What Will a China Trade War Cost?

The Senate passed a bill that would press China to allow the value of its currency to rise. It is time to take stock of what the action would cost America if the House passes similar legislation and the president could not block it. The figure might be well into the hundreds of billions of dollars. That sum could drive the U.S. into a deeper recession. Longer term, it might help American GDP — but that is longer term. The U.S. cannot wait out a trade war with China.

The assumption is that the U.S. would block or add tariffs to the import of some of China’s manufactured goods. This could range from steel to pharmaceutical components to toys. American politicians and labor have long pressed for more tariffs on Chinese imports. The problem is that the U.S. does not have factory capacity configured to replace these imports and could not turn to other countries like Mexico and Vietnam. It would take those nations years to set up the infrastructure to source raw materials and components to meet U.S. needs. Labor would argue that a moratorium on some China imports would allow America to rebuild its manufacturing industry. That is only true if U.S. companies can do without key supplies for the years it would take for firms here to create manufacturing capacity that does not exist.

The other part of a trade war that U.S. business could not weather, at least without a very painful transition, is the ability to export goods and services to China. The range of these exports stretches from software and entertainment to luxury goods. In a worst case, the People’s Republic could block the commerce of U.S. companies based in China. This would ruin the prospects of corporations like McDonald’s (NYSE: MCD) and Walmart (NYSE: WMT), which count on Chinese sales for a large portion of their profits.

Analysts who watch the battle over the yuan expect that the Senate move will prompt China to begin to revalue its currency, at least to the extent that it would satisfy U.S. politicians. But American manufacturers would continue to agitate for more aggressive import bans. Those suggestions would be ignored by Congress in the name of trade peace between the world’s two largest economies, if China makes a public gesture to revalue the yuan.

There is some chance in every pitched battle and debate that the fringe interests take over the center. The 2012 elections are only a bit over a year away. The recession has not ended, at least in the minds of most small businesses and workers. A jobs bill or tax cuts to help American workers may not pass the Congress. And, even if they do, the downturn is deep enough that these actions may not be a remedy. Voters may turn to candidates whose trade policies would be considered irresponsible under most circumstances.

China has a great deal to lose in a trade war. The decisions of the  leadership in the People’s Republic are hard to predict. China will have a new president in less than a year. Xi Jinping and his biases are not well known outside his country. What is knows is that China’s currency reserves could help it last through the early stages of a trade war. But a shuttering of its factories could cause nationwide worker unrest. So, the problems China would face in a major dispute with the U.S. are beyond calculation.

American business and industry do not have access to the capital to allow inventory from China to disappear. Walmart may be the best case in point. Without Chinese manufactured goods, many of its shelves could not be stocked. Apple (NASDAQ: AAPL), at the other end of the U.S. economic spectrum, would lose the manufacturing base for many components of its most popular products.

A trade war may begin before the next U.S. national election. No single piece of evidence suggests that it would not crush U.S. economic and business fortunes.

Douglas A. McIntyre