American Tariffs and the U.S. Economic War with China

 

 

SUMMARY

 

The Trump tariff offensive is couched in domestic economic terms and objectives – to reduce the trade deficit, to reduce the fiscal deficit, to increase domestic manufacturing, especially in technologies with good growth potential or necessary for national security. The economic issues used to justify the higher tariffs, however, are part of a larger challenge - the geopolitical rivalry between the United States and China, and part of a broader objective – to weaken China’s domestic economy.

 

The economic issues used to justify the higher tariffs are less important than the geopolitical issues - the geopolitical rivalry between the United States and China - and part of a broader objective – to weaken China’s domestic economy.

 

 

 

BACKGROUND

 

The conflict with China has been recognized as far back as the Obama administration. Even before then, the United States has used economic tools as political weapons – sanctions, denying other countries access to the international payments systems, attempts to limit imports such as oil. The main economic tool aimed at China before high tariffs has been the virtual embargo of Chinese exports of electric vehicles (EVs) through very high tariffs and attempts at embargoing high-end chips.

 

The United States has been running trade deficits for over 65 years. Trade deficits are partly a function of Cold War strategy (giving non-Communist countries access to the large American market) and partly due to domestic tax and fiscal strategies (low taxes, fiscal deficits, subsidized mortgages, expanding social welfare). Trade policy in the new geopolitical world has to be more nuanced. Fiscal policy must be changed because interest on the national debt is eating the federal budget and jeopardizing America’s influence in the world. For example, interest on the national debt is a larger expense item than national defense.  

 

The worst part about it is that Trump probably could have gotten his original tariffs, outlined when he was running for president, without all the drama - across the board 5-10% with negotiated exceptions and a starting negotiating offer of 30-60% with China. Of course it would have forced all other countries to impose the same tariffs on American exports. But he has now pissed off most of the world; there will be longer term geopolitical repercussions. Countries and trade blocs of countries are accelerating treaties and understandings with each other to avoid trade with the U.S. The financial side is to avoid pricing imports and exports in dollars and bypass the international payments systems denominated in dollars. In the long run, the objective is to change the global structure that depends on the dollar as the reserve currency. This will have adverse economic consequences for the United States. All this may be inevitable but could be managed over a longer period with less impact on the U.S. economy.

 

  

 

There is also unnecessary damage to the U.S. economy. The U.S. economy stopped growing in the first quarter of 2025. All the stated objectives - reshoring, reviving old manufacturing, eliminating trade deficit, greatly reducing fiscal deficit – are important goals but merely self-delusion if Trump thinks they can be accomplished in the short run through higher global tariffs. 

 

Domestic economic adjustments will not come from higher tariffs on imports but will have to come from radical changes in the domestic social and economic structure of the United States.

 

If the United States imposes a 10-20% blanket tariff on the world and other countries retaliate, plus a higher tariff on globally-traded inputs like steel, plus a higher tariff on China (who will also retaliate), there is a high probability that there will be a global recession. All this will cause severe disruptions to the global supply chain that provides inputs and consumer goods to America.

 

The world will blame the United States; there will be short-run and long-run economic and political consequences.

 

It will be another step in lessening American influence in the world. It will damage the American economy if foreign institutions decide to hold fewer American financial assets. This might lead to higher interest rates the U.S. government has to pay to finance its high and rapidly-expanding national debt. Without tax increases, the yearly deficit will continue to be structural; a higher percent of total government expenditures, including interest on the national debt, will be fixed by law and not subject to yearly budgets approved by Congress. For details and analysis, see Government Finance 101.

 

The U.S. economy didn’t grow at all in the first quarter of 2025. Analysts pointed out the surge in imports to beat the higher tariffs as a major reason for the slowdown (imports are subtracted from measured GDP). But higher imports should have led to increased inventories and greater consumer sales (increases GDP). The longer this drama continues, the greater the damage to the American and global economy. 

 

TARIFFS

 

The tariffs on imports are a tax, mostly paid by American households. But it is not collected directly on final sales like a sales tax. Tariffs that are placed in inputs and the wholesale cost of consumer goods that are open to negotiations create uncertain costs and prices. Corporate planning becomes difficult and riskier. 

 

Whatever revenue tariffs raise for the government will be balanced by higher prices and lower income for all American households. Think about that - an income transfer in the hundreds of billions of dollars from American households to the government. Is that what Trump was elected to do?

 

A global tariff of 10% on imports, with exceptions and even assuming a 20% tariff on Chinese imports, will not do much damage to the American economy. A bit of inflation at the retail level. Most large American companies in oligopolistic markets and consumers can adjust. Many small businesses will be hurt. Tariffs could lead to a slightly higher unemployment rate.

 

Or much good. Current estimates average around an extra $100 billion to $150 billion in extra tariff revenue. The higher number is about 12% of the current trade deficit and about 8% of the current fiscal deficit, before proposed tax cuts.

 

 

The currency exchange value of the dollar has fallen 9%, a direct consequence of the uncertainty created by Trump. This is a large move. It makes American imports (exports to America) more expensive to the exporting company, independent of tariffs. When the exporter goes to exchange its dollars for the local currency (yen euro, pesos, etc.) the given amount of dollars earned buy fewer units of the exporter’s domestic currency. The domestic currency is necessary to pay the costs of producing the exports. One strategy is to raise the dollar price of the imported products to earn the same amount of the exporter’s domestic currency.

 

The fall in the price of the dollar relative to other currencies should help American exports. The importer has to buy dollars to pay the American exporter. A 10% fall in the value of the dollar compared to the importer’s currency means it now takes 10% more domestic currency to buy a given amount of dollars. The American producer could lower the price of its exports by 10% to earn the same amount of dollars. American exports are now more competitive in foreign markets. 

 

It is also an added incentive for any country not to price its exports in dollars. The spot price of most commodities is denominated in dollars. But two countries, such as the Russian sale of oil to China, could set to ruble-RMB (yuan) exchange rate, also avoiding dollar-based exchange institutions. Their central banks could set up swap arrangements to guarantee that enough of the other’s currency is available to finance trade.

 

Foreign companies, financial institutions and central banks like to hold dollars because dollars are considered the safest, most liquid currency (issued by the largest economy and most trade currency in foreign exchange markets). Dollars also reduce the transaction costs of international trade. But by creating uncertainty risks about the future value and safety of the dollar, including the large and increasing American national debt, other countries may trade more without the dollar.

 

TRUMP’S TARIFF STRATEGY

 

Trump’s apparent strategy was to unilaterally impose insanely high tariffs on all countries (and penguins), based on a sketchy formula that if all other countries paid the tariffs and didn’t retaliate or change their trading patterns, much of the U.S. trade deficit would disappear. Of course, that wasn’t going to happen. It was a fantasy. If it did happen, the world, including the United States, would have gone into a global recession (or worse).

 

Some people said this was just a negotiating tactic; some countries would settle for higher tariffs than they wanted to. What Trump didn’t count on was that American financial markets, which are forward-looking, immediately began to estimate the future damage and reacted by selling off dollars and American public companies (expecting lower future profits and share prices). The 500 largest American public companies receive about 40% of their sales and 50% of their profits from foreign operations.

 

Millions of small businesses depend on imports from China. Generally, they find it harder to pass on the higher costs from tariffs to customers.

 

 

U.S. ECONOMIC WARFARE WITH CHINA

 

China’s growth rate of real GDP in 2024 was probably about 3%. It was officially 5%, but this is likely a political-motivated overestimate. This is also a substantial slowing of past Chinese growth rates. Major reasons for the slower Chinese growth rates are a slow-down in export growth, drastically-lower net foreign direct investment, and internal problems such as the housing crisis.

 

On May 12, Trump blinked. Trump temporarily reduced most tariffs to 10%, with a surprisingly low tariff of 30% on China.  “The Geneva agreement [with China] represents an almost complete U.S. retreat that vindicates Xi’s decision to forcefully retaliate,” said Scott Kennedy, a China expert at the Center for Strategic and International Studies. The 30% tariff rate is not that much higher than the current effective average tariff on China. Trump’s threat to impose higher tariffs during negotiations now lacks credibility.

 

At the same time, Trump imposed higher tariff rates on steel and aluminum, and threatened higher rates on imported pharmaceuticals. This will hurt the economies of allies, particularly Canada and Europe.

 

Many analysts, in the U.S. and China believe that a tariff level around 50-60% would cause serious damage to the Chinese economy. Trump has thrown away this weapon.

 

Trump greatly reduced the tariff on China before his embargo-level tariffs could do any real damage to the Chinese economy. There was a fall in shipments in April and probably May. China did not agree to any of the “reforms” Trump wanted. China could now reduce the damage with a partial, moderate rebate program to Chinese companies that lose American sales. 

 

China will be in a strong position to get an even lower tariff when permanent tariffs are negotiated during the 90-day trial period. I doubt if Trump will now be able to impose a tariff above 10%, with exceptions, on any country. Qatar will probably get a 0% tariff. That would make a higher tariff on China, say 20%, look high by comparison. 

 

Trump, holding most of the "high cards," has been playing the wrong card game. The game was not to raise money for the U.S. government or reduce the trade deficit or to "reshore" American manufacturing. The game should have been to weaken the Chinese economy. The goal should have been geopolitical rather than some ill-considered domestic economic American goals. 

 

Why would this be possible? Because China has serious internal problems that the U.S. could exploit. 

 

• Unemployment in export industries. According to a high Chinese official, about 170 million jobs depend directly or indirectly on exports. About 25% of the total labor force. Much of exports is labor-intensive production of cheap consumer goods for the American market.
• Lower economic growth rates, exacerbating China's high unemployment rate among young people, especially recent college graduates. 
• Massive overcapacity in many industries, which will not be solved if China has a low growth rate. 
• The housing crisis, which has wiped out much of the savings of Chinese families. A large number of housing units, maybe higher than 50 million, are empty or unsold.
• The beginnings of a demographic crisis, including a massive decrease in the working-age population and a massive increase in the over-60 population. 
• Grossly underfunded retirement benefits for a rapidly aging population supported by a falling number of workers. (See posts).
• Huge environmental cleanup costs.
• Almost zero net foreign direct investment (FDI). Foreign investment has been a major driver of economic growth in the past. In addition, wealthy Chinese families are smuggling large amounts of money out of China. 
• An authoritarian government that will do anything to keep control, including cracking down on any protests resulting from economic stress.

 

 

Making these problems worse would probably have a negative psychological effect. Chinese elites and the middle-class would have less confidence about the future. This is in addition to the negative demographics and a peculiarity of the Chinese labor market. In China, there is widespread discrimination again hiring anyone over the age of 35. If people cannot establish a career when they are young or are fired when they are 35 or over, they have little chance of getting a comparable or better job or have rising income until retirement.

 

All of this, made worse by American tariffs, would further weaken Chinese expectations about a secure, better future. Maybe a Chinese Donald Trump would arise to exploit this anger and anxiety.

 

ALTERNATIVE AMERICAN STRATEGIES

 

To minimize the impact on the American economy, Trump could have left tariffs on other countries alone or reduced tariff on some countries or strategic products. Negotiating lower tariffs with other countries, with reciprocity, would further weaken China's export-driven economy. 

 

The obvious example is to lower tariffs on American cars assembled in Mexico and Canada. Even better, treat the region of the U.S., Canada, and Mexico as a tariff-free trade bloc.  

 

American consumers, with their insatiable demand for cheap consumer goods produced in China, are helping to finance the huge amount of money the Chinese government is spending on developing innovative new industries. The one cheap consumer product Americans can’t buy is Chinese EVs, effectively banned in the United States. An alternative to tax cuts, mostly for upper-income families, could be a VAT tax that most other developed countries have.

 

In the long run, the real economic competition between China and the United States is which country does a better job in developing and innovating new technologies and selling them in the global economy. New technologies will be the source of both domestic economic growth and growth in global exports. Less dependence on fossil fuels, control of renewable resource technology, efficient manufacturing employing automated systems including AI-enhanced robots, EVs and autonomous-driving cars and trucks, pharmaceuticals and medical technology (for an aging global population), and technologies still in the R&D stage such as quantum computing (which would revolutionize computing) and nuclear fusion (which would probably solve the clean energy problems).

 

So the long run geopolitical and economic strategy for the U.S. is close ties with Canada and Mexico, large expenditures on new technology R&D, attracting the best minds in scientific and medical research, move rapidly to renewable energy as the costs of the systems continue to fall (even before the positive externalities of slowing global warming, a cleaner environment and better health), increase domestic supply chain manufacturing through automatic production systems and AI-based management and control software. And produce AI-enhanced robots and drones.

 

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For an analysis of China that is the basis of comments in this post, see

China's Economy, Politics and Demographics

Japan is experiencing the early effects of massive, long-run population contraction. It is likely that China and other countries in East Asia will exhibit a similar downward trajectory. See

Demographics and Population Projections of Japan

If the United States can implement policies to mitigate its internal problems and not alienate the people of other countries, it has a more favorable demographic future than almost any other country. For data and analysis, see

Demographics, Immigration and the Future Economic Growth of the United States