U.S.–China war of words playbook

Putnam Fixed Income Team, 06/23/20


  • Rising tensions have the potential to undermine the global economy and financial markets.
  • The U.S. may impose sanctions, including new tariffs, as China tightens grip over Hong Kong.
  • China’s central bank has been largely hands-off in using the currency as a trade weapon.

The politics of the U.S.–China relationship have clearly become more complicated recently. The war of words between Washington and Beijing has escalated in recent weeks over China’s handling of the coronavirus outbreak and the proposed new Hong Kong security law. The latest tensions have the potential to be more damaging to the economic and market outlook against a backdrop of the presidential election in November. There are two reasons for taking this latest flare-up in Sino-American tensions a bit more seriously.

Retaliatory measures from the White House

First, because the anti-Chinese coalition in Washington is bigger than in the past, the possibility of genuine action rather than empty blather is higher. President Trump has criticized China for its handling of the coronavirus pandemic and has said he is considering using tariffs and other methods to punish China. The recent proposal to make it more difficult for Chinese firms to list on U.S. exchanges seems likely to end up with real teeth.

Congress may also respond with additional sanctions because of what is happening to Hong Kong.

Congress may also respond with additional sanctions because of what is happening to Hong Kong. China’s legislature in late May approved a plan to impose broad new security measures in the semiautonomous city. The national security law, which will be drafted by the National People’s Congress (NPC) standing committee over the coming weeks, will prohibit secession, terrorism, and any act that threatens national security. These proposals have put another nail in the coffin of Hong Kong’s dream for “one country, two systems.”

A bill has just been introduced in Congress that would strengthen oversight of U.S. universities’ use of federal research dollars amid concern that China is stealing intellectual property with military applications. This type of measure is attracting bipartisan support in Washington. Just recently, China and the United States imposed tit-for-tat restrictions on each other’s airline companies. We can expect to see these types of skirmishes between both countries being repeated in coming months. And keep in mind that public sentiment in the United States and other countries has also hardened against China.

China’s currency firepower

Secondly, the Chinese are not without the ability to reply to perceived attacks on their interests. The most obvious tool they have is their currency, the renminbi. This is not a weapon to be used lightly because weakening the currency creates the risk of destabilizing capital outflows from China. Still, periodic bursts of renminbi weakness — which have the potential to send shock waves around the global financial system — could well send a message without risking damage to the Chinese financial system.

The People’s Bank of China (PBoC) has so far sent strong signals that it does not want to see pronounced currency volatility. But the central bank takes its orders from the government, and we cannot be confident that the government’s views won’t change if it feels no need to respond to the changing mood in Washington. We attach no credibility to the idea that China may seek to damage the U.S. economy by selling its Treasury holdings and pushing interest rates higher. China has a long-term goal of diversifying its reserves and reducing the role of the dollar in the global economy. Still, the government won’t pursue this in a way that would harm itself. And it is not clear that the sale of Treasury bonds by China would push interest rates higher, if at all.

Trump’s election playbook

We should not be at all surprised by periodic bursts of hostile rhetoric in coming months. President Trump could threaten to withdraw from or cancel the trade deal that was announced with so much fanfare late in 2019. However, we do not expect him to follow through on this threat. It is possible the threat in itself will be enough to generate some asset market volatility, and it is also possible the administration will impose extra tariffs on Chinese goods. We can also expect further measures against Chinese technology companies to be openly discussed, even if little actually happens.

This is best seen as election campaign rhetoric. Nevertheless, we do think the anti-China coalition in Washington is now large enough that further strains in the Sino-American relationship are likely, no matter the outcome of November’s elections.

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