The United States and China are in a trade war confrontation.
The US exported $143 billion worth of goods to China in 2024, with a trade deficit of $295 million.
To curb that, President Donald Trump ratcheted tariffs that he had never heard of in China, retaliating with a 125% tax on US goods.
Trump has suspended tariffs in most countries for 90 days, but China is not on that list, increasing tensions between the two countries.
Earlier this week, China’s Commerce Department said it was willing to “fight to the end” and accused the United States of violating World Trade Organization rules.
On his part, Trump says tariffs are bringing $2 billion a day. According to Treasury data, tariffs have resulted in 200-mile days.
How can China fight back?
China’s nuclear choice revolves around US debt. China is the second-largest holder of US debt, otherwise known as the Treasury Department, at $7600 billion. Countries like China like to buy US debt, as the dollar is considered the standard currency for international trade, and therefore are low-risk investments. China is second only to Japan, which owns $1 trillion, according to the US Treasury Department.
China, in theory, means that by abandoning its US Treasury holdings, it means selling Treasury holdings that are less than worth. In doing so, China underestimates the US dollar because of the amount it owns.
“As tariff barriers are so prohibited, as we are unable to access each other’s markets, the only source of escalation will become worthy of selling US debt for less than it is worth neglecting the dollar.
“It’s a global outcome, not just domestically, but it could be a truly unexpected outcome,” Jack said.
James Mose, professor of accounting, taxation and law at New Haven University, says that if China buys more debts that the US could issue, it could be bad.
“If we have to issue more debt, it will weaken our economic structure. Of course, it will probably weaken the dollar as it is a pure amount of excess debt,” Mohs told Al Jazeera.
However, it is not clear that China will be down the route to sell its finances. Such a move would hurt China by devaluing dollar assets and strengthening the yuan. It will hurt both global and domestic economic output, as it makes China’s exports more expensive.
China does not want currency at a higher value, as the US dollar is the norm for global trade. This means making more money from other countries’ currencies rather than from their own. However, by owning a large number of US debts, an estimated $3 trillion between US banks and domestic banks, China automatically exploits the value of the dollar.
How the US Federal Reserve can respond
Even if China had made such a move, the US Federal Reserve could quickly counter the damage through aggressive quantitative easing (QE). Under QE, central banks will inject money into the economy by lowering interest rates and buying up key financial assets such as government bonds to stimulate economic activity, as they did during the Covid-19 pandemic.
However, with daily changes in tariffs, central bank decisions are in liquidity. This shows that the Federal Reserve is likely not pushing for interest rate cuts anytime soon. Morgan Stanley predicted that the Fed would not cut the rest of the year.
“It’s hard to even plan what they (the Federal Reserve) will do at this point given that they don’t seem to know what they do on a daily basis or weekly basis,” Jack added.
In the midst of all the chaos, consumers are beginning to pull back. The University of Michigan Consumer Sentiment Index report released this morning shows a decline of 11% from last month amid concerns about what the trade war would mean on issues ranging from personal income to inflation.
The report is far from the only indicator that Americans are concerned about. The conference committee reported later last month that consumer confidence had fallen to its lowest level in 12 years.
“If every news headline that they’re turning on is negative and there’s a threat to nuclear selection by China or other trading partners, consumers will start pulling back spending,” Jack Kess said.