Is this the beginning of a costly trade war?
It looks that way. China earlier this week announced new tariffs on 106 US products including cars, whisky and soybeans. The announcement follows a proposal by the US Administration to target several Chinese imports for tariffs. On Thursday night, President Trump ordered his Administration to consider tariffs on an additional $100 of Chinese imports. China responded that they will fight US on trade “at any cost”.
Because of the trade frictions the major market indexes hit new lows for 2018 on Monday and moved back into correction territory (down more than 10% from the high). The market moved down again of Friday on the renewed trade rhetoric.
A trade war between the world’s two largest economies could put a damper on both the promising US and global growth trends. It could cause rising prices and take a chunk out of GDP at home. Globally, it could hurt the economies of places like Japan and Europe just when they are really starting to break out of a multiyear slump.
This has always been a looming danger to the market ever since President Trump took office after having railed against trade agreements and trade practices of our major partners. That danger just got real.
And go figure, the market hates the whole idea.
Since trade issues are driving the market right now, here’s my take. Generally speaking, the core tenants of US trade policy were formed with a Cold War mentality. The idea was to press our economic advantage over the Soviet Union and gain geopolitical advantage by spreading prosperity to forge strong alliances. The main ingredient behind these agreements was Cold War strategy rather than US economic well being.
Now, here we are 27 years after the end of the Cold War with a bunch of lopsided agreements that disadvantage the US economically. China is the poster child of lopsided trade policy. We’ve opened up our economy to them and we buy their stuff like crazy. Exports to the US, more than anything else, built China into the economic behemoth it is today. We recently ran $500 billion yearly trade deficits with the country. That’s $5 trillion over a 10 year period at the current pace.
Meanwhile, China makes it nearly impossible for US businesses to do business there and reap the rewards of the economic strength we fostered. They close markets to many of our products and shamelessly steal intellectual property as a cost of doing business. They manipulate currencies and play all kinds of nasty games to further press their advantage.
Why do we tolerate it?
After all, China is far more dependent on our economy than we are on theirs. Restrictive US trade policies could really sink their economy. Sure, a trade war will hurt us too, but not nearly as much as them. And don’t forget, their authoritative government could have a tenuous hold on power if things turn south.
But the main weakness of Western culture, and American culture in particular, is a penchant for short term thinking and instant gratification. Standing up to China is like standing up to the bully at school. You may get in a tussle. You may even get your butt kicked. But it’s a small price to pay of ridding yourself of the bully.
Our leaders have been unwilling to pay any kind of a short term price, and China knows it. There’s always an election coming up. Past leaders have been unwilling to endure any kind of economic hit or the alienation of powerful donors from the business world.
There are also whole ecosystems benefiting from current trade policies. If you upset the status quo, it’s like disturbing a wasp nest. Crazed people run around and try to sting you and make the politics of any change very difficult.
This country finally appears to be making a stand. I believe if we stick to our guns China will bend, but not before they feel they’ve sufficiently tested all the bluff out of us. Ultimately, fairer trade relations with China will be beneficial to the US economy and the market. But we will likely have to endure some short term turbulence in the process.
Market selloffs are healthy. If we get an exaggerated selloff because of trade frictions, so be it. The process will benefit the long term trajectory of the market. And, in the end, that is what truly matters.
Forget what all those crazed wasps are saying, this trade confrontation is a good thing, and long overdue. The market appears nervous, but the likely outcome will be that the trade frictions make stocks cheaper in the short term on the way to better long term fortunes.
Tom Hutchinson is a Wall Street veteran with extensive investing and finance experience.
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