The Unlikely Victor: Why China Is Set to Lose a Trade War
Could China possess hidden advantages that will enable it to outlast the U.S. in a trade conflict?
It might appear so. Chinese leaders are reminding the younger generation to be resilient—as the Chinese saying goes—unlike allegedly spoiled Americans. The country’s authoritarian system allows for swift decisions without internal opposition, unlike the more divided American political landscape. Furthermore, China has numerous methods to retaliate against U.S. businesses, which could pressure Washington to de-escalate.
However, these notions are based on an outdated understanding of China and its economic and political structure.
Endure hardship? That may have been true when China was significantly poorer. But now, it faces similar middle-class concerns as the U.S., and the Communist Party’s legitimacy hinges on its ability to improve living standards, not diminish them. (Additionally, over half of Chinese are now overweight, which doesn’t suggest a society of ascetics.)
The idea that a dictatorship can make instant decisions is also inaccurate. Beijing’s bureaucracy is complex, involving extensive deliberation before decisions reach top officials, who then seek consensus from their appointed colleagues.
In fact, regarding trade war decisions, the U.S. operates more like a one-man rule than China does. Donald Trump may have enjoyed using tariffs because he could implement, increase, decrease, or suspend them at will. Congress has ceded its constitutional authority over tariffs to the executive branch, and courts generally defer on matters of national security.
China has various potential responses to U.S. actions, but each has considerable disadvantages. It could match the U.S. tariff increases, which it recently did by raising them to at least 125%, while dismissing the “abnormally high numbers” as a “joke in the history of the world economy.” Indeed, they are now so high that they will likely disrupt orders and trade – although Trump may not see it that way.
As he told his aides during his first administration, “They’ll run out of money first.”
Alternatively, Beijing could target U.S. companies operating in China, as it is beginning to do with antitrust investigations, restrictions on Hollywood films, and blacklisting certain U.S. exporters. However, aggressive measures could deter foreign investment, which is crucial for China’s jobs and technology and has already decreased since the pandemic.
Then there’s China’s supposed dominance over rare earth minerals essential for electronics. However, U.S. firms typically don’t purchase these minerals directly from China. Instead, they are incorporated into components sold to U.S. buyers. Excessive pressure from Beijing could incentivize other countries to match Chinese subsidies for mining and processing these materials.
Finally, financial tools could be used. During the last trade war, China devalued its currency to a degree to offset tariffs of between 7.5% and 25% on its U.S. exports. However, the Chinese yuan would need a massive devaluation to compensate for triple-digit tariffs, which would drastically increase the cost of imports in China and trigger substantial capital flight as Chinese citizens sought to exchange their yuan for dollars or euros.
Conversely, if China tried to sell its holdings of over $800 billion in U.S. Treasury bonds, it would raise interest rates in the U.S. and also increase the value of the yuan, making Chinese exports more expensive – the opposite of China’s objective.
This does not imply that China is helpless. It is generally accepted that trade wars harm all parties involved, and China may retaliate against the U.S. despite potential damage to its own economy. Alternatively, it may remain passive and wait for the U.S. president to destabilize the American economy.
Tariffs of 125% on imports from the U.S.’s third-largest trading partner, encompassing items from Christmas lights to iPhones to industrial parts, will significantly raise prices in the U.S., potentially triggering a recession. And, as is typical with tariffs, the burden will disproportionately affect lower-income individuals. Democrats, and perhaps retailers, may portray the tariffs as a “Trump sales tax.”
That, in itself, will pressure the U.S. to reach an agreement, regardless of China’s actions.
And there is evasion. With the U.S. imposing at least 125% tariffs on goods from China but only 10% on goods from elsewhere, Chinese producers have a considerable incentive to bypass tariffs by shipping goods through other countries. This would greatly diminish the tariff revenue that Trump and other Republicans are counting on to support their agenda.
Both countries have significant reasons to negotiate a deal to de-escalate the trade war. China’s Commerce Ministry indicates it is open to dialogue, and Trump states he wants to discuss a deal with Xi. To encourage a positive response, Trump is using flattery, calling his Chinese counterpart a “brilliant man,” among other compliments.
These comments suggest a shared understanding that a prolonged trade war is detrimental to both nations.