President Trump shocked markets this week when he announced that a new, heavy round of tariffs on Chinese goods will take effect this Friday. Complacent markets had assumed that a trade deal would get done, that it was just a matter of sorting out the details. Now that is far from certain. Failing a last minute deal, which is certainly possible, the trade war is back. And it could get worse.
What most surprised me about the new trade war was not that it started, but that the mainstream financial media denied it was happening for so long. The media have consistently denied the impact of this trade war. Early headlines said that Trump was bluffing and would not follow through on the tariffs. He did. Later headlines said that China was just trying to save face and would not retaliate. They did.
Today the story line has been that the trade war will not have a large impact on macroeconomic growth. It will. The mainstream media have been wrong in their analysis at every stage of this trade war. And it did not see this latest salvo coming.
The bottom line is that the trade war is here, it’s highly impactful and it could get worse. The sooner investors and policymakers internalize that reality, the better off they’ll be.
For years I’ve been warning my readers that a global trade war was likely in the wake of the currency wars. This forecast seemed like a stretch to many. But it wasn’t.
I said it would simply be a replay of the sequence that prevailed from 1921–39 as the original currency war started by Weimar Germany morphed into trade wars started by the United States and finally shooting wars started by Japan in Asia and Germany in Europe.
The existing currency war started in 2010 with Obama’s National Export Initiative, which led directly to the cheapest dollar in history by August 2011. The currency war evolved into a trade war by January 2018, when Trump announced tariffs on solar panels and appliances mostly from China. Unfortunately, a shooting war cannot be ruled out given rising geopolitical tensions.
The reasons the currency war and trade war today are repeating the 1921–39 sequence are not hard to discern. Countries resort to currency wars when they face a global situation of too much debt and not enough growth.
Currency wars are a way to steal growth from trading partners by reducing the cost of exports. The problem is that this tactic does not work because trade partners retaliate by reducing the value of their own currencies. This competitive devaluation goes back and forth for years.
Everyone is worse off and no one wins.
Once leaders realize the currency wars are not working, they pivot to trade wars. The dynamic is the same. One country imposes tariffs on imports from another country. The idea is to reduce imports and the trade deficit, which improves growth. But the end result is the same as a currency war. Trade partners retaliate and everyone is worse off as global trade shrinks.
But the global trade war is not global at all but really a slugfest between the U.S. and China, the world’s two largest economies. In the realm of global trade, the United States is an extremely desirable customer. In fact, for most, we are their best customer.
But China has finally come to the realization that the trade war is real and here to stay. Senior Chinese policymakers have referred to the trade war as part of a larger strategy of containment of Chinese ambitions that may lead to a new Cold War. They’re right.
This trade war will not end soon, because it’s part of something bigger and much more difficult to resolve. This is a struggle for hegemony in the 21st century. The trade war will be good for U.S. jobs but bad for global output. The stock market is going to wake up to this reality. The currency wars and trade wars are set to get worse.
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