Grouchy America, crouching China

The trade war intensified as China came out swinging a day after the US singled it out for special treatment with reciprocal tariffs, announcing an additional 34% tariff on all US imports starting April 10. Beijing's response was on expected lines, with a less immediate impact on the world's largest exporter. The Chinese economy is disinflating, and is better positioned to absorb the inflationary effects of import tariffs. Washington has a lower tolerance for inflation, and Beijing will push this lever to its advantage. The Chinese economy is, however, at greater risk of a growth stall, and it will have to find a way to diversify its exports.

That becomes difficult when its trading partners are trying to accommodate US demands for market access. Risks of recession are now appreciably high in the world's top two economies. The next domino to tip over would be heightened protection against Chinese oversupply in the EU. The bloc would, in that scenario, be importing inflation from both its leading trade partners, the US and China. For the broader basket of emerging economies, the threat of Chinese dumping will predispose them to securing agreements with the US, which will have a lagged impact on their export surplus. Any further escalation between the US and China will drive more favourable outcomes for Trump.

There is little chance of the US industrialising to the degree Trump desires without accompanying Chinese deindustrialisation. The US and Chinese economies have to restructure in tandem. But that would require a more orderly disengagement. China would have to yield its advantage in manufacturing, while the US would have to cede ground in services. So far, the conflict is restricted to manufacturing. But the risks of it spilling over into services are increasing. For retaliation to be effective, China and the EU will target the US tech industry. Markets are beginning to price in this escalation.