President Donald Trump’s recent decision to pause tariffs for 90 days on most US trading partners – while escalating them to a scorching 125 per cent on Chinese imports – has sent a ripple through global markets and diplomatic circles alike. While the S&P 500 surged 9.5 per cent on the news, the real logic behind this move lies not in economics alone but in game theory – the strategic science of decision-making under competition and uncertainty.

This isn’t just trade policy. It’s a geopolitical chessboard, and Trump’s team is playing a high-stakes, multi-player game with sharp elbows and calibrated signals.

The Prisoner’s Dilemma of Global Trade

International trade disputes echo the prisoner’s dilemma, a foundational model in game theory. Each nation must choose whether to cooperate (uphold free trade) or defect (impose tariffs). When both cooperate, prosperity follows. But mutual defection leads to mutual harm – as seen during Trump’s earlier ‘Liberation Day’ tariffs, which triggered sharp market volatility, contributed to equity sell-offs, and heightened investor uncertainty, illustrating a suboptimal equilibrium.

By pausing tariffs on 75+ countries that refrained from retaliating, the US signals a conditional cooperation strategy – a step toward escaping a destructive tit-for-tat spiral. Game theory calls this the first move toward a better equilibrium.

Repeated Games and Trust-Building

Crucially, trade isn’t a one-off event. It’s a repeated game, where today’s move affects tomorrow’s response. Trump’s temporary détente offers allies a strategic off-ramp. Reducing tariffs on partners like the EU, Japan, and South Korea not only calms markets but opens a 90-day window for trust-building.

This move rewards restraint and sets up a framework for ongoing reciprocity – what game theorists call a trigger strategy: cooperate, and we’ll keep cooperating; defect, and penalties follow.

Strategic Signalling and Imperfect Information

The tariff pause is also a signal – a visible action meant to convey intent. Signalling theory suggests that rational players use costly moves to prove they are serious. Trump’s split strategy (carrots for friends, sticks for China) tells the world: ‘We’re open to trade – but not to being played.’

This matters because global trade operates under incomplete information. Players don’t know each other’s red lines or true resolve. Will the US really reimpose tariffs in 90 days? Is China bluffing with its 84 per cent retaliatory tariffs, or is it committed to an all-out trade war?

This uncertainty breeds caution – and increases the strategic value of clear, credible signals.

China as the Defector – and the Leverage Play

In this framing, China is the defector. Beijing’s refusal to compromise, combined with its nationalist ‘fight to the end’ rhetoric, makes it the outlier in an otherwise cautiously cooperative field. Game theory would predict harsh punishment in such cases to deter others from following suit.

Hence, the 125 per cent tariff – a dramatic escalation designed to create maximum negotiation leverage. Trump’s camp believes this economic pressure will ultimately force China back to the table. It’s a risky strategy rooted in coercive bargaining, where a player raises the stakes to force concessions.

But it also opens the door to a credibility trap. If threats aren’t carried out, they become meaningless. Yet if they are, the cost can spiral, entrapping both parties in a Nash equilibrium: a no-win stalemate where neither side can improve their outcome without making things worse.

The Allies’ Strategic Calculus

While the US and China dominate headlines, other players in this game – the UK, EU, Japan – are watching carefully. Game theory suggests they’ll behave like cautious third-party actors, hedging their alliances, diversifying trade, and delaying big moves until the fog of war lifts.

The UK’s statement that it will ‘negotiate coolly and calmly’ reflects a wait-and-see strategy, minimising exposure while gauging which side will ultimately prevail. In multiplayer games, this positioning can offer tactical flexibility – but risks being caught in the crossfire if polarisation deepens.

Implications for Australia

For Australia, the tariff pause offers both opportunity and complexity. As one of the US’s longstanding allies and a major trading partner with China, Australia sits at a critical junction. The 90-day reprieve on tariffs reinforces Canberra’s value as a cooperative partner, particularly given its firm alignment with Western trade norms and military alliances.

But Australia’s deep economic interdependence with China – especially in commodities like iron ore, coal, and agricultural exports – makes it vulnerable to prolonged US-China conflict. If the trade war intensifies, Australian exporters may be caught in the cross-hairs of retaliatory measures or shifting supply chains.

Game theory would predict that Australia, like other middle powers, will pursue a hedging strategy: signalling loyalty to the US while maintaining enough neutrality to avoid triggering Chinese retaliation. This tightrope act has become a defining feature of Canberra’s foreign policy in recent years – and this latest move by Trump only sharpens the balancing act.

However, should the US and China drift into long-term decoupling, Australia may be forced to re-calibrate. The country’s recent trade diversification efforts – including closer ties with India, Southeast Asia, and the UK – align with a game-theoretic strategy of reducing single-player dependency and increasing strategic flexibility.

Behavioural Game Theory: When Rationality Bends

Traditional game theory assumes rational actors. But behavioural game theory reminds us that national leaders aren’t machines – they have egos, domestic constituencies, and political calendars. Trump and Xi may act less out of strategic calculation and more from pride, pressure, or legacy-building. That unpredictability injects non-linearity into the game and makes escalation harder to contain.

In this context, Trump’s approach may echo Richard Nixon’s ‘madman theory’: project unpredictability to keep adversaries off balance. The risk? If everyone plays the madman, nobody backs down.

Conclusion: The Brinkmanship Continues

Trump’s mixed-strategy approach – carrots for compliant partners, a steel bat for China – follows game theory’s script. By rewarding cooperation and punishing defection, he’s trying to rewrite the rules of engagement. Yet with China locked in defiance, the world may be headed for a lose-lose stalemate unless one side finds a credible way to shift the game.

Whether this pause leads to lasting progress or merely delays a deeper crisis depends on three things: China’s next move, Trump’s consistency, and the world’s appetite for brinkmanship.

Because in trade wars – as in game theory – sometimes the biggest win is avoiding the game altogether.