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The writer is a faculty member at Yale University, former president of Morgan Stanley Asia, and author of Accidental Conflict: America, China, and the Struggle of False Narratives.
A back-and-forth between China and the United States on trade this month suggests what may lie ahead if Donald Trump makes good on his campaign promises to up the ante on Chinese tariffs when he returns to the White House.
In a long-awaited move, the United States has just updated export sanctions on China, focusing on high-bandwidth memory chips and semiconductor manufacturing equipment. Washington also added another 140 Chinese companies to the Commerce Department's so-called “Entity List,” making it very difficult for those American companies to supply technology.
As has been the case since 2018, China has been quick to take countermeasures, in this case by banning or restricting US purchases of several critical minerals while tightening controls on graphite. China's retaliatory action constitutes a surgical strike with important strategic consequences for key US industries, ranging from semiconductors and satellites to infrared technology and fiber-optic cables, to lithium batteries and solar cells. These measures are similar to what Washington is pursuing through its “small arena, high fence” strategy aimed at restricting access to critical US technologies.
It is a reminder that revenge is the high-octane fuel for escalating conflict. This is not well understood in US policy circles, which seem to embrace the misconception that China is uniquely indebted to foreign demand and new technologies from the United States. This leaves the other half of the equation. The United States also relies heavily on low-cost Chinese goods to cover the expenses of low-income consumers. The United States needs China's surplus saving to help fill the domestic saving vacuum; American producers depend on China as the third largest market for American exports. This interdependence means that the United States depends on China as much as China depends on America.
Trump doesn't buy this logic. During Trump's first term, US tariffs on Chinese products were raised from 3% in 2016 to 19% by 2020. Trump had the wrong view that there was a bilateral solution for China to the multilateral trade deficit with 106 countries.
This backfired. Over the subsequent years, the total US merchandise trade deficit widened from $879 billion in 2018 to $1.06 trillion in 2023. As expected, in response to the tariffs, China's share of the total US trade deficit fell from 47 to 26 percent over the same period. The five period. A period of one year.
However, the Chinese portion was simply transferred to Mexico, Vietnam, Canada, Korea, Taiwan, India, Ireland and Germany. It turns out that more than 70% of trade diversion away from China went to countries with higher or similar costs, confirming that trade diversion equates to a tax increase on American businesses and consumers.
We expect more of the same in the second Trump administration. As US actions escalate, the scope of retaliation by China is likely to expand. For example, China's recent actions on critical minerals open the possibility of broad restrictions on rare earths, which are of enormous strategic importance to the United States.
Then, of course, there is the ultimate financial weapon – Greater China's $1 trillion direct holdings of US Treasuries (including $772 billion held by the People's Republic of China and $233 billion held by Hong Kong as of September 2024). Arrogant Americans usually reject this possibility, claiming that China would not dare flirt with this nuclear option because it might harm them more than us.
Oh really? There are a couple of “Bad dream” options. Consider this: China may resort to a buyer's strike during upcoming Treasury auctions, or it may begin to shed its outsized status as America's second-largest foreign creditor. Either option would be devastating to the deficit-prone US economy, unleashing havoc on the US bond market, as well as painful collateral damage in global financial markets. Although it seems far-fetched, almost suicidal, for China to spark such a financial collapse, it would be equally reckless to ignore the consequences of an embattled adversary.
Much of the post-election policy discussion has focused on the tariff initiatives that are likely to emerge in Trump 2.0. The interdependence between China and the United States prompts us to think less about unilateral actions and more about retaliatory responses to those actions. Trump's nationalistic vision of “America First” ignores the extent to which the thrifty American economy is dependent on China for goods and financial capital. China has plenty of “Trump cards” to send a very different message.
