Will China back down?

0:08There is still only one story that matters in markets and it's Donald Trump's trade tariffs And look, there's a lot of noise, a lot of confusion. But one thing is now pretty clear. The focus here is very much on China. US imports from China now carry a tariff of 145%. Last time we recorded this podcast, it was 125. It is pretty hard to keep up. Now, the way the US administration is behaving, it's as if China has no leverage here. Just keep ratcheting up the pain and China will buckle. Today on the show, we're going to tell you why that's not quite right. This is Unhedged, the markets and finance podcast from the Financial Times and Pushkin.

0:55I'm Katie Martin, a markets columnist here at FTHQ in rather rainy London. And joining me down the line from New York City, from the mighty Unhedged newsletter, he came here to kick ass and chew bubblegum, and he's all out of bubblegum. It's Aidan Reiter. I actually am out of bubblegum, as you mentioned. it. It's Passover. And usually my family gives me kosher bubblegum for Passover to get me through the week of not being able to eat a lot of things. And this year, I don't have any. Was not aware that kosher bubblegum was a thing. So every day is a school day on the Unhedged podcast, boys and girls.

1:32Aidan, tell me, how much kosher bubblegum does the US import from China? I can't imagine the kosher variety is made in China. But I also don't know how much bubblegum we import from China. But there is a lot of other imports from China. As a whole lot of imports from China. And your glorious president, Mr. Donald J. Trump, has been obsessed with imports from China for longer than you've been alive. This is like a core pillar of his personality. Yeah. Since the 1980s, he's been obsessed with tariffs. Unclear how that economic thinking totally got into his orbit. But then, you know, since 2001, he and to be fair, plenty of others have accused China of not truly abiding by WTO rules, using unfair trade practices.

2:15So wait, wait, wait. WTO for the uninitiated, it's the World Trade Organization. And China was admitted in, I'm going to say 2005? 2001. Oh, 2001. The idea is that people accuse China of paying fast and loose since then. They haven't been playing by the rules. They've been gobbling up global manufacturing. We can argue all day about whether that's fair or not, right? Yeah. I mean, there's arguments to both sides. There's people who accuse them of stealing patents from other countries, of subsidizing their own manufacturing, which is technically against some elements of DWTO rules. Regardless, you know, Americans have been upset about this for a long time.

2:52And Donald Trump and the Republicans have been especially upset about it. So help him. And in 2018, he hit China with the first round of big tariffs, kind of the testing waters for what we've seen today. So he hit China with tariffs on various specific manufacturing imports and then also steel and aluminum tariffs both on China and Europe and the rest of the world. Washing machines, right? You've got to be in his bonnet about washing machines. Washing machines, yeah. Plenty of hard to manufacture things that we also don't happen to manufacture in the United States. China responded a little bit but not too much.

3:25Anyway, going into this administration, we all felt pretty confident that Trump would hit China with additional tariffs. If you read into the various papers put out by people in his circle before this election, they all said, yes, we're going to do tariffs on China and we're not going to negotiate with China. So it was very clear that they wanted to take a maximal approach to China from the beginning. Yeah. But it is surprising how fast it ratcheted up. There's maximal and there's maximal, right? So we will all remember the kind of, you know, flip chart type things that Trump had in the Rose Garden on April 2nd when he was announcing these so-called reciprocal tariffs on the rest of the world on so-called Liberation Day.

4:04I hope you can hear the little bunny ears that I'm putting either side of those words. But China got a particularly tough treatment. And then when Trump rolled back on some of the toughest tariffs on most of the rest of the world, he kept them on China and pushed them higher and higher again and higher and higher and higher. So we came into this already with 20 % on China. And what happened here is, you know, Trump hit them with 34 % additional reciprocal tariffs. So that's about already around like 60 % on one of our largest trade partners. And then what China did was they actually retaliated.

4:35They said 34 after Trump did 34. Then Trump said, how dare you retaliate against me? Here's 50. China said, well, we're going to go 50 back on you. And then the other day when Trump called a 90 day pause on the other quote unquote reciprocal tariffs, he said, but actually I'm adding 125 to China in addition to the 20 that was already there. Also, people seem to be forgetting in this conversation that there's also the quote unquote Venezuela oil tariffs. So the idea of this is he wants an extra tariff on any country that imports oil from Venezuela. Yes. Apart from the U.S., presumably. Yes, because the U.S.

5:07was the largest importer, arguably, of Venezuelan oil just two years ago. But the point is, like, if you took all those together, originally we were looking at 160 to 170 % tariff on China, which is just insane. The thing is, like, so people around the president, people in the administration are painting this as it's not just a kind of childish game of tit for tat. This is about rekindling manufacturing jobs in the U.S. So a little over a week ago, we had Howard Lutnick, the Commerce Secretary, talking on the sort of Sunday TV, saying that he was looking ahead to like a glorious future of millions of Americans screwing tiny screws into iPhones in factories across America.

5:52And you're like, really? This is the glorious future of America that you're trying to build here? But this is what they have in mind is that manufacturing is going to come back to the States. And now like China is finding this whole idea slightly hilarious from what I can figure out, right? I don't know whether you've seen, but if you look online, there are like little TikTok videos kicking around that are made with AI that are coming out of China that have these kind of videos of lots of like overweight Americans really slowly and really badly trying to make things and sew things. And the subtext to this is, you know, China is saying, good luck with this, guys, but you will find that actually we're really good at making stuff.

6:39So you've been tracking China for a long time. You've studied the economy. There is this idea that they've just got no leverage and they're holding no cards here. What do you think about that? I think China has a lot of leverage, if not more than the United States. So we should note that there has been already some backing off by Trump, right? So the effective tariff rate on China now is probably somewhere in the 120s because he exempted smartphones and electronics, which is one of the largest line items we have from China. Because he realized that people were not going to want$3 ,000 iPhones.

7:09You get close to, you know, the day of execution on these tariffs. And actually, it becomes clearer to the administration what that means in real life. It means some very expensive iPhones. It means effectively the administration in creating this exemption for smartphones and some other electronic whiz-bang stuff. That's their way of saying, oh, we now realize that we actually need this stuff and that we can't make it quickly at home. And it's like, yes, we've been trying to tell you this. Yeah, I mean, you saw this in the market, right? 90-day tariff appreave. The market got super excited. It surged like 9 % in the US.

7:46And then the next day, it plummeted again because there's so much stuff we trade with China. And there's a lot of things specifically that flow to lower income consumers in the United States and to base industries. It's the low end goods that you need to put into other things that are manufactured in the US that are going to be really hard to revamp here. So those have been exempted. But there are other big categories that are still in place. So we get most of our stone and glass from China. We get a ton of our furniture, like 30 % of our furniture imports are from China. IKEA, guess what, is not made in Sweden.

8:16And then like a lot of our tchotchkes, like little like trinkets and things that you get at like a convenience store. Those are all from China as well. So this will flow through to most Americans' pockets. I love the American word tchotchkes. We don't have it, but it's like little tiny. They're like trinkets. It's a Yiddish word. Yeah, it's like a knickknack. Knickknacks and trinkets. But so I asked Rob this on the last podcast that we recorded. And in fairness to him, he was a little bit hungover, but he didn't know the answer. Maybe you will. The question was, how on earth is the U.S. going to cope with such a massive step higher in imports from China?

8:53Because there's a lot of small businesses that are not going to be able to wear this, right? No, there was some really good reporting in the FT about small companies that rely heavily on importing small goods from China or their supply chains are really interlinked with China, right? So if you're manufacturing, you know, anything electronic in the United States, you're probably using wires or cords from China. Those have been exempted for now. That might not be the case in a couple months. Who knows? Rare earth metals. China actually just put a ban on rare earth metals. They have like 90 % of the rare earth metals in the world, or at least they own them and trade them if they're not found in China.

9:26And we need those for almost anything from magnets to airplanes. We've done loads of coverage on this, as you can imagine, from the FT. There was a piece I was reading today that was explaining that China can replace the imports that it gets from the U.S. much more easily than the other way around. So, for example, U.S. goods exports to China are very focused on agriculture. Yes. So stuff like soybeans, cotton, beef, and poultry. And China can just get them from Brazil. Yeah. America is an exceptional country, but our soybeans are not more special than other countries' soybeans. No, I'm afraid not.

10:01Whereas those U.S. imports from China are, as you were saying, they're like electronics. It's machinery. It's processed minerals. That's really hard to replace. So China must be thinking, OK, US, knock yourself out. You know, feel free to pay more for our stuff if you want and send some of that money to your tax man. But it's hard to see this. I mean, look, it will hurt China. You know, there will be some effort by the US to try and source stuff elsewhere. But there's an imbalance of power here. And it's not clear that it's in the US's favor to me. Yeah, and also politically. China is not a democracy.

10:44They are what some would call authoritarian, and they have been known to crack down on protests before. During the COVID lockdowns, they had a really draconian policy that kept people in place. And while there was some protest and some uprising, they're able to do that for a year to two years. Whereas in the US, if you have mass backlash, there's going to be a political effect. So it's possible that just as a populist, they're more willing to bear down. And just speaking with friends in China, there seems to be much more a nationalist sentiment of Trump is the aggressor. We as China need to band together to counter these horrible things the Americans are doing.

11:17They're trying to threaten our way of life, et cetera. So there's a bit of a rally around the flag here. So it seems like politically they could also weather this better than the U.S. And economically, probably as well. That being said, China still has a lot of economic woes. For sure. And it's been trying to dig itself out of a hole that's come from kind of collapsing its property sector for a long time. Yeah. But it's got a political system that can weather this. It's got an exporting and economic system that can weather this. But it's also holding quite a lot of cards in terms of markets, right?

11:46You know, one thing, again, as you say, China, not a democracy. Chinese markets do whatever the Chinese authorities want those markets to do. So they could weaken the renminbi with a click of a finger tomorrow. And that would make its imports appear much, much cheaper overseas and would, for a lot of people, wipe out the impact of those tariffs. Now, that would really annoy the Americans, but the Americans are annoyed and annoying anyway. So really, what's to lose here? But the other thing that possibly people are really underestimating here is if you take trade with China down to zero, guess what?

12:23China doesn't need dollars. So that's a very big card that China is holding. So when markets went a little bit gaga last week, one thing that people were running around, certainly the city of London, I'm sure Wall Street too, saying is, oh, my God, is China selling? Are China selling their treasuries? Are they selling their U.S. government bonds? And the sense for now is, no, they're not necessarily selling what they currently own. But is there much need for them to accumulate much more? And the U.S. would suffer if that massive buyer of U.S. treasuries disappeared. So for the non-econ policy and markets wonks among our listeners, maybe it's worth stepping back and talking about the U.S.

13:07broader economic model. Generally, we run a trade deficit with other countries, right? We buy a lot more goods than we send abroad. And in return, we give dollars to other countries. We, you know, the system is washed with dollars. And those usually come back to the United States in the form of other countries buying treasuries. That is a huge benefit to us because while treasuries are also the basis of the rest of the world, they're how we borrow. So the rest of the world buying our treasuries makes yields down. It makes cheaper for us to fund our own domestic things. You've always got buyers there because of that trade relationship.

13:39China has been one of the biggest buyers of treasuries. And if you get that swing buyer, that big buyer out of U.S. treasuries, that has huge implications for the U.S.'s borrowing costs. That will ripple out to the rest of the world. It's hard to track whether or not China is selling their treasury holdings. It's not all kept in China. There's not real-time data. They have been lowering their accumulation over the past couple of years, slowly but steadily. So it's hard to tell if China is actually pulling back from treasuries. But to your point, if you have less Chinese goods being bought by the U.S., you have less dollars circulating in China and you have a smaller deficit in China, they don't need to take those dollars and put them in the treasury.

14:16They can either put them somewhere else or they just have fewer dollars to begin with. Yeah. And also, you know, again, if China were to start selling its massive pile of treasuries, it's got a few trillion there, you know, give or take, then that would hurt the value of the other treasuries that China owns. But what's your sense here? My impression is they might be prepared to wear a little bit of that just for the sake of using that leverage and, again, annoying the Americans. I mean, how much pain do you think they're willing to take on the value of their portfolio here? Yeah, I mean, it's hard to say.

14:54We should note that they did let their RMB depreciate just a little bit the other day. And many people I spoke with said that was more of a threat to Trump and the rest of the administration, that they were willing to take some losses on the Treasury holdings, right? So while they haven't done it yet, they could be willing to. And again, if they were to do that, borrowing costs would skyrocket in the United States. We'd have a lot of our own economic issues. And while it might hurt us, it could hurt China less. So, yeah, it's hard to say what they will do. They have been diversifying away from the U.S.

15:21for a long time, as have a lot of other central banks, right? Like while we talk about the dollar being the most liquid and important currency in the world, there has been a very, very steady march away from the dollar, especially among central banks for a long time now. They've diversified to Singaporean dollars, to Australian dollars. So you could have this steady, if not fast, as you said, they could go faster, just like drain away from the United States. And to your point, they might just start accumulating less. Also, if the U.S. isn't running as large of a trade deficit with China, it's not even possible for them to accumulate more, right?

15:53There's fewer dollars flowing into their system. Yeah, that's one of the reasons why the dollar is sinking now, is the market is trying to get ahead of this lighter demand for dollars from global reserve managers. So it's kind of already happening. So on the sort of final point here, will China blink, do you think? And if it did, what form would that blinking take? What can they give? What can they give to pacify the Donald? I don't know if they're going to blink. If they do blink, I imagine it takes the form of, hey, we're going to stop. If we do start depreciating our currency, we're going to stop that or we're going to, you know, not do the things that you really hate, which is messing with our currency, you know, continuing to pump out cheap goods.

16:35But I don't see a world where China stops its domestic industrial strategy, which is pumping out cheap goods. So I don't really see where they come to agreement over this. That being said, we shouldn't overstate. While China, I think, has a stronger hand, as we said before, it's not a perfect hand, right? They have their own domestic woes. And it's not like they can really export themselves out of this if the Europeans and other countries reject their goods. in that case Aidan Reiter and the US you may as well buckle up and get used to eleventy bazillion percent tariffs on everything you import from China and then you will realize what you import from China let me tell you it will become pretty clear pretty quickly all righty we're going to be back in one sec with Longshot

17:30Okie dokie. It's time for Long Short, that part of the show where we go long a thing we love or short a thing we hate. Aidan, apart from kosher bubblegum, what you got? I am long the donkey excrement analogy. For listeners who didn't hear, last week Katie talked about complications having to do with donkey fecal matter. And we got a lot of funny emails and I have just been enjoying how many people have sent me emails and sent all of us emails about donkey excrement. There's been quite a lively stream of social media posts and emails and even a phone call from my sister relating to Donkir. It's taken on a life of its own, which was not my intention.

18:11All I will say just to reiterate for listeners is it won't work and it won't be fun. Shall we move on? I am short sending ladies in glam catsuits into space so that they can come back from space and then bang on about their hair and makeup I'm not down with this whole thing so obviously a bunch of celebrities like Katy Perry went out into space for like 10 minutes and they came back to earth and started talking about like their eyelash extensions this is not my favourite kind of feminism girls. It's a no from me. I am short. On that bombshell. We are going to be back in everyone's feed on Thursday.

18:56So who knows what the China tariff will be by then? Listen up and find out. Unhedged is produced by Jake Harper and edited by Brian Erstad. Our executive producer is Jacob Goldstein. We had additional help from Topher Forges. Cheryl Brumley is the FT's global head of audio. Special thanks to Laura Clark, Alistair Mackey, Greta Cohn, and Natalie Sadler. FT Premium subscribers can get the Unhedged newsletter for free. A 30-day free trial is available to everyone else. Just go to ft.com slash unhedged offer. I'm Katie Martin. Thanks for listening.

19:47We'll be right back.