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US-China trade

The trade war’s next phase: China retaliates

Published 02 July 2024

Biden’s vulnerability at the polls creates an immediate opportunity for China to establish a credible threat against future US administrations. Regardless of who re-enters the White House, China has an incentive to raise the economic and political costs of the American trade offensive.

The next 12 months will see a noxious combination of rising global policy uncertainty, election risk, and geopolitical risk. Tensions will culminate in the new US administration’s very likely escalation of the trade war against China and China’s retaliation.

After that, one can only hope that a real détente is negotiated – otherwise, the harm to the two economies will seriously increase the already uncomfortably high odds of trade tensions spilling into the military domain.

The irony is that President Joe Biden presides over a resilient economy with a 4% unemployment rate. Yet his approval rating seems stuck at 40% and he is trailing Donald Trump by an average of 6% in the swing states that will decide the election on November 5.

With each passing week – and especially if his polling dips any further – Biden gains more of an incentive to leverage this economic advantage to put pressure on US rivals, in hopes of burnishing his nationalist credentials and salvaging his election bid, or at least solidifying his legacy.

With recent executive actions, Biden’s cooptation of Trump’s hawkish trade policy is complete, which means that the US election has limited bearing on US policy toward China: Beijing faces an escalation in trade pressure regardless of the winner.

Over the past two months, Biden has raised tariffs on Chinese exports of electric vehicles and solar cells, tightened export controls on semiconductor technology necessary for artificial intelligence, and threatened Chinese banks with expanded sanctions for doing business with Russia.

China has retaliated by launching anti-dumping investigations into imports of a key engineering chemical from the US and European Union. Beijing is selling US Treasurys, reducing agricultural imports, and threatening to cut off market access to a range of firms including Apple and Tesla. It is also brandishing export controls on critical minerals.

The sources of strategic distrust run deep. The US is attempting to retain its preponderant global power, while China is demanding a greater say in its region and the world. The US strategic agenda would include closer economic and military relations with Taiwan, even as Xi Jinping demands a “resolution” of the ambiguities over Taiwan’s sovereign status in accordance with China’s demands. There are also disputes between China and the West over Russia, North Korea, the South and East China Seas, and Iran.

That Biden and President Xi Jinping failed to negotiate a strategic détente over the 2022-24 period was not surprising. But they both had – and gave up – short-term incentives to put a lid on tensions. Biden needed to maintain a positive economic and financial environment going into his election against Trump. In keeping with a foreign policy doctrine of solidarity with the allies, Biden initially pursued “de-risking” from the Chinese economy rather than a more aggressive policy of decoupling.

However, an escalating trade war in the final four months of an election campaign creates a different dynamic from that of the “Phase One” trade deal Trump signed with China in 2020 to boost his reelection prospects. It is too late for Biden to sell a China deal to the American people – and he would get pounded by Trump if he tried to do so. As a result, China has an incentive to raise the economic and political costs of the US trade offensive.

Specifically, Biden’s vulnerability at the polls creates an immediate opportunity for China to retaliate and establish a credible threat against future US administrations. Once American escalation becomes a certainty, China has an incentive to act first. If China establishes this threat, its negotiating position will improve in 2025 regardless of the US election outcome. If it does not retaliate, it will invite increased trade policy aggression from Biden or Trump.

What can China do?

Many options have already been laid on the table, including selling Treasurys or controlling exports of minerals, but they can be countered or bypassed by the United States. For example, the faster China dumps US assets and the higher the odds of a superpower conflict, the greater global demand for those assets. As for export bans, minerals and low-value goods are very easily re-exported by third parties. Moreover, the magnitude of China’s retaliation is limited by its own domestic economic slowdown.

China's holdings of US treasuries | Hinrich Foundation

A far more effective approach for Beijing would consist of alliance formation in Eurasia along with commercial diplomacy to persuade American allies and partners that US policy is reckless and harmful to peace and prosperity. Xi is in fact doing both: strengthening ties with Vladimir Putin, even condoning a new Russo-North Korean mutual security pact, while courting Germany, Japan, Australia, and other states eager for Chinese investment.

Structural reforms of China’s domestic economy would seem a necessary ingredient for this commercial diplomacy. Beijing has long spelled out commitments to do so, and will expand on these at its notable Third Plenum in mid-July. Of course, most analysts will see right away that these reforms are not meant to pivot the Chinese economy toward the Western model of free markets and global economic integration – they will still underscore the Xi administration’s focus on centralized Communist Party control and strategic security, including placing an emphasis on high-tech import substitution. But lip service paid toward such reform will at least provide cover for foreign governments worried about the political cost of continuing to deepen trade and investment ties with China.

Left to its own devices, China’s mercantilist trade policy would eventually undermine its diplomatic outreach to nations whose friendship (or at least neutrality) will be necessary in what Beijing expects to be a long contest with the United States.

China’s refusal to embrace consumerism and open key segments of its economy to global markets, even as it continues modernizing and amassing military power projection capabilities, will generate fear and animosity in its region. It will drive various countries into the American fold over time – as long as the US remains committed to a multilateral approach. However, that depends on the US election.

If the United States increases punitive measures on allies as well as rivals in its pursuit of power perpetuation – and, by upsetting the global economy, becomes a greater threat to the stability of Asian states than Chinese ambition – then the US will alienate the very countries that it needs to form a coalition to shape China’s behavior. China will be able to divide the US and its partners without having to make pragmatic trade concessions to the United States.

That would cause the US to grow even more aggressive – out of frustration over its isolation. It would also lend support to China’s preferred combination of mercantilism and saber-rattling as foreign policy, which is designed to break the political will of those neighbors that insist on a return to principles of free trade.

The alternative would be American coalition-building, which poses a greater threat to the Chinese leadership. If Democrats hold the White House, they will gradually persuade European and Asian allies to enforce high-tech export controls and take a tougher approach toward Chinese imports. While the EU raised provisional tariffs on Chinese electric vehicles on June 12, it is moving more cautiously and will need to be thoroughly convinced before escalating the trade war much further.

Either way, it is very hard to see the US and China negotiating a new understanding and mode of living with each other in the next few years. China is using American aggression as a means of managing domestic policy conundrums. The Chinese economy remains unable to recover from a property bust that poses systemic risks to the regime. But resolving the structural imbalances would inflict economic pain on a domestic support base that Xi needs. So it is useful to deflect the blame onto a foreign rival. After all, Xi’s playbook would say, the US is attempting to cut off China’s only avenue of escape from the middle-income trap: high-tech productivity enhancement.

The US, having awoken late to the China challenge, is also using Chinese aggression as a means of domestic power consolidation. The US requires some degree of re-industrialization to improve its strategic security and reduce social inequities. Focusing attention on an external competitor can also reduce political polarization so that strategic imperatives can be met. Both US political parties and the Washington bureaucracy are fully aligned on China as a “peer competitor” that needs to be countered.

Over the past several decades, the US government has failed to coordinate national economic policy to redress social discontent over income inequality, immigration, and both the real and exaggerated loss of manufacturing jobs. China’s central government, for its part, has stifled private sector activity and civil society with obsessive state control, generating nationalism where there used to be entrepreneurship.

Chinese households consume too little by most measures, especially relative to other major economies. As its property sector collapses, the pivot of investment into manufacturing has exacerbated state-driven overproduction and global worries about China’s impact on manufacturing and jobs in other parts of the world.

However, China likely has no intention of offering structural trade concessions that would reduce global imbalances. Instead, Beijing is focused on improving its strategic autonomy and reducing dependency on US markets, since it assumes that the US will use its economic leverage to impose sanctions whenever strategic disputes reach a boiling point.

In short, the year ahead could be summed up in two words: China retaliates.

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Matt is BCA Research’s Chief Strategist, Geopolitical Strategy and US Political Strategy.

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