Donald Trump’s first term as U.S. president ushered in a sweeping trade war with China and his second term promises to double down on the tariffs on China. Pundits disagree on whether his campaign trail pledge to institute a 60 percent across-the-board tariff on imports from China amounts to a bargaining chip for a trade deal or a decoupling strategy.
On the one hand, Trump is known for his unpredictability and transactional inclinations, and there is a lot that he could ask from China. Some of the items that are high on his wish list may include: voluntary export restraints to reduce Chinese exports to the U.S.; more imports of U.S. farm products; more Chinese investments in the U.S. to create jobs; and additional purchases of treasuries. Trump could also request China to exert more influence on Russia, North Korea, and Iran for the United States’ geopolitical interest, and the list goes on.
On the other hand, a 60 percent tariff may not be a tactic to strike a trade deal but an integral part of the “America First” strategy. Some of the emerging signs would attest to this possibility. First, Trump has announced several key Cabinet members who clearly and forcefully denounce China as a strategic rival. These China hawks could make any pragmatic deal-making difficult. Second, Trump may genuinely believe that tariffs are paid by the Chinese side and that tariff revenues can replace other taxes to fund a downsized government. Third, Trump may be disappointed by the results of the Phase One trade deal and decide not to replay the old trick. And finally, Trump may be led to believe that the trade war would devastate the Chinese economy while solidifying the United States’ economic might.
If this latter scenario materializes, then the questions become: How will China respond, and how would this stepped-up trade war affect the Chinese economy?
In Xi Jinping’s congratulatory message to Trump as the president-elect, China’s president called for “stable, sound and sustainable” bilateral relations. That said, Xi would not want to be seen as being “soft” facing the U.S.-initiated trade war. Trump’s initial tariffs were met with China’s proportional retaliation, to the extent that 73.3 percent of China’s imports from the U.S. were subject to retaliatory duties. It is therefore likely that China will impose retaliatory tariffs should the 60 percent tariff come into effect.
But China does not intend to decouple, nor does it want to harm the United States at its own expense. It is true that China has established sweeping new laws in the past few years that could be used as retaliatory measures – for example, blacklisting foreign companies, imposing China’s own sanctions on U.S. individuals or businesses, or enforcing export restrictions on critical minerals. But these retaliatory measures tend to produce lose-lose outcomes. If China decides to blacklist or sanction U.S. businesses, it would only do so in a selective and surgical manner, as in the cases of Skydio and PVH, so as not to discourage foreign investment or disrupt the global supply chain. Finally, it is unlikely for China to sell off the $775 billion worth of U.S. treasuries it holds (as of August 2024). China’s holdings only account for 2.7 percent of the total treasuries or 9.1 percent of the treasuries held abroad; a selloff won’t materially weaken the dollar value or elevate the treasury yield.
The best retaliation, from China’s point of view, is to defend itself from a point of strength. While many observers believe that China today is in a weaker position to weather a U.S. trade war than six years ago when the economy was growing at 6.7 percent rather than around 5 percent, China in fact has fortified its economy to cope with a more hostile international environment in the past few years. China’s exports to the United States took up 19.3 percent of its total exports in 2018; by 2023, this ratio had fallen to 14.8 percent and exports to the U.S. accounted for only 2.5 percent of China’s total GDP.
For the first time in 2023, China exported more to the Belt and Road Initiative (BRI) countries than to the United States, European Union, and Japan combined. Facilitating and enabling the Global South to join global trade through a series of infrastructure and connectivity investments under the BRI, China is able to reap the benefits of more diversified export markets. Further, during the first trade war, China established trans-shipment mechanisms to circumvent the tariff barrier. As U.S. imports from countries like Vietnam, Thailand, and Mexico increased, China’s exports to Mexico and Thailand more than doubled during 2017-2023, and China’s exports of computer components to Vietnam tripled.
In addition, during the first Trump trade war, the RMB depreciated about 10 percent to mitigate the tariff impacts. A 60 percent tariff hike would require some 10-12 percent depreciation of the RMB to offset. It is arguably harder for the RMB to depreciate further this time, given that the exchange rate has already exceeded the 7:1 threshold. The Chinese economy is under deflationary pressure so a real depreciation through deflation would not be desirable. That said, the potential for U.S. inflation to rise due to Trump’s policies could prompt the Fed to slow down rate cuts, while the Chinese central bank may continue to cut rates to boost the economy. The interest rate differentials could continue to weaken the RMB against the dollar. The Chinese central bank and other regulatory bodies would remain vigilant in monitoring capital in- and outflows to manage financial risks.
Finally, Chinese businesses have been investing abroad to establish local production capacity, which not only helps serve the local markets but streamlines the supply chain and avoids tariff barriers. China’s overseas direct investment (ODI) rose by 8.7 percent year-on-year to reach $177.3 billion in 2023, making China the third-largest source of ODI globally. In the first eight months of 2024, China’s ODI reached $110.9 billion, an increase of 12.5 percent year over year.
Most importantly, China plays a long game. Trump’s four years will intensify decoupling and tech containment, but his trade war would cost the U.S. economy dearly. The Peterson Institute of International Economics (PIIE) projected that the 60 percent tariff on imports from China and 10 percent on imports from all other countries would cost a typical U.S. household over $2,600 a year (even after factoring in the 2017 tax cut extension). The tariff plans will stoke inflation, reduce jobs, slow down GDP growth, and worsen income distribution. Even if Trump refuses to make a course correction in the face of the damages, he can only serve one more term – and his successor may not be able to (or even want to) hold out. Economic isolationism will not be economically or politically viable in the medium and long term.
In the meantime, China will be pushed to turbocharge its economic policies to bolster domestic demand and solidify technological self-sufficiency. It will also continue to orchestrate economic diplomacy, elevating its voice and presence in the BRICS, Shanghai Cooperation Organization, APEC, and G-20, among other international groupings and forums. It will engage more actively with the Global South and U.S. allies, as the United States retreats from the global stage. If China is able to seize the opportunity to revitalize its domestic economy and invigorate the multilateral system, Trump’s trade war 2.0 could end up a strategic gift to Beijing.