David Mahon says China is responding to the US tariff war by focusing on its internal challenges while strengthening new alliances with the economic refugees of the fragmenting global order

By David Mahon*

The following is China Watch Summer 2025 briefing by Mahon China Investment Management Ltd, Beijing, and is here with permission.

If the blame is on me,
Everything I encounter can be a remedy.
If I blame others,
Each turn of my thought will be a weapon.

Hong Zicheng, Daoist philosopher 1600 C.E.

Over the last two years, Chinese citizens doubted their government’s understanding and management of the economy and its handling of diplomatic relations, particularly with the United States. Washington’s tariff assault on China has begun to change this and galvanise Chinese society. Many people admire President Xi’s resolve not to capitulate to President Trump, as several of America’s trading partners with less economic leverage have done. When rumours emerged in Washington that President Xi had called Trump to ask him to negotiate, these were promptly and widely dismissed as false in both social and traditional Chinese media. Economic patriotism may not influence household consumption directly, but the Chinese leadership’s resolve is winning back the respect of its people and general confidence is returning.

‘I lost faith in the government during COVID, but the way Xi is standing up to Trump and his bizarre tariffs is impressive. China is under attack. If we can stay unified, we will win. Isn’t it ironic that Trump’s attempts to weaken China are only making it stronger?’

CEO and founder of Zhejiang electronics firm

Washington’s struggle to protect its own market while destabilising those of its competitors and allies is accelerating the decline of US prestige and power. It is also hastening the consolidation of Chinese regional power and global influence.

Red carpets

President Xi’s recent tour of Southeast Asia advanced discussions on settling trade payments outside the sphere of the US dollar. The European Union too is reconsidering its dependence on the dollar and vulnerability to US coercion. Europe will invariably draw closer to China, but on terms more favourable to Beijing than Brussels. After years of submitting to US pressure to help contain China and in the shock of Washington’s abandonment, Europe’s turn to China is driven more by economic self-preservation than any shared vision for long-term development. There will be, nevertheless, future opportunities for enduring economic partnerships as the EU and China find common ground, potentially offering each other stability in an increasingly unpredictable global economy.

Australia appears to have regained a degree of Chinese trust in the last three years, but so long as Canberra remains in the AUKUS partnership and acts as a vassal to the US military, real trust will be elusive. Even as the Australian Labor Party won a landslide victory in the federal election, returning prime minister Albanese made no reference to reviewing AUKUS. China views Australia as an important trading partner and would prefer to woo Canberra away from its enmeshment with Washington over time rather than punish it for perceived past and present transgressions.

Despite so many in the West allying against China politically and culturally over the last 15 years, China is now less reactive in trade talks and increasingly practical when negotiating with nations like Australia and even Japan. Beijing’s priorities appear to be maintaining social stability and prosperity, rather than settling old scores.

‘I don’t like the warped entitlement that comes from China’s feelings of historical victimhood. I also have no time for our so-called wolf warrior diplomacy, which is often just blind reaction under pressure. China is stronger now and needs to operate from strength. We need to build the future rather than litigate the injuries of the past.’

Retired Beijing trade official 

In April New Zealand increased its defence budget substantially, noting the importance of its trade with China while inferring that China was a growing regional threat and trigger for the spending increase. New Zealand is not the only Western country to think they can maintain a flourishing trade relationship with China while treating it as an enemy, and assuming that China will ignore this diplomatic infidelity indefinitely.

‘New Zealand has mostly made its own decisions regarding us, rather than giving into the pressure of its Western allies. First it was criticised by the US, Australia and the UK for negotiating a free trade agreement, and later envied. The current New Zealand Government recently noted its intention to re-join the US alliance against China and seems prepared to throw away four decades of a rare friendship. We understand how policies change in Western election cycles, so out of respect for the past relationship we can wait until the next election to see if New Zealand returns to a less adversarial position. At this stage we have no interest in reviewing our free trade agreement or threatening tariffs, but we have a draft response if the situation deteriorates.’

Trade official in Beijing

A prudent nation talks with adversaries behind the scenes no matter how fraught public exchanges may become. The US Department of Commerce, the State Department and the Pentagon likely maintained low level conversations with counterparts in Beijing even through the period of apparent breakdown of relations. The US-China negotiations in Geneva, which have resulted in a lowering of tariffs for 90 days (30% tariffs on China; 10% tariffs on the US) should nevertheless be viewed cautiously. To most observers it appears that Trump ‘blinked first’ after declaring China must come to him, but then offering that he expected to lower tariffs substantially before talks began. China persuaded the US to start negotiations at pre- ‘Liberation Day’ tariff levels, conceding nothing. A man so inconsistent in his own mind is not only hard to predict; anything he appears to agree to formally, he may suddenly rescind.

Ninety days affords companies little time to reorder their supply chains and investment plans – with many having just done so with the higher tariffs in mind – and there is every chance that further erratic policy announcements will force plans to be changed again and again.

‘I want to wear Nikes; I don’t want to make them.’ (Dave Chappelle)

Trump is as much a manifestation of the fallacy among the US political establishment that America’s trading partners have been taking advantage of its economy, as he is its protagonist. Too many key figures in both parties believe that tariffs on trading partners’ goods, particularly China’s, will help restore US manufacturing jobs that were ‘stolen’ over the last three decades. But these jobs were lost largely to automation and corporations’ decisions to move plants abroad to trim costs and boost profits, not theft from China. With 90% of the US work force employed in services and the US running a services trade deficit with China, Washington’s claim that China is the main cause of its trade imbalance is even more implausible. Debates over economics become irrational when politicians prioritise tribalism and imperial ambition under the guise of national security and economic balance.

The passivity of the Democratic Party toward the Trump administration’s global trade protection racket, attacks on the bureaucracy and civil society is akin to tacit approval. Dictatorships do not just rise on tides of popular support or by coup d’état, but often by increments, stepping into the political vacuums created by the fear, apathy and political indifference of their opponents. The collective silence from Democrats, influential Republicans and in particular former American presidents is ominous. Even as Trump capitulates temporarily on high tariff levels, the chances that he or his successor will be able to restore the US’ covenant with the global economy, so firmly established after 1945, are slim.

Despite significant regulatory changes in the Chinese judicial system to limit political interference in policing and the courts, the Communist Party still stands above the legal system. While this ensures its power, it weakens social and market trust. America’s partners may not have always trusted US political culture, but they trusted the US legal system which oversaw, and when necessary, constrained it.

Just as China’s judiciary evolves and gradually gains increased independence from local, if not national, political influence, the US judiciary is devolving in the face of oligarchal coercion and an increasingly monarchical White House.

‘In the past we seldom engaged in cases where we did not have a political relationship to ensure a smooth process or an advantage. Now we would risk the court’s censure or even a penalty if we tried to influence it through political connections. In commercial and civil matters, the law functions relatively independently for foreign and Chinese firms alike. Anything political is still vulnerable.’

Chinese commercial lawyer Shanghai

Competitor and catalyst

China will likely need to deal with US assaults on its economy for at least another decade, while resisting being drawn into military conflict. Avoiding even a limited military engagement will be difficult as Washington is determined to maintain military primacy in Asia at almost any cost and hopes to provoke China before it gets stronger. Many US analysts postulate that China may already have an edge militarily in the region, particularly in short-range naval missile and electronic jamming systems. Yet geopolitical tensions are not the Chinese Government’s top priority when compared to the challenge of rebalancing the domestic economy. Washington’s continued coercion is acting as a catalyst for Beijing to reform more decisively and boldly than it may have otherwise.

‘We know Trump will hurt us but not so much that it can stop our development. The economics of his tariff plan are stupid. I studied and lived years in the US Midwest and understand the precedents for what Trump is doing. The US strategy to contain China accelerated under Obama. Trump is just a cruder expression today of that aim. We cannot dismiss the underlying motives here, but China needs to get on with increasing consumer confidence, investing in the private sector, and releasing pent-up consumer demand. The government seems to know what it is doing, but I wish they would do it faster!’

Beijing banker

Western governments and companies often over-emphasise their roles as the prime agents of Chinese economic evolution over the last four decades. Chinese urban migration, entrepreneurial flair and implementation of market-friendly policies were equally important at the beginning, and fundamental to sustaining the reforms of the last 25 years. Today China must rely on its internal resources as never before, while staying as open to world markets as the growing trade chaos will allow. China will prosper or falter on its ability to reform social policy at a decent pace. From a country long adept at building supply in the economy while leaving the slower growth of common wealth and the middle class to drive demand, China is at last launching policies that have the potential to drive consumption significantly.

Discounts and relocations

Chinese consumers can now trade in their electric vehicles, smartphones and household appliances to obtain discounts of up to 20% on replacements. Beijing also needs to implement a debt relief programme reducing mortgage costs and loosening consumer finance terms. Local officials need to improve their beleaguered balance sheets but still be incentivised to support industrial SMEs – winners and more average performers alike – to contribute to economic growth and alleviate unemployment.

Unemployment may not be the Achillies heel of the Chinese economy today, but with the diminution of exports and advance of robotics and AI in manufacturing, it has the potential to become so. Present data masks the real unemployment numbers. Migrants from rural areas may lose factory jobs but are never acknowledged formally as ‘unemployed’ for they are still considered to be farmers with land back in their home villages. Many of these migrants may never have worked their land, and have no ability or intention of doing so.

The government’s manufacturing focus, especially on high technology, has helped it to begin rebalancing the economy, but too much capital and support still goes to the state industrial sector, where investment yields are often half that of the private sector. Private sector companies are not just the largest part of the Chinese economy, they give China its global competitive edge. The results of SMEs competing with SMEs at home form a collective dynamo abroad, greater than any endeavours of subsidised Chinese SOEs.

AI firm Deep Seek is a private company, as are the auto companies BYD and Geely, and as is the world’s leading photovoltaic firm Jinko.

Huawei is also a private firm and has survived US attempts to destroy it to remain one of the largest investors in research and development in the world, spending USD 23 billion per year, or almost 25% of its annual turnover. China registered 1.4 million patents last year, compared to the US’ 300,000. Future economic success and failure will not be measured in general manufacturing output, or by trade surpluses and deficits, but by technological innovation and rapid commercial application. The US need not fall behind in this field, and it would be a mistake to underestimate the motivation and ability of American technology firms to compete with China – something from which consumers around the world will benefit. Chinese business leaders are aware that business America and political America are often separate nations in the same country. The former has outfoxed the latter repeatedly since the country’s inception.

Social solutions to economic dilemmas

Some Chinese regions are loosening requirements for urban residency to restore consumer demand and unleash the economic forces of urbanisation that have been fundamental to China’s development. Migrant workers, often highly skilled tradespeople and educated professionals, spend only one third as much as residents, and save 50% more than their professional peers with full residency status. A non-resident worker needs additional savings to meet extra service costs, services that are subsidised for residents. There are 350 to 400 million workers living as migrants in Chinese cities. Rather than being liabilities as many municipal governments perceive them to be, migrant workers could be an enormous source of consumption and investment if they were granted full residency status. Doing so would also help resolve the real estate slump in key cities.

‘The middle-class resists the idea of giving migrant workers residence. Many were once migrants themselves, but they fear losing something if too many become full citizens. Although most can’t tell you what it is they fear losing. Officials often can’t see past the costs of opening up the system, failing to appreciate the consumption boost that would be generated. China is so large and wealth and social services so uneven. We struggle with the idea of internal migration in China in a similar way as the UK and the US struggle with fears about the social impact of external illegal immigrants.’

Zhejiang fund manager

Commentators have been calling for Beijing to reform the residency system nationally for years. As with other past controversial changes, the government is likely to wait until enough towns undertake reforms on their own. Larger inland cities such as Chongqing, Hefei, Zhengzhou, Shijiazhuang and Nanning are already offering residency and other incentives, such as housing grants, to skilled migrants. Most of these cities have also lifted restrictions on access to health care, medical insurance and education for new migrants, so they may enjoy equal benefits to residents.

Envoi

Despite China’s travails, economic growth is strengthening and public confidence improving. The strong first quarter GDP growth of 5.4% could be viewed as exceptional as US retailers stocked goods before Trump’s tariffs hit, but it also reflects genuine improved Chinese domestic consumption. Beijing can instigate further reforms by broadening the tax base, relying less on indirect taxation such as VAT, and rebalancing local government finances. Although the real estate sector is improving in some parts of China and a national crisis appears to have been averted, it remains a major imbalance in many parts of the economy, something faster urbanisation could correct.

The suffering that American people are enduring may be the fire that forges a more resolute nation, one that recovers some of its founding principles. Judeo-Christian cultures can tend to see global disruption in apocalyptic terms, but a natural reset of power has been underway for decades centering around economic growth in Asia. Beijing will continue to focus on its internal challenges while strengthening new alliances with the economic refugees of the fragmenting global order.

In ten years, China will not have replaced the United States as the world’s most powerful country but will likely be a strengthened participant in a multipolar world which will include a still highly consequential US. The two countries will continue to compete – through their currencies, companies and shifting spheres of influence – but it is better for all nations that neither dominates the other. 

*David Mahon was also a guest on our Of Interest podcast. You can listen here.

*David Mahon is the Executive Chairman of Beijing-based Mahon China Investment Management Limited, which was founded in 1985. This Briefing is here with permission.