US-China Trade and the “Great Rebalancing”

The latest regulatory developments on economic security & geoeconomics

By Paul Nadeau, Visiting Research Fellow, Institute of Geoeconomics (IOG)

MOU Issued on Japan-U.S. Agreement: On September 4, U.S. Secretary of Commerce Howard Lutnick and Japan’s lead negotiator Ryosei Akazawa signed a memorandum of understanding (MOU) that detailed the agreement reached between Japan and the United States in July.

The MOU stipulates that the $550 billion Japan committed to invest in the United States should be allocated by the end of Donald Trump’s term in 2029, that the money go toward strategic sectors such as semiconductors, pharmaceuticals, critical minerals, shipbuilding, liquid natural gas (LNG), artificial intelligence (AI), and quantum computing, and that a committee would be established by the president and chaired by the Secretary of Commerce to oversee the investment and make recommendations, aided by a consultation committee consisting of delegates from Japan and the United States. The United States will propose projects for investment and Japan will have two months to respond and transfer the necessary funds into a special purpose vehicle (SPV) that the United States will create for each investment. Japan may refuse to participate in a project, but in that case the United States may raise tariffs on Japan in response to that refusal. Profits will be split evenly between the Japan and the United States up to the point where Japan has recouped its investment, at which point Japan will receive 10 percent of the profits and the United States will receive 90 percent. Akazawa said that the agreement remains unsettled, pointing to expected presidential orders on most-favored-nation status for pharmaceuticals and semiconductors which have still not been issued.

Japan Expands Sanctions on Russia: On September 12, Japan expanded its sanctions program against Russia by freezing the assets of 14 individuals and 51 organizations and lowering its price cap on Russian crude $47.60 from $60 per barrel, originally set at the 2022 G7 summit and now in line with the cap set by the European Union in July as part of its 18^th sanctions package, though still not as low as the most recent price cap (see below). Japan also continues to buy Sakhalin Blend crude, a byproduct of liquefied natural gas production at the Sakhalin-2 project, which accounts for about 9% of Japan’s LNG imports.

EU Updates Dual Use Control List: The European Union announced an update to its control list of dual-use items on September 8. The updated list adds controls related to quantum technology, semiconductor manufacturing and testing equipment and materials, advanced computing integrated circuits and electronic assemblies, and more.

Trump Administration Eases Path to Enacting Future Deals: On September 6, the Trump administration issued an executive order to exempt graphite, tungsten, uranium, gold bullion and other metals from April 2 tariffs while keeping tariffs on silicone products in place. The move is believed to make it easier to adjust tariffs on aircraft parts, generic pharmaceuticals and other products that can’t be grown, mined or naturally produced such as coffee and certain spices, consequently making it easier to enact bilateral trade deals with negotiating partners.

State Department Sanctions NGOs for Assisting ICC On September 4, the U.S. State Department announced sanctions on three foreign NGOs for having directly engaged in efforts by the International Criminal Court (ICC) to investigate, arrest, detain, or prosecute Israeli nationals without Israel’s consent. The announcement was made pursuant to the executive order initally imposing sanctions on the ICC.

OFAC Sanctions Chinese Chemical Company for Opioids: On September 3, the U.S. Treasury Department’s Office of Foreign Asset Control (OFAC) announced it would sanction Guangzhou Tengyue Chemical Company, a chemical company operating in China that is involved in the manufacture and sale of synthetic opioids to the United States and analgesic chemicals often used as cutting agents that are mixed with synthetic opioids and other illicit drugs.

BIS Relaxes Syria Sanctions: On September 2, the U.S. Commerce Department’s Bureau of Industry and Security announced a final rule relaxing existing restrictions on exports and reexports to Syria of previously restricted items by revising certain license application review policies, expanding existing license exemptions, and adding new license exemptions.

Canada, EU, UK Lower Price Cap on Russian Crude: On September 2, the United Kingdom and European Union announced that they were lowering the price cap on seaborne Russian crude oil from $60 to $47.60 per barrel. Canada announced that it would do the same shortly after to coordinate with the UK and EU price cap.

OFAC Targets Iran Oil Exports through Iraq: The U.S. Treasury Department’s Office of Foreign Asset Control (OFAC) announced that it would sanction a network of shipping companies and vessels led by Iraqi businessman Waleed al-Samarra’i (al-Samarra’i) for smuggling Iranian oil disguised as Iraqi oil. The announcement builds on OFAC’s July 3, 2025 sanctions targeting the network of Salim Ahmed Said, which also smuggled blended Iraqi and Iranian oil and generated significant revenue for the Iranian regime.

Analysis: US-China Trade and the “Great Rebalancing”

By Andrew Capistrano, Visiting Research Fellow, IOG

Following talks this week in Madrid, it appears the US and China have reached a deal over ownership of the TikTok platform, which will likely be finalized during a Trump-Xi call scheduled for 19 September. Optimistic observers may interpret this development as signaling a détente in the wider US-China trade war, opening up the possibility for a bilateral agreement settling longstanding issues and reducing retaliatory tariffs. But while Trump’s tariff pause is now expected to be extended for another 90 days past the 10 November deadline, there are both strategic and structural reasons to remain skeptical that a grand US-China trade deal is in the making.

From a strategic perspective, buying time to make a deal is not the only rationale for Trump extending the tariff pause: another is that allowing talks to continue prevents an escalatory spiral in which China has significant leverage. Beijing has demonstrated its willingness to weaponize its dominance over critical mineral supply chains, such as withholding rare earth magnets when Trump imposed “reciprocal tariffs” in April. Washington has responded with plans for a $5 billion fund to support alternative mining sources, yet it will take years to establish the refining and processing capabilities needed to reduce dependence on Chinese suppliers.

China also has an interest in not returning to the tit-for-tat tariff retaliation seen in April. Exports have been the one bright spot for China’s post-property boom economy, and amid the trade war, exports to the US dropped an astonishing 33% so far in 2025. This has been made up by increased exports to other markets, with ASEAN up 22% and the EU up 10%, but there can be no guarantee these economies will continue to absorb Chinese manufacturing capacity over the long term. With domestic price wars making exports an essential source of manufacturing profits, China will need to keep US tariffs as low as possible until its economy stabilizes or alternative markets are locked in.

In short, both sides benefit more from the status quo of continued dialogue than they would from escalating the trade war. The real question is whether both sides prefer to extend the status quo indefinitely over settling their differences, making concessions, and reaching a deal.

However, from a structural perspective it is unclear whether a deal both sides prefer to the status quo actually exists, since it would presumably have to go beyond Trump’s first-term “Phase One” deal. Consider how Treasury Secretary Scott Bessent has described what a “great rebalancing” of the US-China relationship would look like: raising China’s consumption share of GDP, and simultaneously raising the US’s production share of GDP. That would mean China saves less, consumes more, and runs smaller trade surpluses; while America saves more, consumes less, and runs smaller trade deficits.

On the surface Bessent’s idea sounds like a “win-win” macroeconomic solution. Increasing Chinese domestic consumption has been a central aim of the 14th Five-Year Plan (2021-2025) under the “dual circulation” concept. But it has proven difficult to expand China’s consumption share of GDP without negatively impacting the slim profit margins and international competitiveness of its manufacturers, or else failing to hit the 5% GDP growth target. And while revitalizing US manufacturing is a bipartisan objective, Chinese competition is not the only reason for America’s domestic imbalances. After years of deindustrialization, it will require worker retraining, massive investment, and infrastructure spending to increase the production share of GDP in the US. This might only be possible with a much higher savings rate, at the risk of a sustained shock to the consumption-driven economy.

Therefore, any grand US-China deal would not settle the domestic imbalances at the heart of the trade dispute. To form a stable equilibrium, a trade deal would need to be accompanied by costly structural adjustments on both sides, transforming their economic models and rebalancing consumption and production internally to support a new external balance in terms of trade and capital flows.

Yet global imbalances are deeply entrenched, and represent what might be called a “stable disequilibrium” — a situation in which every actor knows these imbalances are unsustainable, but none has an incentive to drastically alter its economic model. China cannot consume more without political reform that would redirect income from manufacturers to households, and the US cannot save more without triggering a recession. Since every country’s external balance must mirror that of its trading partners, US openness absorbs China’s surpluses, and China’s growth model deepens America’s deficits.

Consequently, the roots of US-China trade frictions are structural. Trump may have disrupted the international trading system and started trade disputes with his unorthodox tariff tactics, but these tactics should be separated from the real problem of global imbalances that had been building up long before his first term in office. Because the WTO system lacked an adequate mechanism to deal with persistent beggar-thy-neighbor economic policies, it could be argued that — one way or another — a great rebalancing was inevitable.

In this context there are three basic ways the international trading system could be rebalanced. First, there could be an “orderly rebalancing” effected through multilateral coordination and the creation of a new set of rules that constrain beggar-thy-neighbor practices. Theoretically, such a system might require persistent deficit countries to depreciate their currencies, and persistent surplus countries to allow their currencies to appreciate, thereby enforcing a stable equilibrium — call it a “self-enforcing WTO”. The model would be something like the creation of the Bretton Woods institutions in 1944, where such a mechanism was proposed but never adopted. Of course, the Bretton Woods system emerged in the aftermath of a world war, and it is unlikely that similar cooperative institutions could be established today given the current state of international relations.

A second path would be a “disorderly rebalancing”, where markets themselves drive abrupt global corrections via financial or debt crises that lead to capital flight, funding pressures, and forced austerity. It is not necessary to explain here how costly and destructive such a “black swan” event would be to domestic economies as well as world trade, and the instability that follows could force political changes within nations or even trigger wars.

The third would be “unilateral rebalancing”, of which Trump’s disruptive approach to trade is one example. Although it clearly violates WTO rules, governments are able to unilaterally choose economic sovereignty over economic integration and try to correct their external imbalances through a combination of trade and industrial policies. In fact, there is not much distinction between the two, since when domestic industrial policies alter the internal balance between consumption and production, the effects are transferred externally via shifts in international trade and capital flows. It is this effect that is the true backdrop to the US-China trade dispute: China’s economic policies negatively impact US industrial ambitions, and Trump’s attempt to regain control with tariffs threatens China’s economic model.

Importantly, unilateral rebalancing can occur slowly, with minimal disruption, or it can trigger a rapid chain of events that leads to outright decoupling, thereby resembling disorderly rebalancing. This is the reason why a status quo of continued US-China trade talks and relatively stable tariff levels is preferable to unpredictable escalation: slow-motion rebalancing allows time for each side to “de-risk” and reduce their economic dependencies on the other. In fact, this process has been ongoing since Trump’s first-term tariffs on China, which were retained under Biden. And since there is no self-enforcing trade deal that could adjust US or Chinese internal imbalances, it appears likely that the least-worst outcome will be the current status quo or a limited face-saving “deal” that does not change the unilateral rebalancing trajectory. If Trump were ever to truly use all the tools at his disposal to force a correction in the US trade and capital accounts, or decouple from China, the current disruption would be mild by comparison.

Nevertheless, in a world of unilateral rebalancing, other states — particularly those that prospered under the rules-based trading system — face an unenviable challenge. Doing nothing means maintaining their current economic openness, absorbing the effects of global imbalances, and allowing their domestic economies to adjust to the industrial policies of their trading partners. For instance, the repercussions of the US-China trade war are impacting the EU, as Chinese exports are rerouted to the European market and US tariffs make European exports more expensive in America. The EU will have to eventually decide whether the costs of economic openness are greater than the cost of pursuing its own unilateral rebalancing.

But crucially, there is a middle path between Trump’s version of economic unilateralism and clinging to the WTO-era vision of rules-based global trade. Even if other major economies are pursuing unilateral policies, aligned states could still opt into a kind of sub-global trade arrangement amongst themselves. In this scenario, “multilateral rebalancing” would be orderly but not attempt a transformation of the international trading system as a whole: it would allow trade between economies that agree to surrender equal levels of control over their external balances, in order to obtain the mutual benefits of classical “free trade”. The idea of a trade agreement between the EU and CPTPP might preserve trade rules at a sub-global level, for example, although bloc members would still need to undertake some internal rebalancing of consumption and production for it to be viable. The key point is that this would be done in a way more cooperative and orderly than is currently possible at the global level.

As difficult as embracing unilateral or sub-global multilateral approaches may be, unless governments take action, the alternative could be worse. Either the US and China will force other states to absorb the shock of their rebalancing — if not decoupling — or markets will impose discipline in a more disorderly fashion.

From a historical standpoint, global imbalances always unwind eventually. Today’s paradox is that the longer the disequilibrium persists, the more fragile the system becomes, and the closer it moves toward a disordered “great rebalancing” that neither the US nor China can control.

（Photo Credit: Shutterstock）

Disclaimer: The views expressed in this IOG Economic Intelligence Report do not necessarily reflect those of the API, the Institute of Geoeconomics (IOG) or any other organizations to which the author belongs.

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