President Trump’s Truth Social post today was a furious reaction to China’s major expansion of rare earths-related export controls earlier this week. Trump said that the U.S. is considering a “massive increase” of tariffs on Chinese goods as well as other “countermeasures.” He implied the potential for expanded U.S. export controls, noting that “for every element that [China has] been able to monopolize, we have two.” He also implied that he is inclined to cancel a meeting with President Xi Jinping notionally planned to take place in South Korea on October 30.
This is a very dangerous moment for global supply chains, including those powering AI, but it is important to note that neither side has yet implemented its threatened measures. There is still a window to back down, and Trump faces significant political risks if he follows through on his threats (loss of a TikTok deal, no hope of China buying U.S. soybeans, risks to U.S. auto and aerospace supply chains from China rare earth controls, and of course worries about U.S. markets and inflation). Watch to see if Secretary Bessent’s channel to Chinese Vice Premier HE Lifeng can help de-escalate before the action-reaction cycle starts for real.
How We Got Here
China’s expansion of its rare earth controls on October 9 was partly a reaction to the U.S. Commerce Department’s announcement on September 29 that it will implement a long-anticipated “affiliates rule,” aka “the 50% rule.” The rule means that if the U.S. has imposed export controls on a particular company (Chinese or otherwise), export controls now also automatically apply to their subsidiaries if they hold 50% of equity or above. In practice, this is a major broadening of the scope of U.S. controls, impacting exports – including of semiconductors and semiconductor manufacturing tools – to hundreds of Chinese companies.
In response, China’s Commerce Ministry issued four orders that collectively mark a massive expansion of China’s control over rare earths and related technologies – at least in intent, with much depending on implementation. Any product around the world that contains at least 0.1% Chinese-made rare earths by value must receive a license from China to be exported to a third country (this is similar to how the U.S. has used the Foreign Direct Product Rule to restrict the flow of third-country goods and services to firms such as Huawei). Perhaps even more provocatively, China also announced that it reserves the right to approve the export of rare earths used in the production of semiconductors at 14 nanometers and below – in effect saying that Beijing will exert its own control over the global semiconductor supply chain, much as the U.S. has done through a different segment of the supply chain (design and manufacturing technology).
While China’s moves are thus an effort to match the U.S. export control regime, they are disproportionate response to the 50% rule and one that Trump and others in Washington regard as an act of hostility. It matters that this came at a time when Trump was already on the defensive over the hit to U.S. farmers from China’s refusal to buy U.S. soybeans unless the U.S. lowers tariffs on Chinese goods.
It is not clear to us whether Beijing miscalculated or is playing hardball, but one critical ingredient in the mix is the very palpable sense of confidence that China’s leadership feels vis a vis the United States. We picked this up on our recent China trip, and it has been repeated in conservations with interlocutors. That confidence comes from several factors, including Trump’s earlier de-escalation of export controls after China’s rare earth restrictions threatened U.S. auto and aerospace supply chains, as well as Trump’s backing down from 100%+ tariffs on Chinese imports in May. Trump may have to prove Beijing wrong for this calculus to change.
Advances in Chinese AI models and even some domestic advanced semiconductors have also contributed to Beijing’s swagger, as seen in China’s chilly attitude towards allowing Chinese firms to buy Nvidia chips. Indeed, we believe one of Beijing’s key motivations is forcing Trump not to impose additional restrictions – and probably to loosen existing restrictions, such as on high bandwidth memory – on China’s semiconductor sector at a time when domestic firms are starting to make inroads in advanced chips, but still face several years before they are capable of manufacturing competitive chips at scale.
Where Things Could Go
Neither leader benefits from a re-escalation of tensions, whether in terms of tariffs or export controls. For Trump, the risks include:
- Wobbly U.S. markets and the risks of inflation and goods shortages from sharp tariff hikes
- Loss of China’s approval of the TikTok sale just as it reaches the finish line
- No hope of Chinese purchases of U.S. agricultural goods, or a Boeing deal now under negotiation
- Disruption to U.S. auto, aerospace, and semiconductor supply chains (among others) from China tightening rare earth exports.
Xi Jinping runs the risks of hurting an already shaky Chinese economy and of looking as though he has mismanaged the U.S. relationship, all as he looks toward a fourth term in office in late 2027. U.S. chip controls could also set back China’s own AI and chip aspirations at a critical time.
Because neither side has really implemented threatened measures (the 50% rule, China’s new rare earth controls, and Trump’s latest threats today), there is still a window to back down before the action-reaction cycle kicks into gear in full. We would watch to see if Treasury Secretary Bessent and Chinese Vice Premier HE Lifeng speak in coming days, utilizing a channel that has recently been effective. It is not certain the Trump-Xi meeting is off, as it would be an important juncture to lower tensions and calm global markets.
But there are clear risks for escalation, in which case we are back to a dynamic of the two sides determining who has “escalation dominance.” As always, that is a question not only of economics but also political tolerance, in which case Trump is generally more vulnerable than Xi due to the nature of the two countries’ political systems.
The potential pathways for escalation include:
- U.S. hikes on tariffs on China, with China responding reciprocally (replay of the post-Liberation day tit-for-tat).
- U.S. imposes controls on jet engines, industrial chemicals, and semiconductor inputs to China. China responds by tightening rare earth exports, hurting U.S. auto, aerospace, and semiconductor/AI supply chains.
- If the tit-for-tat continues unabated, a risk that the U.S. imposes financial sanctions on China. Bessent will be cautious about using this tool unless as a last resort, given the likely tumult for global markets.
