U.S.-China Trade War: A Zero-Sum Game Doomed to Fail?
How tariffs, rare earth bans, and game theory are reshaping global trade.
Game theory posits that rational actors will act in their self interest to maximize their aims, but will back down when factors no longer preserve their self interest. Or if the actors do not trust each other, will act unilaterally and create a “prisoner’s dilemma” or “zero sum game” where one side has to “win” at the expense of the other. The U.S.-China trade conflict, now in its seventh year, has evolved into a textbook example of a non-cooperative game — one where two rational actors, locked in a struggle for economic and technological supremacy, prioritize unilateral self-interest over collective aims. The risk of escalation is a protracted stalemate (with no winners) or a continued escalation where the hawk backs the dove into a corner to force concessions and “win” the game.
What began with tariffs on steel and solar panels has spiraled into a multi-front trade war where the U.S. has imposed 245% duties on a vast array of imports from China while forcing export bans on advanced semiconductors (the AI diffusion rule). China for its part has retaliated with industrial subsidies, 125% tariffs on U.S. goods and cutting off exports of essential rare earth metals. The result? A costly stalemate that economists warn could reshape globalization itself and drive the world in a recessionary spiral.
While the U.S. has initiated the “trade war” can we assume that rational actors will eventually reach a “Nash-Equilibrium”? The Nash equilibrium is a state in which no player has an incentive to unilaterally deviate from their chosen strategy, given the strategies of their counterpart. In practice, this means both sides may settle into a mutually suboptimal but stable pattern of behavior, as any unilateral concession would be exploited by the other. This has generally been true in U.S.-China trade relations over the past 10 years, as U.S. companies remain entrenched in China and China exports a large number of goods to the U.S., incentivizing mutually beneficial outcomes and efficiencies of labor, capital, IP sharing and finished goods.
The philosophical justification that has chaotically emerged from the U.S. administration for these new round of tariffs is to “level the playing field”. Yet, the U.S.has long tolerated a deficit in exporting goods with its trading partners in exchange for a surplus in services. The current U.S. administration posits that trade deficits and imbalances gut its manufacturing base and hurt domestic industries. But these are structural issues, and cannot be corrected overnight when the industries in question rely on complex global supply chains, some of which were reconfigured from the previous trade wars (e.g., Apple moving more i-phone production to India or retailers to Vietnam).
Moreover, the U.S. has long maintained dollar supremacy that allows it to run trading deficits with countries, who also sustain the dollar’s strength through their longstanding purchases of U.S. treasuries. And the U.S. debt problem cannot be fixed with tariffs as the slowdown in trade and imposition of higher costs for businesses will offset any small gains in tariff collections.
Meanwhile, in classic game dynamics, China and Japan have begun liquidating U.S. Treasuries, elevating yields and increasing the cost of American debt financing. This has alarmed the U.S. administration as it conflicts with their aim of lowering interest rates and threatens the dollar as the world’s reserve currency. While the U.S. has announced exemptions and pauses for select trading partners and for critical sectors including semiconductors, energy, and solar panels, the markets have rejected these ad hoc corrections and have punished game participants across the board.
The overarching effect has been to inject uncertainty into global supply chains and reduce business and consumer confidence. American tech giants such as NVIDIA, Apple, and Broadcom which remain deeply reliant on Taiwan’s TSMC are itself exposed to geopolitical risk. To complicate matters, China announced a restriction of rare earth exports which are essential for electric vehicles and the semiconductor industry. The AI critical NASDAQ 100 is shedding a fifth of its value as technology firms such as Microsoft recalibrate their data center and chip investments while Nvidia and AMD confront new export restrictions. Silicon Valley will surely feel these knock on effects through slowing of venture capital investments, IPOs, and M&A’s, particularly in the red hot AI race.
At the Economic Club of Chicago, Fed Chief Jerome Powell cautioned that tariff-induced inflation could place the Fed’s dual mandate in jeopardy, as lowering rates to support growth would likely exacerbate price pressures. The administration reacted with threats to fire the Fed Chairman. Yet, the administration, for its part, has articulated no coherent endgame beyond vague references to ongoing trade negotiations with various countries such as Vietnam and Japan. But while it continues to ratchet its rhetoric against China, it is not likely that China will make significant concessions in the near term which conflict with its state mandated goals.
So who blinks? Will we reach a new Nash-Equilibrium that stabilizes markets albeit with reconfigured global supply chain and trading blocs or will increased escalation spiral the global economy in a prolonged recession?
