Why A Trade War Between The US And China May Lead To An Economic Crisis

The US and China are the two largest economies in the world. The gross domestic product of the US in 2017 was US$19.39 trillion and the gross domestic product of China in 2017 was US$12.24 trillion. The combined gross domestic product of the two largest economies in the world in 2017 was therefore about 40 per cent of the world gross domestic product. One can take economics tuition from a good economics tutor to acquire a deeper understanding of the meaning and the uses of gross domestic product. Economics Cafe Learning Centre is a renowned economics tuition centre which offers economics tuition to individuals who are interested in learning economics for the purpose of acquiring knowledge. The Principal Economics Tutor at Economics Cafe Learning Centre is the highly sought-after Mr. Edmund Quek. Due to the sheer size of the combined gross domestic product of the US and China, a trade war between the two economies, particularly a full-blown trade war, may lead to an economic crisis.

Fall in International Trade

When the US increases tariffs on China’s goods, China’s exports to the US will fall which will lead to a decrease in aggregate demand resulting in a fall in national output and therefore national income. The link between national output and national income is taught in standard economics tuition classes conducted by qualified economics tutors. When households in China experience a fall in income, they will reduce consumption expenditure which will lead to a fall in imports. As the US is a major export market of China, this will lead to a fall in exports in the US. When exports in the US fall, aggregate demand will fall and this will lead to a decrease in national output and therefore national income. When national income in the US and China decrease, consumption expenditure in the two economies will fall and this will lead to a decrease in imports. As the US and China are the two largest economies in the world, this will lead to a substantial fall in exports in the rest of the world resulting in a large decrease in world output and therefore world income.

Fall in International Investment

With an increase in tariffs on China’s goods in the US, the US will become less attractive to foreign firms which export goods to China. Similarly, with an increase in tariffs on US’s goods in China, China will become less attractive to foreign firms which export goods to the US. It follows that a trade war between the US and China will lead to a fall foreign direct investment in the two economies. The link between tariffs and foreign direct investment may not be obvious to some. However, the knowledge can easily be picked up in economics tuition conducted by an experienced economics tutor. When this happens, aggregate demand in the two economies will fall and this will lead to a decrease in national output and therefore national income. As discussed earlier, this will lead to a fall in imports in the two economies resulting in a decrease in exports and therefore national income in the rest of the world.

Selling US Government Bonds as a Weapon

In order to retaliate against the increase in tariffs imposed by the US, China may sell its holding of US government bonds which is the largest in the world. The Chinese government currently holds about US$1.17 trillion of US government bonds. If the Chinese government sells a large chunk of its holding of US government bonds, the prices will fall which will lead to an increase in the effective coupons. Economics tuition at Economics Cafe Learning Centre covers the financial aspect of economics which includes the link between the prices of bonds and the effective coupons. As a result, the costs of borrowing of the US government will rise which will increase the budget deficit which will make the high public debt-to-GDP ratio even higher. In the worst-case scenario, this will lead to a recession in the US and therefore the rest of the world.

Jacky Liu

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