The U.S. and China announced a 90-day suspension of mutual tariff escalations, lowering “reciprocal” duties from a staggering 145% to just 10%, with remaining U.S. levies (notably a 20% fentanyl-specific tariff) holding total duties at 30% on Chinese imports.

Markets surged. Nasdaq futures jumped 3.7%, the Dow rallied 840+ points, and Brent crude popped nearly 3%. But underneath the optimism lies a fragile standoff—a textbook case of iterated prisoner’s dilemma at global scale.

This isn’t peace. It’s a Nash equilibrium forged under duress, sustained by mutual pain and bounded rationality.

Game Theory Lens: Iterated Prisoner’s Dilemma

In a single-round prisoner’s dilemma, the dominant strategy is defection. But in iterated interactions, the payoff matrix shifts. Reputation, retaliation, and future expectations matter. Cooperation becomes rational if players value future payoffs more than short-term gain.

US-China trade fits this model. Since 2018, both nations have toggled between cooperation (market access, tech sharing) and defection (tariffs, blacklists). Each tariff hike brought a symmetric response—mirroring the “tit for tat” strategy that often defines iterated games.

Now, both sides have adopted temporary cooperation—not from trust, but strategic necessity.

Why This Ceasefire Happened Now

1. Mutually Assured Economic Disruption

By late 2024, the economic pain became undeniable:

• China was facing factory shutdowns on a 2008 scale. Cities like Foshan saw air fryer and sofa manufacturers laying off hundreds, with workers sleeping in parks to save money.
  

• The U.S. confronted bond selloffs and investor panic. The Treasury market recoiled when reciprocal tariffs hit, threatening the dollar’s safe-haven status.
  

A feedback loop had emerged: tariffs hurt both sides, and financial volatility imposed costs neither side could ignore.

2. Political Realignment

The U.S. sidelined trade hardliner Pete Navarro and elevated Treasury Secretary Scott Bessent—a moderate economist—to lead talks. Bessent’s Geneva summit with Chinese Vice Premier He Lifeng resulted in the tariff pullback. In game theory terms, this was a pivot from grim trigger strategy (permanent defection) to tit-for-tat with forgiveness.

Notably, both sides retain leverage:

• The U.S. preserved its fentanyl-focused tariffs.
  

• China can still throttle rare earth exports or shift procurement to allies.
  

The temporary nature of the truce reflects a Nash equilibrium: no side can unilaterally improve its position without risking greater retaliation. Both accept a suboptimal, but stable, outcome.

Strategic Signaling and Face-Saving

In game theory, signaling is critical when information is incomplete. Both China and the U.S. structured the deal to preserve ambiguity:

• China lowered tariffs uniformly—signaling equality, not weakness.
  

• The U.S. framed the deal as a win for fentanyl control, preserving political capital.

Each side publicly emphasized domestic benefits, while privately conceding enough to keep trade flowing. This duality is classic game-theoretic signaling: say one thing, play another.

Economic Pressure as a Rational Constraint

Despite strongman rhetoric, both sides are bounded by economic interdependence.

From China’s Side:

• Top U.S. exports to China include soybeans, crude oil, and semiconductors—key inputs for Chinese growth.
  

• Firms like Gongyuan Furniture and Shenzhen appliance makers resumed operations as U.S. orders returned, despite absorbing some tariff costs.

From the U.S. Side:

• Top Chinese imports—electronics, transmission gear, and batteries—are critical to U.S. manufacturing.
  

• Cutting China out would spike costs in sectors like EVs and defense tech.
  

The chart below shows the persistent U.S. trade deficit with China—but also how reliant both are on bilateral flows:

Even as the trade war escalated, bilateral trade volume remained high. Interdependence reduces incentives for long-term defection.

The Shadow of the Future: Strategic Diversification

In repeated interactions, the shadow of the future—a concept explored in depth by Pedro Dal Bó (2005)—refers to how the prospect of future engagement incentivizes cooperative behavior today. When players value future payoffs highly, they are more likely to cooperate now, even at short-term cost. Sustained cooperation becomes a rational equilibrium, not a moral choice.

Applied to U.S.-China trade, both sides are playing a long game. Despite public saber-rattling, each is adjusting strategy to preserve optionality in future rounds.

Both sides are now investing in alternatives:

• China is accelerating outbound trade with Africa, ASEAN, and Latin America.
  

• U.S. companies are nearshoring to Mexico and Vietnam, and pouring capital into semiconductor self-sufficiency.

This mimics the strategy of hedging in game theory: reduce exposure to a single adversary to gain flexibility in future rounds.

But diversification has limits. Most supply chains, from rare earths to iPhones, still run through the Pacific. The result? Delicate mutual reliance—akin to a Nash equilibrium where exit is costly, and cooperation, however imperfect, remains the dominant long-term strategy.

Investor Implications

This ceasefire is not peace. But for dealmakers, it offers:

• Stability in valuation assumptions for U.S.-China-exposed assets.
  

• Reactivation of supply chains in consumer durables, tech, and industrials.
  

• A 90-day window to price risk, secure shipments, and plan capital deployment before the next inflection.

Expect deal activity to return in sectors most hit by tariff volatility—particularly EVs, consumer electronics, and intermediate goods.

The Bigger Game: Tech Hegemony

At root, this conflict isn’t just about tariffs. It’s about control over the 21st century’s economic levers—AI, chips, and EVs, and this is not an ending game, it is an infinite one, as the NVIDIA CEO called it “an infinite race”.

U.S. strategy centers on containment: limiting China's rise in advanced tech via export controls and investment bans.

China's strategy focuses on self-sufficiency, plus image management. Beijing now positions itself as the stable partner for global trade—undercutting U.S. alliances with Europe and Asia.

In this broader game, the tariff truce is a mere move—not an endgame.

Will Cooperation Hold?

Mark Williams of Capital Economics nailed it: “There is no guarantee that the 90-day truce will give way to a lasting ceasefire.”

And that’s by design.

In iterated games, temporary cooperation is sustainable only if defections are punished and future payoffs remain high. Right now:

• Both sides are watching for slippage.
  

• Investors are cautiously optimistic, not euphoric.
  

• Each round becomes a trust test.

Unless structural issues—tech bans, capital flows, WTO disputes—are addressed, the default path remains escalation.

Conclusion: Truce as Nash Equilibrium

This 90-day pause represents a fragile equilibrium. Neither side “won,” but both retreated from collapse. In game theory terms, they’ve reached a local maximum—suboptimal, but preferable to mutual destruction. The next move will depend not on goodwill, but whether either side believes defection yields a better payoff. Until then, cooperation—tense, tactical, temporary—prevails.

Bottom Line for PE & M&A Professionals:

• Use this truce window to assess China exposure in portfolios.
  

• Watch for nearshoring trends in manufacturing-heavy targets.
  

• Be prepared for another pivot—this isn’t the final round (because there is no final round, is an infinite game).

Sources & References

BBC. (2025). Faisal Islam: US and China deal is significant, but not an end to the trade war. https://www.bbc.com/news/articles/cvgv5n00e0jo 

BBC. (2025). Relief on China's factory floors as US tariffs put on hold. https://www.bbc.com/news/articles/cy8d9ygd4yqo 

Bó, P. D. (2005). Cooperation under the Shadow of the Future: Experimental Evidence from Infinitely Repeated Games. The American Economic Review, 95(5), 1591–1604. http://www.jstor.org/stable/4132766 

CNBC. (2025). U.S. and China agree to slash tariffs for 90 days in major trade breakthrough. https://www.cnbc.com/2025/05/12/us-and-china-agree-to-slash-tariffs-for-90-days.html 

El Pais. (2025). Five charts that explain the US-China trade relationship. https://english.elpais.com/economy-and-business/2025-04-11/five-charts-that-explain-the-us-china-trade-relationship.html 

US Census Bureau. (2025). Trade in Goods with China. https://www.census.gov/foreign-trade/balance/c5700.html