Just when the U.S.-China trade conflict seamed at an impasse, the two parties agreed to a 90-day truce this past weekend that lowered duties on Chinese and U.S. goods to 30% and 10%, respectively, from 145% and 125%. The reciprocal tariff rates that ensued after President Donald Trump’s “Liberation Day” announcement on April 2 have been suspended, while the 20% duties imposed on China tied to fentanyl and the 10% universal tariffs are left in place.
Negotiators for the two countries reported “substantial progress” in the talks, and markets greeted the news enthusiastically. U.S. and international stock markets rallied, while the dollar appreciated against most currencies and gold sold off.
The markets’ favorable response reflects relief that the biggest threat to the global economy — a full-blown trade war between the U.S. and China — will lessen if a lasting trade agreement can be reached. Trade between the two countries had ground to a virtual halt, which carried implications for the rest of the world: The U.S. and Chinese economies account for nearly 45% of world GDP.
Apollo Chief Economist Torsten Slok, who previously assigned a 90% probability of a U.S. recession, now claims that the tail risk has been eliminated by the announcement. He believes investors can now think about a return to a more normal environment.
The latest assessment of the Yale Budget Lab is the May 12 changes to China’s tariffs will reduce the negative impact on the economy by 40% from its previous assessment. U.S. consumers now face an overall average effective tariff rate of 17.8%, down from the previous high this year of 27.6%, which is still the highest since 1934.
Some observers nonetheless are skeptical that a long-term solution to the trade dispute is at hand.
One reason is that details of the agreement have yet to be worked out. In a Bloomberg interview, Treasury Secretary Scott Bessent said it’s “implausible” that reciprocal tariffs on China will go below 10%, while the April 2 level of 34% for reciprocal tariffs that Trump announced “would be a ceiling” if China accedes to U.S. demands.
Second, China is known to reach trade agreements but not to follow through on them. For example, during Trump’s first term the two sides signed a “phase one” trade deal in which China agreed to purchase an additional $200 billion in U.S. goods over two years. However, it wound up buying less than 60% of that amount, according to the Peterson Institute for International Economics.
Third, Trump’s goal of eliminating the bilateral trade imbalance between the two countries of nearly $300 billion in 2024 will be very difficult to achieve. Trump views trade as a zero-sum game, in which countries that run surpluses are the winners and those that incur deficits are the losers. However, if the duties of 145% on Chinese goods and 125% on U.S. goods had been kept in place, both economies would have suffered irreparable damage as a result of supply-side disruptions.
Now that the two parties have backed off from the precipice, the respective leaders should have greater appreciation that they need each other to be successful. That said, they cannot continue doing what they have done since China was granted entry into the World Trade Organization at the end of 2001.
It has long been apparent that China’s development model is overly reliant on exports and investment, while the share of household consumption is among the lowest in the world, at under 40% of gross domestic product. China’s policymakers repeatedly have pledged to reduce reliance on exports and increase domestic demand, but the results thus far have been disappointing. Meanwhile, there has been growing resistance to the flood of imports from China not only into the U.S. but into the European Union and other countries, as well.
At the same time, Bessent indicated in a Bloomberg interview that the supply-chain disruptions during the Covid-19 pandemic made it clear the United States cannot be overly reliant on imports of certain products that are vital to national security. They include semiconductors, certain medicines and steel among others. He also stated the long-term goal was not to achieve a generalized decoupling of trade but to de-risk trade between the two countries.
One issue that is yet to be determined is whether the U.S.-China accord will serve as a template for other trading partners of the U.S.
Andy Laperriere, head of U.S. policy for Piper Sandler, observes in a report to clients that it is possible Trump may have found a tariff formula for now that consists of a 10% universal tariff, 25% product tariffs, and a 30% tariff for China.
Trump, however, prefers bilateral deals to multilateral trade agreements, because he thinks he can extract greater concessions from countries that are in weaker negotiating positions than China. Fox Business reporter Charles Gasparino claims that Trump caved on China’s core demands because the bond market rebelled against his reciprocal tariffs. Trump couldn’t risk higher bond yields, because the U.S. government needs to finance its exorbitant debt on favorable terms.
Meanwhile, Bessent has observed that negotiations with the European Union could be slower, because the EU suffers from a “collective action problem,” whereby the Italians may want something different than the French.
Finally, one caveat that trading partners of the U.S. need to keep in mind, according to Laperierre, is that nothing is ever permanent when it comes to Trump’s tariffs.