China prepares to retaliate against potential trade war with Donald Trump

China is preparing for potential retaliation against new tariffs if Donald Trump restarts the trade war upon his return to the Oval Office next year. Trump has promised to impose further tariffs due to what he claims are China’s unfair trading practices.

This move could hardly come at a worse time for Beijing, as exports are one of the few bright spots in the world’s second-largest economy, which is already slowing and unlikely to hit this year’s 5% growth target.

After Donald Trump first stormed the White House eight years ago, rattled Chinese leaders responded to his tariffs and fiery rhetoric with force, resulting in a trade war that plunged ties between the globe’s largest economies to multiyear lows.

This time around, Beijing has been preparing for Trump’s return by deepening ties with allies, boosting self-reliance in tech, and setting aside money to prop up the economy that is now more vulnerable to fresh tariffs already threatened by Trump.

While some retaliation to those moves might be unavoidable, China will focus on exploiting rifts between the US and its allies, experts say, and aim to lower the temperature to help strike an early deal to cushion the blow from trade friction.

China will strike back in the first rounds of another Trump trade war to build negotiating leverage, Wang Yiwei, an international affairs expert at Beijing’s Renmin University told Washington Post.

“China definitely will retaliate,” he said. “We need to hit to let Trump know, if you do this, the cost may be higher in other ways.”

Donald Trump’s approach to China policy remains unpredictable, but he has vowed to impose 60% duties on all Chinese goods, in addition to the measures from his first term that President Joe Biden largely maintained. Before Biden hands over power to Trump on January 20, he and Chinese leader Xi Jinping are set to meet in Peru this Saturday, following the Asia-Pacific Economic Cooperation forum in Lima.

This meeting is crucial, as another trade war would have severe consequences for China. However, analysts believe Beijing is better prepared this time around.

Why Trump’s sweeping tariff threats increase risks for China’s economy this time

A threat by Donald Trump, who has been elected as the next U.S. president, to impose 60% tariffs on US imports of Chinese goods poses major growth risks for the world’s second-largest economy.

Not only are the tariff rates much higher than the 7.5%-25% levied on China during his first term, the economy is also in a much more vulnerable position.

This is what is different:

Property market crisis

In 2018, the property market was strong, driving about a quarter of China’s economic activity. That meant local government finances, heavily reliant on auctioning land for residential projects, were not questioned so forcefully.

This helped China absorb the tariff shock. But since 2021, real estate has been in a severe downturn and local government revenues have plunged.

Housing oversupply means this sector may never return to the driving seat of Chinese economic growth.

This helped China absorb the tariff shock. But since 2021, real estate has been in a severe downturn and local government revenues have plunged.

Housing oversupply means this sector may never return to the driving seat of Chinese economic growth.

The International Monetary Fund calculates total government sector debt at 147 trillion yuan ($20.7 trillion) at the end of 2023. Add household and corporate debt and that number surpasses 350 trillion yuan - roughly three times the size of the economy, according to the Bank for International Settlements.

Weak domestic demand

Low wages and pensions, high youth unemployment and a feeble social safety net leave China’s household spending below 40% of GDP, about 20 percentage points behind the global average.

Boosting that requires either more debt or an overhaul of how national income is distributed, so that it benefits households at the expense of government and businesses.
That could be achieved by changing how companies and households are taxed and how government spends the money, raising retirement, health and unemployment benefits and removing an internal passport system responsible for huge rural-urban inequalities, among other reforms.

So far, however, authorities have focused on upgrading the export-reliant manufacturing sector instead, with remarkable success in electric vehicles, solar energy and batteries.
But this also prompted tariffs in the United States, Europe, Turkey and elsewhere.
China may be able to boost external sales in areas where its economy is extremely competitive, but has little control on external demand.

Deflationary pressures

The property crisis, the debt overhang and weak consumption have all fuelled deflationary pressures. China’s policy of redirecting resources from the property market to the manufacturing sector, rather than consumers, has fuelled what Western governments describe as industrial overcapacity. This has led to factory gate deflation.

Producer price inflation was 4.6% in July 2018 when Trump’s first tariffs came into effect. In September 2024 this stood at minus 2.8%. Consumer price inflation has ground to a paltry 0.4% from 2.1% over that period.

Deflation, which hurts consumption, businesses and growth, could get much worse if tariffs shrink external demand, exacerbating industrial overcapacity.

Limited room for currency depreciation

The yuan ended 2019 roughly 10% weaker against the dollar than in early 2018, when Washington flagged the tariffs plan and 4% weaker in trade-weighted terms against all currencies. The U.S. curbs increased the effective tariff rate on all Chinese exports by 2.4 percentage points, according to Capital Economics analysts, which means that the yuan’s depreciation more than offset the tariff impact.

This time, the yuan might have to fall 18% against the dollar to fully offset 60% U.S. tariffs, implying a rate of 8.5 per dollar, the analysts calculated - levels unseen since the 1990s Asian financial crisis.

Worried about capital outflows, authorities tried to prevent the yuan from weakening past 7.3 earlier this year. A full adjustment looks unlikely.

Other factors

During the COVID-19 pandemic, Washington unleashed trillions of dollars in stimulus, including cash handouts to consumers, some of which was spent on goods made in China.

Also, after Russia’s invasion of Ukraine, Moscow got shut out of many Western markets, pushing it to source more goods from China. These were unexpected opportunities for Beijing, and are unlikely to be repeated.

With inputs from agencies.