The opening salvos have been fired and the body count could soon start piling up. No, I am not talking about the steel and aluminum tariffs announced by Trump a couple of weeks ago (which seemed to be more of a ploy to try and encourage favorable NAFTA/trade negotiations rather than a real act of ‘war’). Rather, the sides doing battle now are the world’s two biggest economic guns – the U.S. and China!
While the tariffs announced so far have been smallish contrasted against the $375 billion annual trade deficit the U.S. has with China (as reported by the U.S.), there is the threat that things could escalate quickly. To be sure, aggressive rhetoric is not only erupting out of Trump, which you would expect, but from China representatives as well.
“This is the first of many. This is number one, but this is the first of many.” Trump
“China is not afraid of and will not recoil from a trade war. China is confident and capable of facing any challenge….China would fight to the end to defend its own legitimate interests with all necessary measures.” Statement of the Chinese Embassy in the United States
Given that President Trump has previously pointed to the stock market rally as a celebration of his Presidency, it is a little surprising that he seems oblivious to the negative market movements that have coincided with his quest for tariffs. It has been 21-days since Trump shocked with “trade wars are good, and easy to win”, and there is scant evidence that any major financial market anywhere is remotely pricing in that trade wars are “good”. In fact, with U.S. steel stocks being hammered yesterday as still more countries were granted exemptions, Trump has injected volatility into the financial markets by first enacting tariffs and then additional volatility by allowing so many exceptions to the tariffs.
Quite frankly, with the exception of Director of The National Trade Council Peter Navarro, it is difficult to find anyone that works for President Trump that actually believes trade wars are “good”. Wilbur Ross spent yesterday trying to do some damage control, contending that tariffs are a starting point for negotiations and repeating that the President wants to quickly trim the trade deficit with China by $100 billion. But exactly how this number comes to fruition as each U.S. tariff is met with opposing tariffs isn’t at all clear.
“There will be some ultimate retaliation [from the Chinese] but I don’t think it’s going to be the end of the earth” Ross
As if to provide a comedic note to try and calm jittery financial markets, Ross added:
“It Is Not As Though We’re Blowing Them [China] Up…This Is Not Going To Put China Into A Depression. Not Going To Put Us Into A Depression.”
In short, the end goal for the U.S. is to use tariffs as a bargaining chip rather than an actual tool to reduce the trade deficit. Given that tariff missiles do no explode inside of a vacuum, it remains unclear if this goal can be reached without the brandishing of additional weaponry.
The Ongoing Trade War’s Potential Nightmarish End
While negative market reactions and tit-for-tat trade tariffs make for interesting reading, they alone are unlikely to usher in the next financial calamity. The reality is that be it currency rigging, government subsidies, or tariffs, “trade wars” are taking place all the time, and none of the tariffs announced to date warrant the type of media frenzy they have created.
This said, if the battle lines continue to be aggressively drawn the real threat is that a miscalculation by either side(s) will escalate the current spat into the land of U.S. debt (or the U.S.’s most important export). The idea of selling, or threatening to sell, U.S. Treasury Securities to spite a ruthlessly debt hungry (and now tariff starved) United States of America has smoldered to the surface during every major market kerfuffle since 2000, most recently with a report that China’s penchant for U.S. debt was waning.
“Financial markets were jolted Wednesday by a report that China — the biggest foreign holder of U.S. government bonds — could curtail its purchases, a shift that has spooked investors already leery of a rise in interest rates at the start of 2018.” January 10, 2018
Given that President Trump previously applauded the prospect of a trade war, one can only imagine what would come out Trump’s twitter-mouth if, and more likely when, the foreign threat of selling U.S. Treasuries to combat the U.S.’s new found bravado arises – “you don’t want to own our debt anymore? Fine, I’ll get Powell to print $21 trillion tomorrow…suckers!”
Incidentally, although foreign interests currently hold only $6.2 trillion in U.S. Treasury Securities (TIC) and China, the largest holder, owns only $1.1 trillion, Trump is probably smart enough to know that if you are going to monetize a few trillion you might as well print the entire $21 trillion and get it over with…
Just as U.S. policy makers have historically railed vocally against trade deficits only to concede that little can be done without unleashing unintended consequences, foreign holders of U.S. debt have criticized USD hegemony but done little to end it for fear of imploding the global economy. In short, Trump can indeed end trade deficits if he really wants to, and China can definitely end USD hegemony if it really wants to, but neither side is likely to enact their nuclear options given the theory of mutually assured financial destruction.
But while ‘end of the earth’ actions are unlikely from China or the U.S., the threat of such actions is plausible. And as wild market movements in recent days suggest, the mere mention of weaponizing U.S. debt by anyone could be enough to turn today’s somewhat cordial trade spat into something entirely more vicious.