Trade war is only getting started

While Australia looks to friends in the US to argue our case on tariffs, we remain hostage to where the real action is taking place. This is between the US and China. As Treasury noted on Monday, if Donald Trump’s trade war persists, 80 per cent of the impact on Australia’s GDP will come from a slowdown in demand in China. Since Treasury did its pre-budget calculations, it has been all bad news on the US-China front.

As financial markets have tried to second-guess whether the US President is indulging in a high-stakes bluff, the trade war has morphed from a negotiating ploy to a full-blown diplomatic breakdown between the world’s two biggest economies. Mr Trump has doubled down on China, lifting tariffs by an additional 84 per cent, bringing the total of the tariffs imposed in his second term to 104 per cent. In what has been an escalating dispute, Mr Trump has imposed 20 per cent duties on Chinese imports in retribution for imports of the socially destructive drug fentanyl. He imposed an extra 34 per cent tariff on China as part of what was presented as a shock-and-awe global fightback.

When China said it would retaliate against his actions, Mr Trump imposed an additional 50 per cent tariff.

Unlike other nations – notably Israel, Vietnam and EU members – China has elected to hit back first rather than negotiate its position. Xi Jinping responded to the reciprocal tariff with a blanket 34 per cent tariff on all US imports as well as curbs on US access to rare-earth minerals. The language from the Chinese Communist Party leader through his economic and media bureaucracy is that China will fight to the end. On Tuesday, China’s central bank allowed the yuan to fall in value against the US dollar, offsetting some of the impact of tariffs. The state is expected to respond further with stimulus spending and direct market support for local companies. All of these measures have grave economic risks for China and point to the political pressure the tariffs represent for Mr Xi.

As a result, without a circuit-breaker the potential is for a protracted dispute with unpredictable outcomes. As The Wall Street Journal observes, China sees Mr Trump’s actions as an existential threat aimed at keeping it from surpassing the US as the world’s biggest and richest economy. Mr Trump sees China’s dominance of global trade as the surest sign that the international trading system is rigged against the US.

The US President can point to the numbers for some justification. China in 2024 reported a global goods trade surplus of about $US1 trillion, while the US had a deficit in goods trade of $US1.2 trillion. About $US300bn of this deficit was directly with China but a large portion of the rest was with countries including Mexico and Vietnam that had been used by China to circumvent tariffs imposed by the first Trump administration.

This is why the US is using reciprocal tariffs to cut off China’s access to the US market through third-party destinations.

The US also is looking urgently for alternative supplies of rare earths and minerals to break its dependence on Chinese sources. This presents Australia with a long-term opportunity, but it is swamped by the reality of what a prolonged showdown between China and the US on trade will mean.

As financial markets continue to digest what is happening, Mr Trump is getting ready to increase the pressure further with a set of tariffs specifically aimed at pharmaceuticals. In an act of national self-sufficiency over economic prudence, this is designed to draw drug-makers back to where the market is, the US. It all signals that the wild ride is far from over.