A Full-Blown U.S.-China Trade War Would Be Catastrophic

I was a guest on i24 News last week, on a panel discussing the brewing tit-for-tat trade war with China.

I discussed how both U.S. President Donald Trump and Chinese President Xi Jinping are entering this showdown from positions of strength.

You can watch that interview here:

In the U.S., the economy is growing at over 3%, the fastest pace in the last decade.

On the other hand, China is not as reliant upon exports as it was 10 years ago. Its exports as a percentage of its gross domestic product (GDP) are about 20%, down from 37% in 2006.

These two factors make it an almost certainty that the trade war will go further than anyone thinks.

Let’s Not Repeat the 1930s

I mentioned at the top of the i24 interview something that caught my attention last week. It was a simple 10-word tweet from Ray Dalio, founder of Bridgewater Associates, the world’s largest hedge fund.

Dalio is revered in the financial community for his fund’s outstanding track record and the fact that it has amassed $130 billion in assets. He’s also considered a top economic historian, as Bridgewater’s success has come from finding the “deepest possible understanding of how the world works.”

So when Dalio tweeted: “Today is the first day of the war with China,” it caused me to sit up and take notice.

It appears that Dalio intentionally left out the word “trade,” and that was likely a reference to the last time trade wars resulted in real war.

This happened in the 1930s, when protectionist policies led to a further collapse of global GDP. As countries struggled to deal with sick economies, they turned to tariffs and quotas to revive domestic manufacturing.

A Trade War Is a Race to the Bottom

With the passing of the 1930 Smoot-Hawley Tariff Act in the United States, a trade war broke out between the U.S. and Europe. This was a race to the bottom that led to the Great Depression and tipped off the rise of nationalist movements in Germany and Italy.  We all know how that ended.

Given the advances in military technology over the past century, repeating these mistakes could be catastrophic.

To be fair, the current global average tariff rate around 5% is a far cry from the 60% average tariff rate after the U.S. passed the Tariff Act:

U.S. Average Tariff Rates

However, you can see in the above chart that these trade wars have a tendency to escalate rather quickly, as happened in the 1860s and then again in the 1920s and ‘30s. That’s because tariffs in one country are typically matched by tariffs in another, as we are witnessing with the current U.S.-China tit-for-tat.

Perhaps Dalio’s prediction is too pessimistic. The markets, for their part, seem to think this situation will be quickly resolved. The SPDR S&P 500 ETF (NYSE: SPY) has rallied about 3% since the first U.S. tariff went into effect on July 6.

But sometimes the market gets it wrong before it gets it right.

Regards,

Ian King

Editor, Crypto Profit Trader