What’s driving the new trade war?
The US and the European Union are close to imposing a new wave of protectionist trade measures, though for different reasons. In the US, President Trump has motivations to reignite the trade war.
His summit meeting with Chinese President Xi Jinping gave rise to hopes that the two countries would sort out their differences over trade, at least enough to allow their trade truce to be extended when it expires in October. However, this may not stop President Trump from mounting aggressive trade measures against other countries.
For political reasons, he needs to distract attention from the misjudged war on Iran, which is eroding Trump’s political support just as he prepares for the midterm elections in November.
Taking the initiative to impose tariffs and other trade restrictions on China, Europe and other countries will make him appear to be in charge again and help shift political attention to an issue which Trump may think he has more control over.
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Moreover, after the Supreme Court negated his first set of tariffs, Trump has decided to use other legal provisions which allow him to impose tariffs, such as under Section 301 of the Trade Act of 1974. The investigations and other preparations to use these provisions will be completed soon, and a new wave of tariffs is likely to be enacted by July.
Tariffs are also needed to fill the fiscal hole created by the loss of roughly US$130 billion ($166 billion) of tariff revenues due to the Supreme Court ruling. The US administration has to find the money to pay back the now-illegal tariffs while meeting additional fiscal demands arising from the Iran war.
The Pentagon is asking for an additional US$200 billion in defence spending for this fiscal year. For the next fiscal year starting in October, Trump is seeking a 50% increase in the military budget to US$1.5 trillion. These fiscal demands come on top of the weaker revenue base resulting from the tax cuts and rebates that Trump’s signature budget law of last year promised.
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Growing unease in the bond market over the US fiscal position is making the need for additional revenue more urgent. In mid-May, the US Treasury had to accept a yield of 5.046% on its bonds, the highest since 2007. The administration needs to convince financial markets that it has the fiscal position under control. To do so, it needs significant new revenue, which, given the political difficulty of raising taxes, tariffs are currently among the few ways to generate revenue.
The Trump administration is serious about ramping up trade actions. Vietnam has come under pressure, for example. The US Trade Representative has described Vietnam as a “Priority Foreign Country” on intellectual property rights — this is a status reserved for nations with “the most egregious IP-related acts, policies, and practices with the greatest adverse impact on relevant US products”.
It is the first time in 13 years that a country has been so described, suggesting that the US is now willing to reach deep into its protectionist toolkit to justify its trade aggression. Vietnam is probably just the first of many targets for a new trade campaign by the US.
Europe’s concern is more with China
Separately, Europe’s agitation over China’s growing export competitiveness is reaching a critical level. The Industrial Accelerator Act could allow it to use coercive measures to get exporters such as China to set up production facilities in Europe and to transfer technology to Europe.
There is growing angst in Europe over Europe’s industrial base being undermined as a result of China’s trade strategy. Europe saw its solar panel industry collapse as a result of Chinese competition and is now watching in horror as its once-impregnable position in automobiles is upended. In addition, Europe’s trade deficit with China has burgeoned to US$113 billion in January to April this year, up by around a quarter from the same period in 2025.
It is determined to fight back and intends to do so by going beyond traditional complaints to the World Trade Organisation and the use of anti-dumping levies. In moves seen as targeting China mainly, the European Commission has drafted new rules requiring companies in sectors such as chemicals and industrial machinery to diversify their supply chains. The European Trade Commissioner, Maros Sefcovic, is reported to have prepared tariffs on Chinese chemicals and machinery imports.
For its part, China has vowed to retaliate vigorously against these planned measures, setting the stage for an ugly trade confrontation in the coming weeks.
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Trade shifts make these disputes harder to resolve
First, Europe, the US and many other countries increasingly view China as pursuing an asymmetric and unfair trade strategy. Its ‘Made in China 2025’ and China’s ‘dual circulation’ strategy have been highly successful, but they are widely seen as aiming to make other economies more dependent on China while reducing China’s own dependence on them in high-value sectors. As a result, many believe conventional trade measures are no longer effective and that stronger measures are needed to change China’s approach.
Second, the other related change in recent years has been the far greater focus on national security and resilience of supply chains. This policy concern has been reinforced by what happened with the closure of the Strait of Hormuz, which exposed how reliant the rest of the world was on the Persian Gulf region as a source not only of oil and gas but also of aluminium, helium and fertilisers. Governments are now even more determined to reshape their economies so as to preclude excessive reliance on limited sources of key items.
A third change is in what policymakers understand as the drivers of export competitiveness. China’s recent export success is not just due to low costs but to its incomparable economies of scale, its long-term investments in frontier technologies and its success in creating complex ecosystems that others cannot easily replicate, such as the Pearl River Delta in China.
Further complicating things is a fourth factor: we are in a world where the normal equilibrating mechanisms that help to mitigate the effects of a country achieving immense competitiveness are not operating as they previously did. Previously, a successful exporter would see its currency appreciate, and its domestic costs rise as rapid growth in its export sector consumed scarce domestic resources of labour and other factors of production. But this is not happening in China’s case:
Far from appreciating, China’s yuan has actually depreciated significantly in recent years. Since the pandemic ended in late 2022, the real effective exchange rate of the Chinese yuan (a measure of underlying currency value) has fallen by around 13%, when China’s growing export prowess should have caused it to appreciate.
Rather than rising, China’s domestic costs have been driven down by deflation due to its overcapacity and overinvestment. So, the gap in cost competitiveness between China and its trading partner is not closing; it is actually widening.
In the past, it might have been possible for, say, European governments to negotiate with individual Chinese companies seeking to export their goods to Europe and press them to locate production in Europe and transfer technology. But the Chinese state has tremendous control over its private sector companies and is unlikely to allow this equilibrating mechanism to work either.
Finally, underlying all this is a more fundamental set of imbalances, arising from structural and policy features of the big economic powers:
The US has been a chronic undersaver, and this is getting hugely worse. In April, the personal saving rate fell to 2.6%, compared to the 2000-2019 average of 5.2%. The US government is dissaving, as a result of its burgeoning fiscal deficit. That brings its national savings rate down, just as the huge success of its technologically proficient companies is resulting in its investment share of GDP rising. The gap between America’s investment and savings is therefore widening. That means that its external deficit will grow, fuelling policymakers’ concerns.
On the other hand, the EU is underinvesting. Its overregulated economy is deterring private investment, leading to chronic underperformance in productivity and technological progress, which are important underpinnings of export competitiveness.
Finally, China is underconsuming or oversaving. Its household sector is saving more — the bursting of the real estate bubble destroyed wealth, which has to be rebuilt by cutting back on consumption and raising savings. Inadequate social safety nets and weak income growth also restrain consumption.
These imbalances are deeply rooted in the structures of these three economies. Reducing the imbalances which lie at the heart of trade disputes cannot be achieved quickly or easily.
Only an intense negotiation involving major compromises by all the major parties can resolve these disagreements. But the increased distrust among the big powers does not encourage the kind of give-and-take needed to work out a new grand accord.
In the mid-1980s, the threat of a trade war pitting the US against export powerhouses such as Japan and Germany was averted by the Plaza Accord. In essence, the successful exporting nations agreed to allow their currencies to appreciate substantially, which eventually helped to bring the US trade deficit under control. But that was an agreement among the Western powers who shared common values and were strategically dependent on each other. The relationship among the US, China and Europe does not have these factors that would allow for a compromise.
The World Trade Organization (WTO), which might have had a role in mediating to find a compromise, is in no condition to do so. America has undermined the WTO through its vetoing of judges for the WTO’s arbitration function, while its unilateral trade war has marginalised the WTO as a forum to work out trade issues.
Southeast Asia needs better coordination to address this
The region will soon face the grim reality that the new trade war will expose it to collateral damage: the US and Europe will view exports from the region containing Chinese components as a means of China indirectly exporting to their markets.
Countries in the region need to step up diversification of their economies in order to better withstand worsening trade frictions. But the real upside will come not from individual actions but from Southeast Asian countries better coordinating their trade strategies so that they can negotiate collectively with these far more powerful trading powers. Asean will also need to work together with other friendly parties, such as Japan and South Korea, to gain strength in numbers.
Unless it does these, it will be a party with limited bargaining clout, and Southeast Asia will not be at the top table of global negotiations on trade. As Canadian Prime Minister Mark Carney said, if you are not at the table, you will be on the menu. That is a fate Asean must avoid.
Manu Bhaskaran, CEO, Centennial Asia Advisors
