Why Trade War Is Now Set To Get Much Worse

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:

  1. 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
  2. The current round of tariffs will likely have small effects
  3. 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:

  1. The tariffs so far are politically popular even in agricultural and industrial states
  2. 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.

* * *

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.

* * *

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.


philipat karenm Tue, 07/10/2018 - 22:44 Permalink

I don't buy the argument that China can't go as far as the US with Tariffs because China imports less from the US. At the end of the day, it is only the total absolute amount of imposed tariffs that matters. So China could just double-up the tariff rate, increasing for instance from 10% to 20% or 30% as necessary on the same imports from the US to achieve the same absolute (Total amount in Fiat) imposed tariiff total.

And China will also be highly selective so as to maximize the secondary effects as far as possible. For instance, stopping US oil imports will allow China to import more oil from Iran. And tariffs on Boeing's will result in an increase in Airbus orders in the most rapidly growing aviation market.

And IMHO, all these articles miss the point that it is US Corporations not China who will suffer most because all the profits from offshore low cost manufacturing accrue to said US Corporations not China, other than the creation of employment and a small contract manufacturing margin. And this WILL impact the equity "markets".

In reply to by karenm

ebworthen philipat Tue, 07/10/2018 - 22:55 Permalink

"Why At This Point, Trade War Is Likely To Get Much Worse".

Good!  This means that:  Harley's, booze, corn, pork, beef, bread, milk, cheese, cars, and maybe even real estate and rent will become more affordable for U.S. citizens. 

Fuck China, the E.U., NATO, and the rest.

Bring our troops home.

U.S.A. not globalism.

In reply to by philipat

philipat ebworthen Tue, 07/10/2018 - 23:07 Permalink

That very much depends on how the major US Corporations, who caused the trade deficit, respond. Nobody forced them to screw the American people by offshoring all their production and nobody can force them to bring the jobs and their new enhanced profits back home. So far, their reaction has been pretty much as expected: more offshoring to avoid tariffs on imported raw materials and moving production from China to Vietnam, Indonesia, Thailand etc. I don't see a single example of any US Corporation bring the jobs back home. And products which are made domestically will increase not decrease in price as import costs rise. It isn't the Government that pays the tariffs but the average US consumer.

In reply to by ebworthen

jcksn77 philipat Wed, 07/11/2018 - 23:06 Permalink

Your last point is fair, but, I think that a XX% tariff on ALL imports, regardless of where they're made, input costs considered, will eventually earn at least a break-even payback on a 50-year factory.  It won't matter where corporations move.  Especially when you consider the politics.   

In reply to by philipat

MuffDiver69 Tue, 07/10/2018 - 22:30 Permalink

We had a 1000 point drop already this year. I do chuckle seeing the proposed tariff list being released as Trump lands in Brussels...they have no clue what’s gonna hit them...I have more fun laughing at the multi- national corporate Fake News though and their predictable responses....sorta like :


“Isn’t it an amazing coincidence that every issue and action by Trump brings identically worded statements all over the nation by every media outlet and journalist and politician on the left? Almost like a conspiracy.Trump electors won’t vote for him in the Electoral College,Trump is mentally unfit to lead, Trump is colluding with the Russians, Trump is going to overthrow Roe v.Wade.

And spontaneous protestors arrive with professionally produced placards and banners with the same phrases. Wow.

TrustbutVerify Tue, 07/10/2018 - 23:46 Permalink

We do have a choice.  We can buy goods made in the USA instead of China or other slave wage nations.  A few months ago I did some research and for the first time in a while bought a pair of American made running shoes.  I can tell already they last 5 times as long as the previous iconic "American name brand" that were made overseas, as so many are.  

I went to buy a staple gun at Home Depot and there were 5-6 available for sale.  They were traditional iconic (even macho) American name brands, sporting industrial yellow and black lettering, suggesting, "We mean business."  Laughably, only one was made in the USA.  Now that I've done my research its the American made staple gun I will buy.  And, interestingly, it was the one that had the least macho design.  Just a simple, heavy duty, construction.  

So, it can be done.  We just have to make effort.  "Effort"...almost a forgotten virtue in the United States.  

PitBullsRule Wed, 07/11/2018 - 00:31 Permalink

If you've ever had two pit bulls locked in a fight, you know you can't get them apart, they will fight until one is dead and the other is almost dead.

Trump and Xing are both pit bulls, and once they lock onto each other, they are both too fucking stupid to unlock. Only problem is, our economy goes down with these two assholes.

Utopia Planitia Wed, 07/11/2018 - 00:32 Permalink

If there is a "trade war" and it is "getting worse" it's because the "leaders" of several other nations have not bothered to engage Trump in his attempt to discuss/negotiate.  Instead they are using standard libturd tactic of "everything has to be done the libturd way or I'm going to get pouty faced and sulk".

PitBullsRule Wed, 07/11/2018 - 00:35 Permalink

You deplorables will pay for Trumps ego.

When the farmers go broke, they will sell their farms for pennies on the dollar, to Chinese. When the companies shut down factories in the US, to move to China, you assholes will lose your jobs, and you assholes will see your house prices plummet. You guys will take the brunt of the damage, and you deserve it.

So its just a matter of watching this slow motion train wreck happen, and enjoying it.

Yen Cross Wed, 07/11/2018 - 01:21 Permalink

  Why all he dislocation in the usd/chf for the last couple of weeks?

  Something is going to snap. There should be more liquidity before the Tokyo fixing.

   I'm doing really well trading the chf range vs $usd, but I see better opportunities.

  The $usd is so heavily vested, and rates moving higher again.

straightershooter Wed, 07/11/2018 - 01:53 Permalink

OK, here's China response to the 200 billion....

1. China, this time, only retaliates against 40 billion of us exports, but at a tariff rate of 50%. Thus, the amount of tariff shall be the same, that's same score,same intensity.

2. China will forbid any iphones made in china from being exported to the US. Thus, forcing apple to ship it out of China to a place other than US first. Furthermore, China will tax any iphones exported into China at the rate of 50%. Yes, iphones will be included in the 40 billion new tariff list.

Here you go....Very simple, right. Never say China will be out of options.....

brooklinite8 Wed, 07/11/2018 - 04:45 Permalink

When will Trump impose tariffs on outsourcing on Campanies like TCS, Wipro and Cognizant. Also some American companies make their products mostly out of the USA. I think Trump now should pick majority of those companies and go for it and get it done.

Goodsport 1945 Wed, 07/11/2018 - 07:53 Permalink

You can blame the companies who outsource jobs for this - all in the name of higher profits and company stock (executive options) valuation.  Perhaps the US should impose an additional tax on corporate profits, based on the percentage of foreign content - both materials and labor.