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A 90-day US-China trade truce brings momentary calm to a long-running tariff battle, offering relief to supply chains and agitated global markets
Image Source: Getty
After months of escalating tariffs and economic tension, the United States (US) and China have agreed to a trade ceasefire, rolling back most of their tariffs. This offers relief to global markets and supply chains and comes when other ceasefires—from India-Pakistan to Russia-Ukraine—are also being explored. While temporary, the deal marks an important pause in a damaging standoff between the world’s two largest economies.
The costs of an economic war between two of the largest nations might exceed the costs of an actual war—it might be possible to escape a national war, but not a recession. President Donald Trump’s second term in office led to the beginning of the US-China trade war. What started with an initial 10 percent tariff on Chinese imports on 1 February 2025, had escalated to 145 percent by 10 April. China retaliated against each incremental tariff and ended up levying a 125 percent tariff on US imports. This nearly stopped bilateral trade, significantly plummeting the stock markets.
Figure 1: US-China tariff rates toward each other and the rest of the world (ROW)
Source: PIIE
While the US exports soybeans, pharmaceuticals, aircraft, and petrol to China, it imports smartphones, laptops, batteries and other electronics. The US imports much more than it exports—nearly US$ 300 billion more. Although Trump’s decision to embark on this protectionist rampage was justified using the fentanyl and illegal immigration crises, underneath it was a sense of American pride and nationalism. The idea that domestic manufacturing would restore jobs and prosperity to America pushed the Trump administration into dismissing the role of international comparative advantage entirely.
Protectionist policies essentially distort competitive prices and raise domestic prices, causing consumers to lose purchasing power—the very Americans Trump wanted to protect. The rule of comparative advantage dictates that under free international trade, each country would produce what it is relatively most efficient in. China, which began its export boom on the back of labour-intensive exports, has a comparative advantage in those goods. The US would also be better off if China continues to produce and export those goods. Restricting Chinese exports would have imposed an asymmetric burden on the US economy, with higher inflation and lower supply.
The Kiel Institute for World Economy used its Kiel Institute Trade Policy Evaluation (KITE) model to simulate the effects of US-China tariffs. It found that bilateral trade would decline by more than 70 percent in the long run. Inflation would rise by 5.5 percent and shrink the US Gross Domestic Product (GDP) by 1.6 percent. While China would also face an output shrinkage of 0.6 percent, the effect on prices would be different. Since China is a net exporter, reducing trade would entail an influx of goods into the domestic market. Domestic competition would grow fiercely, pushing down prices, which would not be a welcome change for producers. The rest of the world would be affected, facing both income reduction and price surges. These numbers underscore why the US had to act—the spiralling costs of protectionism were not just economic abstractions but real pressures threatening household budgets, business stability, and the government’s ability to borrow affordably.
Bond prices and yields move in opposite directions due to the instrument’s structure. When the vigilantes start dumping bonds, the prices fall, and yields go up, making it costlier for governments to borrow.
It was not just the laws of international economics that made the Trump administration reconsider its decision, the bond vigilantes played an equally important role. Bond prices and yields move in opposite directions due to the instrument’s structure. When the vigilantes start dumping bonds, the prices fall, and yields go up, making it costlier for governments to borrow. Usually, during global crises, buyers turn to the US market and lower the US bond yields. However, this time, it was different. There was a large exit from the US bond market, raising the cost of borrowing and making fiscal deficits more expensive.
No matter how important nationalism is, one must bow to the power of the invisible hand. However, markets and nationalism are not necessarily distinct—they allocate resources most efficiently unless there are regulatory frameworks which unintentionally allow rent-seeking. Struck by the tides of market forces, China and the US resorted to a new trade deal on 12 May. Both nations struck down tariffs by 115 percent, retaining an additional baseline tariff of 10 percent. While the tariff elimination is currently in place for 90 days, it is unlikely that the nations will regress to absurd retaliatory measures later.
A bifurcation of international trade would be costly and hamper the optimal distribution of global production.
The US is retaining the additional tariff to curb its trade deficit with China and control the offshoring of American jobs. China will also remove the retaliatory tariffs and suspend or remove the non-tariff countermeasures. This is not Trump’s first attempt at striking a deal with China; a Phase One trade deal was signed on 15 January 2020 to ease the US current account and promote collaboration with China on trade practices. However, this deal failed, with China not complying with its import commitments from the US and the lack of institutional support from the US, especially during the pandemic.
Things can be different this time, provided a comprehensive trade deal is designed, retaining certain aspects of the Phase One deal but with firmer and more specific commitments. While interventions distort markets, they can also be used to nudge them in a socially desired direction. How China and the US approach their trade arrangements will be consequential for the two nations and the emerging world, which is trying to establish its positioning in global supply chains. A bifurcation of international trade would be costly and hamper the optimal distribution of global production. Economic mechanisms must be politically neutral to achieve global cooperation on universal issues such as climate change.
Arya Roy Bardhan is a Research Assistant at the Centre for New Economic Diplomacy, Observer Research Foundation.
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Arya Roy Bardhan is a Research Assistant at the Centre for New Economic Diplomacy, Observer Research Foundation. His research interests lie in the fields of ...
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