This Is What A Trade War With China Would Actually Look Like

Episode Summary

Executive Summary: The episode examines the escalating U.S.-China tariff dispute and whether it constitutes a true trade war. Brad Setser argues that if both sides implement their proposed tariffs, it meets a reasonable trade-war threshold, though he expects escalation to stop after the first round. He explains why bilateral trade deficits can be misleading, why China’s leverage over Treasuries is overstated, and how tariffs could redirect trade, raise some prices, and reinforce China’s industrial policy push.

Main Topics: Defining a trade war (Priority: 5/5): The hosts and Brad Setser debate whether the U.S.-China conflict is a trade war or just an early-stage negotiation. Setzer defines it as significant trade restrictions and a significant retaliatory response, with further escalation not necessarily required. Tariffs, retaliation, and likely market effects (Priority: 5/5): The discussion covers the U.S. Section 301 tariffs on Chinese goods, China’s retaliation targeting key U.S. exports, and how tariffs could raise consumer prices, shift sourcing, and alter trade flows rather than simply stopping trade outright. Why bilateral trade deficits are misleading (Priority: 5/5): Setser explains that a U.S. bilateral deficit with China does not by itself prove an unhealthy relationship because trade can balance across multiple countries; the global deficit is more economically meaningful because it reflects borrowing or capital inflows. China’s industrial policy and technology transfer (Priority: 4/5): The conversation explores China’s 'Made in China 2025' ambitions and the ways China pressures foreign firms toward technology transfer through joint ventures, market access, and subsidy structures, even when not formally mandated by law. Treasuries as alleged leverage (Priority: 5/5): The hosts ask whether China could retaliate by selling U.S. Treasuries. Setser argues that this leverage is limited, because China’s reserve growth is slowing, the Fed matters more than China, and China would need to reinvest elsewhere, muting the effect. Possible paths forward in the dispute (Priority: 4/5): Setser lays out three scenarios: a negotiated compromise, a one-round tariff exchange that stabilizes, or continued escalation. He thinks the most likely outcome is tariffs implemented on both sides, then the conflict stops there.

Key Arguments: A trade war can be reasonably defined as one country imposing substantial trade restrictions that trigger an equally substantial retaliatory response from another country. Standard anti-dumping and safeguard cases are narrower, rules-based remedies; Section 301 is broader and allows the U.S. to target sectors it believes pressure China to change unfair practices. A bilateral trade deficit with China is not inherently meaningful because global trade flows can be balanced through third countries; only the overall deficit reflects true external financing. China’s tariffs on soybeans, aircraft, and autos matter more than earlier symbolic retaliation because these are major, strategically important sectors for the U.S. economy. The Treasury market is not as vulnerable to Chinese selling as popularly believed, because China’s reserve growth is slower, and the Fed has more power to stabilize yields. China’s leverage is stronger in markets where the Fed does not normally intervene, such as agency debt or other credit spreads, than in Treasuries alone. Tariffs may raise prices for some U.S. consumers and businesses, but in many cases the larger effect will be trade diversion to non-Chinese suppliers. China’s industrial policy goals in sectors like aviation, semiconductors, and vehicles create real trade tensions because they emphasize import substitution and domestic champions. The most likely equilibrium is that both sides impose tariffs and then stop escalating further, while negotiations continue in the background.

Data Points: U.S. tariffs targeted value: $50 billion - Approximate value of Chinese goods targeted by the U.S. Section 301 tariff proposal U.S. tariff rate: 25% - Rate proposed on roughly $50 billion of Chinese imports China retaliatory tariff target: about $50 billion - China’s announced or threatened retaliation against U.S. exports U.S. GDP share affected: roughly a quarter of a point of GDP - Setser’s estimate of the size of $50 billion relative to the U.S. economy Tariff effect size: a little over 5 basis points of GDP - Approximate direct GDP effect if the tariffs were fully paid U.S. car tariff: 2.5% - Existing U.S. tariff on cars, contrasted with much higher light-truck tariffs U.S. light-truck tariff: 25% - A legacy tariff cited as an example of historical trade-policy scars China current account surplus comparison: smaller than Japan, the euro area, and the combined Asian NICs - Used to show China is no longer the dominant source of global financing for the U.S. deficit China reserve growth: not growing very fast - Reason Setser downplays near-term Chinese Treasury buying power China’s 2007 reserve accumulation: about $600 billion per year - Historical peak period when two-thirds of reserve growth reportedly flowed into U.S. bonds

Pivotal Quotes: "I think a trade war is a series of measures, I guess, a significant set of trade-restrictive measures by one country that prompt an equally significant response from another country." — Brad Setser: His definition of what qualifies as a trade war "The U.S. is violating its WTO commitments by raising tariffs against Chinese goods, at least in the Chinese view." — Brad Setser: Explaining why the Section 301 action is legally controversial "I think if we proceed to the stage where we actually implement the tariffs ... and if China proceeds to implement the tariffs in response, I think, for all intents and purposes, that would meet a reasonable standard for a trade war." — Brad Setser: Clarifying when the dispute becomes a true trade war

Implications: Listeners should expect market volatility, sector-specific winners and losers, and likely one round of tariff escalation rather than a complete rupture. The episode suggests Treasuries are not a simple pressure point, while industrial policy and tech transfer remain the deeper U.S.-China fault lines.