In a note written on Monday, ahead of today’s latest escalation by the US which unveiled a list of $200BN in incremental tariffs sending risks assets sharply lower and yet which was perfectly expected and previewed both here and elsewhere as it was part of Trump’s escalating tit for tat trade war strategy as summarized in this chart shown first nearly three weeks ago…
… Standard Chartered’s new head of Global G-10 FX strategy Steven Englander made an accurate prediction: more tariffs are coming.
Englander first’s point is that last Friday, as the original $34BN in tariffs were unveiled officially launching the trade war, is that shortly afterward, investors took a benign view of the first round of tariffs, for three reasons:
- The US economy has a strong head of steam; China’s economy is somewhat sideways or faltering a bit and its financial markets have been under pressure, leaving the US asset market more resilient
- The current round of tariffs will likely have small effects
- The EU is sounding more conciliatory
And, as he correctly added, these three factors also provided the Trump Administration with incentives for a more aggressive round of tariff imposition, for the following two reasons:
- The tariffs so far are politically popular even in agricultural and industrial states
- Tariff measures are very easy to reverse
But it was his next point, one which we have made numerous times and just this morning again most recently, that was most crucial and explains why the tit-for-tat trade war escalation between the US and China is only set to get much worse:
The temptation (primarily for the US but for trading partners as well) is to keep ramping up measures to convince the other side that they are serious about staying the course. Tariffs can be rolled back quickly when an agreement is reached.
And the punchline:
Because the long-term consequences are likely to be so modest and reversible, the incentive is to move aggressively in the short term. If tariffs are popular politically, there are even more likely to be extended. That said, with so much going on in this week politically in the US – the Supreme Court nomination and meeting with NATO and the Russian president— the focus may be elsewhere.
It was… for about 24 hours. Then, with the SCOTUS judge in the bag, and with Trump en route to NATO, the UK and Putin, the president decided to lob a bomb and blow up the market’s uneasy peace that had hit just settled with 3 days to go until earnings season.
The bigger point is that, as Englander adds, “this cycle will stop when one side or both feel enough pain to back down.”
Clearly, the US, with its “decoupled” economy and the S&P back to 2,800 is nowhere near “pain”, as for China, it is more likely that Xi will first take a bullet than concede… unless of course the stock market crashes and a recession ripples across the country, starting the one thing Beijing is most afraid of: a middle-class revolt (points we made over the weekend).
As a footnote, Englander frames the argument as similar to that made by Sam Peltzman with respect to seatbelt usage. He argued (and produced evidence) that drivers would drive less safely because mandated safety devices reduced the consequences of an accident.
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So what does this mean in practical terms? Well, as Englander claimed – correctly – even before today’s $200BN in new tariffs were floated, “the US is likely to press its perceived advantage”, to wit:
The US will probably push the tariff cycle further because they see China as more vulnerable. The value of China’s goods exports to the US is almost four times as high as US goods exports to China.
The ability of China to implement simple tit-for-tat tariffs on goods runs out at about USD 130bn (based on 2017 imports from the US). The US exports about USD 60bn of services, importing little, so China might match the US further, although taxing services is more complicated than taxing goods. China’s greater exposure, combined with the perceived US economic and asset-market advantage, is likely behind the US Administration’s view that tariff wars are ‘easy’ to win.
In simple terms this means that if the US extended tariffs to cover a wide range of goods, and – as the case may be – even cover more goods than China physically exports as Trump has bluffed (raising the stake as much as $800 BN in Chinese tariffs), China would quickly run out of room to tax US exports.
At this point its only recourse would be to implement additional non-tariff controls, which Englander – and everyone else – views as “a very serious escalation.”
There are of course also other ways China could respond: Tariffs make it more expensive to buy goods, but so do exchange rate fluctuation, sales taxes and other events, like dumping some or all of one’s Treasuries to demonstrate irrationality and threaten mutual assured destruction. In other words, “more expensive does not mean unavailable” and non-tariff measures have far more potential to disrupt supply chains and make goods unavailable, potentially raising prices sharply. That is precisely what China is contemplating right now
This is how Englander wrapped up his piece on Monday:
The very limited set of tariffs imposed so far, and the retaliatory measures by trading partners, are probably not enough to indicate who will blink first. The question is how a much broader second or third round of tariffs would be received.
One day later we may be about to find the answer now that $200BN in tariffs has been proposed.
However… before Trump considers the latest escalation salvo a trade war victory, there is a “but”: the current enthusiasm for trade measures may be short-lived if prices on store shelves begin to rise sharply, as is sure to happen if a lengthy trade war evolves, with tariff levels ratcheting higher and higher.
For now, however, we are far from that point, and as such, the US Administration likely sees going a lot further in terms of tariffs as advantageous.
There is just one thing that can stop Trump in his tracks sharply and forcefully: a market crash.
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As for the big question facing traders tonight, and into earnings season, it goes as follows: will China respond and if so, how? Luckily we know the answer: back in mid-June, Beijing said it would retaliate “forcefully”
“If the U.S. loses its senses and publishes such a list, China will have to take comprehensive quantitative and qualitative measures,” the Ministry of Commerce said at the time.
As Bloomberg adds, it is China’s Mofcom that has been tasked with formally retaliating against the U.S. on trade, so be on the lookout for statements from them. There’s also the daily media briefing by the Ministry of Foreign Affairs in Beijing, where China tends to double down on its rhetoric in these instances. That’s at 3 pm Hong Kong/Beijing time.
We doubt China will leave anyone in a state of suspense for too long.