Trump’s China Dilemma

Will China hawks in Donald Trump’s administration push it towards a confrontation that transcends tariffs and adopts financial sanctions of the kind that the US and European Union have imposed on Russia? If they do, China’s leaders will have to decide whether to disengage from the dollar-based international monetary system.

With Donald Trump back in the White House, the high tariffs he promised to impose on Chinese imports are not China’s biggest concern. China’s leaders understand that tariffs are more meaningful to Trump as political and symbolic measures than as economic weapons that will seriously impede China’s growth and development.

The real dilemma facing China is whether or not to decouple its economy from the dollar-dominated international monetary system, transforming the BRICS group of large emerging economies into a Bretton Woods-like arrangement. The answer will depend not on tariffs or TikTok’s fate, but on whether the Trump administration’s pro-China hawks can push it toward a confrontation that goes beyond tariffs to include financial sanctions.

Tariffs are overrated as a weapon to subjugate China, especially when combined with promises of big tax cuts and radical deregulation at home. After all, both measures are likely to increase profits and stock prices in the US, accelerating the flow of foreign capital into the country. While the federal budget deficit will grow, the dollar will continue to strengthen — and mitigate the negative effect of tariffs on Chinese exports — as long as investors believe that the rise in US Treasury bond yields will not overshadow the rise in stock indexes Americans. The gap between domestic savings and investment—the root cause of the U.S. trade deficit with China and Europe—will widen.

Trump faces a difficult trilemma: Can he combine high tariffs, a weaker dollar and the continued global hegemony of the American currency? Having carefully studied the 1985 Plaza Accord, Chinese leaders anticipate that Trump will try to do to them what Ronald Reagan did to the Japanese 40 years ago. In other words, China can choose its poison: a massive appreciation of the renminbi or heavy tariffs on Chinese imports. But this brings us to the political and geostrategic dimension of the problem.

Trump understands that China is not Japan, whose postwar Constitution was written by American officials and where 55,000 U.S. troops are stationed. Furthermore, China is no longer as dependent on the American market as it once was, having diversified and made its wholly owned products and supply chains indispensable around the world.

The chance of China capitulating and accepting a sharp appreciation of the renminbi to avoid Trump’s tariffs is extremely slim, to say the least. Chinese officials know very well that the revaluation of the yen under the Plaza Accord was instrumental in permanently derailing Japan’s industrial and financial rise.

Still, even if Trump knows that China will not accept revaluing the renminbi to avoid its high tariffs, he will still impose them for political and symbolic reasons. Then a negotiation will begin and a compromise, involving slightly lower tariffs, will be reached.

As James K. Galbraith predicts, the impact of these tariffs on Chinese manufacturers will be modest as world trade recalibrates, with the U.S. buying more from Vietnam and India, while Chinese exports to Europe and the rest of the world they shoot. If there is one economic bloc that will suffer massive economic losses as a result of Trump’s tariffs, it is the European Union — not China.

Likewise, the growing digital technological divide between China and the US is already benefiting large companies in both countries. In China, groups of engineers are already making great strides in manufacturing advanced microchips that the country would never have produced without the New Cold War that Trump started during his first term — a policy that former President Joe Biden maintained and even intensified.

Meanwhile, America’s combination of cloud-focused capital, strength in digital research and development, and Trump’s tariffs have already motivated European companies to redirect their investments to the US. In short, it is Europe, not China, that has reason to despair at the prospect of Trump’s tariffs.

This does not mean that China has no reason to worry. The big question is whether the pro-China hawks in the US will be satisfied enough with high tariffs and anti-China rhetoric or whether, as is likely, their belligerence will develop a self-propelled dynamism. More to the point, will they convince Trump to move from mere import tariffs to the kind of financial sanctions that the US and EU have imposed on Russia?

If they do, the Chinese government will need to resolve its great dilemma sooner or later. Should it anticipate financial sanctions by trying to transform the BRICS (Brazil, Russia, India, China, South Africa and five new members) into a Bretton Woods-like monetary system, with the renminbi at the center and the Chinese trade surplus as collateral? Or should it remain within the dollar system and bid for time until the US’ internal contradictions are resolved?

So far, China has kept the brakes on. Although it is developing several payment systems, it is not pressuring the BRICS to evolve into a monetary system. BRICS Pay, for example, is a fascinating experiment that combines blockchain technology with cross-border central planning to create a payments system that ends the Western monopoly on bank transfers. But as all payments are still denominated in different currencies without a common collateral, BRICS Pay is as close to being a monetary system as the SWIFT interbank payments system is to imitating the eurozone.

To turn the BRICS into a serious challenge to the dollar-based international monetary system, China would have to make its surpluses available to the BRICS, so that the rupees that Russia receives for its oil exports to India can be exchanged at a rate almost fixed per renminbi to be spent on Chinese products — something similar to what the US did in the 1950s and 1960s to support the Bretton Woods system.

This would be a giant step for China and a serious challenge to the dollar’s dominance. Whether China will give it or not will depend on geopolitics, not economics.

By Yanis Varoufakis, former Greek Finance Minister, leader of the MERA25 party and professor of Economics at the University of Athens.