Trade war all fun, games until the next crisis hits

Back in June, when Donald Trump announced tariffs on US$50 billion in imports from China, only the most starry-eyed trade optimist would believe that the trade dust-up between the world’s two largest economies would end there; after all, Washington was already busy drawing up a list of more Chinese things to tax.

So Monday’s salvo — another US$200 billion in goods will be subject to a 10-per-cent levy starting next week, bringing the total tariff target to about half of Chinese exports to the U.S. — could hardly be characterized as a surprise. Nor could Trump’s threat to hit another US$267 billion in imports if China should have the temerity to retaliate (it did), an extension that would basically tariff all Chinese imports.

Give the U.S. president this much: he quite often follows through on his threats, no matter how stupid they are. Maybe that’s why investors largely shrugged off yet more stupidity on the trade front, with major world indices recovering and then some after a small dip on Tuesday.

Trump being Trump, one supposes it’s all just to be expected, and whatever damage the tariff escalation might do may have already been baked in to stock prices. Also, it could have been worse: the U.S. tariff level is only 10 per cent — which is not 20, or 30, or whatever. And China’s retaliation was relatively contained: at US$60 billion, it comprises only a partial tit for Trump’s full tat.

So there you have it. Just another day in Smoot-hawley 2018: The Sequel, coming to a store or a factory line or a car dealership near you — at least, it will be coming near you, if Trump makes good on various threats against not only China, but other trading partners, too, including Canada.

Of course, China is the primary target. The Trump administration’s original rationale for tariffs involved the massive trade deficit the U.S. had with the Middle Kingdom, which it believes (erroneously) is some kind of debt americans have to pay. One small problem with that, though: under Trump, and even after the imposition of the first round of tariffs, the U.S. deficit arising from trade in goods has got only more massive. Which is not surprising, given the strengthening greenback under the hiking Federal Reserve and the temporary boost to consumption from the Republican tax cut. It’s also not surprising because importers aren’t stupid: when they know or believe that prices are going to rise in the future thanks to impending tariffs, they are going to stock up. And that apparently is what they’ve been doing.

So the fact is, the Trump tariffs have actually increased the U.S. trade deficit with China. But never mind, the president assures the world that they are the best way to convince Beijing to “end their country’s unfair trade practices,” which he and his trade adviser Peter Navarro believe are the reason for the trade deficit in the first place. (They are not.)

At this point, the only real question about Trump and trade policy isn’t whether, but how much — as in, damage to the global economy. To this point, investors seem to be largely discounting the impact. But that might end up looking like a short-sighted view.

Clearly, the Trump administration believes China is in a weak position. (It seems to believe that about Canada and the European Union, as well.) And that might be true: Chinese growth is slowing, its stock market has taken a pummelling, and the yuan has depreciated against theu.s. dollar by almost 10 per cent since the spring. Export growth is also tapering off — although it’s still in the 10-per-cent annual range, and the devalued currency will only help support that.

Personally, I doubt the Chinese economy is as weak as Washington believes, but even if it is, trade is less of an opening to take advantage than it used to be. Between 2006 and 2017, trade’s share of Chinese GDP fell from nearly 65 per cent to less than 40 per cent, according to the World Bank. Trade with the U.S., in nominal terms, has also soared during that period, by about 75 per cent, but China’s GDP has grown by more than 3,000 per cent over the same period.

Still, a full-on trade war with China, in which the U.S. taxes everything, could shave as much as a percentage point off GDP growth, by some estimates. (Let’s leave aside the adverse impact on U.S. GDP, which could be substantial.) That’s not nothing. And it could slow Beijing’s efforts to engineer its evolution into a consumption-led economy, while prolonging the legacy of credit expansion, support of stateowned enterprises and rot in the financial system.

It’s worth remembering, too, one big contributing factor to China’s indebtedness: the Great Recession. When it hit in 2008, Beijing embarked on a massive fiscal stimulus plan, plowing hundreds of billions into higher government expenditures, bank lending and infrastructure mega-projects. That might seem like profligacy now, but the stimulus — more than 13 per cent of GDP at the time — not only cushioned the recession’s blow domestically, but also created a huge surge in demand that effectively pulled the world economy up by its bootstraps.

Here’s the point: undermining China’s position as a support for global growth injects risk into the system, and that’s what Trump’s tariffs are doing. If and when the next global meltdown comes around, a trade war will make China less able to pick up the slack. In an economic crisis, a country might or might not get by without friends — but you sure as heck need trading partners.