China has unused weapons in escalating trade war: Don Pittis

With only days to go before China and the United States triggerpunishingtariff penalties on one another's exports, it seems impossible to imagine either countrybacking down.

As both sides talk tough, once again global markets, including in Shanghai, New York and Toronto, declined sharply.

On Sunday, China had announced its latest weapon in its economic battle with the U.S., namely 700 billion yuan ($142 billionCdn) in new stimulus for domestic industries.

No backing down

Markets knew Beijing was planning to make new money available to help its companies cope with the U.S. trade restrictions. Butthe newly announced dollop of liquidity was larger than expected. In anticipation, the Chinese currency slid further against the U.S. dollar.

Scheduled tokick in the day before the countries apply their tit-for-tat tariffson July 6, the measuresshow China is preparing its economy to withstand the U.S. trade attack, says Gordon Houlden, director of the University of Alberta's China Institute.

"Many people say 'Wellthey don't have to worry about politics because they're the Communist party and they're unelected,'" says Houlden,"Of coursethere's some truth to that, but public opinion does matter for them as well, and I think the government, or the regime if you wish, is under pressure to stand up for its own interest and the interests of China."

On the U.S. side, after his recent climb-down on separating immigrant families, U.S. President Donald Trump is unlikely to want to be seen caving to China in advance of the U.S. midterm elections.

In fact there were early reports yesterday that Trump was upping his attack on China byrestrictingthat country's investments inU.S. technology companies to prevent them from stealing secrets. But by mid-morning it appeared Treasury Secretary Steve Mnuchin was walking that back.

Fake news

Calling stories from two of the world's most reliable and prudentbusiness news sources, the Wall Street Journal and Bloomberg,"fake news," Mnuchintweeted that they had got the wrong end of the stick. The restrictions, he wrote,applied not just to China "but to all countries that are trying to steal our technology."

Later as U.S. markets fell, trade adviser Peter Navarro played it back even further, saying there were no plans for restrictions on Chinese investment. It was the kind of confusing narrative investors have come to expect from the Trump administration.

Houlden, who just returned from a week in the U.S. capital monitoring political reaction there, says it appears the trade war threat is getting worse.

"There is damage being done," he says.

Certainly China's stock markets are feeling the effect, with theShanghaiindex now down nearly 20 per cent from recent highs, what analysts usually call a bear market. Some stocks fell 10 per cent in a single day.

Harley exporting jobs

ButU.S. stocks were also affected, partly because one of thetargets of overseas tariffs, U.S. motorcycle maker Harley Davidson, announced it was moving some jobs abroad. According to the Trump's "make Americagreat" script that wasn't supposed to be the way it happened.

Even after the confusing series of corrections from White House officials, U.S. tech stocks were down sharply, with the NASDAQoff about two per cent on the day.

Houlden says he's afraid the growing animosity between the two sides may not be something easily patched up after the midterms are over.

"I think there's still lots of negativity out there," he says. "There's a bedrock I felt in Washington of anti-China feeling."

Like many others,Houldendoesn't seeanimmediate easy fix.

"On the other hand, the capacity to do damage to each other is so great that there has be a rationality that will appear at some point."

China's strategic game

Whether or not Trump'stweet-led policycan be described as rational, Greg Chin, a Chinascholar at Toronto's York University, says it appears China is trying to be.

"A far as I can read it, the Chinese haven't really gone for the jugularyet," says Chin, who is currently working on a book about the internationalization of the Chinese currency.

While Trump always quotes trade in physical goods, he fails to mention the huge value of goods and services sold to the Chinese by U.S. companies operatingin China. As the trade war heats up, Chinese consumers could show their displeasure by cutting back on those purchases, doing significantdamage to U.S.-listed companies.

There are many other things China could do, but so far Beijing has shown restraint, and Chinis convinced that, unlike many other countries, including the U.S. and Canada, China has a long-term plan worked out.

"The Chinese have actually had a lot of time to think about this," he says. Theylistenedto "the noises"Trump was makingduring his campaign.

"And knowing China, they've been strategizing for a while. How do we deal with this guy and how do we roll this stuff out?And how do we not over-react when he's over-reacting?"

China holds a large chunkof the U.S. government's long-term debt, more than $1 trillion US.

It has an enormous and growing domestic economy. By some measures it is already bigger than the U.S. Asformer Goldman Sachsbanker Jim O'Neill recently stated, China createsan Italy every two years.

It has depended on the U.S.for a lot of that growth. But now U.S. protectionism is addingpressure to look for new suppliers andnew markets.

"The United States can do things that bring pain to China, the Chinese economy, Chinese companies," says Chin."But at the same time I thinkthe UnitedStates could overplay its hand."

Follow Don on Twitter @don_pittis