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The author is a faculty member at Yale University, former chairman of Morgan Stanley Asia, and author of Accidental Conflict: America, China, and the Clash of False Narratives.
This month’s trade retaliation between China and the United States suggests what will happen if President Donald Trump follows through on his campaign promise to raise tariffs on China when he returns to the White House.
In a long-awaited move, the U.S. just renewed export sanctions on China focused on high-bandwidth memory chips and semiconductor manufacturing equipment. The U.S. government also added 140 more Chinese companies to the Commerce Department’s so-called “entity list,” effectively making it much harder for these U.S. companies to supply technology to Chinese companies.
As has been the case since 2018, China has been quick to counterpunch, in this case by banning or restricting U.S. purchases of several key minerals while tightening controls on graphite. . China’s retaliation is a surgical strike with major strategic implications for major U.S. industries, from semiconductors and satellites to infrared technology and fiber optic cables to lithium batteries and solar cells. These measures are comparable to what the U.S. government is seeking in its “small yard, high fence” strategy aimed at restricting access to critical U.S. technology.
This is a reminder that retaliation is a powerful fuel for conflict escalation. This is not well understood in U.S. policy circles, which seem to harbor the mistaken notion of a one-way dependency, with China uniquely dependent on external demand and new technology from the United States. This eliminates the other half of the equation. The United States also relies heavily on low-cost Chinese products to help income-constrained consumers make ends meet. The United States needs China’s surplus savings to fill the domestic savings gap. And U.S. producers rely on China as the country’s third-largest export market. This codependency means that the United States is as dependent on China as China is on the United States.
Mr. Trump does not accept this logic. During Trump 1.0, U.S. tariffs on Chinese goods increased from 3% in 2016 to 19% by 2020. President Trump mistakenly believed that China could resolve its multilateral trade deficit with 106 countries bilaterally.
That backfired. In the years that followed, the overall U.S. merchandise trade deficit widened from $879 billion in 2018 to $1.6 trillion in 2023. As expected, due to the tariffs, China’s share of the total U.S. trade deficit fell from 47 percent to 26 percent over the same five-year period. period of years.
However, the Chinese portion was simply diverted to Mexico, Vietnam, Canada, South Korea, Taiwan, India, Ireland, and Germany. It found that more than 70% of trade diversion from China went to high-cost or similar-cost countries, highlighting that trade diversion is tantamount to increasing taxes on U.S. businesses and consumers.
More of the same is expected in the second Trump administration. And as U.S. actions escalate, retaliation from China will likely increase as well. For example, China’s recent actions on critical minerals raise the possibility of widespread restrictions on rare earths, which are of great strategic importance to the United States.
And, of course, there is the ultimate financial weapon. That’s $1 trillion in direct holdings of U.S. Treasury securities by Greater China (including $772 billion in China and $233 billion in Hong Kong as of September 2024). Unsuspecting Americans usually ignore this possibility, arguing that China would not dare to bring up this nuclear option because it would do more harm to them than to us.
oh really? There are several “bad dream” options to consider. China could go on a buyer’s strike during the upcoming Treasury auction, or, even more extreme, could begin to lose its huge position as America’s second-largest foreign creditor. Either option would be catastrophic for the deficit-prone US economy, cause severe collateral damage to global financial markets, and wreak havoc on the US bond market. While it seems outlandish and bordering on suicidal for China to cause such a financial collapse, it would be equally foolhardy to ignore the “tail risk” implications of an adversary falling into a trap.
Much of the post-election policy debate has focused on the tariff initiatives likely to be introduced in Trump 2.0. The codependency of China and the United States prompts us to think less about unilateral actions and more about retaliatory responses to those actions. President Trump’s nationalist “America first” perspective ignores how dependent the savings-poor American economy is on China for goods and financial capital. China has many “trump cards” to send very different messages.
