Why you should expect the trade war to escalate

Nick Hubble

Tomorrow, it begins for real. The trade war gets hot. Donald Trump’s tariffs come into effect. $34 billion in Chinese goods will be subject to 25% tariffs.

But if you ask the man himself, the trade war began many years ago. The US is just fighting back for once.

Chinese subsidies, intellectual property theft and all sorts of other mercantilist policies have robbed the US of its manufacturing jobs and IP at the same time.

The EU itself is a trade war measure. It was founded on high trade restrictions and plenty of subsidies designed to combat American economic might. The EU’s creation was about becoming a trading bloc to rival the US and China.

Chinese leaders would respond to all this by saying Trump is right. The trade war is not new. But Trump doesn’t go back nearly far enough. As far as China is concerned, today’s trade wars began with the Opium Wars of the 19th century.

Back then, the US and Britain completely ravaged China to fix their own trade deficit. Militarily and by poisoning Chinese society with an addictive substance. Gunboat diplomacy was used to keep trading ports open for opium flooding into China.

The Brits sent their poppy products from Afghanistan. The Americans from Turkey. They got a heck of a lot of silver in return to fix their trade deficit. The Chinese got a national addiction problem so bad that it led to a rebellion.

These days it’s the US that’s suffering from opioids. Funny how things change…

The story is pretty similar for Japan, but without the opium. Under the cover of Western guns, the Japanese opened up their economy to the West in much the same way.

But maybe the opium wars of the 19th century and the opening of Japan don’t go back far enough either.

Ironically, the US’ creation was also triggered by a trade war dispute. The East India Company (EIC) had secured permission from parliament to sell Asian tea directly into the colonies instead of having to trade via middlemen.

The middlemen and other tea smugglers threatened by the new trade route crept on to the first three EIC ships to enter Boston Harbour dressed as Indians and dumped the tea into the harbour. The rest is history.

As you can see, trade war policies are the very basis of our nations (and the EU).

The question of trade war righteousness becomes who has the longest memory. Clearly the first homo-economicus, whoever he was, started the trade war. The real question is whether he was American, Chinese or European. Then we’d know who to blame for the rest of history’s tit-for-tat trade wars.

The latest trade war development

History may highlight the absurdity of what’s going on, but you still have to pay attention to profit and protect your wealth.

According to Reuters, the Chinese have been approaching the EU about issuing a joint statement against Trump’s trade wars. The Chinese vice-premier said he’s ready to detail just what concessions China could make to the EU on trade.

This section of the Reuters report made me laugh out loud:

Chinese state media has promoted the message that the European Union is on China’s side, officials said, putting the bloc in a delicate position. The past two summits, in 2016 and 2017, ended without a statement due to disagreements over the South China Sea and trade.

“China wants the European Union to stand with Beijing against Washington, to take sides,” said one European diplomat. “We won’t do it and we have told them that.”

In a commentary on Wednesday, China’s official Xinhua news agency said China and Europe “should resist trade protectionism hand in hand”.

“China and European countries are natural partners,” it said. “They firmly believe that free trade is a powerful engine for global economic growth.”

But the EU politicians aren’t interested according to the five EU officials Reuters asked.

Notice the effect Trump is having. It’s one I’ve pointed out countless times in Capital & Conflict.

Trump is pushing his opponents in the opposite direction to the one he wants them to move in. He wants free trade, so he pushes for a trade war. It’s human nature to push back, which in this case makes China push for freer trade – precisely what Trump wanted.

It’s clearly working. Its own government news agency declared itself to be in favour of free trade above.

Trump now has the momentum. As with North Korea, Japan, South Korea and so many of his domestic battles.

But I’m worried he’s miscalculated this time.

Why free trade falls to nationalism

Economists in favour of free trade often debate with their detractors in a very predictable sequence of arguments.

Free trade is good because it increases the size of the total “pie” of GDP. Things are made where they’re cheapest, leaving us with more “stuff”.

The detractors reply by pointing out this leaves many of us high and dry. Recently, that’s been manufacturing in the West. The total pie may be bigger, but not everyone’s share of that pie is bigger.

The free trade economists’ reply to this is where the true division lies: yes, so-called distributional effects within a country from opening trade can harm some sections of the economy. But why do you favour people in your home country over those in the country where the manufacturing boom takes place?

We send huge amounts of foreign aid, but won’t allow them to compete on trade…

The idea is that people shouldn’t complain about the losses from free trade just because the gains are outside their home country. It’s nationalistic. Which is a devastating accusation for those left-wingers who usually complain about the effects of free trade.

Of course, countries don’t compete fairly in trade. But having the Chinese government subsidise our consumer electronics and the EU government subsidise our favourite cheese is hardly a problem. Unless we’re paying into the EU budget.

When nationalism trumps self interest

If you’re wondering why you should care about all this, the answer is simple. Nationalism is one of the few fervours that can trump economic self-interest. People do stupid things when they’re in love, drunk and feeling patriotic. The Germans have a saying, “There’s a reason why patriot rhymes with idiot.”

Meanwhile, the world’s economic prosperity, and our financial markets, rely on economic self interest being the dominant emotion. They rely on economic warfare being a paradox. All warfare is inherently uneconomical. It’s a waste. Unless you’re a Keynesian and believe warfare leads to prosperity.

So if nationalism gains the upper hand, damaging each other’s economies and crashing financial markets is the next logical step.

What Trump is doing is betting that EU and Chinese leaders value economics over nationalism. That’s true of Japan and South Korea, who already folded in the trade war. But the EU is desperate for a patriotic boost. And the Chinese put politics before economic wellbeing.

Trump already made clear that the long-term gains from the trade war outweigh short-term shocks to the stockmarket. But he’s assuming a victory at the end.

So far, he’s been right. The US market is holding up. The European one struggled with Italy’s May bond market spike. The Chinese market is in a proper bear market.

If the trade war really does heat up, and China puts nationalism before economic wellbeing, things could take a turn for the worse on Western markets too.

History suggests that trade wars don’t end until the guns come out. That is the whole point of the nation state – one of its deepest origins. We shouldn’t expect anything else.

Until next time,

Nick Hubble
Capital & Conflict

Category: Uncategorised

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