We’ve seen this before, and we will likely see this again.  Although the official report claiming China as a currency manipulator has been postponed, the looming potential for a trade war between two of the world’s largest economies continue.  But, will this really happen?

Absolutely not.

This is the second year in a row that Congressional leaders have voted to hear a bill that would not only brand China a currency manipulator but also “level the playing field.”  The current bill would help to offset Beijing provided subsidies that allow Chinese made goods to remain extremely competitive in the market.  US companies would be able to levy steep tax and import tariffs on China based imports, hopefully allowing US goods to be competitive domestically.  It would also bring the value of the Chinese yuan up against the US dollar.  Strong critics of China’s currency policy have noted that the Chinese yuan is still estimated to be as much as 25-40% undervalued against the greenback.

But, passage of the bill would not only sour political relations between the two nations, it would deeply cut into a massive two-way trade flow that is currently valued at about $300 billion this year.  US companies reliant on Chinese made electronics and raw materials are likely to take a massive short term hit as profit margins would likely increase on the back of higher tariffs.  Not to mention, a trade war would only be detrimental to the US’s export position to the Asian nation.  Currently, China is the United States’ 3rd largest export market – right behind both Canada and Mexico.  A retaliatory action set by the Chinese would effectively cut off about $70 billion in export revenue for US companies.

Plus, US lawmakers subject themselves to a potential treasury dumping measure by Beijing officials.  Let’s not forget.  China is still the largest holder of US treasuries in the world.  Any threats made through import tariffs could be met with retaliatory selling in US treasury notes and bonds.  Currently, China owns about $1.14 trillion in US assets.  This is compared to the second largest, Japan, which owns about 18% less at $936 billion.

Top 6 US Treasury Holders (in billions) – Source:  US Treasury

Now, a complete selloff of US bond holdings isn’t likely or even realistic.  But, the massive amount of US debt that China holds still makes Beijing existence a consideration when it comes to US revisions on trade policies.

Given the history of the bill – since its origins as the Schumer-Graham bill back in 2005 – and the comings and goings of Congress, a US/China trade war is unlikely to happen.  The most likely scenario involves further pressure from Congress and the US Treasury as well as appreciation for the Chinese yuan.  For the record, USDCNY has appreciated by about 20% since the end of 2006, recently hitting a record high.