How the Sino-American geopolitical relationship evolves during the second Trump presidency may prove to be the key economic and financial market issue in 2025 and beyond. To be sure, the incoming Administration’s strategy is still evolving. Pundits consider which of the so-called “C” policy options Mr. Trump will implement, and what the ultimate strategic objectives are.

On one extreme, will the transactional President-elect view the relationship in “Competitive” terms, and forge a “Cooperative” relationship with Chinese President Xi? This might involve a “Grand Deal” in which China improves access to its local market for US goods and investment. In exchange, United States might become less vocal in its opposition to China’s stance on Taiwan’s future in pursuit of its “America First” economic agenda.

At the other end of the spectrum, will the new Administration seek to “Contain and Confront” China’s regional and global ambitions? This might involve the full implementation of the pledged 60% tariffs on imported Chinese goods. In addition, pressure could be applied on US firms to limit China investments, and to “home-shore” supply chains and manufacturing jobs, especially in strategically important economic sectors (much like the Biden Administration’s CHIP Act).

Hopefully, cool heads will prevail, and a pragmatic direction will emerge. Indeed, the second option involves potentially unnecessary and dangerous risks of direct “Conflict”. And, the proposed tariff hikes could lead to a politically damaging increase in US inflation (the higher levies on China alone would add up to 0.5% to US prices). Meanwhile, the first alternative may lead allies (in Asia and elsewhere) to question America’s geopolitical reliability, especially if its commitment in Ukraine weakens as appears likely. Nevertheless, despite America’s divided domestic politics, there exists a strong consensus that the US-China trading/investment relationship is unfair, and China’s military buildup is worrisome. Therefore, financial markets should expect assertive US policy action in coming years.

China, however, will not stand idly by. Investors should anticipate that China will retaliate to the threat of US trade restrictions. Indeed, already critical material exports are being curbed, and anti-trust actions against Nvidia are proposed. In addition, China will diversify its trade and investment ties with other nations, and may seek to deepen its political ties with Russia and its influence in other countries of the “Global South”.

Despite efforts to prepare for Trump 2.0, China’s economy is more vulnerable than in 2018 when US tariffs were initially increased. Indeed, in light of ongoing domestic structural adjustments and the worsening international environment, Chinese GDP will struggle to grow 3-3.25% in 2025 unless additional stimulus is forthcoming. President Xi’s inability to produce healthy economic growth with have implications for Chinese monetary policy, equity markets, and the Remimbi (RMB).

Structural Issues: Stiff Headwinds Still Prevail

In several previous blogs, I have discussed the important structural adjustments China’s economy is undergoing currently (see the websites Archive section). Indeed, even before the uncertainties of Trump 2.0, China’s long-term growth potential had slowed towards 4%. And, despite ongoing policy actions, many of the headwinds still prevail. For instance, corporate indebtedness is still rising, not declining (Chart above). In other countries, deleveraging took several years, and led to a long period of economic underperformance.

Likewise, despite effort to address the well-documented over-capacity in the property sector, the inventory of unsold houses continues to rise. With housing demand expected to remain weak for the foreseeable future, previous experience suggests the needed adjustment could take several additional years (Chart above).

In addition, progress toward rebalancing the economy towards domestic consumption and services has stalled since the pandemic (Chart above). Indeed, President Xi has deemphasised this goal, while prioritising key manufacturing sectors (e.g. technology, climate transition) in pursuit of the China 2025 agenda. In light of the risks posed by Trump 2.0 tariffs, China would be wise to refocus on efforts to support household incomes and to stimulate domestic spending.

Likewise, reversing the slowing trend in worker productivity is vital in light of China’s declining population. The IMF indicates Chinese service sector efficiency is both accelerating and growing faster than in the manufacuring area (Chart above). As a result of abandoning the rebalancing objective, therefore, China is not exploiting the huge growth potential an expanding service sector offers.

Whatever It Takes?: Options Are Limited

At the height of the Euro crisis, ECB President Mario Draghi pledged to do “whatever it takes” to counter the region’s deflationary slide. To be sure, China’s recent actions to address the property crisis are both meaningful and appropriate. But, are authourities willing to do whatever it takes?

With the Chinese economy caught in a classic “liquidity trap”, the efficacy of monetary policy is greatly limited. The missing ingredient has been government efforts to directly support household incomes and spending. Indeed, rather than stimulating economic growth, the impact of fiscal policy has been broadly neutral in recent years.

The Chart above provides the reason. Along with the surge in private debt, government liabilities have soared also. And, with the budget deficit exceeding 7% of GDP, China’s debt ratio will continue to rise sharply in coming years. Therefore, budgetary options are more limited than following the intial tariff hikes in 2018.

Without “fiscal space” to stimulate growth, the burden will continue to fall on monetary policy. So far, the actions taken have failed to improve consumer confidence (Chart above). Likewise, fixed asset investment slowed to 3.3 last year, and will decelerate again in 2025. In countries facing similar housing adjustments, real interest rates eventually became negative. Therefore, I expect the PBOC to eventually cut rates towards 1.5% (another 150bp).

Diversify: China “Derisking” Too

Deglobalisation, derisking, diversifying, and home-shoring supply chains are key global themes. China is at the centre of these developments. To be sure, Chinese exports to the USA have slumped since the 2018 tariff implementation; in part displaced by other Asian competitors. However, to offset the adverse impact, China has deepened its trading links with other Asian countries (Chart above). Indonesia and Vietnam have been two big beneficiaries.

Likewise, China has responded by altering its supply chains with considerable direct investments abroad. Again, other Asian nations, especially Malaysia, Vietnam, Indonesia, and Thailand have been key winners (Chart above). Mexico has benefited from both greater trade and investment with China — with much trade redirected to the USA. Meanwhile, bilateral investments in Europe and the have USA slowed.

However, China’s increasingly uncertain economic outlook has produced a sharp slowdown in FDI into the country. Indeed, while other Asian nations have seen FDI inflows rise in recent years, investments into China have slumped (Chart above, right panel), as European and American manufacturers redirected regional supply chains.

Even though China successfully diversified trade and investment links, the Yuan depreciated following the 2018 tariff hikes. Despite recent weakness, the Chinese currency is not undervalued yet (Chart above). In response to higher US trade levies, declining interest rates, and weak economic growth, the exchange rate may decline 10% or more towards CNY/$ 8-8.25.

Strategic Implications

• The Washington consensus points to an assertive US policy towards China in coming years. Tariffs of 60% on all imports from China will add 0.5% to US inflation. US Federal Reserve may only lower interest rates twice in 2025.
• China will retaliate, adapt, an diversify. However, China is more vulnerable than in 2018. Rising US import levies may reduce Chinese economic growth by 0.5%. GDP may struggle to expand 3.25% without considerable additional macroeconomic stimulus.
• The burden will continue to fall on the PBOC. Chinese interest rates may decline another 150bp towards 1.5%.
• The remimbi will depreciate towards CNY/USD 8 or beyond.
• Chinese equities are cheap. However, the initial favourable market reaction to earlier monetary stimulus may fade unless authourities are willing “to do whatever it takes” to offset deflationary pressure. This will require additional interest rate cuts, and tangible support for households and consumer spending.