George Magnus: Nobody Can Win This Trade War

Deutsche Version

US President Donald Trump is keeping the global financial markets on edge. His policies are unsettling investors, and a tremor in the bond market forced him to suspend the «reciprocal» import tariffs against most countries for 90 days on April 9. At the same time, Trump has escalated the conflict with China; Beijing is hitting back just as hard.

What's in store for the coming weeks, will Trump and President Xi Jinping be able to agree on a deal?

Economist and China expert George Magnus is not overly optimistic. «The rupture is so big now that it’s difficult to imagine peace breaking out in the traditional sense,» says the former chief economist at UBS Investment Bank in an in-depth conversation with The Market NZZ. Trump has caused a terrible mess with his actions, but Washington’s criticism has a point: «The philosophy behind China’s economic model is pure mercantilism. They make a virtue of export surpluses and accumulating foreign exchange reserves. That’s what’s wrong.»

The United States and China have entered a full-blown trade war. Who is in a better position to win this?

First of all, I think the term trade war understates the nature of what’s going on. Once you get to tariff levels that are so high as they are now, the exact percentage number doesn’t really mean anything anymore. In effect, this is a trade embargo. The US ships roughly $150bn worth of goods to China. At 125% tariff levels, those $150bn will dwindle very quickly. China ships $440bn worth of goods to the US, and I could see that dropping by up to 75% over the next 18 months. Normally this only happens when countries go to war with each other. That’s effectively what is happening here. They are driving towards a trade embargo. So I don’t think anybody can win this war. No one will be spared the effects. It’s just a question of who loses less.

Who loses less, then?

Both sides have enormous amounts at risk. The US economy may tip into a recession this summer. The leading indicators of consumer confidence, inflation, and capital spending are all flashing warning signs. Due to rising prices, the Fed will have to keep interest rates higher, so stagflation is the outcome. For America, the economic news is bad, and the political news is bad, because the allies of the US no longer feel they are allies, they don’t know how to deal with the Trump administration. Hence we see a big move by investors out of the dollar and out of US assets.

What’s for China to lose?

This trade war is distinctly unwelcome for the Chinese Communist Party, which only last month, at the National People’s Congress, revealed its alarm at the underlying fragility of China’s economy. The government can ill-afford a trade torpedo as it tries to stabilize its beleaguered property sector, along with debt and asset deflation in local governments. China’s economy is not healthy. People are losing jobs.

Couldn’t the central government just boost fiscal spending to soften the blow?

Sure, in theory, they could boost domestic demand. But that’s the problem. If China, with its 1.4 billion people, had an income and consumption structure like the US, the UK or Switzerland, then their economy wouldn’t be in the situation it’s in. But it doesn’t. Why? Because the CCP is wedded to mercantilism, industrial policy, and export promotion. They try to boost growth through exports. But who’s going to take China’s overproduction voluntarily? Many countries all over the world are raising trade barriers against China. They’ve reached the end of the road with their growth model.

The Party leadership vows to fight this trade war to the end. What gives?

I think maybe because the people in China have been through such enormous hardship in the past, the argument is that they can withstand a lot of pain, in a way that wouldn’t happen in the US. So you can make the point that the CCP is more immune to public pressure than the Trump administration. That is likely. But I don’t see China as a winner. Both sides have reasons to sit down and try to hammer out some kind of an agreement. Which I still think is likely.

How will the trade war evolve from here?

My hunch is that both sides have reached a peak in terms of hostility. They just have to try to find a way to pull back from that. A week ago, China’s Ministry of Commerce said they would not engage in a further escalation of tariffs. That was interesting, they didn’t have to say that, but they did. If they really wanted to wave a finger at the Americans, they could let their currency dive, say to 8.50 or 9 yuan per dollar. That would be a kind of a casus belli. But Beijing does not want to risk that. Or they could target American companies much more aggressively. Of course that’s all still possible, but right now we get more signals that they want to negotiate.

During the first Trump presidency, Washington and Beijing reached the so-called Phase One Deal, which was signed in January 2020. Could that be a starting point for further negotiations? Or are we past that?

My hunch is we’re past that. Both sides have moved on since then. China’s self-reliance shtick plus its diversification of markets since then mean that it’s much more difficult for the US and China to reach an agreement today. The rupture between them is so big now that it’s difficult to imagine peace breaking out in the traditional sense. What they still might be able to do is to reach a loose agreement to basically stop fighting each other commercially as aggressively as they are now. Perhaps China will buy more LNG from the US, perhaps there will be some agreement about TikTok or other areas of contention. Perhaps that will lead to both sides rolling back some of the extreme tariff increases. They still will end up with very high tariffs against each other, but maybe not quite as high as they are today. They might reach a modus vivendi agreement, rather than a solution to the trade problem.

Do you see any potential for a deal that will get us back to where we were before?

No. That’s too late. Well, I suppose there could come a point if the political blowback in America is so large, if the consequences of tariffs for the US economy are so extreme that Trump has to abandon his policy. That seems far-fetched at the moment, but not impossible. But that unquestionably would be a big win for China.

The political leadership both in Washington and in Beijing has entered an escalatory spiral. How can anyone deescalate now without losing face?

I think Xi Jinping has a much bigger issue with losing face than Trump does. If your question is who’s going to blink first, then I would expect it to be the Americans. Trump is fickle. We could see it with the implementation of this whole tariff program. It was quite obvious that the Trump administration didn’t give much thought to how they were going to build up the leverage that they wanted to exercise through the use of tariffs. They used all kinds of laws to impose all sorts of tariffs – just a complete dog’s breakfast. Absolutely hopeless. They have already been forced to pull back. The retreat on the so-called reciprocal tariffs, the exemptions of electronics and other goods, that just shows you that there is a lot of sorting out to do.

There were big tremors in the bond market before Trump adjusted his stance. Treasury yields went up, the dollar weakened. If the US were an emerging market, this would be a sign that capital markets are starting to lose faith. How do you see that?

The confluence of rising bond yields and falling currency is definitely an ill wind. This is not supposed to happen. It speaks to fragile confidence, an expression of angst. If this happened persistently, it would tell you something horrible is going on.

Treasury Secretary Scott Bessent has spun the narrative that this was all part of a grand strategy. They now want to negotiate deals with the likes of Japan, Korea, India, and the EU, to then confront China as a group. Does that make sense?

As an objective it makes sense. Whether it was all part of a plan, I very much doubt that. Of course, if you want to confront China, you want to have Japan, Korea, the EU on your side, because together you are much more powerful than you are on your own. I get Bessent’s reasoning, but my question would be if they think they are going about it in the right way. The clumsy, inept way they have imposed their tariffs obfuscates the reason why they are doing this. The reason they’re doing this is because of global imbalances, and those imbalances are because of unfair trading practices, primarily because of mercantilism in China. The Americans do have a point there.

Do you agree with the statement that the US is crashing the rules-based liberal world economic order that it itself had created after World War II?

Yes, with a caveat. There is no question that the US was the founder of the rules-based international economic order, and there’s no question that they are destroying that order now. The caveat is that the reason we’re here, and the reason that the international economic order has proven so easy to destroy, is because it was already flawed. The world trading system was unsustainable.

And China is to blame for that?

The problem is that the system couldn’t deal with the huge surplus of China. It was never equipped to discipline countries that ran large, consistent trade surpluses. Of course there are other chronic surplus countries, like Japan, Germany or Korea, but in terms of sheer size and impact, nothing compares with a $20 trillion economy which is China. The Chinese understate quite significantly how big their surplus is. In manufacturing they probably have a surplus of about $2 trillion. Its current account surplus is reported at about 1% of GDP, but in truth it may be nearer to 4%. That’s too big for the world to handle. Trump has chosen to tackle this problem by taking a sledge hammer. But it’s quite important not to lose sight of that problem. Because the status quo ante wasn’t sustainable.

China would say it’s not their fault that they’re competitive and that the entire world wants to buy their products.

Yes, but that’s a half truth. It is not disputed that the Chinese are really good at three things: One, adaptive innovation. Not just copying, but adapting the stock of knowledge to create good products. Two, they are very good at scaling things up, and therefore, three, they are very good at selling that stuff at low prices. And as we know from the example of electric vehicles, these are quality products, top of the range. I don’t have an issue with the argument that the Chinese should be recognized as very efficient and proficient exporters.

But?

But what is the purpose of having a trade surplus? This goes back to Adam Smith, who famously said that the purpose of exporting is to be able to import. To be able to consume other things. That’s the big thing that’s missing in China. They don’t import enough, they don’t consume enough. China’s exports last year grew four times as fast as world trade, and imports didn’t grow as fast as world trade. Something’s wrong there. The philosophy behind China’s economic model is pure mercantilism. They make a virtue of export surpluses and accumulating foreign exchange reserves. That’s what’s wrong.

Since late 2024, the government promised to vigorously support consumption. What’s so hard about that? What prevents the CCP from boosting domestic demand?

It’s because they have a very Leninist view about how an economy works and how national prosperity is created. We are both old enough to remember that there used to be a slogan in China called Common Prosperity. We spent months trying to define what it meant, right? Well, for Xi Jinping, it was never really about income redistribution and privatization or creating the sort of consumer environment that we hoped for. They don’t mean that at all. They want to create the most dynamic industrial economy in the world, from which the trickle down benefits in terms of jobs and incomes would flow to the population. They are very very supply-side focused. They have devoted a lot of attention, rhetoric and money to evolving the most expansive industrial policy of any country ever. It’s all designed to grow their so-called strategic emerging industries and to boost exports.

But still, they have now given a high priority to boosting domestic consumption. Is that empty talk?

You’re right, the shift towards boosting consumer demand to their first level priority is notable. There have been some nods towards that aim. They increased their trade-in program subsidy, where consumers can trade their old phone, car or washing machine for a new one. Also, they are paying slightly higher amounts for pensions and healthcare expenses. But so far, there hasn’t been any strong expression to embark on tax reform, income redistribution, an abolition of the hukou system, or privatization of state assets. Xi is very opposed to welfare payments, he sees them as a Western corrupted practice. There are a few brave Chinese economists at think tanks who have called for such measures. But so far the government hasn’t done it. I’m skeptical that they’re comfortable with the idea of what strengthening household incomes and consumption implies. Because if you really transfer economic power to the citizens, households, and small firms, you are transferring political power as well. I don’t think they want to do that. Remember, during Covid, supporting consumption was notably the one thing we in the West did, but they didn’t do at all in China.

You said that the rules-based international economic order was flawed before Trump. If you were given the task of designing the new order: What should it look like?

In a way, we are still dealing with the problem that the Americans and the British tried to tackle in 1944 when they set up the Bretton Woods system. The Americans, under the leadership of Harry Dexter White, prevailed, and the Brits, led by John Maynard Keynes, lost the argument. But I think we need a system that is able to distribute the burden of adjustment between deficit and surplus countries. There is this deeply ingrained thinking that trade – or more precisely: current account – surpluses are good, while deficits are bad. We have to get rid of that mindset. We need mechanisms to make it difficult or awkward for countries that have both excessive deficits or surpluses. We also have to rethink the whole idea about what we mean by reserve currency and how it is created. We are not talking about a tweak here. We are talking about a big monetary reform.

Those are pretty much the arguments that Keynes made in 1944.

Absolutely. He was quite prescient. I don’t have much optimism that any of this could happen in the immediate future. I just hope we don’t have to go through a cataclysm in order to have a new Bretton Woods.

Some people in the Trump administration, like Stephen Miran, Chairman of the Council of Economic Advisers, make the argument that the status of the dollar as the reserve currency is a burden for America. Is there any merit in that argument?

There is some, yes. I read the Miran paper several times, looking for evidence of his claim that the reserve status of the dollar has led to its being overvalued. He didn’t really provide any. But knowledgeable people like Brad Setser at the Council on Foreign Relations tell me it’s probably true. To me, the reserve status of the dollar can be an exorbitant privilege and an exorbitant burden for America at the same time. Only the US capital market is large and open enough to absorb all the surplus savings of the surplus countries. That influx of capital is the flip side to the big current account deficits of the US. It would probably be better for the functioning of the global financial system if instead of the dollar we had an internationally agreed and managed currency, providing liquidity to the world economy. Of course, the chances of that happening, of China and America agreeing to something like this, are pretty slim. I also think that the US still likes the idea that their control of the financial system gives them leverage. They are corroding it, given their behaviour at the moment, but it probably won’t disappear very soon.