Stephen Roach's nightmare involves Romney triggering a trade war with China

A Chinese bank staff member counts stacks of 100-yuan notes. Many U.S. policymakers believe that China manipulates its currency.

US policymakers have long argued that China manipulates its currency. Presidential candidate Mitt Romney has gone so far as to say he would call China a currency manipulator on his first day in office. And the US has filed WTO complaints about Chinese curbs on exports of rare earths and other raw materials.

But a trade war could be damaging to president Obama's goal to double US exports by 2014 since China is the country's third largest export market. Remember, US exports to China surged 542 percent from 2000 - 2011.

In an editorial for Caixin Stephen RoachYale professor and former chairman of Morgan Stanley Asia — imagines what would happen if Romney were to become president and the US were to pull the trigger, setting in motion a trade war with China.

We summarize here:

  • If Romney were to take office and dub China a currency manipulator, the charge would necessarily under the Omnibus Trade and Competitiveness Act of 1988, kick off "immediate high-level negotiations between US Treasury officials and their Chinese counterparts at the Ministry of Finance. Not surprisingly, the negotiations stall and both parties blame the other in vitriolic press releases."
  • In early February after the first State of the Union address, The Defend America Trade Act of 2013 (DATA) will be signed into law on President's Day. The act will be "modeled after the currency manipulation "remedies" of countervailing tariffs first proposed by Senators Charles Schumer and Lindsey Graham in 2005" and China will be seen in violation of the new statute.
  • Negotiations between president Romney and Chinese president Xi Jinping and premiere Li Keqiang will fail and the US will impose a 20 percent tariff on all Chinese exports to the US.
  • This would cause plant shutdowns in China and Beijing would declare this "to be an act of economic war" and would file a complaint with the World Trade Organization (WTO).
  • China would in turn impose 20 percent tariffs on US exports to China, which would "hit growth starved America right between the eyes." And Wal-Mart would increase average price increases of 5 percent and attribute that price hike to increase in tariffs on imports, other retailers would do the same and the American consumer would "hunker down further in response."
  • "The stock market is hit by the trifecta of a perfect storm — pressures on profit margins and expectations of lower growth and higher inflation. The bond market is clobbered by the sharp deterioration in inflationary expectations and by the realization that the Federal Reserve, with its zero interest rate policy, is seriously behind the curve."
  • In response Washington "passes an amendment to DATA — upping the just-imposed countervailing tariffs on China by another 10 percentage points".
  • China, the biggest holder of US debt, retaliates by not buying any more US debt. "Long-term interest rates spike, and within two weeks yields on 10-year Treasuries pierce the 7 percent threshold. At the same time, the dollar plunges and the US stock market, which had already corrected by 20 percent in the first half of 2013, falls another 10 percent by the end of August."
  • China also says it might consider selling US treasuries if it has to.
  • The US turns to foreign producers that are more expensive than China, delivering a blow to the country's middle-class and by the fall of 2013 there is "little doubt of the severity of renewed recession." Meanwhile, Chinese economic growth slips to below 6 percent and the country prepares for another massive stimulus.

More from our partners at Business Insider:

Business Insider: How To Quit The iPhone And Convert To Android

Business Insider: 10 Things You Need To Know This Morning

Business Insider: Nomura: SELL!

Business Insider: Welp, This Was Probably Neil Barofsky's Last Time On CNBC

Business Insider: The 10 Craziest Lines From National Review's Story On Why Mitt Romney Should Win 100% Of The Female Vote