A year after the ‘Liberation Day’ tariffs, the US–China trade relationship looks more peaceful than many expected. The constraints of mutual dependence have proven strong enough for both parties to keep the trade-war ceasefire. President Donald Trump’s Beijing visit in May reinforced that impression, with both sides agreeing to build a ‘relationship of strategic stability’.
But as long as China perpetuates its overdependence on external demand, this can only be a stalemate, not a true end of hostilities. Other countries, meanwhile, may become more active in seeking to counter China’s manufacturing dominance.
Imbalances continue to widen
Despite headwinds from US tariffs, China’s 2025 trade and current account surpluses as a share of China’s gross domestic product reached their highest level since 2009 (Figure 1).
Figure 1. China’s external balances widen anew
% of GDP, as of 1 January 2025
Source: Macrobond, State Street Investment Management, Oxford Economics
When assessed against global ex-China GDP (to adjust for China’s growing weight in the world economy), the imbalance looks even starker. Last year, the rest of the world ran a trade deficit with China equivalent to 0.8% of its combined GDP, a new record high (Figure 2). By comparison, at the peak of Japan’s manufacturing dominance, the rest of the world’s trade deficit with Japan reached a one-time peak of 0.6% in 1986.
Figure 2. China’s trade surplus reached new highs in 2025
China’s trade surplus as a share of global ex-China GDP, %, as of 1 January 2025
Source: Macrobond, State Street Investment Management, Oxford Economics
China’s domestic demand deficit
China’s external surpluses are the combined result of both its impressive manufacturing prowess on the one hand and its languishing domestic demand on the other. While China’s growth rate has been relatively stable at around 5% over the last several years, trade has accounted for a larger share of that growth than had been the case before Covid-19. With the property sector still languishing, consumer spending seems unlikely to rebound meaningfully. If so, Chinese growth will either naturally moderate further, or external demand will have to continue to act as a bridge.
Figure 3. External demand still key driver of Chinese growth
%, as of 1 January 2026
Source: Macrobond, State Street Investment Management, China National Bureau of Statistics
China’s external surpluses are problematic
While this dynamic can temporarily work, if prolonged, it could become an existential threat to China’s trading partners’ manufacturing ambitions. The modest (though uneven) decrease in China’s external imbalances that characterised the second half of the last decade has more than reversed.
Despite stated intentions to reorientate the economy towards domestic demand, there is no compelling evidence that this is occurring. Instead, the data suggest a geographical redistribution of a growing imbalance across a wider group of economies (Figure 3).
Figure 4. China’s trade balance with select trading partners
$tn, as of 1 January 2025
Source: Macrobond, State Street Investment Management, International Monetary Fund
Is Europe the next front?
While China’s trade surplus with the US has shrunk greatly in recent years, its trade surplus with the euro area has more than doubled since 2020 (from $95bn to $216bn). The relative shift is even starker. In 2020, China’s trade surplus with the US was more than three times the size of its surplus with the euro area; by 2022, it was roughly twice as large. Last year, it was just 30% larger.
This is an extraordinary shift that does not appear to receive sufficient attention in European capitals, nor, for that matter, in many other capitals around the world.
On current trends, an EU–China trade war seems only a matter of time, though it may still take a while to snowball. Geopolitical fracturing means more reliance on domestic and regional demand everywhere. The US is a more closed economy than a decade ago, and Europe will have to follow suit.
Simona Mocuta is Chief Economist and Elliot Hentov is Chief Macro Policy Strategist at State Street Investment Management.
This is an edited version of an article first published by SSIM.
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