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China could devalue its currency, which would make its exports cheaper and partially offset the U.S. tariffs that make the...

5 new ways China can retaliate in the tariff war

President Trump and his trade advisor Peter Navarro have been ramping up the rhetoric on China ever since the 2016 campaign.

Then came real economic pressure beginning in March, when the president announced the first round of tariffs on Chinese goods. China slapped retaliatory tariffs on American goods in response, a move as predictable as it is time-honored.

WATCH: Meet the Trump trade adviser whose tariff policy is about to be tested

Even free market Adam Smith, arch-enemy of protectionism, wrote in “The Wealth of Nations,” that “when some foreign nation restrains by high duties or prohibitions the importation of some of our manufactures into their country,” revenge “naturally dictates retaliation, and that we should impose the like duties and prohibitions upon the importation of some or all of their manufactures into ours. Nations accordingly seldom fail to retaliate in this manner.”

This was the Trump administration’s rationale from the get-go: America was retaliating against China’s restraint of our manufactures into their country — by piracy, subsidies, currency manipulation and other “prohibitions.”

But whoever fired the first shot, the tariff war is steeply one-sided. We slap tariffs in triple-digit millions on Chinese goods; they retaliate with double-digit millions on ours. Why the disparity? Because of the U.S.-China trade imbalance.

China is vastly more dependent on trade, which makes up more than a third of its economy, than the U.S., where trade constitutes barely one-eighth. So if China can’t retaliate, dollar for dollar, what can it do?

Here are five basic options:

1. Bond dump

That is, China can start selling off U.S. bonds or threaten to do so. According to the U.S. Treasury,  China held $1.165 trillion worth of U.S. debt at the end of August. If China started unloading or even just threatening to unload, it could spook the bond market and the already shaky stock market by forcing up interest rates on Treasuries.

Why? Because with so many U.S. bonds suddenly flooding the market, the U.S. would have to offer higher rates to lure more investors to buy new bonds, which we need to keep issuing to cover our federal debt, growing at a rate of about $1 million every 30 seconds or so, according to the U.S. Debt Clock website (worth consulting if you’re into getting dizzy).

By the way, interest payments on the federal debt are already the fifth largest federal expense the government has. If interest rates spike, so do the payments, forcing us to borrow even more, onward and upward.

There is also this: If interest rates are going up in the U.S. already, and the Federal Reserve is committed to raising them further, as it has said it would, then unloading U.S. bonds now, before they lose more value, could conceivably turn out to be a savvy investment move.

2. Squeeze U.S. firms in China

Restrict their ability to repatriate profits to America; discourage Chinese citizens from buying American; make life difficult in a thousand ways. As the ever-iconoclastic “Fight Club” enthusiast “Tyler Durden” noted in June on his Zero Hedge website, citing JP Morgan economist Michael Cembalest:

“Over the last decade, U.S. companies made large investments in their Chinese subsidiaries. In fact, the bilateral U.S. trade deficit with China almost disappears once you include sales of in-country subsidiaries.

In other words, U.S. companies are doing almost the same amount of business in China as Chinese companies are doing in the US, but through their subsidiaries rather than via exports.”

Moreover, writes economist Dean Baker on his blog, Beat the Press, if China shut U.S. firms out of its market “this would be a huge hit since its economy is already 25 percent larger than the U.S. economy.”

3. No more Chinese visitors to America

Prohibit Chinese tourists and students, that is. Three million Chinese tourists came here in 2016 and spent more than $30 billion. More than 300,000 Chinese students are matriculating in America. Indeed, U.S. universities increasingly rely on Chinese students who pay full freight for tuition.

4. Devalue the RMB

China’s currency has already fallen by 8 percent since February. If it were to devalue a lot more, Chinese exports would become cheaper, thereby offsetting, at least partially, U.S. taxes that make them more expensive.

5. Make sweetheart trade deals with everyone else

Cozy up to the rest of the world economically, isolating the U.S.

Could it backfire?

Sounds like quite an arsenal of options, wouldn’t you say? Well, on second thought, these moves might hurt China’s economy more than ours, all five of them. How?

1. Unloading our bonds and flooding the market with them would drive down their value because of the sudden surge in supply and drop in demand.

It wouldn’t be a fire sale, exactly, but China isn’t holding more than $1 trillion worth of U.S. Treasuries in order to lose money on them. Plus, the U.S. Fed could buy up the bonds so markets and the dollar are jolted.

2. Squeezing U.S. firms in China might be very painful, but they’ve been allowed in for a reason: they bring American know-how with them.

Chinese consumers and fast-food emulators might survive the closing (or takeover?) of the 400-plus Walmarts that do business there, the more than 2,500 McDonaldses and the more than 3,300 Starbuckses. But what about losing technology transfer from the likes of General Motors and Qualcomm?

3. Banning Chinese visitors from coming to America? The immediate cost to Chinese tourists and students is obvious. But the long term cost to the Chinese economy could be higher.

Higher education may be America’s most competitive global industry. The Chinese come in droves to learn from the world’s best labs and researchers. Denying access to them means learning less.

4. Devalue the RMB? Imports are already becoming more expensive due to China’s retaliatory tariffs. They will become even more expensive if the currency plunges.

Moreover, this strategy is the very opposite of strategy 1: a bond dump. The way a country devalues its currency is using it to buy the currency of other countries. It’s a major reason China has been buying all those U.S. bonds, which you buy with U.S. dollars, which you get in exchange for your currency.

So “if China were to sell off a significant amount of U.S. assets,” wrote Joe Wiensenthal of Bloomberg recently, “that would cause the yuan to soar, which is precisely what they don’t want to have happen in a trade war.” Because it would make their exports more expensive, not less.

Adds the eminent macroeconomist Olivier Blanchard: “Difficult to do right, as [devaluation] might indeed trigger large capital outflows.” In other words, Chinese citizens with considerable RMB savings inside China might race to get their money out of the country before it falls further in value.

5. As for making sweetheart deals with the rest of the world, the problem isn’t that it would hurt the Chinese economy but that it may be impossible to pull off.

Do other countries really want to make trade deals with China and risk being inundated with Chinese exports?

The bottom line: China can inflict economic pain on the U.S. in several ways. But each comes with costs to China that risk being a lot greater than those to the U.S.