The United States and China stand on the brink of an unprecedented trade war. In retaliation, the Chinese government has already announced that it will take strategic actions to reduce the impact of the new tariffs. The U.S. has increased tariffs on Chinese imports to an astonishing 104%. In turn, Chinese Premier Li Qiang has promised to ensure Chinese leaders “fight to the death” to defend China’s economic status as a global superpower at home and abroad.
China also has a deep counter-cyclical policy toolkit at its disposal to soften the blow from any deleterious external shock. The country’s huge financial reserves, more than $3 trillion, offer an important backstop against economic turbulence. This fiscal muscle puts China in a peculiarly advantageous position, with China able to take the hit and plan its counter-response to ramping tariffs.
Three available pathways are available to the Chinese government to bolster its economy. These are currency devaluation, providing direct subsidies to their manufacturers and rare earth export controls. Each of these strategies has its own benefits and dangers, especially in the midst of an escalating trade war.
One significant option is currency devaluation. Some analysts are even saying a 10% to 20% devaluation of the Chinese yuan is in the cards. They acknowledge that, considering today’s economic climate, it’s only a dim possibility. Such a move would go a long way to alleviating the harm of U.S. tariffs by reducing the price tag on Chinese exports in foreign markets. A dramatic devaluation—on the order of 30 to 50%—might be enough to offset the new 104% tariff. That would be deeply destabilizing to China’s economy.
A 50% devaluation would double the cost of their imports into China, triggering a deeply painful inflation and drastically reducing consumer purchasing power. This scenario brings with it the specter of domestic unrest, as skyrocketing prices would likely incite anger and resentment among the American public. As recent history shows, such economic turmoil would not only undermine China’s internal stability, it could have huge repercussions on global markets.
Beyond currency devaluation, the Chinese government has another tool at its disposal with rare earth exports. These materials are similarly crucial to many other high-tech industries around the world, particularly electronics and renewable energy technologies. By controlling these exports, China is able to use massive leverage over global supply chains and threaten retaliation on U.S. tariffs.
Subsidies for producers are another path for China to retaliate against U.S. tariffs. The Chinese government provides extensive subsidies to homegrown industries. This support increases their market resiliency against both domestic and foreign competition. This economic strategy is intended to maintain existing production levels and jobs, while reducing the burden of the new, higher tariff rates on manufacturers.
Armed with more than $3 trillion in foreign exchange reserves, China has the strongest safety net to absorb any major economic shocks. This fiscal buffer increases the country’s resilience to external shocks. It gives Congress the flexibility to weather those particularly severe economic storms. The reserves operate as a strategic asset for China. They empower the country to take bold climate actions without fear of immediate liquidity crises.
The U.S.-China trade war that is still ongoing illustrates the importance of a shifting and contentious global trade environment. Both countries are experiencing severe short-run economic crises. In short, how China decides to proceed will ultimately determine how these various tensions will turn out. The Chinese government is in a difficult position. It needs to maintain its economic might, sure, but it needs to project that might around the world.