Countering US Tariffs: China's Economic Strategy (Part 1)
"Some people see the devaluation of the yuan as a strategy to hedge against tariffs, but I personally don’t think this is effective." – Zhang Yansheng
Today’s edition features an excellent interview with Zhang Yansheng (张燕生), conducted by Mandy Zuo for the South China Morning Post. Many thanks to them for allowing us to share it here. Sinification will resume its weekly posts after the Christmas break. Wishing everyone a very happy holiday. — Thomas
Key Points
Trump’s threats to raise tariffs on China could either be genuine or just a negotiating tactic.
Implementing such tariffs would entail huge administrative costs, which might deter the new administration from imposing them.
If enacted, there is broad consensus in China to avoid a tit-for-tat response.
Although domestic pressure to retaliate could arise, Beijing will probably respond by strengthening its commitment to free trade.
However, this does not mean China would accept new tariffs passively; rather, it would seek ways to circumvent them.
Although a small faction of “extremists” in Washington advocates for tariffs, the broader American business community remains committed to trading with China.
Regardless of his intentions, Trump cannot compel other countries to act against their own interests.
China cannot fully offset the impact of high tariffs through yuan devaluation. A more effective strategy would involve further liberalising the economy, boosting domestic demand and expanding investments outside the US.
In the long term, China aims for the yuan to become a super-sovereign currency.
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Confidence remains the most important issue in China’s capital markets. The Chinese government needs to get better at communicating policy clearly and managing market expectations.
Despite several policy announcements since September, the market, businesses and scholars remain unconvinced that sufficient action has been taken.
Although China’s economic challenges are solvable, the next five years are expected to be more difficult due to uncertainties stemming from Trump’s second term.
In stimulating the economy, the government is rightly focusing on quality rather than just maximising GDP growth.
A target growth rate of 4.5% would be both reasonable and acceptable.
China must reduce its vulnerability to potential US economic sanctions without becoming obsessed with self-reliance or shifting toward mercantilism.
Instead, China should aim to foster a shared global innovation ecosystem and make funding available for international collaboration.
China’s past success has come from reform and opening, its adherence to the principle of “seeking truth from facts”—prioritising practical solutions over dogma—and its focus on development. Future success will depend on staying true to these principles.
Enhancing total factor productivity will require systemic reform. For example, China’s innovation system struggles to translate scientific and technological achievements into practical applications.
China could learn from US legislation which allows inventions funded by federal programmes to be attributed to the inventors’ organisations.
Mutual understanding between Hong Kong and the mainland is essential for leveraging Hong Kong's unique advantages. This includes ensuring that the special administrative region retains its autonomy
* Today’s post is too long to be sent out all at once. Part two will follow tomorrow.
The Scholar
Author: Zhang Yansheng (张燕生)
Year of Birth: 1953 (age: 70/71)
Position: Researcher, China Academy of Macroeconomic Research; Chief Researcher, China Center for International Economic Exchanges
Previously: Senior researcher, Institute of Foreign Economic Research, National Development and Reform Commission (20+ years); Presided over or taken part in research projects for several of China’s five-year plans; Lecturer, Central University of Finance and Economics (1984-1996)
Research focus: International finance; international trade
Education: BA Sichuan Normal University (1982); MSc Huazhong University of Science and Technology (1984)
Experience abroad: University of Colorado; University of Toronto; World Bank Economic Development Institute
ECONOMIST ZHANG YANSHENG ON HOW CHINA CAN SURVIVE TRUMP THREATS, AVOID JAPAN’S MISTAKES
Zhang Yansheng (张燕生)
Interview by Mandy Zuo of the South China Morning Post (16th November 2024)
(Illustration by OpenAI’s DALL·E 3)
1. China’s economic outlook for 2025
SCMP: China’s Politburo recently laid out its economic strategy for 2025, which includes a more proactive fiscal policy and a “moderately loose” monetary policy. What are your thoughts on these developments?
Zhang: Next year is crucial to the Chinese economy, as it marks the transition from the 14th to the 15th five-year plan. [Reactions to] the [government’s] combination of a more proactive fiscal policy and moderately loose monetary policy, along with “unconventional” countercyclical adjustments, suggests that despite the numerous policies introduced since September, the market, businesses and academics believe these measures have been insufficient.
Next year’s focus will be on increasing central fiscal spending and adjusting the deficit ratio, which is essential for addressing financial shortages among local businesses and the public. This year’s fiscal deficit ratio in the US was estimated to be 7.8 per cent compared to China’s 3.8 per cent, indicating room for a potential increase in China - though not implying we need to immediately catch up to the US.
There will be a stronger emphasis on local transfer payments and the use of special local government bonds as capital to help improve local government asset and liability conditions. This is vital for resolving debt problems among businesses, which can stimulate the national economic cycle.
The core issue with the “moderately loose” monetary policy is how to effectively utilise both broad and targeted monetary policies. Targeted policies will likely focus on sectors like technological innovation and green transformation. Fiscal measures are seen as crucial because they directly inject capital into the economy, while monetary policies need to address currency stability and deflationary pressures.
Expanding domestic demand comprehensively is also a priority, especially if external conditions worsen, such as potential tariffs or the removal of China’s most favoured nation trade status. Reducing dependency on external demand and bolstering domestic demand are key. Developing new productive forces through innovation and demand-driven strategies is critical. Increasing citizens’ incomes and addressing their concerns will also be important for boosting the middle-income group’s growth.
As regards stabilising the real estate and stock markets, the focus is on preventing systemic risks similar to Japan’s real estate bubble, which led to prolonged economic stagnation. For real estate, the emphasis will be on resolving issues like ensuring the completion and delivery of housing projects.
For the stock market, maintaining confidence and expectations is essential as it impacts personal finance, innovation incentives and corporate financing. The government is expected to continue refining and targeting its policies in these areas.
In my understanding, [the Politburo’s phrase] “unconventional tools” refers to solving specific problems. These might include enhancing consumption by ensuring stable incomes, which relates to wages, property, business and transfer incomes. Policies should aim to establish mechanisms that sustain consumption, address short-term consumption deficiencies and remove major cost burdens like education, healthcare and housing.
2. The threat of tariffs
SCMP: Everyone in China is worried about Donald Trump’s second term as US president. He threatened 60 per cent tariffs and said he would consider removing China’s most favoured nation trade status during his campaign. Do you think this will materialise?
Zhang: Trump, in my view, has a great deal of contradictions. For example, he recently said that he would impose a[n extra] 10 per cent levy on China, 25 per cent levy on Canada and Mexico respectively. He blames Mexico and Canada for being irresponsible, they don’t control the drugs, they don’t control the illegal immigrants. While for China, he said raw materials for drugs come from China. But what we don’t know is whether such a statement is a negotiating move, or a threat of what he will actually do. This remains to be seen.
This reminds me of his investigation into steel and aluminium in 2018. At that time, China only ranked 11th in terms of steel exports to the US, after Japan, South Korea and some countries in Europe. But he began the 301 investigation targeting China, and then the trade war escalated. So that was his first move. Looking at the current threat, it’s very much like what happened in 2018.
Regarding his election vow of a 60 per cent tariff on China and a 10 per cent tariff on the world, this is much like the Smithsonian Agreement from the early 1970s. This was the cancellation of the convertibility of the US dollar to gold at US$35 [an ounce]. The US at that time demanded the other major countries either appreciate their currencies or pay tariffs. These big countries said, “Well, who am I to pay you a tax in the form of a tariff?” They chose to devalue. Finally, Bretton Woods went bankrupt.
Sixty per cent is actually a big threat to China, and I would assume Trump would think the US is losing out as the trade deficit is too big. There is also the argument that China’s most favoured nation status should be revoked. How will this play out with his other threats? It doesn’t make any sense. It’s like a war.
There is a lot of ambiguity in Trump’s threats, and he looks very random.
Of course, judging from his previous run for the presidency, he has a trait called “talking the talk”. He’s a businessman, not a politician. So this is one aspect where we have to be on higher alert.
There is also a theory that the tariff may be a bargaining process, but what will emerge at the end of the day? In my view, there’s a consensus that we don’t take countermeasures. As a famous Chinese saying goes, “A gentleman settles a dispute through communication instead of a fight.” So we can take the moral high ground.
3. Alternatives to a tit-for-tat response
SCMP: What will happen to China if it doesn’t counter the tariffs?
Zhang: Some studies show China may suffer a huge loss without countering. But no countering from China does not mean that China will not circumvent them. Countering is tit-for-tat action, while circumventing is what companies can do to avoid tariff barriers.
For Trump, one concern is the administrative costs to carry out the tariffs. In terms of trade, we see hundreds of thousands of traders with goods coming from all directions, how can he know the origins? That could involve lawsuits, which can drag on for years or decades. So he has to figure out if he can actually do that. He needs to think about the cost of acquiring and processing information. It’s almost impossible.
Will Mexico listen to you? You’re going to put 100 per cent tariffs on Mexico, and the Mexican president immediately said she’s countering it. China’s investment in Mexico can bring technology, tax revenue and jobs. It’s impossible for Mexico to hurt their own interests just for Trump. He thinks of himself as God.
SCMP: Are China and its companies more prepared to deal with a second trade war? What cards do you think the government can play? And how much room do Chinese companies have to manoeuvre in terms of diversifying export destinations?
Zhang: I think China will respond by saying free trade, free investment and free movement of labour and factors of production are good. China will tell the US, “If you are unkind to me, I won’t fight you. You are doing wrong, why should I do wrong?”
From this perspective you can see that China's response to protectionism is not to follow. “You think you’re the only country in the world?” Over time, we can see that extremism will be crushed little by little.
The next step for China is we need to ensure the economy will be good. The most important card to play is further deepening reforms in a comprehensive manner and promoting modernisation, with the most critical part being a high level of institutional opening up.
Trump threatens new anti-drug tariffs on ‘day 1’ for China, Canada, Mexico
We will also be open to the United States market because the US business sector wants to do business with us. We can distinguish between the vast American business and academic community from the few extremists in the government.
For China, if there is political pressure to retaliate, then we have to do the work on that. I think the probability of us countering as the next step is small.
4. Devaluing the yuan
SCMP: What does Trump mean for the yuan? What will be the next trends in the exchange rate? How will yuan internationalisation go?
Zhang: Some people see the devaluation of the yuan as a strategy to hedge against tariffs, but I personally don’t think this is effective. With tariffs as high as 40 per cent or 60 per cent, you can’t devalue the yuan enough to offset them. And what can you do if the US establishes limits on Chinese exports or changes rules to restrict purchases?
So you have another strategy, which is to retain the market. Liberalise the businesses and let them explore.
Don’t think about regulating day in and day out. Focus on expanding domestic demand, how to expand our market with its 1.4 billion people. We want our economy to be good, for people to have confidence and dare to spend. Chinese people work very hard. Nobody wants to live on subsidies if they have choices, and what they want is to earn money through hard work.
5. Increasing imports and advancing RMB internationalisation
SCMP: Many economists say the size of China’s economic stimulus will depend on Trump’s tariffs. For example, if the tariffs are relatively heavy, then the stimulus would in turn be larger. What do you think?
Zhang: First, the era of the past 45 years – when China participated in international circulation and divisions of labour – is over. In that era, China’s outward-oriented economy was characterised by exporting, serving other people’s markets and developing ourselves by utilising other markets. If you are a small economy, you can do that. But if you are a big economy, the world will give you a hard time. That is why a big country should expand its imports, not its exports.
China is not a country with a heavy foreign dependence. China’s foreign trade dependence was 64 per cent in 2006, 34 per cent in 2021, and I believe it will probably be 24 per cent in the next 10 years. This means the numerator – the growth rate of imports and exports – is decreasing, and the growth rate of GDP in the denominator is increasing. China is becoming more like a big economy.
So if we focus on the [PRC’s] domestic economy and expand non-US trade investment and business dealings, then we won’t have that much to lose. You can cry wolf – or cry tariff – to drive domestic restructuring and build the people’s wages up, help the people live a good life.
If we can drive up domestic consumption, that means imports can go up. Imports mean a trade deficit, which means outflow of the yuan, because foreign merchants sell Chinese customers goods and settle more payments in yuan. When this happens, we need to leverage Hong Kong, Singapore and London and actively develop an offshore yuan market.
But we need to figure out one thing: what is the purpose of the internationalisation of the yuan?
I believe the long-term goal of internationalisation is development of the yuan into a super-sovereign currency, a process which will slowly unite more currencies.
6. Improving market confidence
SCMP: The Chinese government has rolled out policies to stimulate domestic demand, such as a trade-in programme and various subsidies. Do you think these measures are effective? How can consumer confidence be further enhanced?
Zhang: First of all, I believe the trade-in programme for durable goods is valid. If you look at the latest consumption data, the effect of the programme is quite obvious – especially in appliances and automobiles – but overall consumption is weak.
Consumption downgrades are still the trend. Once I asked a young man: are you getting paid less? “Not really.” Is your job security at stake? “Not really.” I said, then how come your consumption has downgraded? He said because confidence has downgraded. I asked but why, if nothing has changed? He said almost every day there’s news about lay-offs or bankruptcies.
So there’s a massive impact from the downsizing of big foreign firms, big private firms, big internet firms or big state-owned enterprises. Why? They may want to prepare for tough times. Even though they have strong financial positions right now, they may think they can’t make it through the next three to five years.
So how can the government reform so these companies can see the coming spring? The government has to address issues like the financing of the stock market, which now doesn’t work. How can you make it work? That’s why one of the central government’s policies is to boost the capital market. I think the core issue is still a question of confidence.
But our government is not very good at managing expectations, which means our government is not very good at communicating with the market. I’ve been asked what the policy package is about. Does it work? This is something where the government is in the best position to articulate, right? But there are always questions. First, why doesn’t the government talk to the market? Secondly, why doesn’t the government talk to the market in human language?
When I was conducting research on Wall Street, the Wall Street people said: if your government learns to talk to the market, the market will cooperate. The market will know if it goes against you, it loses money, and if it goes with you, it makes money. We are now on the opposite side. We all know the famous saying “don’t fight the Fed”.
Why doesn’t China learn? The Hong Kong side is very good in this aspect. The mainland has to learn from Hong Kong.
Another important point is deflation. The government hasn’t stepped in over the past few years, not until recently. So it takes time for the economy to turn around. People have to see to believe, see things are serious this time around and then people’s confidence can go up. They dare to invest, dare to consume and develop the economy.
7. Long-term prospects for China’s economy
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