Why China is Not Afraid Of A Trade War

The unprecedented tariffs the United States has imposed on China marks a significant escalation in Washington’s efforts to undermine the Chinese economy. While the Trump administration may act as if it ‘has all the cards’ to halt China’s ascent, Beijing is well positioned to weather the storm, and the US President’s vacillations could end up undermining his own country.

The interconnected nature of the global economy means protectionist measures can often have unintended and self-defeating consequences. As such, the US strategy of imposing steep tariffs on China carries inherent risks for its own economy. American consumers could bear the brunt of increased costs as companies pass on the tariffs through higher prices, leading to reduced consumer spending, lower economic growth, and higher interest rates.

US companies could also be adversely affected, having become deeply entwined with Chinese manufacturers over a period of decades. Prominent US firms rely on Chinese supply chains for a myriad of components and finished products. As a result, Trump’s tariffs on China will not only undermine importers and add costs for consumers, they will also harm American manufacturers operating in China as well as those that operate on US soil and import components from China.  

This could be why we have seen US stock markets decline combined with higher bond yields, as investors price in increased recession risk due to reduced consumption in the United States combined with higher inflation from the tariffs. Several of America’s most iconic brands such as Apple, Tesla, and Nike, have seen their share prices tumble as markets price in costly supply chain disruptions and lower worldwide demand for American products.  

Trump hopes his tariffs will undercut China’s manufacturing dominance and encourage companies to reshore manufacturing stateside. But the uncertainty around the tariffs actually make it more difficult for large businesses to make decisions about where they manufacture their products. Even if the tariffs remain in place, establishing new supply chains takes time and the US could simply end up running even larger trade deficits with other nations. This transition could also increase production costs and delay products getting to market.

This is why the US President has already exempted computers, smartphones, solar cells, and semi-conductors from his tariffs to protect companies like Apple from potential catastrophe and there is a good chance that despite his rhetoric Trump will seek a deal with Xi Jinping to end the trade war following the reversal on his ‘Liberation Day’ tariffs. Despite the tough talk, when the EU, China, and Canada retaliated with levies of their own, Trump backed down.

The EU approved targeted tariffs on a wide range of US products, including almonds, orange juice, poultry, soybeans, steel, aluminium, tobacco, and yachts. Canada joined in and applied tariffs on US cars not covered under existing trade agreements. Combined with stock market turmoil, China’s firm response, and global investors dumping US Treasuries, Trump capitulated.

What happens next is anyone’s guess. But while losing access to the US market would be a significant blow to China, it is not insurmountable. Chinese manufacturers already sell the majority of what they produce at home and can easily redirect exports to other countries. Beijing has devoted considerable financial and diplomatic resources to this end.

The promotion of local currency trade could also prove instrumental in supporting the purchasing power of emerging market economies to offset US losses. The People's Bank of China’s digital payment system, which bypasses SWIFT and the US dollar, has already integrated other nations. Payments are completed in seconds instead of days and fees are significantly lower.

Nevertheless, a pivot to new export markets presents its own challenges. A sudden influx of Chinese goods into emerging markets could trigger complaints from local producers, leading China’s emerging market allies to implement protectionist measures of their own.

As such, the Chinese government is expected to take this opportunity to implement economic reforms. Beijing will look to expand China’s domestic service sector and implement initiatives to boost domestic consumption, rebalancing the country’s manufacturing and export dependent economy to become more resilient to external shocks.

China’s low inflation rate puts it in a strong position to implement fiscal and monetary policy stimulus, allowing Beijing to fund reforms without worrying about rising prices. This contrasts the United States, where above target inflation rates may constrain the Federal Reserve's ability to employ similar stimulus measures without exacerbating inflationary pressures.

While the Chinese currency could continue to depreciate in the short-term, a weaker yuan would enhance the competitiveness of Chinese goods in other markets, offsetting some of the effects of the tariffs. However, a weaker yuan also poses the risk of capital outflows and the government could be forced to tighten capital controls having already implemented measures to stabilize its financial markets to ensure investor confidence remains intact.

Despite the tariffs, Chinese goods are likely to continue flowing to the US via intermediaries such as Mexico and Vietnam, especially now that Trump has lowered the baseline tariff rate to 10% for all countries beside China. As such, the effectiveness of Trump’s tariffs on China could prove relatively limited and US efforts to reshore manufacturing and reduce China’s influence over global supply chains appears likely to end in failure.  

At the same time, Beijing will continue to exert pressure on the United States during any potential negotiations and has already restricted the export of rare earth minerals. Indispensable to the production of advanced weapons systems, precision-guided missiles, and next-generation fighter jets, these rare earth restrictions could negatively impact US military readiness.  

Rare earth elements, mined and refined predominantly in China, are crucial to everything from radar systems to electronic warfare equipment, and although the Pentagon is hurriedly exploring alternative sources, the reality is that the US defence industry remains vulnerable to supply chain disruptions in this area.

In addition to rare earths, plenty of American farmers still depend heavily on the Chinese market as an important source of revenue and China’s counter-tariffs could reduce income for this influential demographic. This could deepen the rural discontent that made Trump’s populist rise possible while eroding political support for his policies in states like Iowa, Texas, and Louisiana.  

We could also see China continue to sell their holdings of US Treasuries and divert investments to emerging markets instead. Combined with an increase in the supply of goods that once flowed to America, this could bring down interest rates and boost economic growth and consumption in developing countries, offsetting market share losses Chinese exporters face in the US.

So while Trump’s tariffs appear menacing, there are a number of factors which indicate that the worst effects can be mitigated. China’s large domestic economy, low inflation rates, ability to redirect exports, and effective countermeasures put China in a strong position. In contrast, the US looks vulnerable, and Trump’s tariffs could simply end up hurting America.