Tensions between the U.S. and China reached new heights on Sunday as President Donald Trump said that it was in his power to declare the ongoing trade war a national emergency and that he regrets not raising tariffs higher than he did on Friday. Declaring such an emergency would give the U.S. President broad authority to impose sweeping sanctions on trade between the two countries. The impact of that move would deliver a far more devastating blow to an already slowing global economy than the tit-for-tat tariffs that have been the major weapon of choice for each country thus far. 

“In many ways this is an emergency,” Trump, speaking at the G-7 leaders meeting over the weekend, said about escalating trade tensions, according to CNBC. “I could declare a national emergency, I think when they steal and take out and intellectual property theft anywhere from $300 billion to $500 billion a year and when we have a total lost of almost a trillion dollars a year for many years.” He added that he had no plans as of yet to declare such an emergency.

Asian markets fell on Monday with China's Shanghai Composite Index and Shenzhen Composite Index falling around 1% and Japan's Nikkei closing 2.2% lower. However, U.S. stock market futures were rescued after Trump in the early hours said the two countries "will be getting back to the table" after China called U.S. trade officials. "They have been hurt very badly but they understand this is the right thing to do and I have great respect for it. This is a very positive development for the world," he said.

Trump's comments came only days after announcing via Twitter on Friday an order for U.S. companies to cease operations in China and return to the U.S. “Our great American companies are hereby ordered to immediately start looking for an alternative to China, including bringing.. …your companies HOME and making your products in the USA,” he tweeted, triggering a selloff that saw the Dow fall 600 points.

The comments were prompted by China’s announcement earlier that day to ramp up tariffs from 5% to 10% on more than 5,000 U.S. goods, including soybeans, oil and aircraft. The total value of those products is estimated at $75 billion and the tariffs are likely to have an especially negative impact on exporters in Midwestern states, home to some of Trump’s key constituencies, according to MarketWatch.

Trump responded in kind, boosting already existing tariffs on close to $250 billion worth of Chinese imports from 25% to 30%, which the President said would take effect on October 1. He also said that the proposed tariffs on an additional $300 billion of Chinese goods that are set to take effect on September 1 and December 15 would be raised from 10% to 15%, according to CNBC.

US China trade balance

What It Means

The escalation of tariffs risks squeezing profit margins to the point where trade between the two countries no longer makes economic sense. Indeed, even before the tit-for-tat tariff war began over a year ago, some U.S. companies had already begun shifting operations out of China. But Trump’s recent threat to call a national emergency has raised fears that even for U.S. companies where operating in China might remain feasible, imposed sanctions would make it forbidden.

Specifically, Trump could invoke the International Emergency Economic Powers Act (IEEPA), created in 1977. In the event of a national emergency, the law would allow Trump to block the activities of individual companies or whole sectors of the economy, according to experts cited by CNBC. The law has been used by past presidents to freeze the assets of foreign governments, such as when Jimmy Carter did so against the Iranian government in 1979. According to the Congressional Research Service, "as of March 1, 2019, presidents have declared 54 national emergencies invoking IEEPA, 29 of which are still ongoing. Typically, national emergencies invoking IEEPA last nearly a decade, although some have lasted significantly longer."

Whether or not Trump could actually order U.S. companies operating in China to leave is debatable. “If he declares the requisite international economic emergency, he has broad powers, most of them sanctions against the other country,” said William A. Reinsch, an international business scholar at the Center for Strategic and International Studies. But he added that he did not think the law gave Trump the authority to order U.S. companies to completely cease operations in China, according to the New York Times.

Trump’s suggestion that he has the power to order companies to relocate appears to stretch the original intention of IEEPA, said international trade lawyer Judith Alison Lee. Yet, she conceded that the law was written broadly enough that it still leaves that possibility open. “The IEEPA framework is broad enough to do something blunt,” said Tim Meyer, director of the International Legal Studies Program at Vanderbilt Law School in Nashville.

Given the fact that U.S. imports from China far outweigh its exports ($539 billion imported vs. $120 billion exported in 2018) it might seem that tariffs and further trade sanctions would be far more damaging to China than the U.S. However, that analysis ignores the complex interconnections that make up today’s global economy. Anything that hurts China’s economy hurts the global economy and will have severe repercussions for the U.S. economy.

Already, signs of a global economic slowdown are well underway. Germany’s manufacturing sector is contracting and China’s economy has weakened to its slowest pace in 27 years. That weakness has spread to the U.S. with the latest survey of manufacturing executives suggesting the sector contracted in August for the first time in the past decade since the Great Recession. The Federal Reserve has already cut interest rates to ease monetary conditions and is expected to make further cuts before the year is out.

“Global growth is subdued, and we describe it as fragile. There are many downside risks. One of the risks we keep flagging is risks on the trade front,” Gita Gopinath, chief economist at the IMF, told CNBC on Friday. “The developments that we’re seeing as recently as today give us great concern about what’s going to happen to growth going forward.”

Looking Ahead

While the conflict between the world’s two largest economies will have many casualties there may also be some beneficiaries as global trade is rerouted to other markets. Vietnam would likely be the largest beneficiary, but Chile, Malaysia and Argentina would also benefit, and the biggest gains would come from U.S. importers looking for new trading partners, according to economists at Nomura