China's economy is showing a divergence. Exports are looking healthy, but the domestic economy is faltering.

To stay afloat, China needs global demand more than ever.

Don't tell that to US President Donald Trump, who is just itching to put up tariffs that would hit the country's exports.



If there's anything you can take away from China's economic data for the fourth quarter of last year, it is that the country needs the world more than ever.

Nobody tell Donald Trump.

Yes, China's reported gross-domestic-product growth held up at 6.8% in Q4, but the perplexing story in the numbers is that China's domestic economy is slowing down under purposely tighter economic conditions.

Societe Generale called this "an uneven picture of very strong external demand and weakening domestic demand" and noted that net exports' contribution to GDP increased during 2017. At the same time, both domestic consumption and investment saw their contributions to GDP decline from 2016.

Chinese officials are tightening credit to slowly ween the country's financial and corporate sectors off of debt financing. Now, this isn't to say policymakers have taken a hatchet to the system or anything, but what little they have done is starting to make an impact.

This makes the economic health of the rest of the world incredibly important to China, because as its domestic economy slows it will depend on demand from the rest of the world to keep its economy going. It also means Trump's promises to control imports from China to the US could make things particularly painful — if he follows through.

As good as it gets

"Although investment regained some strength in 4Q, domestic demand overall is unlikely to rebound much further from here given the relentless policy tightening, which will strain credit conditions further," the Societe Generale analyst Wei Yao wrote in her note explaining China's economic divergence.

All forms of credit slowed down in 2017.

Signs of strain can be seen in both the public and private sectors. An example: In the public sector, the local government in Baotou, in the country's Inner Mongolia region, is allowing civil servants to lend money to the government using a special instrument with a guaranteed annualized return of as high as 12%, according to the Financial Times.

HNA, one of China's biggest conglomerates, is offering an instrument to its employees as well. According to The Wall Street Journal, that investment is promising returns of 9.5%.

You can see why, in this environment, China's government is so focused on the One Belt One Road initiative — its ambitious infrastructure plan to build out land-based trade routes across Asia. The country needs outside money. It needs to use its oversupply of commodities like steel. It needs to put its companies to work, especially massive, heavily indebted quasi-state enterprises.

Vulnerable

Enter into this equation Donald Trump.

In the coming weeks, his administration is expected to make decisions meant to slow the flow of Chinese goods to the US. These goods include aluminum, steel, washing machines, and solar panels.

It's clear the two sides are circling each other. Last week, there were reports that Chinese authorities were considering slowing or stopping their purchase of US Treasurys (an unlikely move that would largely backfire). Earlier this month the Chinese government also targeted Delta and Marriott — Delta for listing Taiwan and Tibet as countries on its website and Marriott for listing Taiwan, Tibet, Macau, and Hong Kong as separate countries on a customer questionnaire.

Here in the US, the Office of the US Trade Representative again put Alibaba's Taobao on a list of "notorious markets" for counterfeit products for the second year, angering Chinese officials.

Now, there is debate as to whether the measures against these goods will hit their intended target (and not allies).

What could certainly hit the country, though, is the Trump administration's investigation into the theft of American intellectual property in China. The US Commerce Department is preparing a report on the issue (which is very real) that is set to arrive in a few months.

With all of these trade measures — and intellectual property especially — China's reaction will depend on how the Trump administration decides to handle its grievances.

It all comes down to whether the Trump administration decides to work outside the World Trade Organization— as it has insisted it will continue to do with more and more impact — or whether it decides to move within the bounds of international trade law. If it does not, China will have the right to retaliate, and it has said in no uncertain terms that it will do so.

It will just have to do it at a terribly delicate time for its economy — a time when it needs Americans to buy what it makes more than ever.