The relationship between the world’s two biggest economies is in its most serious crisis in nearly five decades. Every time the United States has imposed higher tariffs on China, Beijing has retaliated in kind. What would it take for the escalation to stop? Which economy can suffer more pain?
On the latest episode of FP Live, I spoke with two experts on the economics behind U.S.-China relations: Scott Kennedy, a senior advisor and trustee chair in Chinese business and economics at the Center for Strategic and International Studies; and Zongyuan Zoe Liu, a senior fellow for China studies at the Council on Foreign Relations and a columnist at Foreign Policy. Subscribers can watch the full discussion on the video box atop this page, or follow the FP Live podcast. What follows below is a condensed and lightly edited transcript.
Ravi Agrawal: Scott, you recently returned from China. How has Beijing been preparing for a trade war? How far are they willing to go?
Scott Kennedy: Well, in my travels to China post-pandemic, there’s been a malaise. The economy has grown very slowly; it never really bounced back. People have been questioning whether the leadership knows what it is doing and whether it will reform and change direction to make things better.
But this past month, the mood changed dramatically. That was partly due to DeepSeek and China’s tech successes, and partly because of the announcement of a stimulus. But the big change really occurred 12 time zones away, in Washington, D.C., with President [Donald] Trump—what he means for the world and the contrast with China.
Before, China looked like it was stumbling along. But now, in contrast to the radical revolutionary change that some Chinese call the American Cultural Revolution, China looks comparatively stable and predictable. I found both hawks and more liberal, even pro-American, people believe that China must stand up to the United States. Post-Liberation Day, this consensus in China has grown even stronger. And so for a variety of reasons, both economic capabilities and the view that this is an existential crisis, the Chinese are actually pretty unified and will hold the line as long as they need to. When the Foreign Ministry spokesperson says that, he is actually speaking for a lot of the population.
RA: Zoe, how do the Chinese people see Trump in his second term? A lot of projections show that the current tariff rates could slow China’s GDP growth by up to 2 percentage points, which strikes me as a real blow.
Zoe Lui: The high level of tariffs on Chinese exports to the United States is poised to significantly challenge China’s economic growth. Chinese leadership and economists are clear on this. It’s reflected in both fiscal and monetary policies as revealed during the National People’s Congress in March. Perhaps the White House and the Trump administration misjudged the Chinese willingness to endure pain at the leadership level and even to some extent among entrepreneurs as well. No Chinese officials or entrepreneurs want a trade war, but the Trump administration’s policy theater presents the Chinese leadership cover to walk back previous policy missteps without having to admit wrongdoing, embarrass the leader, or embarrass the party.
And then on the other hand, it gives Chinese state-owned media, like People’s Daily, an opportunity to showcase President Xi Jinping and his viewpoint about the world. It’s evidence that Xi was right. From this perspective, although neither the Chinese leader nor Chinese entrepreneurs or the Chinese people want a trade war, if this is the card they have been dealt, their ability to endure pain is perhaps stronger than last time. And they have better tools to fight back.
RA: Scott, given how many policy flip-flops there have been, is it possible this could all lead to a deal between Trump and Xi?
SK: I do think the two sides will meet at some point, negotiate, and come to some outcome. But a lot of blood will be spilled before that.
The Chinese want to negotiate and already came up with a list of things to offer the Trump administration. But they were surprised by the 10 percent fentanyl tariffs that were imposed twice, and then by the size of the reciprocal tariffs, and they decided to stand their ground. They realize that as the world’s two largest economies, two biggest militaries, the U.S. and China have to find ways to coexist.
Now, a lot of Chinese policies have generated pushback from the U.S. and their neighbors, especially on Chinese overcapacity and security. I’m not sure how much China is willing to compromise on those things, but I don’t think that their goal in pushing back is to decouple, isolate the U.S., and drive our economy off the cliff. They want to put pressure on the United States so that the Trump administration feels as urgent a need to negotiate as Beijing. But they believe they will eventually get to the table, so they are setting up the topics for that table, who will be there, and what the process will look like. Whether that happens in a few weeks or in several months, nobody knows.
RA: What are the chances this will all escalate into other domains? James Palmer at FP reported recently on Beijing’s so-called revenge list of options that includes suspending fentanyl cooperation or further restricting exports of soybeans and other products. How is Beijing calculating what to use in its arsenal, and how hard to push?
ZL: There’s a high risk of spillover to other broader strategic areas. But so far, the risk of militarized conflict between the United States and China is low, partly due to the reopened lines of military-to-military conversation.
But that being said, the way that the Trump administration singled out and escalated tariffs on China put other negotiations with the Chinese government at risk. The Chinese government has expressed willingness to cooperate on fentanyl, not just on chemicals, but also on money laundering. This cooperation would also benefit the Chinese government. But there are asymmetric dynamics in the current escalation of trade tension. Xi has been very laidback and has not accused the U.S. government or the Trump administration. But at the ministry level, there is aggression. And there are other challenges; finding the right people in China and in the U.S. to negotiate are all huge hurdles. But putting that aside, the risk of stalling negotiations in other areas is still very high.
RA: And as Trump has often himself pointed out, the Chinese don’t know who to call when they do want to speak to the Americans. Scott, you travel to China so often and understand how Chinese businesses work. How much pressure might they be able to exert on Xi Jinping? What constraints can the other actors around him impose? What, in your sense, is the likelihood of this trade war leading to something altogether more dangerous, like a hard-power conflict in the Taiwan Strait, for example?
SK: The extent to which this escalates depends on Washington, not Beijing. The Chinese will continue to be reactive to Washington. As Washington escalates, Beijing could too if needed, but it’s not their desire. The big thing so far is the tariffs, which could cut trade in half in 2025 compared to last year. They have been in targeted sectors like rare earths and commercial aviation. We might see more in pharmaceuticals or autos. The next big escalatory step would be financial. The consequences in trade and individual sectors cost billions. When you move to finance, you’re talking trillions. There are 268 Chinese companies listed on American securities markets, with a total market cap of $1.1 trillion. The U.S. could punt them off. You have American banks operating in China. China could pull those licenses. The U.S. could pull licenses for Chinese banks operating here. Then there is the big nuclear financial option and eliminate Chinese banks’ ability to operate in dollars and use SWIFT. That’s the big one. That escalation would impose massive costs to the other side. And there would be huge economic blowback on oneself for doing that. When you blow up a nuclear weapon, everybody suffers. After Liberation Day, the bond market went totally sideways. So cross-strait scenarios, radical changes in Chinese approach toward Ukraine or the Middle East, or significant shifts in U.S. military posture are off the table for now, unless things take a really dramatic turn.
The other place to look is at cyber. The Chinese have engaged in cyberattacks on the U.S. for a long time. The U.S. has probably also done so to China. They could start looking at each other’s critical infrastructure. So this could escalate and spin further out of control. But both sides are receiving advice to avoid certain areas unless absolutely necessary because of the high substantial costs.
RA: Zoe, let’s discuss China’s economy. Beijing has been holding back on unleashing stimulus in recent years. Will this be the impetus for China to make big moves domestically on its economy, for example, by increasing domestic demand?
ZL: That is perhaps the most powerful response that Beijing could do to galvanize domestic consumption and make the necessary push that they have been delaying for decades. But the Chinese government has been talking about this since the early 2000s. They recognize the imbalances in the economy. But this is the first time that the government report’s no. 1 priority is boosting domestic consumption, especially household consumption. Because they recognize that the United States, as well as the rest of the world, is facing a rising wave of protectionism to protect their own domestic market against the devastating effects of the influx of cheap Chinese goods on local economies and communities. In this, the United States is not alone. People talk about Russia as China’s unlimited partner, but Russia also imposed tariffs on Chinese imports. Last year, WTO [World Trade Organization] members filed over 190 unfair trade practice investigations against made-in-China exports. And the majority of those come from developing countries. So China recognizes that their exports face resistance. So, facing the domestic consequences of the Trump administration’s tariffs—shrinking exports leading to factory closure leading to increased unemployment leading to potential social instability—the Chinese leadership realize that they need to boost household consumption. I’m not certain they will do direct household stimulus, in part because of the different standards of income across the country. And because this may boost domestic consumption at a household level, but it will only cushion the economy against the possibility of shrinking export. China can strategically orient toward investment in science and technology, in research and development to decrease reliance on foreign technology. Going forward, China can become a technological superpower as envisioned by Xi Jinping. In other words, this may be a temporary tactical shift, but the wider strategy is not changing.
RA: But people can’t eat semiconductors. If prices are rising and regular folks feel their pensions are too low or they’re not able to enjoy the spoils of the economy, you can imagine some popular resistance. Looking at domestic popular opinion on this issue, how much pain can people sustain?
ZL: Across different groups, the sentiment could be very different. On the one hand, you have Xi Jinping and his generation who experienced major social shocks like the Great Famine, the Great Leap Forward, and the Cultural Revolution. That generation has a higher degree of tolerance and is willing to make personal sacrifices to advance grandiose strategic goals set by the party. And they also happen to be in power. But in contrast, this newer generation grew up in a period of prosperity. Their first major shock was COVID. I’m not sure that they are ready to be shocked again.
But it’s unclear how much Xi Jinping can mobilize the younger generation of Chinese families. The leadership is enacting policies like family support, calling on companies to increase salaries, trying to boost confidence in the Chinese economy. They recognize that it’s a vulnerability that the newer generation’s resistance is a huge uncertainty.
RA: Scott, do you think there’s a possibility of de-escalation? And if one side did, would the other follow?
SK: At some point, we may see the two sides quietly agreeing to stop escalating further and set up a process for discussing their disagreements. Before we get there, we need to see how American diplomacy with Europe, Japan, and others can improve their positions relative to China and whether Chinese diplomacy in Southeast Asia, Northeast Asia improves or isolates relations. They’re still positioning themselves to look strong relative to the other, but at some point, they will probably agree to calm things and find a way to get to a table.
The longer-term question is what can China do with its overall economic strategy and foreign policy to address the concerns of others? Partly, that’s increasing domestic household consumption as a proportion of GDP, which is not too difficult from a technical perspective. China can write checks or deposit money in an Alipay or WeChat account. But the political economy power problem is standing in the way. Xi Jinping thinks that high-tech is the key to China’s economic and national security survival, but he also doesn’t want to shovel cash to Chinese households. He thinks that makes them lazy. But it also means that he undercuts his SOE [state-owned enterprise] allies and others. But if he’s willing to build a social safety net, address people’s housing problems, raise wages, provide confidence about the future, then there will be a natural shift in the direction of supporting China’s household economy. And that will reduce China’s need to run large trade surpluses, which will reduce its trade tensions with others. And that’s in China’s self-interest. It happens to also be in everyone else’s interest as well.
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