How China Can Weather Trump’s Trade War with Nouriel Roubini
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That deal may not be feasible. And if not feasible, then there is a real escalation that leads to an economic war and eventually can lead to a real war. That's the risk we're facing with China. It's not a willingness to have a call, but what happens next?

I'm Stephanie Flanders, Head of Government and Economics at Bloomberg. Welcome to Trumponomics, the podcast that looks at the economic world of Donald Trump, how he's already shaped the global economy, and what on earth is going to happen next. Well, this week, we're focusing on the all-out trade war that the Trump administration has kicked off with China, a trade war that China seems to think it can win.

Just this week, Beijing escalated its clash with Washington, ordering Chinese airlines to halt new Boeing jet deliveries and banning the export of some rare minerals to the US. That comes after that mad bidding up in tariff rates we've seen since the start of the month, which saw US tariffs on some goods go to 145%, China in return taking theirs to 125%. Now, Donald Trump and members of the administration believe they have the upper hand in this fight.

China needs our consumers and our money, as his press secretary put it this week. If so, someone seems to have forgotten to tell the Chinese. At every stage of this tit-for-tat between the world's two largest economies, the Chinese have seemed confident, cocky even. As far as I can see, they've also been a bit more resolute. No exemptions, no pauses.

So is this all bluff? The Chinese, after all, are all about saving face. Or has Donald Trump picked a fight here that the US could conceivably lose? Well, I'm going to go through some of this with Dr. Nouriel Roubini. Nouriel is a senior advisor at Hudson Bay Capital Management and professor emeritus of economics at NYU Stern School of Business.

He's also a former advisor to the US Treasury, where he worked with me, among others, the IMF and World Bank. Nouriel, thank you very much for joining us. Great being with you, Stephanie, today. A pleasure. Let's start with the basics. We have focused quite a lot on the cost to the US economy of these tariffs on China. But putting it simply, what does China stand to lose in this fight?

Technically speaking, actually, the impact on growth of this trade war is more serious for China than it is for the United States on impact before you consider any other macro policies that China and U.S. can implement. And the reason is that China is running a trade surplus relative to the United States of about 2% of its GDP.

while imports from China for the United States are about 1% of the U.S. GDP. So technically speaking, suppose that this tariff remains at the current level and we are having pure autarky, no trade between U.S. and China in the extreme, the impact on Chinese growth is going to be negative 2%.

while the impact on the United States in principle will be only 1%. Of course, the shock is also inflationary for the United States and is deflationary for China, and you have to consider that. But actually, the country that is running a trade surplus with the United States has a bigger shock to their growth and demand than the United States. That's true for China.

It's true for Europe, for Japan, South Korea, Taiwan, and all other major trading partners that have a surplus with the United States.

That is obviously Donald Trump's point, that they need us more than we need them. In fact, Bloomberg Economics has calculated similar kind of numbers to you, Nouriel. Even at the initial level, let alone where they went to, you have more than 2% of GDP at risk in China. You pretty much wipe out most of Chinese exports to the US.

Somehow they're still fighting and they seem to think that actually their ability to withstand this might be a bit greater than America's. So I just, I wonder, why do they seem to be standing so firm in this fight? The question is, what are they doing?

policy reactions. Now, to reduce the impact on growth, China can do massive fiscal stimulus while the U.S. is in a fiscal contraction given the needs of the Besson administration to reduce the budget deficit.

China, because it's the deflationary shock, can do massive monetary and credit easing. Instead, in the U.S., the Fed is going to stay on hold and we're not going to get credit easing. More importantly, China also doesn't face elections.

She's in power for as long as he wants to be, while Trump is going to face midterm election next year. So they can be more patient. China has always had a philosophy of eating bitterness, meaning suffering for the sake of the country. China can also retaliate. Of course, if China imposes like they have similar tariffs to the U.S. ones, at 145 for the U.S., 125 for China, there is no trade, but China can do other things.

China can restrict the exports of rare earths that are mostly produced in China. China can reduce or cut off the exports of refined metals, especially industrial and great metals, 8%.

70% of all refinement of copper is done in China. China can panic Apple, Tesla, and other firms that invested hundreds of billions of dollars from the US into China. And China could also potentially, they've not done it so far, they could use the

potential nuclear weapon of essentially dumping their treasury holdings, and they have a bit less than a trillion of treasury holdings. That could shock, of course, the bond market in the United States. They would be subject to losses, but they could try to do that as well. I think that will be the option of last resort.

And finally, if this trade war becomes a full-scale economic war and China feels that they're being contained and the U.S. is trying to prevent the rise of China economically, and even Besant has spoken about a strategy of economic expansion

encirclement of China, meaning using friends and allies in negotiation with them to then corner China. China may even go after Taiwan. You know, the main reason why China doesn't go after Taiwan right now is because they know that there'll be massive trade sanctions, let alone the potential of a war.

But the potential of a war is limited while the potential of trade sanction is large. But if the U.S. is already imposing such trade sanction that there is not much ability of China to export, you might as well go and take over Taiwan. So a trade war can escalate in a full-scale economic war, and a full-scale economic war can escalate into a real hot war as well. People don't seem to be realizing that.

I want to go through some of those options in a minute. But I guess there's also one point that's worth making, which is China has already learned from the first Trump administration and indeed the tariffs that were maintained and even increased under the Biden administration. They have now had nearly a decade of recognizing that the US is in a different place when it comes to China. And in many ways, their economy has also adapted maybe even a bit more than the US economy has. We were looking at

how it had managed to diversify. It's managed to diversify a little bit more away from the US as the source of its exports than the US has managed to wean itself off China. There's that neural that it's just in a stronger position now than it was a few years ago because it's kind of seen this coming.

Absolutely, they've done that. One cover they'll make is that some of that diversification export is now China and not just Chinese firms, but also American firms and others going for a strategy of China plus one, meaning not just producing China, but other parts of Asia.

Some of the final assembly of many of these goods is done in Bangladesh, in Vietnam, in Pakistan, you name it. And the U.S. right now, even if it reaches an agreement with Vietnam, Bangladesh, and you name it, on reducing the tariffs, they're going to make sure that the local content criteria are strictly enforced.

So the China plus one strategy was a way for both US and other multinationals to diversify the China risk, but also for the Chinese to diversify. But now China plus one doesn't work anymore because there'll be these types of additional restrictions. Yeah, and actually just on that, we're recording this on Wednesday morning, but overnight there was actually a Wall Street Journal story that was talking about how the Trump administration is...

wanting to make as part of its famous negotiations with over 70 countries that are looking to do deals with the US. One of the conditions that they're thinking about is that they take more steps to separate from China. When it comes to a lot of those countries in Asia that already have a very close trading relationship and even a dependency relationship economically with China, how

How realistic is it that you're going to separate some of these economies, Vietnam and Asia, all these places from China in any kind of meaningful way?

Well, what the U.S. can do, and that's legitimate, is to say, if I do a deal with you, Vietnam, and your tariffs are not anymore, say, 46 percent, they're going to be 10, 15, 20, whatever, the negotiations are going to agree, then most of the stuff that you export to the U.S. has to have local contents.

If you take Chinese parts and you assemble them in Vietnam and the value added is only, say, 20% in Vietnam and 80% China, then those goods are not going to be subject to the low tariffs. They'll be subject to higher tariffs. Every trade deal has these local content criteria. So that is something the U.S. can do and say,

This is not Vietnamese good. It's mostly Chinese good that pretends to be Vietnamese, the same way in which the Chinese exported to Mexico and tried to rewrite it this way. So that can be enforced. The second thing that can be enforced, in my view, is that the U.S. can tell

friends and allies that you need to de-risk your relationship with China on stuff that has to do with a key strategic technology. Like, you know, things like AI, semiconductor, high tech, and so on. And the way to do it is already been done when Biden was leaving in January. There was an executive order that essentially says, what are the criteria for AI diffusion? And it has three buckets of countries.

Tier 1 countries are friends and allies, and they have access to as many advanced Navidia chips. They can build as many data centers with advanced chips and use all the AIs, LLMs, and technology of the U.S. There are then Tier 3 countries that are Russia, China, North Korea, Iran, and real rivals, and they cannot have access to any of those advanced chips. And there are Tier 2 countries that are

sort of frenemies or friends, but not trustworthy and say Dubai may not be able to get as many Nvidia chips because maybe their data centers in Dubai are not as safe as those, say, in Canada or in Europe or whatever.

So I think that part of the strategy is going to be to try to de-risk the relationship with China and force people to choose. Do you want to be in tier one or tier two or tier three? And if you decide to be even in tier two, you're going to have less access to U.S. technology than you do. And then you have to use Chinese technology. Friends and allies are going to be in tier one.

Rivals are going to be in tier three and everybody else in the middle will have to decide, do I go with the Chinese AI or I go with the American AI? Because the world will be essentially a world of either US high tech or Chinese high tech. And they're not going to be compatible with each other. That's the world we're moving to. I guess one question is whether China has already progressed so far in some of these technologies, whether it's practical to do that. But that's certainly what you've described.

Makes a lot of sense and I would say is also more consistent with the version of Donald Trump's China policy that the Biden administration pursued.

As long as you can persuade all these so-called friends and allies that they are indeed still your friends and allies after you've threatened all this nasty stuff. Well, you know, let's put it this way. Even after the nasty stuff, NATO members and Europeans and Canadians and Japan, South Korea, Taiwan, they have no choice.

no choice to rely on the US because if they spend more on defense, then the security umbrella is going to remain. And if the security umbrella remains and there is a trade deal on reducing the current tariffs to say half as much, say only 10% for Europe rather than 20 or only 10, 12 for Japan, 24, this country's

have no choice but to stay in the sphere of influence of the United States in terms of security. So in spite of the tension with friends and allies, my baseline is one in which you reach a deal on security, you spend more on defense all over the world, friends and allies, you buy more U.S.

weapons and US tech goods. You buy more energy and LNG from the United States, you buy more of their ag goods, and you do other things. Therefore, even technologically, friends and allies are going to be under the technological order of the US. Because in technology, US is number one, China is a close second, but everybody else is not number three or four. Europe is only number 10.

So they have no choice. They'll have to accept to maintain and remain under the U.S. security, trade, military, geopolitical, and technological influence. I think that's going to be the outcome, whether you like it or not. The idea that the Europeans are going to now embed themselves with China, I think is totally ridiculous. It's totally far-fetched. It's not going to happen. You

You're obviously right that the US does have still a lot of means of persuasion. And it sort of reminds me, one of my colleagues, Josh Green, was saying, you know, it's like it's the sort of Mar-a-Lago version of global trade, not Mar-a-Lago, the currency core that we've talked about on this show.

But the cost of joining the Mar-a-Lago Golf Club was jacked up the moment that Donald Trump even became the Republican nominee, let alone winning the presidency. And there's a sort of pay-to-play element to this. He has the same approach. People should have to pay to play in the U.S. market. So clearly, the U.S. has a lot of cards, as Donald Trump would say. But you identified at the beginning that although the short-term economic cost to China of this war is obviously greater...

they also have a greater macroeconomic room to offset that. So if they have a hit of 2% GDP, they can stimulate the economy in other ways. They have room to do that. They don't have an inflation problem as the US. So they also have a capacity to sustain a bit of pain in a way that potentially the US doesn't have. I just want to test if it's willing to do things that are not necessarily in its interest, but it thinks will be more likely to push the US to change course.

Does that include things like selling those holdings of US bonds? How far can it go on things like that, which people have often thought of as the kind of equivalent of the sort of going nuclear? They're sitting on these enormous stocks of treasuries. Is it feasible that they could sell a lot of those without just inflicting too much pain on themselves? It's an option, but in my view, it's an option of last resort after they've used all the other things we discussed.

because there is a meaningful economic cost to them. Economic costs are the following. If you sell treasuries, depending on their duration, you have a market-to-market loss because bond yields will be higher, and then you're having a loss on the existing stock of your treasury, number one. Number two, if you sell treasuries and you convert those dollars into RMB, the RMB appreciates

And what they're trying to do in China is actually having a depreciation of the RMB as a way of compensating for the trade shock. So you're hurting yourself. If you're selling treasury and you don't buy RMB, you have to buy other currencies.

If you buy yen, euro, Swiss francs, and you name it, you are forcing an appreciation of yen and euro relative to the US dollar. And you're going to create trade fiction, if not a trade war with Japan, with Taiwan, with South Korea, with Europe or whoever.

And at the time where you actually are trying to divide these countries from you because you are forcing an appreciation of this currency and you're transferring then the trade, the tariff risk to them. If instead the last thing you can do, probably, if you cannot essentially sell currency,

treasury and buy RMB because it appreciates your currency or damage your relations with their trading partners like Europe and Asia, you can sell the treasuries and buy gold. And that's what China and other strategic rivals of the U.S. have been doing. And that's why gold has gone higher. Because if you think about it, the only global reserve asset, of

Of course, it's a liquid asset. It's not a currency that cannot be seized by the U.S. It is a liquid bullion because we saw in the case of Russia and Ukraine, not just dollars, but euro, yen, Swiss franc, pounds were seized.

And therefore, the only one that they're going to seize is gold bullion. But gold bullion that you keep in the basement of the PBOC, if you are buying GLD, that is the financial version of gold, of course, that can even be seized or controlled or whatever. So that's, I think, what's the most likely scenario if they decide to sell Treasury. They still get the loss mark to market on the value of those bonds.

But maybe the best thing to do will be gold rather than RMB or rather than other currency. I think that's a possibility. They already have been doing it for a while because if things escalate between the U.S. and China, one of the things the U.S. can do, of course, is to seize their holdings of treasury the same way the holdings of treasuries of Russia were seized, the same way similar transaction restrictions occur for North Korea, Iran, and you name it.

So that's a mutual threat. The Chinese can use that nuclear weapon or nuclear threat, but the US can use the counter-nuclear threat of seizing those assets. It's a game of chicken between the two sides. But one side doesn't have an election coming up.

in fact, will be around for the foreseeable future. That's true. On the other side, as I said, a huge amount of the manufacturing of China, 2% of GDP, but the larger fraction of the manufacturing is 30% of GDP, is export to the U.S.,

Suppose this factory all have to shut down because you're not going to be able to reroute those exports to other countries because other countries will have the same problem. Excess supply, that excess supply implies that part of their industrial base manufacturing is obsolete, is essentially stranded asset. And that's a huge cost in terms of capital losses, but a bigger loss in terms of jobs.

massive job losses, unless again China does stuff to increase domestic consumption and consumption of services. And those factory workers may become eventually over time service workers. You can do it over a medium term of a few years. You cannot do it in 12 months. So both sides have capability and threats and both sides have significant upside costs and risk.

it goes both ways. But you're right that Xi Jinping doesn't face election. But, you know, as we saw during COVID, when people become restless, they can go in the streets even in China. And millions of unemployed, the factory workers could be a threat even in the case of China. So it's not as if political pressures are zero in China and they're maximal in the United States. It's a bit more complicated than that.

Final question, Nouriel. I think some have been surprised in the last few weeks at China's apparent willingness to dig in and not blink, as perhaps they have in some past rounds. Even earlier this year, they were responding in a quite measured way to the initial tariffs that Donald Trump had put on.

Do you think that this will change, that they will ultimately come to the table, as Donald Trump's people would say? Or is there something a bit different now? Have the stakes been just raised too high in terms of their face, apart from anything else? Well, you know, there's a game of chicken between Trump and Xi. And there is a third person in this game of chicken is Powell as well at the Fed. And I've said for a while that the

strike price for a Trump put is a price much higher for the Powell put and is also much higher than for the Xi Jinping put, meaning Trump is going to blink before the Fed and Trump is going to blink before Xi Jinping. Guess what? Trump has been blinking by starting negotiations with friends, allies and enemies, 70 countries. The exception is China. Powell has not blinked.

so far and is unlikely to blink. And this game of chicken between Trump and Xi Jinping is continuing, but in the short run, the Chinese can be more patient

Trump is saying he's waiting for a call from Xi Jinping. Xi Jinping is saying, "You started this trade war. Maybe you should make the call." The point is not whether you make a call. There are backside channels through which people can organize a phone call within Xi and Trump. That may happen. But even that is not the issue. There could be a phone call. You can have a beginning of negotiation to de-escalate.

But the problem is that the sets of policies that may be acceptable to Trump might be empty or a null set compared to the sets of policy that are acceptable to Xi Jinping. Because like last time around, it's not just about politics.

tariffs. It's also about non-tariff restrictions. It's about restrictions to FDI. It's about joint ventures. It's about intellectual property rights. It's about government procurement. It's about the fact that China has subsidized exports, low wages, the cost of capital, the cost of energy, the cost of water, the cost of land, pretty much has subsidized everything for the last decades.

Telling China give up on state capitalism and become a true market economy without any of these policies is something that is not acceptable. The problem is that the kind of deal that the U.S. wants is to win, essentially, fully the economic war with China. And China's going to consider that one as a strategy of full economic containment of the rise of China. So even if they sit down, I fear that instead of a grand bargain in which you de-risk the

on technology, but you don't decouple on everything else, that deal may not be feasible. And if not feasible, then there is a real escalation that leads to an economic war and eventually can lead to a real war. That's the risk we're facing with China.

It's not a willingness to have a call, but what happens next? Jenny Welsh, our chief geoeconomics analyst, who was the Taiwan advisor in President Biden's National Security Council, wrote a piece with the headline last week, I dealt with China, here's why they'll fight. After years of sitting across the table from Beijing and official negotiations, I've learned this.

They guard their pride, drive a hard bargain and play the long game. I guess we're going to find out whether Donald Trump can do those things. Noura Rabini, thank you so much. That was great. Great being with you, Stephanie. That was great. Thanks a lot.

Thanks for listening to Trumponomics from Bloomberg. It was hosted by me, Stephanie Flanders, and I was joined by Nouriel Roubini. Trumponomics is produced by Samer Saadi and Moses Andam, with help from Chris Martlew and Amy Keene. Special thanks to Flora Pine. And sound design has been done by Blake Maples. Brendan Francis Newnham is our executive producer. And please, to help others find the show, please rate and review it wherever you listen to your podcasts.

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