Why China Chose to Fight Back: Inside Beijing's Trade War Strategy

Gavekal Dragonomics' Arthur Crober reveals why China retaliated against US tariffs despite economic risks and how Beijing plans to outlast Washington's pressure campaign.

Key Takeaways

• China retaliated against US tariffs primarily out of frustration after being unable to establish diplomatic contact with the Trump administration
• Chinese leadership believes they can "outlast the US in a war of economic attrition" due to their authoritarian system's stability advantages
• The "rebalancing toward consumption" narrative has been pushed by outside economists, not the Chinese government, which prioritizes investment-driven growth
• China's response toolkit includes rare earth export controls, domestic stimulus, and cash-for-clunkers programs while carefully avoiding actions that would scare away foreign investors
• Trump's tariff strategy lacks coherent policy goals beyond demonstrating dominance, making meaningful negotiations extremely difficult
• Chinese companies are rapidly internationalizing to avoid tariffs, following the same playbook used by other industrial powers historically
• A meaningful trade deal would require allowing Chinese companies to invest significantly in US manufacturing, which Trump mentioned but others oppose
• Current US-China tensions don't constitute a "Cold War" given extensive economic linkages that dwarf historical US-Soviet trade levels

Timeline Overview

• 00:00–15:00 — Why China chose to retaliate despite export dependence; frustration over failed diplomatic outreach attempts; baseline confidence in weathering economic pressure
• 15:00–30:00 — Chinese long-term strategic thinking versus short-termism myths; century of humiliation narrative reality; investment-driven growth philosophy differences from Western demand-side economics
• 30:00–45:00 — Effectiveness of US tariff strategy questioned; Chinese companies internationalizing like multinationals from other countries; impossibility of isolating China given global economic relationships
• 45:00–60:00 — Chinese exemption strategy for protecting vulnerable sectors; retaliation tools including rare earth controls and antimony export bans; balancing punishment with business friendliness
• 60:00–75:00 — Consumption rebalancing myths debunked; China's rapid consumer spending growth pre-COVID; infrastructure and lifestyle improvements in Chinese cities
• 75:00–90:00 — Policy continuity from pre-Xi era in investment-focused approach; Xi's coordination improvements and foreign policy assertiveness changes; potential offramps requiring Trump administration policy coherence

China's Strategic Calculation Behind Retaliation

Beijing's decision to fight back against US tariffs despite economic vulnerabilities stemmed from diplomatic frustration and confidence in their system's ability to withstand prolonged economic pressure.

• China spent months before Trump's inauguration "trying to get messages to him to kind of lay out, make it clear that they were interested in talking, suggest some things that could be on the agenda" but "hit a stone wall" with no Trump administration officials willing to establish contact
• The 20% fentanyl-related tariffs in January particularly angered Chinese officials because "they'd spent a lot of time last year negotiating an agreement with the Biden administration, which they complied with, which made a real dent in the exports of fentanyl precursors out of China"
• Chinese leadership calculated they had developed sufficient economic resilience through years of "girding themselves for more self-sufficiency to insulate themselves against external shocks" following the first Trump trade war and Biden export controls
• The political logic favored retaliation since "even if they hadn't retaliated they were still facing tariffs of over 60%, so no matter what they did it was going to be bad" and fighting back provided better domestic narrative control
• China's confidence stems from believing "they can outlast the US in a war of economic attrition" given their authoritarian system's advantages over America's electoral democracy with its shorter political cycles
• The retaliation served multiple purposes: demonstrating strength to domestic audiences, following successful precedents like Canada's Mark Carney winning elections by "pushing back against the so-called bully," and maintaining credibility even in a one-party state

Investment Philosophy Versus Western Economic Assumptions

Chinese economic policy operates from fundamentally different assumptions about growth drivers than Western Keynesian demand-side economics, creating persistent misunderstandings about Beijing's priorities.

• The "rebalancing toward consumption" narrative "has been a project of economists mostly outside China" and "has never been a project of the Chinese government itself" despite repeated Western calls for such changes
• Chinese authorities "don't believe" that "demand drives everything" unlike Americans raised "in this sort of Keynesian world" but instead believe "that investment drives everything" including "progress productivity future income growth"
• China's leadership maintains that "to secure the growth of the future that is stable well balanced whatever we need to invest in the right things" making investment steering "the principal job of government economic policy"
• Pre-COVID China was "the fastest growing consumer economy in the world by an order of magnitude for 20 years" with "total aggregate growth more than triple what you saw in India" proving they "didn't really have a consumer spending problem"
• The government's recent consumption focus emerges from "facing a lot of headwinds in the export economy largely from the US but not just the US" including "tariff battles with the European Union over electric vehicles"
• This philosophical difference explains why Chinese stimulus emphasizes production capacity and infrastructure rather than direct consumer payments that Western economists typically recommend for demand stimulation

The Futility of US Isolation Strategy

American attempts to isolate China economically face insurmountable obstacles given Beijing's deep integration with global supply chains and the mathematical impossibility of convincing other nations to sacrifice their primary economic relationships.

• The Trump administration's broader tariff strategy represents "chaos" rather than coherent policy, driven by Trump's desire to "demonstrate dominance over everyone" and his inexplicable preference for tariffs as "a tool that as president he has the legal authority to use without restraint"
• Scott Bessent's offer of reduced US tariffs in exchange for tougher China restrictions is "loony" because "there are now 140 countries in the world that trade more with China than with the United States"
• China has become "the number two source in the world behind the United States of direct investment and it's growing" with "economic relationships with many countries, including in Latin America, much deeper than those of the United States"
• No "sane leader" would accept deals trading small US tariff reductions for sacrificing relationships with their "principal economic" partner, particularly in Southeast Asia where "their economies are completely tied to China"
• Chinese companies are naturally internationalizing through "act one of what is clearly going to be a very long process of Chinese companies turning themselves into multinationals just like the companies of every other industrialized country have done"
• This internationalization has "many many drivers not just tariff avoidance" including proximity to different markets, following the same pattern that Japanese, German, and American companies pursued during their industrial development phases

China's Calibrated Response Mechanisms

Beijing employs a sophisticated mix of retaliation and economic support measures while carefully avoiding actions that would drive away foreign investment critical to their continued development.

• China's retaliation focuses on "companies that may sell a lot to China but don't have a lot of investment on the ground in China" to avoid harming businesses with significant local operations
• Rare earth and critical mineral controls represent China's most potent weapon, with antimony export bans "starting to create real headaches in defense and other kinds of technology related supply chains" since there's "basically no viable source of production in the United States"
• Export control strategy targets materials where China controls "60 or 70% of global refined supplies" while ensuring "reasonable domestic substitutes" exist before restricting any particular company or product
• Domestic stimulus includes traditional monetary policy, expanded fiscal spending creating "one of the biggest budget deficits in history," and innovative programs like cash-for-clunkers for both "households and businesses"
• Income support targets "people lower in the income spectrum" with small monthly pension increases because "those are people who basically spend most of what they have" maximizing economic multiplier effects
• The careful balance reflects awareness that "their economy still needs international businesses to participate in China at many different levels" and they "do not want to scare them away"

The Consumption Rebalancing Myth

Western assumptions about China needing to shift from investment to consumption ignore both the country's historical consumption growth success and the government's philosophical commitment to investment-led development.

• China achieved unprecedented consumer spending growth where "up until COVID the fastest growing consumer economy in the world by an order of magnitude was China's for 20 years" with no economy coming "even close to the rate of consumer spending growth"
• Chinese cities now feature extensive "first class urban infrastructure in places like Shanghai, Shenzhen, Beijing, and increasingly in interior cities like Chengdu" where "things work quite well"
• Healthcare and social safety net improvements mean "they have greatly increased the coverage of healthcare, there's universal almost universal pensions, even for farmers in the countryside they get something"
• The government's recent consumption focus stems from external pressure rather than internal conviction, recognizing they need to "do a little bit more to boost the consumer part of the economy" given export headwinds
• Consumer stimulus tools remain limited with programs like expanding "pension payments focusing on people lower in the income spectrum" but "consumer behavior is pretty sticky in any country" limiting short-term impact
• The philosophical gap persists because Chinese leaders genuinely believe their investment-focused approach drives long-term prosperity more effectively than Western consumption-led models

The Search for an Offramp

Resolving the trade war requires Trump administration policy coherence that currently doesn't exist, with China waiting for Washington to make the first move toward meaningful negotiations.

• China has "been very clear in their communications that they are happy to talk" but "we're not going to make the first move" forcing Trump to "figure out how to unstick this"
• Trump's primary motivation appears to be "demonstrating that he has power and that other people have to show submission and deference" rather than specific policy outcomes, creating negotiation difficulties
• Chinese leaders "will not play that game" of showing submission because "they are too big, they are too strong, they have too much at stake domestically in terms of their own political credibility"
• Potential solutions require either Trump and Xi meeting "face to face because in both systems, no one really has the authority lower down to make a move" or market pressure forcing policy changes
• Market dynamics currently work against deals because investors "are convinced that a deal will happen" despite lack of evidence, removing pressure on Trump to negotiate since "markets are happy"
• Meaningful agreements would require allowing "Chinese companies to invest a lot more in the United States" since "you cannot" achieve re-industrialization "without significant participation by China" given their manufacturing leadership
• The fundamental challenge remains that "people in the administration who have actual policy aims" need to "seize control of that process" from Trump's dominance-focused approach

Beyond Cold War Framing

Current US-China tensions, while serious, lack the economic separation that characterized actual Cold War conditions, requiring new frameworks for managing great power competition.

• Economic linkages dwarf Cold War precedents with China-US trade representing "17 or 18% of our total global trade" compared to US-Soviet trade that "never was more than about 1 or 2%" even after Soviet collapse
• American companies generate "somewhere between five and 700 billion dollars a year of annual sales" in China, "triple or more the amount of exports that go from the United States to China"
• Cold War framing proves "not only not useful but toxic" because it reinforces American tendencies to view other countries as either "our ally or we are at war with you" with no middle ground
• China "is not a place that can be beat, it is a large country, it's not going away, it is very integrated not just with the US but with the entire global economy"
• Successful coexistence requires accepting "adversarial components to the relationship and really deep competition not just in economics but geopolitics" without resorting to wartime mental frameworks
• The solution involves finding "what is a state of coexistence with China that you don't have to define in these martial terms" while acknowledging serious competitive elements

Summary

China's trade war strategy reflects calculated confidence in their economic resilience combined with frustration over failed diplomatic engagement attempts. Beijing's retaliation serves domestic political purposes while their response toolkit carefully balances punishment with protecting foreign investment relationships. The fundamental challenge lies in Trump's dominance-focused approach conflicting with Chinese unwillingness to show submission, creating a standoff that requires either market pressure or policy leadership changes to resolve.

Practical Implications

• For Policymakers: Recognize that China's investment-focused growth philosophy differs fundamentally from Western consumption-led models, requiring adjusted negotiation approaches that account for these philosophical differences
• For Investors: Understand that Chinese retaliation targets companies without significant local operations while protecting those with substantial in-country investments, influencing market access strategies
• For Businesses: Prepare for continued Chinese internationalization as companies establish global operations to circumvent tariffs, creating both competitive threats and partnership opportunities
• For Analysts: Move beyond Cold War frameworks when analyzing US-China tensions, recognizing unprecedented economic integration levels that require new conceptual approaches to great power competition
• For Negotiators: Focus on substantive policy outcomes rather than symbolic victories, particularly exploring Chinese investment in US manufacturing as a potential breakthrough area for meaningful agreements
• For Markets: Recognize that current optimism about inevitable deals may be misplaced given fundamental negotiation obstacles, potentially creating correction opportunities when reality becomes apparent
• For Society: Understand that coexistence with China requires accepting competitive relationships without resorting to wartime mental frameworks, developing nuanced approaches to managing great power tensions