China prepares a counter to Trump’s upcoming tariff blitz

Response to US levies set to include currency and export changes that will raise prices for American consumers

Donald Trump, during his first term as US president, meets China's President Xi Jinping at the 2019 G20 summit in Osaka. AP

Donald Trump has wasted no time in making sweeping changes to US economic policy. On his first day back in the White House, on January 20, he announced a series of executive orders and threats to impose tariffs on key trading partners by February 1.

Among them was a threat to apply levies of up to 100 per cent on Chinese goods coming into America, if Beijing failed to agree to the sale of the TikTok app in part or fully to a US company. Many experts expected a tariff hike on day one of Mr Trump's presidency, but his decision to delay placing levies on Chinese goods immediately is tied to ongoing negotiations over TikTok.

The US President has also signalled a willingness to engage with Chinese President Xi Jinping before finalising any tariff decisions. China is, nonetheless, taking the tariff threats seriously, and is bracing for the potential economic fallout.

The geopolitical wrangling comes at a tough time for China’s economy. The yuan dropped to a 16-month low against the dollar this month, weakening to about 7.26 yuan a dollar, as fears of tougher US tariffs and problems within the Chinese economy weigh on China’s currency.

Analysts suggest that further weakening may be in store, with some predicting a drop to 7.5 yuan a dollar by the end of the year.

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China’s central bank, the People’s Bank of China, has already intervened to stabilise the currency, including a record offshore bill sale of 60 billion yuan in Hong Kong in January to deter speculative trading.

While a weaker yuan could make Chinese exports more competitive, it risks the US making accusations of currency manipulation. But it may be seen by officials as necessary to prop up exports because, domestically, China faces deflationary pressures.

Consumer prices barely rose in December, edging up just 0.1 per cent year on year, as a three-year property downturn weighs on consumer demand. Meanwhile, producer prices remained in deflationary territory for the 27th consecutive month, slipping 2.3 per cent in November, signalling weak demand for goods at factory gates.

These figures come despite Beijing’s efforts to stimulate domestic demand, including adopting a “moderately loose” monetary policy and introducing subsidies for consumers to upgrade household appliances.

While this helped China claim it had met its growth target of 5 per cent last year, analysts warn that a reliance on exports and government stimulus is unsustainable, especially with Mr Trump threatening fresh tariffs.

This all signals a challenging economic outlook for China. So, what options does Beijing have in the face of US tariff threats? And what are the implications for the global economy?

One option available to Beijing is to devalue the yuan against the dollar to absorb some of Mr Trump’s proposed tariffs. A second option is a further diversification of exports by Chinese firms, something that began during the first Sino-US trade war, between September 2017 and December 2019.

China has become the world’s largest exporter, through its price competitiveness in global markets, yet its foreign trade has faced major disruptions due to the first trade war.

In response, the country has diversified its export markets to reduce reliance on the US. By strengthening its trade relationships with developing countries, such as those in Latin America, China has decreased the proportion of its exports destined for the US.

Between 2017 and 2024, Chinese exports to America have slumped from approximately $505 billion to $401 billion, official US data show. Reducing its relative dependence on the American market will partially insulate China from the fallout from a renewed trade war.

Beijing’s last line of defence is to encourage domestic firms to raise the prices Americans pay for Chinese goods. This is why, if Mr Trump’s proposed tariffs go into effect, they are expected to exacerbate inflation in the US.

Tariffs invariably increase the cost of imports; research has shown that these costs were almost entirely passed on to American businesses and consumers during the first trade war. One study found that higher prices led to a welfare loss of $68.8 billion in the US.

This means that the financial burden of tariffs is born domestically as well as by foreign exporters. That is because higher import prices contribute to inflation, reducing consumers’ purchasing power and driving up living costs.

In a joint analysis published last week, I demonstrated that a 60 per cent increase in tariffs on Chinese goods raises US consumer prices by 1.9 per cent. Any wage gains would likely be offset by faster price increases, placing additional strain on American households.

This has implications for the future course of US interest rates. The Federal Reserve is expected to hold rates steady at 4.25-4.5 per cent when it meets on Wednesday, following three consecutive cuts since September, due to steady job growth and slowing inflation.

However, if Mr Trump’s tariffs stoke higher inflation, the US central bank may be forced to maintain or even raise rates for longer than anticipated.

This is a major economic problem for America. Higher interest rates typically strengthen the dollar, because they attract foreign investors seeking higher returns.

But a stronger dollar makes US exports more expensive for foreign buyers and curbs their competitiveness in global markets. This can lead to a decline in export volumes.

This will create a double-whammy economic shock for the US. Mr Trump’s proposed tariffs on Chinese goods coming into America will already increase the cost of imports, leading to higher prices for consumers and contributing to inflation.

Combined with a potential reduction in exports due to a stronger dollar, the US could face both higher living costs and weaker trade performance. This means that Mr Trump’s trade policies risk creating a lose-lose scenario for the US economy.

China, meanwhile, has prepared a multilayered defence against potential tariffs: diversified trade relationships, currency devaluation and the ability to raise prices on US consumers.

All of this suggests that Mr Trump’s high-stakes approach won’t yield the desired concessions. It is more likely to backfire. And that would be bad for the world economy, exacerbating economic woes on both sides of the Pacific.