“The purpose of the trade war can be found in this mathematical model, which was developed during the Cold War between the US and the USSR. In initiating a trade war with the US’s geopolitical allies Canada, Mexico, and now the EU, Trump is forcing a non-cooperative game on his trading partners without any negotiation or restraint,” Sylvester Eijffinger, Emeritus Professor at Tilburg University wrote on April 4 in a column for the Centre for Policy Research, a London-based thinktank.
What is game theory? Game theory is a field within mathematics that is applied to strategic decisions, from wars to corporate negotiations. Nobel Laureate John Nash built on earlier works and proved, in 1950, that two rational parties acting only in self-interest don’t lead to an optimal outcome. It is best illustrated in the popular example called the prisoner’s dilemma.
In this example, two prisoners are being interrogated separately for a crime. In the Prisoner’s Dilemma:
If both prisoners choose to confess and betray the other, both of them get the worst punishment.
If both prisoners choose not to confess, they both get a relatively lighter sentence.
If one prisoner betrays and the other cooperates, the betraying prisoner is released, and the cooperating prisoner receives the harshest sentence.
Therefore, the optimal outcome for both prisoners is not to act in self-interest and not to confess. This is called the Nash Equilibrium. However, the dilemma occurs because both prisoners are tempted to confess to the crime, as it may lead to full freedom if the other person has not.
Application of game theory in geopolitics
Game Theory was applied extensively during America’s Cold War with the Soviet Union.
In 1969, then-US President Richard Nixon used the same theory to threaten a nuclear attack on Vietnam in a bid to end the war that was draining American resources without moving towards an outcome that it wanted. Nixon’s attempt failed, and the war continued till 1975.
Trump himself used the same strategy to better effect against North Korea, in August 2017, repeating the threat of a nuclear attack on Pyongyang after the Asian country tested intercontinental ballistic missiles. Eventually, Trump would meet North Korean dictator Kim Jong Un in June 2018. While the meeting didn’t achieve the US objective of ending Kim’s nuclear ambitions, Trump supporters would argue that he managed to drag the South Korean dictator towards diplomacy more than any other US President before him.
Is Trump using game theory to contain China’s rise?
Many suspect that Trump may
be attempting something similar to contain China’s rise as an economic superpower. He has raised the stakes with the highest tariffs in over a century, followed by threats of even higher import duties on Chinese imports in response to retaliation from the Xi Jinping administration.
What does Trump want from China? “President Trump acted with conviction to impose tariffs on imports from China, using that leverage to reach a historic bilateral economic agreement,” a White House statement dated February 1 said.
A tariff war is not necessary for a trade deal. What the US wants to curb is China’s growing global influence. Building a world-beating infrastructure, helped by low wages and a suppressed currency, that allows manufacturing at scale, at competitive prices, makes China a key supplier for almost anything important in the modern economy — from chemicals to smartphones to critical minerals and green technology, to name a few. One of the things Trump wants is for China to appreciate its currency, which would make its manufacturing less competitive.
China would want to displace the US as the world’s biggest economy by nominal GDP. It’s already bigger than the US by purchasing power parity, which measures domestic production and living standards.
The rise of China has been the biggest challenge to American hegemony in nearly a century, and Trump wants to reverse that as much as he can. “Tariffs are taxes that are necessary in times of an international great power conflict to assure domestic capabilities for production,” billionaire investor Ray Dalio argued in a recent post.
The US still has an edge over China in semiconductor manufacturing, military might, and geopolitical alliances (at least until Trump unleashed tariffs even on friendly countries). It would want to maintain the lead, even if it requires stopping China’s progress by, say, limiting access to advanced semiconductor chips, and other such measures.
At the same time, Trump wants the US to rebuild its manufacturing base at home to reduce dependence on China. It’d be a tougher game as long as China has the advantage of a cheaper currency, low wages, and a more centralised economy where even private enterprises are directed by the government’s priorities.
What’s the Nash Equilibrium in the US-China trade war
Game theory would suggest that the optimal outcome for the world’s two biggest economies can be achieved if both refrain from acting only to protect their domestic economies. The question is who will blink first?
China is the world’s second-biggest holder of US bonds, after Japan. Beijing held over $759 billion worth of US treasury bonds at the end of December 2024, second only to Japan, whose stock amounted to nearly $1.06 trillion. China’s stock of US debt could be bigger than $1 trillion after accounting for the unknown sums that China holds via custody accounts in Europe, Robin Brooks, a senior fellow at Brookings Institution, a Washington D.C.-based think tank, told the British publication Telegraph on April 7.
Essentially, China has invested enough in US debt that it gives it leverage during its negotiations with the US. If Xi Jinping orders his folks to dump a sizeable chunk of US bonds in the market, Trump will face a surge in borrowing costs and destabilise his government. The US Federal Reserve can step in to save the day, but as Dalio has already warned, America’s debt, at over $36 trillion (over 3 times its GDP), is already ‘dangerously unsustainable’.
In comparison, China’s debt-to-GDP ratio was 60.5% in 2024. However, its economy is too dependent on the US for exports. Owning a trillion dollars’ worth of debt in one country also means that Xi Jinping has a stake in keeping the US far enough from bankruptcy. China’s own economy is sluggish, which would limit Xi’s ability to raise the stakes.
As I argued in a column in January 2025, the two countries have an incentive to reach a ‘cold accord’ instead of starting another war, cold or hot.
A US-China alliance may be in line with how archrivals Britain and France teamed up against Germany ahead of World War II.
For China, it would end the uncertainty of tariffs, at a time when the world’s second-largest economy is in the doldrums. China can strike a deal that allows it to continue to trade with the US and have a sphere of unchecked influence, one that doesn’t overlap with that of Trump’s America.
If Trump and Xi reach a pact, Russia will have to spread its soldiers thinly across its 4,300-kilometre-long border with China, which has been contested in the past. The pact would help limit Moscow’s desire to expand its territory for a longer period. Putin may agree to end the war if the US gives up on its wish to include Ukraine in the North Atlantic Treaty Organisation (NATO)which Trump doesn’t like anyway.
However, such a pact between the US and China will have profound implications for the rest of the world. You can read more about it here.
