Part 1: All eyes turn to the US-China relationship
April 30, 2025
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8 min read
Mabrouk Chetouane: The rate of tariffs on Chinese goods is, for now at 145%. How is this impacting the Chinese economy? And, perhaps as a follow on do you expect China to impose further non-tariff barriers in retaliation?
Bo Zhuang: First, the GDP impact. Above 100% tariffs are already prohibitive and could theoretically drag GDP growth lower by up to 2%. But it is unlikely that we will see that full effect. We will likely see some rerouting of exports. We believe about a third of exports can be quickly replaced and so we would expect them to disappear immediately. Another third of exports are, in our view likely to fall by about half. The remaining 30% of Chinese exports don’t have an easy substitute. In other words, it is unlikely that the US will find an alternative within six months. So, I think it's more likely GDP growth drag will be about 1.5% spread out over the next 12 months. But beyond 12 months perhaps this trend will continue simply because other emerging market countries will pick up the slack and Chinese companies outward direct investment in countries like Vietnam, and Mexico in an effort to minimise the impact by arbitraging the different tariff rates. As a result, you will likely see a significant drag on domestic Chinese manufacturing investment. On top of that, China's net foreign direct investment will turn from positive return to negative. Not only that, but Chinese companies could also move overseas because of these tariffs because they will build production lines outside of China to meet US needs. That will be a drag over the medium term.
MC: So, what is China’s next step?
BZ: I think China is prepared for a protracted standoff. It's quite unlikely that China will say, OK, we need to sign the deal in the next few months. When the tariffs were 10, 20%, as they were previously, there was an incentive for China to negotiate in order to delay the tariff, delay any escalation. Now that tariffs are where they are, I can’t see China agreeing to sign a deal for 100% tariffs or even 50% tariffs.
The second point to make is that China has publicly said it doesn't know what Trump wants. So, they don’t know where to start in terms of negotiations. As a result, I believe we won’t see a deal this year. I think there is a 50% chance we’ll see a deal in 2026; even if they start negotiations, it is far too soon to forecast anything for this year. The other thing to note is that China is likely to continue with its non-tariff retaliatory measures, which are effectively a replica of what the US has been doing. So, for example, imposing tariffs on rare earth minerals is similar to what the US has been doing by imposing tariffs on AI chips. There is also a chance that we will see China start to actively use its anti-monopoly laws to effectively sabotage American companies’ Chinese businesses. The problem is that it is hard to figure out the growth impact of these types of non-tariff measures on growth. It is more likely to have an equity market impact, so we will be watching for that.
MC: Given what you have just said, is there a danger that China could end up in a period of ‘Japanification’ - ie the weak growth and inflation coupled with very low interest rates, which characterised Japan’s economic situation from the early 1990s following decades of rapid growth? And, if so, is it not at the moment for the government - especially, in the context of an aggressive trade war - to implement an aggressive fiscal policy?
BZ: I think it is the right moment. In my view China will fire a fiscal bazooka later this year. I believe China is on the path toward Japanification. But let's define what Japanification is first: it is a long period of low or negative inflation, during which Japan’s export sector was moving overseas and the government was doing small tranches of fiscal stimulus throughout the period without allowing banking sector to make adjustments, while simultaneously allowing the currency to appreciate.
China is definitely thinking ahead. It has studied what happened in Japan and one of the key reasons I believe China has been so stubborn in its resistance to US demands is because it fears following a similar path. The lesson I think they have learned is that one of the key reasons Japan entered into Japanification is because it caved into the US trade war. It allowed the Plaza Accord to happen; it allowed the Yen to appreciate. It allowed export capacity to move overseas, basically hollow out its domestic industrial capacity.
And that's how China is thinking. So, how do they remain competitive in the export space? They need to invest more to make sure, whatever happens, that China’s goods are still competitive globally. How did China survive through the Trump 1.0 with all the tariffs 10%, 25% percent tariff, how did they not lose global market share, they invested more and took a long-term approach by selling goods into emerging markets. I think that China will continue to adapt a similar approach now.
That said, I think the fiscal bazooka I mentioned earlier will be very different from what we have been hearing the markets call for. Historically, when we talk about China stimulating consumption, it tends to help other emerging markets by buying more commodities. This time around, it will not have as much global spill over. The goal will be to strengthen its domestic growth to around 4-4.5%, to ensure they can negotiate with the US from a position of strength and it will do so, I believe by pouring more money into things like AI and more domestic consumption through mechanisms like the elderly pensions and the fertility subsidy, which is ostensibly designed to encourage people to have children but it is effectively a consumer stimulus in disguise.
MC: Moving to a slightly different topic, Xi Jinping’s recent tour of neighbouring countries to present the country’s new digital currency is perfectly aligned with Beijing’s longer-term strategy of shoring up its autonomy from the US by concluding trade agreements and strengthening trade relationships with other Asian countries. We are seeing something similar in Europe. How do you see the relationship between China and Europe evolving?
BZ: I think that the EU and China have similar goals on the tariff war, but I don’t think there is a sincere alliance. Instead, they have a temporary common goal to force the US to back down. One good example is the discussion about replacing the current European tariff on Chinese EVs with a minimum price policy. I think China will take that as a very friendly gesture. With regards to dumping, I don't think it is an immediate concern. The reason being that Chinese exports to the US account for roughly 3% of GDP. If you assume as we said earlier that about one third of that is immovable, then they only really need to find a home for two thirds of that or, roughly two percentage points of GDP. Then, if you assume that China will look to try and boost domestic demand (by expanding consumer subsidies) they can probably absorb about 1-1.5 percentage points, which means the rest of the world would only need to absorb about 0.5 percentage points of Chinese GDP, which is largely in line with how China has been expanding in the past few years.
I think the bigger problem is that while China has no plans to reduce production, the rest of the world is also expanding production capacity. So, at the global level capacity is expanding faster than demand growth because everyone is trying to produce more.
MC: Are you worried that we could find ourselves in a situation, where excess supply leads to instability?
BZ: If we extrapolate too far, yes, we risk a crisis. However, that's a longer-term concern—perhaps 5 to 10 years down the line. But I think over the next two to three years one trend is for sure - higher inflation in the US and lower inflation in the rest of the world.
Written in April 2025, before the US and China trade agreement that was announced on 12 May
