There could be a silver lining for Australia if Trump escalates the trade war with China

• If the US proceeds with further tariffs against China, Morgan Stanley expects Chinese policy makers will respond with stimulus efforts.

• Since 2009, there’s been a strong correlation with Chinese money supply and the RBA’s commodity price index.

• Morgan Stanley says if China boosts liquidity and credit growth, there could be “resources opportunities” for Australian investors.

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An all out US-China trade war would hurt global growth by cramping supply chains and weighing on the Chinese economy, Morgan Stanley says.

But in response, Chinese policy makers would most likely take efforts to stimulate the economy. And that will probably be good news for commodity prices, which in turn bodes well for Australian exports.

Overnight, reports indicated that the US has reached out to China for further trade talks. But markets are still braced for whether or not the Trump administration initiates tariffs on another $US200 billion of Chinese goods.

Morgan Stanley's Australian equities team based their analysis on a 25% tariff on that amount, above the UBS base case of 10%.

"If this eventuates, our China economics team estimates that if Chinese policymakers were to maintain GDP growth at 6.4% in 2019, they would need to increase broad credit growth from 11.6% y/y to 14.5% y/y," analysts said.

And since the 2009 financial crisis, there's been a steady correlation between China's liquidity levels and Australia's primary commodity markets:

To calculate "Free Liquidity", the analysts took the growth in China's M1 money supply, then subtracted the producer price inflation (PPI) rate and growth in industrial production.

M1 is defined as the total amount of money and circulation that can be immediately converted to cash. Examples include physical currency and bank deposits.

What's clear is that when China boosted liquidity when the economy wobbled in 2015, the RBA's commodity price index also bounced off its lows.

And Morgan Stanley said the potential stimulus from China in the event of a trade war would be similar to those 2015 levels.

"While this would likely take some time to feed into the real economy, we are watching the People's Bank of China's balance sheet and broad credit growth for signs that a step up in stimulus is taking hold."

The analysts said the broader effects on the Australian economy would be "mostly indirect," with the impact from international supply chain disruption estimated to be a little over 0.1% of GDP".

However, given the potential policy response from China, the analysts said to "look for resources opportunities" if the US goes ahead with further tariffs.