Trump shock pushes US and China toward decoupling cliff edge

Janet Yellen stepped to the podium a year ago this week in Beijing to deliver a reassuring message. The US doesn't want to decouple from China, the then-Treasury secretary said. "Our two economies are deeply integrated, and a wholesale separation would be disastrous for both."

Twelve months on, President Donald Trump's more than 120% tariffs on Chinese goods and Beijing's determination to fight back in kind mean the seismic cleavage Yellen warned of is rapidly becoming a reality.

About $19 trillion has been wiped off the world's equity markets since the S&P 500 Index closed at a record high on 19 February, and this week's selloff in Treasuries is the worst since the pandemic. Economists have rushed to price in a US recession as Washington and Beijing engage in a dangerous bout of economic brinkmanship.

The White House says Trump "has a spine of steel and will not break." On Wednesday he ratcheted up pressure on China, raising the import duty to 125%, even as he announced a 90-day pause on reciprocal tariffs for dozens of other trade partners. Beijing, meantime, has vowed to "fight to the end." Earlier on Wednesday it responded to Trump's previous move by raising Chinese tariffs on US goods to 84%, making it clear to all that President Xi Jinping is in no mood to cave.

While Trump's track record of sudden tariff pauses and U-turns means nothing can be ruled in or out, officials in both capitals privately say there's little prospect for a near-term detente.

Speaking at a fundraising event late Tuesday, Trump said officials in Beijing "want to make a deal." But a social media account affiliated with Chinese state media which is often used to signal official thinking on trade said that China isn't "afraid of trouble" and while the door isn't closed for negotiation, "it won't happen this way."

Officials across major economies other than China have complained behind closed doors about a lack of clarity on what Trump and his trade hawks want from them, with many struggling to even reach an interlocutor from the administration.

Former ambassador to the US, Cui Tiankai, was in Washington last week for private meetings with think-tanks and other stakeholders but deliberately avoided meeting anyone inside Trump's circle, according to people familiar with the discussions. Cui's take on the impasse: Trump wants China to come asking for a deal and that's not something Beijing is prepared to do, the people said.

'Liberation day'

China's stance on the America First president has gone from optimism around the time of his inauguration, to frustration, to fight mode.

Despite agreeing to establish a "strategic channel" in a call between Xi and Trump on Jan. 17, there was no mechanism established for dialogue. Repeated rounds of tariffs starting with fentanyl-related ones in February signaled to Beijing that things may not go their way, with the latest levies and additional 50% triggering a determination to strike back.

"The US and China are in a full-blown trade war, and grand bargain delusions can be shelved," according to Arthur Kroeber, a New York-based partner at Gavekal Dragonomics who was previously based in Beijing. "In essence this means that Trump is committed to ending US trade with China."

That leaves the two economies with a combined GDP of $46 trillion locked in a game of chicken. At stake is almost $700 billion in two-way annual goods trade, China's estimated $1.4 trillion of portfolio investments in the US, and less obvious but no less significant variables such as people-to-people links forged over decades at businesses and universities and public opinion that's souring on both sides.

A poll last year by the Pew Research Center found eight in 10 Americans had a negative view of China, but a Pew survey released on Tuesday also found 52% believed US tariffs on China would hurt both them personally and the US.

Bloomberg Economics estimates that 100% US tariffs on Chinese goods would virtually wipe out all US imports from the Asian manufacturing powerhouse over the medium term. Overall, the average US tariff rate on all nations reaches 24.7%, meaning a hit to US GDP of 3.6% and a 2.1% increase in the Federal Reserve's preferred inflation measure over the next two to three years.

As the US ratchets up tensions, its own companies are illustrating how dependent America is on Chinese imports and how Trump's ambitions to spur a golden age for manufacturing, ironically, depend on the relationship with his trade adversary.

Businesses big and small are already anticipating a hit and asking for exemptions from the China tariffs. Companies including global giants like BASF, Ford, Ingersoll Rand and even Tesla have filed more than 1,100 requests already for exemptions from tariffs on machinery from China that they say they need to set up or expand production lines in the US.

Capital and intermediate goods make up around 43% of total imports from China, meaning "there is the perverse possibility that if those goods do not come into the US, it may slow down manufacturing in the US, and it may mean a loss of jobs in the short run," said Olu Sonola, head of US economic research at Fitch Ratings.

That's just one of the myriad ways the divorce stands to hurt both economies and reverberate globally. Indeed, there are already signs of fallout.

Global cargo volumes are showing signs of slowing as the world's big two economies duke it out. The World Trade Organization has warned Trump's rolling tariffs will trigger an overall contraction of around 1% in global merchandise trade volumes this year – a cut of four percentage points from the WTO's previous projections.

Weaker demand

"We're likely to see a significant drop in container demand to the US in the near term, and possibly in the intra-Asia manufacturing ecosystem too," according to Judah Levine, head of research at Freightos Group, a leading air-freight booking platform.

Emily Stausbøll, a senior shipping analyst at Xeneta, a digital freight platform based in Oslo, said freight shippers are easing or freezing imports in the wake of the tariffs and "the trade war between the US and China is a major driving force."

At factories across China, orders are already being halted and prospective US customers going quiet, though some are set to be harder hit than others.

One garment maker from the eastern Chinese province of Zhejiang was asked by a US buyer to temporarily hold shipments scheduled for April after Trump's tariff announcements. The factory manager is bracing for a reduction in order volume as the company is unable to offer steep discounts to offset tariffs.

Another factory manager at a Henan-based specialized glass maker sees few options for US buyers who need their certified safety glass to make welding helmets. In the short run, workers will need to pay double for their welding helmets, and in the long term Trump will be out of office, says the manager, who thinks the company can withstand the tariffs by focusing on customers in other regions.

Wu Xinbo, director at Fudan University's Center for American Studies in Shanghai, says Chinese officials have gained confidence they can endure a trade war with America given the nation's ability to keep advancing in new technologies such as artificial intelligence, despite tariffs and technology restrictions imposed over the first Trump presidency and Biden administration.

China's criticism

"China isn't in a hurry to open negotiations because as time goes on we may be in a better position," he said. "The US is going to face retaliation from China, the EU, Canada and maybe others. And internally – you see the stock market response, the slowdown in economic growth, inflation concerns – I think Trump is facing a situation that he didn't expect."

The White House argues that the trade deficit with China means that tariffs give the US more power in a trade war. "America holds the leverage and everybody knows that and therefore they should seek a detente and they should offer concessions," Stephen Miran, the White House chief economist, told Bloomberg Television on Tuesday.

But Evan Medeiros, who advised former President Barack Obama and Treasury Secretary Hank Paulson on China policy while they were in office, says that's a misreading of all the surgical economic tools from export controls to anti-trust and cybersecurity reviews that Chinese officials have at their disposal.

In a new study published Tuesday, Medeiros and co-author Andrew Polk document a whole suite of "precision-guided economic munitions" that China has that are "designed to inflict targeted and often substantial pain for political and geopolitical purposes."

Those, Medeiros argues, give China an asymmetric advantage in any economic conflict with the US. "The issue with a tariff war is that both sides suffer. And the big question in the US-China relationship today is who suffers more and who can withstand more pain?" says Medeiros, who is now at Georgetown University.

 "The Chinese, recognizing this, developed an entirely new toolkit to engage in competition with the United States, that gives the Chinese the ability to inflict very specific pain on very specific actors in the United States with no corresponding cost or pain for themselves. And if you're getting into a long-term economic competition with the US, which they are, this is incredibly useful."

Trump's attempt to increase pressure to force a negotiation is "a dangerous strategy," Medeiros says. "The Chinese don't want to negotiate with a gun pointed at their head."

New tools

China is already using the new toolkit to hit back at the US. Last week, it announced it would investigate a US firm in China, placed other US companies on its own "entity list" which effectively bans them from buying from China, and also imposed licenses on exports of some rare earths on which many US companies including Tesla are reliant. The result will likely limit shipments in the short term and make it harder for US firms to buy them.

It could escalate that by banning US companies from buying Chinese produced rare earths, as it did for some other critical minerals last year. China controls most of the production and processing of a whole host of critical minerals.

Two influential Chinese bloggers this week posted about other options, including banning imports of US poultry, curbing services imports and suspending cooperation on the fentanyl issue. Beijing could also weaken the currency to make its exports cheaper, or sell off its holdings of Treasuries, although both those actions would have serious negative consequences for China as well.

The spiraling costs of such tit-for-tat measures is so serious that some veteran China watchers say a compromise is inevitable, according to Joerg Wuttke, a partner at Albright Stonebridge Group in Washington who spent about three decades in China and previously served as president of the European Union Chamber of Commerce in China.

But Wendy Cutler, a former senior US trade negotiator who now leads the Washington office of the Asia Society Policy Institute, says Trump's latest punitive tariffs make any deal between the two economic superpowers less likely in the short term. "Every week it gets more difficult to achieve," she said. "Maybe things have to get a lot worse to get better."

Even before the latest tariffs, the existing levies on Chinese goods were driving US importers to alternative sources for anything they could replace. For those products for which there is no alternative, the reality will be simply that US companies and consumers will have to swallow the cost of the tariffs.

"There are Chinese goods that we have no substitutes for," said Derek Scissors, a longtime China hawk at the conservative American Enterprise Institute in Washington. "And for those goods that we have no substitutes for we're going to have to pay until we have substitutes."

China makes more than 70% of lithium ion batteries, smartphone and computer monitors the US imports, and almost 90% of the gaming consoles, according to Bloomberg analysis of 2024 trade data. In some unexpected places the dependency is even higher, with more than 99% of the electric toasters, heated blankets, calcium, and alarm clocks coming from China.

Scissors says his read is that Trump still wants to make a deal with China. "I want to partly decouple from China, so do others," Scissors says. "That has never been President Trump's view. Ever." But Trump's misreading of the dynamics with China means that he is walking the US closer to a decoupling than ever before.

"The way we get decoupling out of this is almost accidental," Scissors says. "It's not Trump's intention. It's not China's intention. But if they won't bargain with him for perfectly understandable reasons, we're going to end up decoupling."

Xi has also shown his willingness to gamble with the Chinese economy in the name of consolidating power, with a years-long regulatory tightening aimed at internet platforms. "If you're going to crack down on the Chinese private sector, then taking an American trade war blow is pretty straightforward," Scissors said.

Scott Kennedy, an expert on the Chinese economy at the Center for Strategic and International Studies in Washington, says if Trump wants to bring down the US trade deficit with China, he may end up doing so via a recession that reduces demand from American consumers.

"Tariffs to eliminate those bilateral balances and the rapidity in which they've been imposed without care for their consequences is nonsensical," Kennedy says. "The trade deficit will be lowered, but at the cost of American jobs and wealth and its standing in the world."