Trump’s China policy: Phase Two or Phase Nil?

Trump is assembling a team of loyalists to ensure that his administration can purge resistant bureaucrats and implement his policies. One of the common threads running through the new cabinet is a hawkish or aggressive approach toward China and trade. Howard Lutnick, the Commerce Secretary favors "across the board" tariffs, believing the US is treated unfairly in the global trading environment. Scott Bessent, the Treasury Secretary, supports "optimal tariff theory," arguing that tariffs' negative impact on US consumers is overrated and that foreign manufacturers will cut prices to maintain market share. He advocates for rigorous screening of technologies related to AI, quantum computing, surveillance, and chips. Pete Hegseth, the Defense Secretary, listed "deter[ing] aggression in the Indo-Pacific from the Communist Chinese" as one of his priorities during his confirmation hearing. Mike Waltz, the National Security Advisor, calls China the US’ "greatest adversary" and wants to change the policy of "strategic ambiguity" with Taiwan to increase deterrence. Marco Rubio, the Secretary of State, is a happy warrior against Marxism-Leninism and Communism. This lineup suggests that China will dominate Trump's national security and foreign policy decisions. It will spur Trump towards competition rather than cooperation with the world’s second-largest economy.

Meanwhile, China's economic data reveals a reliance on its old growth model of investment and exports. China nearly missed its 5% GDP growth target in 2024 due to negative trends in governance, private investment, and foreign trade relations. Beijing implemented last-minute stimulus measures towards the end of last year to hit its growth target, but monetary policy easing proved ineffective and fiscal easing fell short due to local government revenue shortages. Total household consumption stands at just shy of 40% of GDP, which is anemic by international standards. Capital formation remained flat, driven by declining fixed asset and real estate investments. Yet, China’s investment in manufacturing and infrastructure performed reasonably well, as the country fell back on exports as the driver of growth and the government increased bond issuance for infrastructure projects. Strong exports combined with weak imports drove China’s trade surplus to a record US$992 billion in 2024, just above 5% of GDP, in no small part thanks to US economic resilience spurring global demand.

In essence, China is facing the problem of "Japanification" with total debt at about 300% of GDP, the general price level shrinking, and real interest rates pushing 2%. Chinese authorities are responding in a similar way to Japan in the 1980s-90s by relying on export competitiveness and periodic bursts of infrastructure spending, while praying for a technological breakthrough. The United States is responding in a similar way as it did with Japan, by initiating a trade war and demanding structural reforms that lead to an appreciating currency and economic rebalancing. The difference is that the US and Japan were strategic allies in the 1980s with Japan clearly as a junior partner. As Japan fell into its "balance-sheet recession," the US reduced its protectionism, and the strategic alliance endured. By contrast, the US and China are strategic rivals; there is a general lack of trust in between. As the US continues to pressure China into painful macro adjustments, Beijing continues to seek self-sufficiency rather than open itself to renewed US influence.

Trump promised at his second inaugural address to usher in the "Golden Age of America" and to be a "peacemaker and unifier" around the world. So he may still pursue a Phase Two deal, although its chance of success is only 50/50. The US trade deficit with China has collapsed and now stands at a mere 0.3% of GDP, from twice that much at its peak when Trump first ran for office. Many of China’s exports are now transshipped to reach American consumers, hence Trump’s threats to third parties that re-export Chinese goods. But this could well turn out to be a futile game of Whac-A-Mole. And at the crux of the issue is the fallacy that Trump is the sole driver of the US-China trade conflict. In recent years, China has been spending its savings on industrial policy to try to achieve technological breakthroughs and military modernization. Its goal is economic self-sufficiency and a sphere of influence in East Asia. Meanwhile, the US is wagering that global savings will continue to fund its technological and military superiority. The goal is private wealth, continued innovation, and continued strategic dominance.

Trump’s cabinet will encourage him to reduce US commitment to Ukraine and the Middle East and "pivot to China", but this strategic shift would be problematic. For one, While Trump may be keen to cut a deal with Russian President Vladimir Putin to reduce US military support for Ukraine (and help fund US tax cuts), foisting a ceasefire on Kyiv sends a damaging signal that democracies lack the resolve to defend partners that do not have mutual defense treaties. Such a deal would be manna to China and a fatal blow to American allies.

Achieving a strategic understanding with Beijing that ensures the US and China have a new mode of living with each other ought to be the most important goal of Trump’s China trade policy. Ideally, a long-term agreement would include codes of conduct in the Asia-Pacific, as well as for the use of technology, artificial intelligence, space, cyberspace, and other lawless frontiers. But the current geopolitical context is very different from that of the 1980s through the 2000s. At that time, the US sought to play the role of global coordinator in an increasingly democratic and capitalist world. Now the US regrets the way that China benefited from the system it built. It therefore seeks to play the role of global disruptor.

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