$2.6tn could evaporate from global economy in Taiwan emergency

Sanctions against China would be a double-edged sword

Aug. 22, 2022

Yangshan deep-water port in Shanghai, where containers are stacked. © Reuters

A report on how Western sanctions might impact China sent shock waves through the State Council, China's cabinet, in April.

The report, prepared by China's Ministry of Public Security and Ministry of State Security, analyzed what would happen if the U.S., Europe and Japan were to react to a Taiwan emergency by imposing economic sanctions on China, as they did to Russia over that country's invasion of Ukraine.

"If the U.S. and allies move to slap sanctions," the report says, "our country will return to a planned economy closed off to the world."

What worried State Council members was a national weak point highlighted by the report. "There is a high risk of [China] facing a food crisis," the report warns.

If Chinese exports and imports are disrupted due to Western sanctions, China's earnings abroad would disappear, and essential items would stop being imported.

A halt to imports of soybeans, among other essential items, would affect the Achilles' heel of China, as the country relies on the U.S. for 30% of its soybean imports. China is an agricultural powerhouse. But the truth is that its soybean self-sufficiency rate is less than 20%.

Soybeans are used not only in the production of edible oil, which is essential for Chinese cuisine, but also as feed in pig farming. Pork accounts for 60% of the meat consumed in China.

If the supply of soybeans to China is halted, the country's 1.4 billion people would be beset by food problems immediately.

China boasts the world's biggest population, and the Chinese Communist Party keeps it together by using an iron fist. But the party's support is pragmatic and more fragile than widely thought.

"I become sensitive to pork price rises, as they also affect prices of beef and chicken," said a 54-year-old trading company employee in Beijing who declined to be named, recalling what happened in 1989.

In June 1989, the Chinese military suppressed pro-democracy student protests in Beijing's Tiananmen Square. While the protesters were shouting pro-democracy slogans, inflation was accelerating.

The consumer price index surged at a pace of between 20% and 30% on a year-on-year basis. Some say that spikes in the prices of pork and other items amplified social unrest, becoming an indirect cause of the protests.

On July 4, the National Development and Reform Commission, which steers Chinese economic policies, secretly summoned officials of domestic pig farming companies to a meeting room near its building in central Beijing.

The move came after farm-gate pig prices soared by just over 40% in one month and doubled from March. The commission instructed pig farming companies to stop being unwilling to sell. It has also begun to consider releasing frozen pork under its jurisdiction to stabilize the market.

Beijing is nervous about the supply, demand and prices of pork, which is an important part of the country’s diet. (A food market in Beijing in July.)

As the party controls everything, from domestic politics to diplomacy, it would draw a strong public backlash in the event of an emergency. China is wavering over whether to rush to unify Taiwan with the mainland as a political achievement.

Meanwhile, the U.S. is not necessarily firmly united in its policy toward China.

In mid-June, Sen. Robert Menendez, a Democrat who chairs the Senate Foreign Relations Committee, and Republican Sen. Lindsey Graham introduced a bipartisan bill to sanction China in the event of a Taiwan emergency.

The "landmark legislation" sends "a clear message to Beijing not to make the same mistakes with Taiwan that Vladimir Putin has made in Ukraine," Menendez said in a statement.

The bill includes the introduction of such measures as the exclusion of China from the international payment network, but it would not be easy to legislate.

That is because the U.S. has a lot to lose through sanctions against China.

Using the Organization for Economic Cooperation and Development's Trade in Value Added (TiVA) database, Nikkei estimated the amount of economic loss that would be caused if trade between China and major countries ground to a halt.

The OECD database makes it possible to analyze the trade structure of each country on a value-added basis.

According to the estimates, a total of $2.61 trillion would evaporate -- an amount equal to 3% of the world's gross domestic product. China's GDP is 10 times larger than Russia's. China also boasts the world's largest total trade value.

Based on the analysis, which used the latest 2018 data, if Chinese exports to Japan, the U.S. and Europe became impossible, there would be downward pressure worth $1.6 trillion on the Chinese economy. This means 7.6% of China's nominal GDP would disappear.

Japan would suffer a bigger loss as a percentage of GDP than the U.S. or Europe.

If Japan's exports to China were halted, its economic size would shrink by $190 billion, or 3.7% of its GDP. Europe would lose 2.1% of its GDP, while the U.S. would take a 1.3% hit.

If Japanese, U.S. and European trade with China were all disrupted, a total of $1.91 trillion in added value would evaporate. This equals 2.2% of the world's GDP.

In the event of a confrontation between China and the 38 OECD member nations -- which include not only Japan, the U.S. and European countries but also other nations -- the impact would be more immense.

The confrontation would result in the disappearance of $2.61 trillion in added value -- $1.34 trillion in added value that China gains from exports to the OECD member nations and $1.27 trillion in added value that the OECD member nations gain from exports to China.

Global trade shrank by 8% due to the impact of the coronavirus pandemic. The decline in global trade as a percentage of GDP stood at 2%. Although a simple comparison is impossible, a Taiwan emergency could cause a more serious global depression.

All countries, companies and individuals are connected to China in one way or another.

Precisely because this is the age of "Great China," economic sanctions against the country would be a double-edged sword. How could the worst be prevented without drawing such a sword? If it could not be done, the world would face an immeasurable crisis.

Lesson from Ukraine crisis: China aims to reduce its dollar dependence

If a Taiwan emergency occurs, the world economy could take a devastating hit through sanctions against China. Some companies have begun to prepare for a possible scenario in which imports from China grind to a halt and the passage of ships through the Taiwan Strait stops.

Meanwhile, China is also moving to reduce its reliance on the dollar after learning a lesson from Western sanctions against Russia over the Ukraine crisis.

"We need to assume not only U.S.-China economic decoupling but also the situation in which we cannot sell products in China. We must cultivate Asian markets other than China," said an executive at a major Japanese automaker.

Motor show in Nanjing, China in April 2022. © Kyodo

Alarmed by a rising percentage of China sales in its overall sales, the automaker has issued an instruction to its employees to prepare for various geopolitical risks.

The war in Ukraine has exposed the risk of a fracturing of the closely knit global economy. The World Trade Organization estimates that imports from the Commonwealth of Independent States, led by Russia, will decline by 12% in 2022. Among other things, the U.S. cut exports to Russia by 80% in March and banned the export of high-tech products. Russia can export energy but is finding it harder to obtain electronic components and other goods from abroad.

What would happen if increasingly authoritarian China invaded Taiwan, resulting in economic sanctions being slapped on the world's biggest trading country?

The estimates took into consideration only a halt to trade. In reality, it is believed that two-way investment between China and many other countries would also be largely halted, and turmoil would spread in financial markets.

The effects of comprehensive sanctions against China on economies would be immeasurable because such sanctions would also inevitably cause global logistics disruptions and other indirect effects.

China is already moving as if it were preparing for U.S.-led economic and financial sanctions.

One of the moves is to enhance China's resilience against the privileged strength of the dollar, which was highlighted by Western sanctions against Russia over the war in Ukraine.

The dollar accounts for 40% of international payments for purposes such as trade and investment. Reducing China's reliance on the dollar directly increases its security.

The percentage of the use of the yuan in China's external payments, including transactions with Hong Kong, rose to about 50% in 2020. The yuan is used as a settlement currency for nearly 20% of China's foreign trade.

Using its negotiating power as the world's largest importing country, China is urging many countries to accept payments in yuan.

Brazilian mining giant Vale has agreed to yuan-denominated exports, while a news report said in March that Saudi Arabia would consider yuan-denominated crude oil transactions.

There is a strong possibility that China will expand yuan-denominated transactions for items such as lithium, a metal used in batteries that power electric vehicles, in the future.

Russia, prevented from using the dollar, has also increased yuan-denominated exports of coal and other items under Western sanctions. According to the Reuters news agency, a major Indian cement company in June used yuan to pay a Russian company for coal.

Yosuke Tsuyuguchi, a professor at Japan's Teikyo University who once served as the first head of the Bank of Japan's Beijing office, said that "relevant authorities in China are believed to have approved yuan-denominated transactions between third countries."

"It could become a major trigger for the yuan's internationalization," he added.

The yuan is still not easy to use outside China, as capital transactions are restricted and exchange rates are controlled by the Chinese government. But, Tsuyuguchi said, "there is a possibility that it will become important as a settlement currency in trade transactions in Asia."