How China got Trump to fold on tariffs
Yuan devaluation after April 2 sparked a broad EM sell-off that spilled back to the US
There have been many reversals on US tariffs since inauguration day on January 20. But there’s only one reversal that truly matters in the big picture, which is the one that followed the rollout of reciprocal tariffs on April 2. China played a pivotal role in this reversal, highlighting the leverage it has over the US. This post goes through what happened and draws lessons for the future.
China’s ultimate retaliatory weapon in the tariff confrontation with the US has always been currency devaluation. China used this weapon successfully in Trump’s first term, allowing the Yuan to fall 10 percent versus the Dollar, which was close to a full offset to US tariffs imposed at the time (the US tariffed half of all Chinese imports at 25 percent in 2018, pushing its average tariff rate up 12.5 percent).
The Yuan devaluation in 2018 ended up spilling over into a broad sell-off across emerging markets (EM), many of whom export to China and thus needed to devalue in sympathy to remain competitive. The scale of that volatility ultimately spilled back to the US, with S&P 500 falling 15 percent in Q4 2018, setting the stage for de-escalation of the tariff conflict and - ultimately - the Phase I deal with China.
Now look at what happened in April 2025. China had been keeping the Yuan more or less stable against the Dollar since inauguration day (black line). But - following the reciprocal tariff rollout on April 2 - it allowed the Yuan to fall against the Dollar. Just like in 2018, EM currencies reacted quickly and violently (blue line), falling sharply against the Dollar as well. This EM sell-off spilled back to the US, with ructions in the US Treasury market and a steep S&P 500 sell-off, setting the stage for the 90-day pause in reciprocal tariffs that was announced on April 9 as well as the subsequent de-escalation of the tariff confrontation with China.
The lesson from this episode - and the one in 2018 - is that China has huge leverage over the US. That leverage isn’t conventional retaliation in the form of its own tariffs or export controls, but currency devaluation. That devaluation destabilizes financial markets globally and in the US, ultimately helping to bring the US around on tariffs.
Two points are worth noting in conclusion. First, no other country has the kind of heft in global financial markets that China has. This means devaluation is potent as a retaliatory weapon only for China. Second, the sensitivity of global markets to Yuan devaluation is acute. After all, China devalued the Yuan against the Dollar only by around 1 percent in early April. A very potent weapon indeed.
The claims in this post probably deserve a longer reply, since there are so many assumptions about China’s currency management philosophy that are incorrect. But first let me remind everyone of what happened when China devalued in August of 2015. Capital flight increased; the effect could be even worse today because of the disappearance of FDI. That episode was a disaster for the Chinese economy and stock market, not the rest of the world.
Back in 2008 in Foreign Affairs (Reconsidering Revaluation) David Hale and I made two points: as long as China has a closed capital account, and a government-not a market-controlled exchange rate, it can never be a global financial superpower. Mundell’s Trilemma says you cannot have it all.
China is however a trading superpower, but almost all international transactions sooner or later touch the USD. What happened in April had many causes, but China was not in the driver’s seat because of a small devaluation of yuan—nor did the US react by “folding” to its devaluation threats.
Markets, including EM’s reacted to US-China tensions and broader macro fears, not exchange rates.
Finally, China might use its exchange rate as a tool, but the PBoC manages for stability, not global financial disruption.
Really glad to have you on here! Long form better than twitter! A few questions as time allows: What to make of EM not intervening to bring their currencies back in line with China’s? To what extent would a dramatic devaluation undermine China’s expressed goal to establish the Yuan as a reserve & trade alternative? Why is it the Yuan still pegged to USD in the first place given the impact our monetary policy choices inevitably have on THEIR economy? If tariffs globally can offset export competitiveness from
deval, what would deval do to consumers in a country that imports 40% of food, 60% of fuel and the low-margin manufacturers that must still import raw materials? Are financial markets and asset prices really all that matter or matter most in great power competition? Thank you, sir! And welcome to the platform!