China just gut-punched Trump. Is it time to worry?

Ardern fields questions over Government's response to leaky buildings at Middlemore Hospital and the escalation of the 'trade wars' after China retaliated to US tariffs on steel and aluminium.

The United States and China are not in an all-out trade war yet, but they're getting closer to it. That's why the stock market tumbled this week and soybean farmers are panicking.

On a grand scale, the latest development is unlikely to send the U.S. economy into a recession. Growth is strong and so far China has only threatened $50 billion tariffs on U.S. goods. The tariffs haven't taken effect yet, but even if they do, they are minuscule in relation to America's $18 trillion economy - 0.3 percent to be exact.

But that doesn't mean there won't be pain.

Certain parts of America - especially Illinois, Iowa, Minnesota, Indiana, Washington and Kansas - will feel it acutely. And more Americans will get hurt the further the brinkmanship goes, especially if the stock market sell-off ends one of the longest bull markets in US history.

Here's a quick recap of what happened in the last 24 hours: On Tuesday evening (US time), the US announced its intent to put 25 percent tariffs on 1,300 Chinese imports. The tariffs won't take effect until late May at the earliest, but the message to China was clear: Trump wants China to buy more U.S. stuff and do a better job protecting US intellectual property.

China, normally known for "measured" responses in its trade dealings, fired back Wednesday with a gut punch to Trump, saying it intends to put 25 percent tariffs on the top goods America exports to China: Airplanes, soybeans and cars. America's tariff list was full of a lot of products, mostly parts of machines, that are traded on a smaller scale. But China is taking aim at key US industries, and two of them - soybeans and cars - are concentrated in states Trump won.

US president Donald Trump has announced a range of international trade tariffs in recent weeks. Photo / AP

The tariffs have yet to take effect on either side, so there's plenty of time for the two governments to negotiate - and Wall Street, soybean farmers and many executives are really hoping they will.

"China's rapid and aggressive response to the proposed US tariffs has raised the stakes for both sides. But its move to publish a list of counter-tariffs is primarily intended as a deterrent, and we think there is still time to de-escalate trade tensions before the tariffs come into force," said Julian Evans-Pritchard, senior China economist at Capital Economics.

The White House sent mixed messages Tuesday morning.

"Even shooting wars end in negotiations," Commerce Secretary Wilbur Ross said on CNBC just before the markets tanked. He went on to say he was "a little surprised that Wall Street is surprised by [Chinese retaliation]. This has been telegraphed for weeks."

Trump followed with a tweet saying "you can't lose" in a struggle like this with China, escalating fears this is only the beginning.

But Larry Kudlow, Trump's new top economic adviser who has long been a champion of free trade, told reporters outside the White House that Trump "wants to solve this with the least amount of pain . . . I can't emphasise that enough." Kudlow's words were far more soothing, but they seemed to contradict Trump, and the president will have the final say.

Trump is making a big gamble here. Trump's move, whatever reaction it draws, is aimed at a more favourable long-term reaction from China. But how much is he willing to sacrifice? And how long is he willing to go?

There's broad agreement around the world that China hasn't been playing fair on trade. Businesses are especially upset at how China has restricted the growth of U.S. companies in China. The Chinese government wants to build up domestic industries, especially in tech and high-end manufacturing, but they are doing it partly by taking some U.S. know-how and forbidding U.S. companies from getting much of a foothold in the Chinese market. Many Democrats and Republicans agree that former Presidents Barack Obama and George W. Bush didn't go hard enough on China, and they think Trump is right to press China harder.

But while there's significant support for Trump going after China, there's also significant concern about his methods. Trump has dismissed the usual path of taking China to court at the World Trade Organization or trying to get a bunch of U.S. allies to make a coordinated move. Instead, he's going it alone.

Photo / Getty Images

"If protecting US intellectual property is the ultimate goal here, I'm not sure how destroying shareholder wealth, damaging CEO confidence and making the American farmer the main sacrificial lamb here after six years of pain on the farm is going to get us there," said Peter Boockvar, chief investment officer of the Bleakley Advisory Group.

Here's where the pain is likely to hit hardest: The immediate risk is to the parts of America that produce the goods China plans to hit with tariffs. China accounts for 60 percent of US soybean exports, according to Goldman Sachs. That means a major buyer of US soybeans would basically disappear if the tariffs go into effect. American soybean farmers are mainly located in 10 Midwestern states (Illinois, Iowa, Minnesota, Indiana, Nebraska, Ohio, South Dakota, Missouri, North Dakota and Kansas). Trump won eight of those ten states in the election.

But the Chinese would feel pain from this move as well. They consume a lot of soybeans. While Brazil and Argentina also send a lot of soybeans to China, the Chinese demand could not be fulfilled by those South American countries alone. It would take time for more fields to be planted in other parts of the world. That means soybean prices are going to rise in China.

"China would ultimately be the one paying for these soybean tariffs," wrote Damien Courvalin of Goldman Sachs in a research note Wednesday.

It's a bit more complicated in the airplane sector because there are really only two major players in the aircraft market: American company Boeing and French company Airbus. It's obvious where China will turn now. The two companies are fierce rivals that have been competing heavily for contracts with China as the world's second-largest economy beefs up its commercial airline fleet. Boeing stock tumbled more than 2 percent Wednesday and is down about 9 percent in the past month as trade fears rose on Wall Street. It's unclear whether Airbus could meet all of China's needs, at least in the short term.

Snohomish County, Washington has the highest concentration of workers in the US making airplanes and airplane parts, according to the Labor Department. The state of Washington didn't go for Trump, but it's far from the only place that would feel the Chinese tariff pain on Boeing planes. Factories around the country produce parts for the aerospace industry. After Washington, the next biggest areas with the highest concentration of employment in aerospace are located in California (a blue state), Kansas (a red state), Texas (a red state) and Connecticut (a blue state). Parts of Ohio, Massachusetts, Alabama, Pennsylvania, Indiana and Florida also have significant exposure, a reminder of the wide supply chains for cars and planes.

Then there's the larger risk to the economy if the stock market continues to nose-dive: At the moment, the stock market is down just more than 10 percent from record-high levels in January. This is a situation known as a "correction." It's not fun, but it's fairly normal and doesn't mean the bull market that has been going since March of 2009 is in jeopardy.

But if stocks fall more - 20 percent or more - then the market will experience what is known as a "bear market." That's usually a lot harder to recover from. It often causes investors, and usually the broader American public, to lose some confidence in the economy. People often start to spend less when they see the market down so much out of fear things are getting a lot worse, a scenario known as the "wealth effect." If people feel poorer when they look at their investments and retirement accounts, they often close their wallets.

"There's a growing possibility we'll end up in a trade war and that is a risk to the brisk growth we were expecting this year and next," said Karen Dynan, a Harvard economics professor and former Obama staffer.

Then there's the potential panic in corporate boardrooms. If a true trade war breaks out, executives at top companies are likely to halt some spending on new factories out of fear of what's going to happen next. That starts to erase the good that was supposed to come from the tax bill. The large corporate tax cut from 35 percent to 21 percent was supposed to encourage businesses to hire more people and invest more in new products and factories, but all the uncertainty from trade could curb a lot of that spending. The fall in markets also makes it harder for companies to get money to expand operations.

"There's a risk of destabilising financial markets... if the market reacts strongly and negatively to protectionism, then we could see a real decline in asset values and a pullback in lending that would be really bad for the economy," said Dynan.

Right now, these are mostly fears about what could happen. But the Chinese are not backing down easily against Trump like the South Koreans did. Trump says a trade war would be "easy to win." But he didn't promise it would be without casualties.

- Washington Post