of the free trade agreement between Mexico and the US.

While China’s policymakers, particularly Xi, might be reluctant to try to reduce China’s over-dependency on exports by showering consumers with money, its economy needs – and has the fiscal capacity – to reduce the imbalances that could prove unsustainable in the event of a full-scale trade war.

No one wins in a trade war, but China’s severely unbalanced economy makes it vulnerable to being the biggest loser if Trump does do what he has pledged to do. The national congress in March will provide a clearer insight into how it plans to address that vulnerability.

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