The Trade War Is Here to Stay

The trade war is not going away any time soon. All the signals are flashing for a worst-case scenario in which both sides harden, a resolution becomes further and further out of reach, and the damage compounds.

There's a growing awareness that a full-blown trade war might be the new reality, and not simply a tactic intended to pressure the Chinese into making trade concessions. The conventional wisdom on the building trade conflict had seemed to be that Trump was using tariffs to bring the Chinese to the table in order to get a trade deal that corrected the unbalanced trade relationship. Particularly after the failure of the most recent round of trade talks, this should finally be revealed as wishful thinking. Even Trump himself seems to have given up on issuing empty reassurances that the dispute is weeks or days away from a resolution. Many economists and other commentators are still unsure about where this is all headed, but increasingly signs are pointing to a long war that could do substantial damage to both sides, and to the larger global economy.

Ernst doesn’t see a trade deal happening this summer (Politico)

Trump's easy trade war hits snags as China plays the long game (Bloomberg)

China Faces New ‘Long March’ as Trade War Intensifies, Xi Jinping Says (NY Times)

Trump’s Tariffs, Once Seen as Leverage, May Be Here to Stay (NY Times)

The consummate dealmaker, in his usual fashion, has painted himself into a corner, having exhausted his very small repertoire of negotiating tricks (threats and tantrums). He did not think through the possibility that a negotiating party might have self-respect and refuse to submit to bullying, even if doing so is costly. He is notorious for never retreating, even in the face of overwhelming resistance and evidence that he was wrong. If he were to back down now, it would show weakness, in part because it would represent an admission that he was wrong on tariffs and trade to begin with. It is now painfully obvious that Trump has no endgame. This was clear even before the trade escalation began - if trade wars are easy to win, why bother with a lot of needless contingency planning?

Both Trump and the Chinese leadership are willing to be patient on resolving the trade conflict. The Chinese are tired of dealing with an unhinged, totally unreliable negotiating partner, and are willing to play the long game and wait this one out. Xi is planning on a much longer time frame than the 2020 election. Trump, to the extent that is he exercising any strategic or long-term thinking, has repeatedly stated that it is worth a perhaps substantial investment of time and economic burden to correct a disadvantageous trade relationship that has been bleeding the US dry for a generation or more (refs). It doesn't really matter whether this is true - the Republican congress has ceded all of its authority to Trump, so his thinking (however confused and ill-informed) is the only opinion that matters. 

There are other troubling signs that Trump will stick fiercely to his guns on trade issues. He firmly believes that the current tariff situation is in itself a positive outcome ("Tariffs will bring in FAR MORE wealth to our country than even a phenomenal deal of the traditional kind"), even better than a conventional trade deal. It would be easy to interpret these statements as typical Trump hyperbole, a crude attempt to put a positive spin on a bad situation. But in combination with other things we know about Trump's view on trade and relationships in general, they very worryingly suggest that Trump really is fine with just doing this tariff thing for a while. It is still not entirely clear whether he actually believes that China pays for US tariffs. My suspicion is that he did truly believe this for most of his life until some point in his presidency when many advisors pointed out to him that this was not the case. But unable to deal with the embarrassment of admitting, even implicitly, that he was tragically wrong on such an important issue, he is using his well-developed powers of deceit and distraction to create an alternative reality instead of reckoning with the one at hand.

I suspect that the mainstream view of the expected damage from this conflict is a dramatic under-estimation of how much a protracted global trade war could weigh on the global economy. My instinct is that the current discussion of the worst-case scenario still falls well short of the mark. Many estimates of the potential economic fallout are remarkably glib ("UBS economists estimate that hiking Trump tariffs to 25% on $200 billion in imports would cut U.S. annual economic growth by 0.2% to 0.35%, but the hit would come in the first six months. This excludes an as-yet unknown Chinese response.") Stock markets have been wary of the conflict but have largely still assumed that the dispute will be resolved with a trade deal, and therefore have not priced in the full effects of a long trade war. Some Wall Street analysts, though, have started to make the case that this view is dangerously misguided - when the reality begins to set in, stocks could get hammered.

Remember that, despite the existence of a whole industry devoted to forecasting, economists are remarkably bad at predictions, particularly of the type we are dealing with here - rapid and very damaging disruptions of an existing positive trend. These predictions sound a lot like the predictions about the housing market in the run-up to the last financial crisis, when the consensus view was that trouble in the housing market would slow growth but remain contained.

Economic models are typically not good at predicting highly dynamic shock-type events. A full discussion of the reasons why this is the case could occupy a whole long article on its own - suffice it to say for now that there are a number of reasons this is the case:

  • such models typically rely on linear relationships
  • they almost never include multiple mechanisms, coupling, feedback and other such features present in highly complex systems
  • there is cognitive bias towards a view that the economy can be managed, and away from the idea that it or other systems can spin violently out of control

The US-China trade relationship is such a prominent feature of the world economy that any model of trade war effects that does not include multiple secondary and systemic effects simply is not credible. The economic mainstream has gotten it disastrously wrong on these kinds of events before, and there's no reason to think that the proper lessons have been learned from those failures. The effects of a long trade war could be much, much worse than most economists are predicting. Like the housing bubble, this trade conflict could be the event that dangerously destabilizes the global financial system to the brink of collapse.

Update (May 30, 2019): the outlook is rapidly worsening. Trump is now moving to place punitive tariffs on Mexico over the immigration issue. More tariffs on EU countries are probably not far behind.

Update (June 1, 2019): Analysts are now saying that we might be at the beginning of a decades-long new Cold War with China