4 powerful weapons China has in its arsenal to win the US-China trade war

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By Bryan Borzykowski, CNBC

Last week, the U.S. fired the latest shot in its trade war with China, revealing a list of tariffs that it could slap on $200 billion worth of Chinese goods. While China has, to this point, been matching U.S. tariffs dollar-for-dollar – both countries instituted tariffs on $34-billion of items in June — if the U.S. forges ahead, China will have to use a different, and more damaging, set of weapons.

[post_ads]In theory, the U.S. could place tariffs on $505 billion worth of Chinese items, which is the total dollar value of goods imported from China into the U.S. in 2017. President Trump already said he's willing to put tariffs on all these goods should the need arise on Friday. China only imports $130 billion worth of U.S. goods, so there’s no way it can match President Trump’s latest tariff threat.

That doesn’t mean it can’t retaliate, though. In fact, when it comes to non-tariff measures, it can do much more to hurt America than vice-versa, says Kristina Hooper, Invesco’s chief global market strategist. “China has a much larger arsenal of weapons than the U.S.,” she said. “Tariffs are just the tip of the iceberg in terms of what China has.”

How can China retaliate if it can’t do tit-for-tat tariffs anymore? Here are four ways the Red Giant can hit back.

1. Stop buying U.S. Treasurys

China is one of the largest holders of U.S. Treasurys, owning about $1 trillion of bonds in 2017, according to the Federal Reserve. Like most investors, it wants to stash greenbacks in something safe and U.S. bonds are still solid investments. However, if the Chinese government gets pushed too far, it could decide to sell off its holdings or stop buying new U.S. bonds — and that could have a significant impact on the U.S. economy. “It’s the nuclear option,” Hooper said.

If China floods the market with U.S. Treasurys, bond yields could climb. That’s problematic: Treasury holders around the world, including the U.S. government and the average citizen, will see their bond prices drop. Higher yields also make it more expensive for the U.S. government to borrow through new debt issues, while companies that issue corporate debt, would have to pay higher borrowing costs, too.
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There are many reasons as to why China wouldn’t do this — it would make China's own holdings lose value and there’s no good safe alternative for their dollars, but if they really want to hurt America then this will do just that. “This will take away revenues at a time when the government is already running large deficits, so it places more pressure on the U.S.,” Hooper said. The U.S. deficit is expected to hit $804 billion for fiscal year 2018, according to the Congressional Budget Office.

2. Devalue the yuan

If China really wants to annoy Donald Trump, and make tariffs moot, it could devalue the yuan. In fact, this might be the best tool it has to get back at the U.S. “Currency is the most effective lever to offset the impact of tariffs,” said Salman Baig, a multi-asset investment manager at Unigestion, a Geneva-based investment firm.

If the yuan falls by about 8 percent, which it has done since mid-March — one U.S. dollar now equals 6.77 yuan — U.S. importers would only see a 2 percent rise in the cost of Chinese goods. Why? Because if the cost to buy Chinese items falls then any tariffs added on to the price tag will bring the total value of that item to where it is today. Companies won’t feel much of a difference, Baig said.

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