Economists at Bank of America Merrill Lynch (BAML) have developed a theory as to whether trade tensions between China and the United States will increase or decrease based on three topics – approval ratings, stock levels, and trade.

A large portion of the economists’ theory depends on whether the trade conflict will impact stocks negatively or if Trump can maintain his approval rating ahead of the U.S. midterm elections.

According to BAML economists Ethan Harris, Aditya Bhave, and Helen Qiao, “The U.S. is likely to continue to take measures against its trading partners until the equity markets respond or there is a dip in the president’s approval rating.”

U.S. stocks are moving back toward the record highs reached earlier in 2018. Last week, Trump stated that he was prepared to place more tariffs on all Chinese goods entering the U.S.

The president told CNBC that he is ready to go to 500, referring to the dollar value of U.S. imports from China in 2017.

I’m not doing this for politics – I’m doing this to do the right thing for our country. We have been ripped off by China for a long time.

The current tariff on Chinese goods is already $250 billion. If Trump decided to increase this amount, it would create a challenge for Chinese lawmakers because the value of U.S. exports entering China was close to a quarter of the Chinese exports coming into the U.S. in 2017.

China’s reply to the $200 billion in proposed tariffs has been hesitant, according to Harris, Bhave, and Qiao.

Chinese officials have promised to retaliate; however, the exact nature of the reciprocation has not been determined. China imports only $130 billion worth of goods from the U.S.

“Since it has already imposed or promised higher tariffs on over $50 billion of U.S. goods, it has limited room to raise tariffs further.” Because of this, Harris Bhave, and Qiao believe that China has three options: place larger tariffs on U.S. imports, capitulate to U.S. demands, or start of war of attrition.

The economists do not believe China will increase tariffs. It would mean the “reordering of supply chains, which would impose additional costs on the Chinese economy and negatively affect China’s image as an economy that is opening up and reforming.”

BAML also believes that China is unlikely to bow to the demands of the U.S., especially when there is popular support for a rigid response to the U.S. trade tariffs. Therefore, the most likely scenario is a war of attrition.

A war of attrition would be the middle path. It is expected that there will be some retaliatory tariffs, but in smaller amounts than those imposed by the U.S. There may be greater restrictions and regulations on the U.S. companies that are operating in China as well.

“Additionally, policymakers might become more tolerant to renminbi depreciation, although they are unlikely to weaponize the currency.”
Among the compromises, greater imports from the U.S. and intellectual property protection measures are likely. This is mostly because China was already leaning toward these reforms before trade tensions escalated.

BAML explained, “With its carrot-and-stick trade policy and domestic easing measures in place, we think China will go into a wait-and-see mode. In our view, Chinese policymakers think they can outlast the U.S., holding out until the U.S. equity market corrects or the ‘sticker shock’ effect of the tariffs starts to impact public opinion in the U.S.” However, it will not be without risk.

There is scope for miscalculation in a war of attrition, according to the economists. “Our game – theoretic analysis of trade negotiations suggests that visible pain is the motivator for de-escalation and compromise.” Miscalculation from either side would be a costly side effect for consumers and businesses. Investors should prepare in case a misstep ensues.

By Jeanette Smith


Business Insider:Trump’s tweets on stocks and his approval rating hint where the trade war with China may be heading

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