US president Donald Trump has made Huawei the biggest story in tech right now by banning it from doing business with US companies. Huawei, China’s tech champion, has lost access to Google’s Android and Intel’s chips, and it’s even seen other international partners like ARM and Panasonic bowing to American influence and discontinuing trade. Having previously been on track to becoming the world’s biggest smartphone maker, Huawei is now in such dire straits that the best metaphor its founder could come up with to allay fears is that the company is like a plane with a hole in its side: not doing great, but still up in the air.
Bludgeoning Huawei with the ban hammer is, by Trump’s own admission, a negotiating tactic to focus China’s attention on American discontent with the existing trade relationship between the two countries. It lands atop a pile of punitive 25 percent tariffs he’s imposed on many Chinese imports to the US, and a promised further round of such tariffs on practically every Chinese export imaginable.
Two expert China observers tell The Verge that China very much cares about these restrictions on its most important overseas market, and it has every incentive to respond, whether to alleviate the sanctions or as a show of its own economic strength. But both agree that China has few, if any, good options available.
Veteran diplomat Hosuk Lee-Makiyama asks pointedly, “What does China have left to retaliate with?” It’s already imposed tariffs on the few classes of goods for which it wants to protect its internal market, and it’s excluded American internet giants like Google and Facebook, so what can China realistically threaten to do as a counter measure? Some observers, such as Ben Thompson in Stratechery, note that “China took the first shots” in the present trade war when it threw out many US tech firms, and it is now the US who is finally responding.
I'm of two minds.
On one hand, I am quite concerned about the direction the US-China tech not-so-cold war is headed.
On the other hand, after having to deal with the Great Firewall for a decade…..
Part of me just wants to say…
Cry me a fucking river, China. pic.twitter.com/CeQ0PZz6jn
— Elliott Zaagman (@ElliottZaagman) May 22, 2019
Lowy Institute’s Elliott Zaagman has spent the past 10 years living in and observing China, and he argues that the country’s economic prosperity is more brittle than it first appears. China’s “already at a point where growth rate is not an output, it’s an input,” meaning the government sets the goal it wants to hit each quarter and banks lend to hit that number. Beijing has done more monetary expansion, he says, than the US Fed, the Bank of Japan, and the EU combined. This has spawned a number of toxic asset bubbles — such as in housing, which has had trickle-down consequences of people taking on debt backed by overpriced real estate. Talking to him and Lee-Makiyama, you get the sense that China’s economy is closer to a pyramid scheme than a truly thriving and flourishing giant.
Retaliation is particularly risky because China’s economy relies on ever increasing trade with the world, as evidenced by the massive Belt and Road Initiative to develop land and sea routes for faster transport of goods. And Huawei, though a privately held entity, has been very helpful in procuring high-value overseas business with its lead in network infrastructure, 5G equipment, and, most recently, premium smartphones. Lee-Makiyama notes that because the country lacks a social safety net, it cannot afford to ever take its foot off the gas, which is what the Huawei setback inevitably represents. Economists, he says, have long held 6.5 percent economic growth as the threshold below which China can’t dip if it’s to sustain its growing debt, and China reported 6.4 percent growth in the first quarter of 2019, before Trump’s harshest tariffs had taken effect.
It’s in this context that we must look at China’s apparently formidable arsenal of weapons it could deploy against the US.
There are also more sophisticated kinds of financial warfare. China holds a trillion dollars of US debt, which it could dump on global markets and thus trigger an interest rate spike for the US economy. The Washington Post’s Robert J. Samuelson explains the mechanics of this succinctly, however he argues that China would be doing almost as much harm to itself in the process. A slowdown in the US economy would lead to even less appetite for Chinese exports, the US dollar might also go down in value and make Chinese goods less appealing, and whatever US treasuries China is left with would also be worth less. This illustrates the inherent symbiosis between Chinese production and American consumption, which have together formed the backbone of the global economy over the past 20 years.
The most threatening retort since Huawei was turned into a trade pawn by Trump has been a visit by president Xi Jinping to a rare earths facility. This was a wordless reminder of China’s dominance in collecting and processing the rare earth minerals essential to every smartphone, laptop, hybrid car, and practically anything more advanced than a gas oven. The CEOs of two US headphone manufacturers tell The Verge that China is the only place to buy the neodymium magnets required for their products: one said China is the sole source, the other said it controls 95 percent of the market. If you struggled to wait a few weeks for those sweet new Powerbeats Pro to go on sale, try waiting months and months for an alternative source of magnets.
And yet, as my colleague James Vincent has already set out, rare earths are not the secret weapon China imagines them to be. They’re not all that rare, the response to Beijing hoarding its supply would be production becoming economically viable and ramping up elsewhere, and the ultimate outcome would be fewer jobs and fewer exports for China. Lee-Makiyama sees this as an untenable scenario and points to China’s ill-fated attempts to use rare earths as a trade cudgel in its dealings with Japan and the US in the past.
Finally, and most obviously, the Chinese government could just do the tit-for-tat response of imposing sanctions on American businesses operating within its borders. Even with some older-model iPhone assembly in India, the vast majority of Apple’s smartphone business is built on Chinese land. Chipmakers are even more dependent, as an analysis from HSBC finds that Apple compatriot Qualcomm has 65 percent of its revenue vulnerable to disruption in trade with China. Other US tech firms with similar exposure include Broadcom at 54 percent, Micron at 51 percent, and AMD, Intel, and Texas Instruments all pinning at least a quarter of their revenues on continuing trade with China.
US consumers can also be hit through impositions on brick-and-mortar retailers. Chinese imports account for 26 percent of Walmart’s merchandise, which is on the low end compared to a more typical number like Target’s 34 percent, according to UBS. Additional research by UBS says the Trump administration’s tariffs imposed on Chinese imports “could put $40 billion of sales and 12,000 stores at risk.” The American Apparel & Footwear Association calls the next round of tariffs “a self-inflicted wound that will be catastrophic for the nation’s economy.” If tariffs are catastrophic, what would a total ban from China look like? This is arguably the most effective weapon Beijing could wield in its negotiations with Washington, but the corresponding hit on Chinese trade would be every bit as disastrous.
In Lee-Makiyama’s estimation, no scenario that involves China cutting off or constricting business with the outside world will be palatable to the country economically. Even with its rapidly growing national consumer market, China is still in need of more consumers for its goods and services. And with Apple and its compatriots like Nike, General Motors, and Walmart employing millions of Chinese workers, Trump has the leverage he needs to play hardball. That situation won’t last long, the diplomat warns, and now might prove to be the last good chance for the US to lean on the mutual dependency it has with China. If the trade relationship remains as it is, China will eventually grow its way to be colossal both as producer and consumer, and then American influence would be null.
For the US, what’s at risk are company revenues and profits. The country’s broader economy may suffer, but Lee-Makiyama says few people would notice if the GDP growth rate dipped from 3 to 2 percent. The same contraction for China’s economy, he contends and Zaagman agrees, would be disastrous. This asymmetry is at the heart of why the Trump administration can afford to be self-destructive in its tariff regime while China cannot indulge in similar costs to score trade negotiation points.
The Chinese government was “definitely caught off guard” by the brusqueness of Trump’s actions, says Zaagman, which was “not anticipated at all.” That might explain why Beijing didn’t make fuller or better contingency plans for a situation like today. Then again, Xi might find consolation in the fact that the same surprise must also be reverberating inside the offices of US tech giants, as Asia economic observer Tony Nash, formerly of the Economist Intelligence Group, questions why American companies hadn’t diversified their manufacturing sooner. Their lack of preparedness may give China some reassurance that hostilities won’t escalate much beyond their current point without China firing back.
Without having a clear and coherent plan for its reaction, which neither Lee-Mikayama nor Zaagman believe Beijing is even close to right now, the best strategy for China is to do nothing material and maintain a “strong and silent” posture — which is exactly what the country is doing, commenting only to say that it “won’t flinch.”
The damage, “the stuff that saps one percent off GDP growth every year,” says Zaagman, has already been done. Silicon Valley investors are now looking for startups with reduced China exposure; big US tech manufacturers are exploring Vietnam, Mexico, and other potential production outlets; and China has found its prejudices that it can’t trust the US confirmed. Now that Trump has pulled the big red Huawei lever, China is wise to avoid hurriedly mirroring the move. Then again, it’s not like it has much choice.