The Case for “Avalanche Decoupling” From China: Planning for Dramatic U.S. Action in a Crisis Will Make One Less Likely

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The Case for “Avalanche Decoupling” From China
Containers and cargo vessels at the Qingdao port in Shandong province, China, May 2022China Daily / Reuters

By Eyck Freymann and Hugo Bromley

As tensions rise in the Taiwan Strait and the South China Sea, U.S. efforts to deter Chinese aggression suffer from a fundamental credibility problem. The United States has conventional and strategic tools to deter Beijing, including the threat of punishing economic sanctions. But China is much too big and integrated into the global trading system to expel it from the world economy overnight. A sudden economic break between Beijing and Washington would be devastating for the United States and catastrophic for the rest of the world. Financial panic and supply chain disruptions would fracture the international economic order and undermine U.S. leadership. China might calculate that the United States would be unwilling to take such risks—or that even if it tried, the rest of the world would resist U.S. pressure to choose between the two powers.

Punishing Beijing for unprovoked aggression would be essential to maintaining U.S. credibility and leverage, but it would have to be balanced with U.S. interests. These include preserving macroeconomic and financial stability, dollar hegemony, and a functional and rules-based international trading system, as well as breaking U.S. and allied dependence on the Chinese market. Even in an extreme crisis scenario—for example, if Beijing attacked U.S. bases in East Asia during an invasion of Taiwan—attempting a total and immediate economic decoupling from China would be a costly and dangerous gamble. It would subordinate all other U.S. interests to a punishment strategy that might not even work.

But there is another option. Rather than threatening economic Armageddon if China crossed U.S. redlines in East Asia, Washington could offer an affirmative vision for how the international economic system can evolve to protect the vital interests of the United States, its allies, and third countries. This vision should include a U.S.-led allied agenda to protect economic security in peacetime, as well as a contingency plan to broaden and accelerate that program during and after a potential crisis of Chinese aggression.

The plan is “avalanche decoupling.” If Beijing crossed one of Washington’s redlines, the United States could work with its allies to manage the resulting global financial crisis, reshore critical supply chains away from China as fast as possible, and trigger a ratcheting trade policy to unlink noncritical supply chains over the longer term. The plan would also initiate the creation of an Economic Security Cooperation Board, a new institution with membership open to all countries except rogue states such as Iran, North Korea, Russia, and of course China. The ESCB would ensure that the decoupling process was rules-based, driven by market forces rather than command and control, and protective of its members’ national and economic security interests, while acknowledging that most countries would continue to trade with both the United States and China. A credible U.S. commitment to this kind of economic leadership during a crisis would not only help stabilize the international economic system but also potentially transform it in a way that benefited most of the world at China’s expense.

GRASPING THE THREAT

U.S. policymakers must understand that even if rapid decoupling hurt China more than the United States, it would still cause the American economy massive economic pain. Small businesses would bear the worst of it, but every sector would be affected. For example, if the United States suddenly prevented China from importing commodities such as soybeans, global prices would collapse, plunging U.S. farmers into crisis. China also represents nearly one-third of global manufacturing, and most of the world’s supply chains depend in some way on at least one component or machine made in China. Deliberately disrupting these supply chains would lead to an inflation crisis far more severe than the one that followed the COVID-19 pandemic. The U.S. Federal Reserve would face an impossible choice between raising interest rates, which would contain skyrocketing inflation but put millions more Americans out of work, or keeping interest rates low, which would protect employment but risk entrenching high inflation.

A crisis of this scale and scope is impossible to model with precision, but the United States’ closest allies are probably even more vulnerable. One major study from researchers at the University of Hyogo and Waseda University found that if Japan’s imports from China dropped by 80 percent for two months, Japan could suffer a ten percent hit to its GDP. European economies would also be crippled. Volkswagen, for example, has a significant part of its supply chain in China and sells 40 percent of its cars there. Australia sells nearly one-third of its exports to China. Saudi Arabia and other major oil exporters would be similarly vulnerable to a collapse in prices if China’s energy imports were restricted. Because of these risks, Washington should not assume that even its closest allies would be willing to go along with maximum economic punishment—even in the most extreme conflict scenario. U.S. partners might even publicly undermine U.S. sanctions threats in the run-up to a crisis, just as they did in the months before Vladimir Putin’s full-scale invasion of Ukraine in February 2022.

The United States would also have to consider the effect of its economic response on financial markets. The outbreak of a confrontation between the United States and China would trigger a moment of economic uncertainty greater than the Wall Street crash of 1929 or the collapse of Lehman Brothers in September 2008. The best historical reference point is the outbreak of World War I, when markets faced “paralysis,” as then British Permanent Secretary of the Treasury John Bradbury put it, and the London Stock Exchange closed for six months.

China is too big to expel it from the world economy overnight.

If the U.S. threat against Chinese aggression is to shatter global supply chains rather than to reassure markets, paralysis will quickly turn to panic. At first, the United States would probably suffer less than the rest of the world, because in times of geopolitical crisis, investors usually sell risky assets and buy assets perceived as safer—including U.S. Treasury bonds. But global stock markets would still plummet, and without decisive intervention the global financial system could collapse. U.S. attempts to impede third parties’ trade with China through sanctions or blockades would trigger a geopolitical backlash. Neutral countries and private firms, driven by economic self-interest, would likely find ways to circumvent such restrictions to maintain access to China’s vast market.

Furthermore, China is adaptable. Beijing uses capital controls to keep money inside the country and has over $3 trillion in declared foreign exchange reserves. With these tools, Beijing could probably insulate its banking system from a sudden shock. China has also amassed vast stockpiles with enough oil, food, minerals, and semiconductors to feed its economy at somewhat normal levels for months or even years, even if maritime trade were completely curtailed. Beijing could also buy commodities from Russia and other neighbors by land or even receive deliveries by air. And if necessary, China could ration food and energy to civilians to sustain its war machine.

Economic deterrence thus requires convincing Xi Jinping of two key points: that the United States can impose devastating and durable economic costs on China despite potential challenges, and that the United States would not respond to a crisis in a way that undermined its own interests and created opportunities for Beijing. The United States must show Xi that it has a credible plan to achieve full economic decoupling over time if necessary—and that the strategy for achieving this goal would not only serve U.S. interests but also benefit allies and neutral partners in the short and long term.

SETTING PRIORITIES

Rather than brandishing threats of economic devastation, the United States should focus on communicating its affirmative vision for international economic order. The driving force behind that vision should be respect for the sovereign right of states to safeguard their economic security within a rules-based international framework. China needs unfettered globalization to sustain its broken economic model, but for the United States international trade is not an end in itself. Trade can bring prosperity, but sovereign security interests come first.

The domestic markets of the United States and its closest allies would anchor this vision. Australia, Canada, Japan, the United Kingdom, and the United States together represent 40 percent of global demand. No matter how much the Trump administration reduces the U.S. trade deficit, U.S. consumers will remain by far the largest market for most of the world’s manufactured goods. China, in contrast, represents just 15 percent of global demand, and it runs a large structural current account surplus—exporting vastly more than it imports. As China fights to sustain its growth model against increasingly challenging economic headwinds, it has come to depend on other countries deindustrializing and buying Chinese goods instead. And because Beijing has proved unable and unwilling to rebalance its economy toward domestic consumption, this trend seems set to continue. The United States and its allies can therefore offer most countries something that China cannot: rules-based access to sell into their markets, and thus a pathway to future prosperity.

To strengthen deterrence against Chinese aggression and to prepare for a potential crisis, the United States and its partners must break their dependency on China for critical products. This effort must start now, and there must be a plan for a crash reshoring of critical production if a crisis breaks out. China is already pursuing its own version of this policy, through efforts to create industrial and technological self-reliance in goods such as semiconductors. Most traded goods are not critical, however, and decoupling those goods outside a crisis would be strategically unwise.

Even in a crisis, trying to “friend-shore” supply chains for noncritical goods would be both economically inefficient and geopolitically problematic. The best way to pull noncritical production out of China would be through a fair, market-driven process overseen by robust, U.S.-led institutions that can protect the global economy against China’s dumping and other predatory behavior. An affirmative vision for order after a rupture in global trade requires a clear plan to build such institutions over time, potentially starting before a rupture occurs.

The U.S.-led vision for a postcrisis economic order should hold to four principles. First, Washington would reshore critical production as fast as possible but impose no restrictions on noncritical supply chains on day one of the crisis. Second, the United States would maintain dollar hegemony. Third, it would not ask other countries to decouple from China, and it would build its own decoupling into a wider program of economic support open to all countries, including neutrals. Finally, when third countries would inevitably be found illegally transshipping goods from China across the U.S. border, Washington would commit to enforcing its anti-China trade policy against them in a rules-based manner, subject to appeal and external adjudication.

GAINING MOMENTUM

Building on these principles, we propose the contingency plan, avalanche decoupling, which the United States could enact unilaterally in response to a crisis triggered by Chinese aggression. The plan would leave noncritical supply chains open initially, while setting a longer-term decoupling process into motion through two policy pathways. The first is a system of automatically ratcheting tariffs or quotas on products and parts produced in China. The second is the Economic Security Cooperation Board, which would have two intertwined mandates: providing direct dollar support to member states and supporting its members’ enforcement of discriminatory trade policies against nonmember states.

In this plan, no country would be forced to decouple from China, and any decoupling would take place nominally in compliance with World Trade Organization rules. In the United States, Congress would revoke China’s Permanent Normal Trade Relations status. It could also modify Section 232 of the Trade Expansion Act of 1962, which gives the president broad authority over tariff policy, to label trade with China as a “systemic national security threat.” On this basis, Congress or the president could set in motion an indefinitely ratcheting tariff on trade with China in goods and services. Congress could design the tariffs to increase at different speeds for different products and industries, depending on the complexity of the supply chains involved and the difficulty of reshoring them. This approach would avoid unnecessary shortages of noncritical goods while credibly signaling to all companies selling capital markets that they need to make immediate plans to exit China’s market. If these ratcheting tariffs were enshrined in U.S. law, removing them would require bipartisan agreement in Congress, not just an executive order, which would enhance their credibility.

Core allies such as Australia, Canada, Japan, and the United Kingdom would likely join the United States by imposing similar measures. The European Union would be unlikely to pursue full decoupling because responsibility for trade policy resides in Brussels, and it may be hard to get consensus for decoupling from all 27 European Union member states. Still, it would be advantageous for Washington to coordinate closely with Brussels and other important trading partners.

Trade can bring prosperity, but sovereign security interests come first.

The ESCB would provide an institutional framework that combined direct support to member countries, modeled partly on the Marshall Plan’s Economic Cooperation Administration, with a new rules-based process to support accurate reporting of trade with China. Members would not need to decouple from China themselves, but they would have to meet minimum rules of origin requirements set by the United States and other donor nations. The ESCB would help member states strengthen customs enforcement and provide an independent mechanism for determining whether a state was failing to enforce the rules of origin requirements. Any country found to be systematically noncompliant would lose access to the ESCB’s economic support. If violations continued, the ESCB would work with the United States and its core partners to determine whether that country, as a systemic transshipment point for Chinese goods, would also be subject to the discriminatory tariffs in a specific product or overall. The ESCB could also play a crucial role in facilitating collective resilience against China’s economic warfare. If Beijing retaliated against any ESCB member state, the institution could potentially provide financial compensation to that state.

The power of the avalanche decoupling mechanism is that it harnesses market forces to create a process that gains momentum over time. As tariffs or quotas ratcheted up, firms would face growing incentives to move production out of China. The predictable schedule would allow them to allocate capital as efficiently as possible during this transition. Meanwhile, countries such as Brazil, India, and Nigeria, seeking both continued ESCB economic support and to attract new investment and employment in manufacturing, would be incentivized to strengthen their customs enforcement. Once firms made investment decisions based on the expectation of the ratchet, they would gain strong incentives to lobby against repealing or modifying the ratcheting tariff. They would also likely put pressure on countries where they had invested to meet the rules of origin requirements. If China retaliated through import or export controls, it would only accelerate the avalanche by confirming to the private sector that China’s market was no longer reliable.

As a deterrent, avalanche decoupling targets China’s real vulnerability—its export manufacturing base. China’s export sector employs nearly 100 million workers and constitutes nearly one-sixth of its GDP. China’s economy already faces strong structural headwinds, including industrial overcapacity and deflation. Beijing has no way to substitute the permanent loss of its largest external market. In the longer term, avalanche decoupling would aggravate the mounting challenges that China faces from an aging population and a growing debt, undermine the foundation of the country’s prosperity and social stability, and potentially put Xi Jinping’s vision for “national rejuvenation” out of reach. Furthermore, the mechanism is flexible and can be trialed in pilot form immediately. Pursuing avalanche decoupling for critical products like active pharmaceutical ingredients and drones would be a good start.

Avalanche decoupling offers something essential for effective contingency planning: an affirmative vision for how the United States would sustain and lead the international trading system if China forced a geopolitical rupture. Rather than trying to force countries into a binary choice, Washington would maintain an inclusive system that neutral parties could accept while continuing to trade with Beijing. The United States would be offering benefits to partners that an indebted, overcapacity-dependent China could not: short-term support in a time of profound economic uncertainty, and the long-term opportunity to develop by taking prize manufacturing jobs from China. After 30 years of breakneck globalization in a complex system of sovereign states, simple threats of punishment are no longer a viable approach to deterrence against China. But if U.S. economic contingency planning focuses on U.S. and allied interests and works with market forces rather than against them, Washington will be well placed to preserve peace and stability in East Asia and beyond.

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Eyck Freymann is a Hoover Fellow at Stanford University and Nonresident Research Fellow with the China Maritime Studies Institute at the U.S. Naval War College.

Hugo Bromley is an Applied History Research Fellow at the Center for Geopolitics at the University of Cambridge.

They are the authors of On Day One: An Economic Contingency Plan for a Taiwan Crisis.