Why Scott Kennedy Thinks The Us-china Trade War Is ‘far From The Endgame’

Scott Kennedy is a senior adviser and trustee chair in Chinese business and economics at the Washington-based Center for Strategic and International Studies think tank. He has visited China on numerous occasions over the past 37 years and written extensively on the country, particularly regarding its economic policy and relations with the United States.

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The Trump administration has offered a variety of explanations for their approach to international trade and management of the global economy. The one that seems most persuasive to me is their view that the international trading system has been deeply unfair to the US for a long time. The US has maintained lower tariff and non-tariff barriers than those from other countries, whether allies or not.

As a result of viewing the system as unfair, they believed that they could not use the World Trade Organization and other traditional means to get a better outcome. So instead, they decided to use the leverage of denying access to the American market to force through change.

We saw the dramatic results unfold on April 2 and in the days afterward, in their effort to switch from a multilateral system of common tariffs based on most favoured nation status and national treatment to one based on reciprocal tariffs negotiated line by line, country by country.

This is not necessarily where they want things to end. Rather, they want to start negotiations that could result in tariffs potentially coming down if possible.

The sudden shift in the US’ approach to the international system sent financial markets down all over the world because it would mean, at least in the short term, a huge reduction in global trade and investment, higher inflation and a potential recession.

The American bond market reacted in a way that was particularly unexpected. Typically, when stocks go down, the bond market improves, and vice versa. On this occasion they both worsened, which raised the possibility of systemic financial problems.

As dramatic as the imposition of “reciprocal tariffs” was, the quick withdrawal of those tariffs to a lower rate for most of the world came about just as suddenly. The global economy has been on an unbelievable roller coaster the past weeks.

If you have followed [Trump] in recent years, he has had very consistent views about tariffs and trade imbalances. He decided that regardless of whether you are a supposed friend or competitor with the US, if you maintain a large trade surplus with the US, you should be penalised and pressure should be put on you to reverse those policies.

Now, the way the administration actually calculated the specific tariff levels deviated significantly from that original conception, because they ended up basing their numbers on what they thought it would take to bring the trade deficits back into balance.

The figures they did use were higher than if they had calculated a level based on a combination of actual applied tariffs plus an estimate of the tariff-equivalent amount for non-tariff barriers, which is what observers had expected.

There is an important debate to be had about whether trade balances – deficits and surpluses in goods and services – are synonymous with whether trade is fair. I do not think that they are. Many countries, including China, maintained significant non-tariff barriers, which unfairly restricted trade and investment opportunities for foreign businesses, but those restrictions are reflected in trade balances.

They are reflected in many other things, such as reduced market shares and squeezed profits. So I understand why the administration has taken this approach, but it does not align with my view of international economics, and markets have reacted quite negatively.

We are far from an endgame at the moment.

The US and China have looked for ways to cooperate and manage their differences for a very long time on trade and commercial issues. It was a big reason the US was such an advocate for China’s entry into the WTO in 2001.

The US and China have had bilateral trade negotiations over the 24 years since. There have been many twists and turns in that relationship. Sometimes they have found common ground; other times they have not. Currently both sides have imposed significant restrictions on the other, and there may be more to come.

China has raised restrictions on rare earths, put various American companies on the unreliable entities list, and recently launched antitrust investigations. Chinese airlines have stopped taking delivery of aircraft from Boeing. If they have done this at the direction of Chinese authorities as a way to penalise the US, it is possible the US will respond in kind.

It is also possible that we would see this dispute move from the trade and corporate realm to the financial realm. Each side has points of leverage that they could use to impose financial pain on the other.

China has 286 companies listed on American securities markets with a market cap of roughly US$1.1 trillion. There is a significant amount of American direct investment and portfolio investment in China. There are financial institutions from both sides operating in each other’s countries.

Washington and Beijing could take action on any of those things. Of course, there would be potential significant economic blowback from doing so, but they might still decide that the cost is worth it.

If the US was to suddenly push Chinese companies off the American securities markets, they would have to use some extraordinary laws to do so.

These Chinese companies collaborate with companies all over the world, including American companies. Doing so would be a significant risk for the US.

But these are incredible times. China could conceivably sell its holdings of US Treasuries. There are probably additional holdings by related parties to China that are held outside China. Probably a few hundred billion US dollars’ worth.

The treasury market has already taken a big hit without China lifting a finger. It is unclear to me what the consequences on the market would be if China were to sell.

The market might just yawn. If it does have no reaction, China would have lost this very important asset that is an anchor for its savings. That would be quite risky. And it would potentially be blamed for causing a global financial crisis.

Right now China has, perhaps surprisingly, some moral high ground. It can claim to be the victim. It has a lot of sympathy around the world. But if it tries to induce an American financial crisis, a lot of that sympathy would disappear.

At some point the pain for both sides from escalation will rise significantly. There will be inflation or deflation. There will be job losses. There will be a rise of domestic criticism and a call to find an off-ramp. Eventually that growing economic pain will translate into political pressure on both sides to come to the table. The two sides are not quite there yet.

In the meantime, the two sides are trying to negotiate with others, to raise their own leverage and isolate the other. So we likely are still at least a month or two away from the US and China really sitting down to hammer out their differences.

It will take more pain and more time for them to get into a mood to negotiate with each other. The topics of discussion will be: who will represent each side at the table, and what the timeline might look like. I think that is all up in the air.

This could be a relatively focused negotiation, just around trade and commercial issues. Or it could expand to include fentanyl, cross-strait issues and Ukraine. It is really unclear what the boundaries of the topics could be.

They might want to wrap up negotiations in just a few rounds, or they could break it up in stages. How they will be segmented and what the process will look like are entirely up in the air.

One thing that really needs to be resolved in the pre-negotiation process – what are they trying to achieve? Are they trying to “put Humpty Dumpty back together again” and preserve this commercial relationship? Are they looking for an amicable divorce? Or are they looking for a fundamental change of rules about what the relationship looks like? Are they looking to achieve a more balanced commercial relationship or much more fundamental changes about how the US, China and potentially others do business?

They may end up concluding it is just too difficult and complicated to continue to be interdependent, and instead choose some type of decoupling process. I do not know which of these it is going to be, but it would be helpful if they consciously decide what their goals are.

Before they sit down to lay out their ultimate goals, it is just going to be one tariff for one tariff, one investment for another investment. Hopefully, people realised that the global economy came to the edge of the abyss and said they did not want to go there.

The world deserves a more thoughtful negotiation that addresses some of the underlying challenges, rather than piecemeal discussions with superficial results.

If you look at the extent of the US-China relationship, you will see that we are still deeply intertwined. In 2024, the two countries’ trade was valued around US$650 billion.

There are several thousand American companies on the ground in China that annually sell about half a trillion US dollars’ worth of goods and services. Several hundred Chinese companies in the US sell around US$80 billion in goods.

We have deep financial interconnection through our securities markets – stocks, bonds, corporate bonds and government debts – and people-to-people ties are quite deep.

In science and technology, there is an extensive amount of collaboration even with everything that is going on.

Perhaps compared to five years ago, just before the pandemic, we are somewhat less important to each other in our commercial relationship. But the absolute weight of the relationship is still monumental.

Efforts to move supply chains and impose bans on certain technologies – there has been less success with those policies.

So even though China and the US are less significant to each other – its exports to the US now only account for 14 per cent of all its exports compared to 19 per cent five years ago – the indirect connectivity is still wide and deep.

In Asia, most of those goods are still produced for the US as the final market. So the two economies certainly are not decoupled.

We might be able to envision what that might look like, given the extent of the tariffs that have been imposed and the possibilities of continued escalation. But that’s not inevitable. Time will tell whether cooler heads prevail on both sides – on all sides, because this is not just a US-China dispute if we end up in a much more fragmented world where there is a lot more decoupling than just the US and China – and are able to find a pathway back to a more integrated global economy.

The problems with the international economic system did not start on April 2. They have been building for quite some time.

Some of those problems are reflected in relations between countries, because of tariff barriers or industrial policy restricting trade for reasons of national security, public health or the environment.

However, even though some companies and workers benefit from globalisation, there have also been losers from globalisation, and challenges within countries can be as big as the challenges between countries.

In fact, the rise of Trump has to be connected to the story of the winners and losers of globalisation and their relative power in the US political system. We have very regionally divided benefits, and the downsides of globalisation are quite regionally concentrated. That has given rise to one of the sources of his political influence.

The US, Europe and others have tried to be extremely polite, using the rules of the WTO and patient bilateral diplomacy, but [Trump] never felt that those negotiations really resulted in the changes they needed to see. I am not talking only about China, although China is an important case. I am talking about many instances that have generated such frustration, which is now exploding onto the global scene.

So we are at an inflection point, where countries are re-evaluating the rules and norms to manage relations with each other. That seems appropriate, not only between countries but for groups within countries. And we all have a huge stake in finding success in that effort.

If you just think about artificial intelligence and what that is going to mean for people in manufacturing and for labour all around the world, it is a huge challenge.

If you think about what climate change is going to mean for economies – accessing water and natural resources and our lives, we have some huge challenges coming to us.

It is a monumental task to figure out how to pull back from where we are right now and come to some agreement. I am not optimistic that all parties are going to figure this out.

Further escalation is likely in the near term and maybe beyond trade. But the mission is pretty clear: we have to come up with a fairer, more resilient international economic architecture. The system needs significant reform.

Even Chinese officials and scholars have long called for reform of global economic governance. Some of their proposals are not universally accepted, but the idea that reform is needed is now widely recognised.

Can they find a common win where everyone agrees? That is the ultimate question.

In the very near term, the Chinese leadership has a variety of ways to withstand pressure from the US and the rest of the world. They have a lot of fiscal room they could use to stimulate the economy. They could offer market access benefits to many other countries. Moreover, China’s financial system is a relatively small proportion of their economy compared to the US. So a drop in the Chinese markets is not lethal. There’s a lot of ways China can withstand pressure and preserve that approach.

But the ultimate effect, over the long run, depends on what the Chinese leadership’s ultimate goals are.

Do they want to try and preserve the current economic model, which is based on using advanced technology and the “new productive forces” as the primary engine of growth?

There may be some very temporary resolutions of this problem, but we will be back at this intersection very soon.

China’s economic model – as a consequence of China’s scale – creates not only macroeconomic imbalances domestically, but global macroeconomic imbalances that other countries will continue to be upset about.

So the question is, will China use this crisis as a way to double down on its current model? Or do they see it as an opportunity to shift in the direction which others have been calling for – including calls within China – to restructure their economy based on domestic household consumption?

If they do that, it will suck a lot of the air out of the balloon that is international frustration with China. It will also be a huge source of greater domestic confidence.

Chinese households’ real wages have not grown as fast as they need to. They do not have a sufficient social safety net to help them take care of their health throughout their lives and sufficient pensions for when they retire.

The growth of Chinese production has not been matched by Chinese consumption. The most widely mentioned statistic in the US policy community related to China over the last decade has been that China represents 30 per cent of manufacturing but only 18 per cent of manufacturing consumption.

The gap is even larger now than it was when we started talking about that a year or two ago. It is likely that the gap is going to grow even larger. That is unsustainable globally. It is one reason we are at this intersection today.

China could use this as an opportunity to reform its economy in a way that even domestically there are strong calls for.

If China just does what is in its own self-interest, it simultaneously will address a lot of the concerns that others have brought to China at the negotiating table.

The [Chinese] leadership recognises that infrastructure investment and property cannot be the sole source of Chinese growth.

As it moves from a middle-income country to an economy with advanced industries and services, it is going to shift. But this is proving to be a very difficult transition.

It obviously needs to find a way to resolve the existing debts to complete as much housing as possible, and figure out how to make those development companies do well so they can continue to operate, particularly in third- and fourth-tier cities. There has already been a lot of progress in first- and second-tier cities.

There is a question about how to improve the financial circumstances of local governments. It means looking at a variety of ways to reform how the centre and localities divide tax receipts, responsibilities and expenditures. It also means thinking about new income sources. China has to go back to reconsidering implementing property taxes.

The imposition of new taxes on property would probably slow the economy in the short run, but at some point they need to grapple with property taxes so that local governments have sufficient resources to provide the necessary public goods.

You can start with extremely low rates by imposing against those with the most ability to pay and gradually phase it in and adjust as you need.

It seems that the housing market problem is intimately connected with local governments’ finances, and so both of those things have to be addressed together.

In a recent Track-2 dialogue we conducted with Chinese partners, the general conclusion was that US dollar dominance was rock solid. The likelihood of other currencies, whether the euro, the yen or yuan, replacing the US dollar for international trade and finance, was quite low.

That is partly because of how liquid American markets are; the ability to buy and sell anything and move your money in and out via the US dollar. That is the product of millions of independent choices every single day. So there is an element of network effect to the entrenchment of the dollar.

A sustained crisis with the American economy could raise doubts about the US dollar as a stable reserve currency, and make people think about potential alternatives.

If the US dollar moves from being a risk-free asset to one that has some risks, that would be how things could potentially change.

It could be caused by a few more moments like the days after the Liberation Day – not the initiatives brought by central banks in Beijing, Brussels or Tokyo, but choices made in Washington.

When the world’s currency system has shifted, it usually has done so quite abruptly over the span of a few years. It does not look like we are anywhere near such a turning point yet.