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How Trade Wars Act Like Mini Hot Wars

Trade frictions throttle down economic activity like a knob on a water faucet.


Fiat money has no value other than the economic activity that supports it. A hot war, if extensive, can lead to a collapse of economic activity for a protracted period of time. If that happens, the money in circulation becomes worthless and there is no economic activity to support its convertibility into goods and services. That painful cause and effect has given gold enthusiasts a lot of inspiration for the past 5,000 years.

Fiat money can work without hot wars and trade wars, but there is much to be desired on those fronts for many developed and emerging market currencies in the world today – like the Syrian pound, for instance:

Graphs are for illustrative and discussion purposes only.

The Syrian pound has basically lost 90% of its value, due mostly to the hot war there. Unless there is a hard peg, with external financial support to maintain it, like there is in Syria, the weaker currency and accelerating inflation rate spiral would bring about a Zimbabwe- or Venezuela-style hyperinflation.

Graphs are for illustrative and discussion purposes only.

Trade wars have often become hot wars. The Chinese cite the Opium Wars in defense of the present trade skirmish, in reference to when the British muscled themselves into China and Hong Kong. Citing the Opium Wars is a little ironic, as the Chinese are more at fault now, not the Trump administration.

The present situation with China is still not a full-blown trade war, in my opinion. Trade wars act like mini-hot-wars as trade frictions throttle down economic activity like a knob on a water faucet. The higher the tariffs are, the less the flow of trade and economic activity will be. Global trade is shrinking because of the Trump tariffs, but the good news is it has not nosedived yet, as in 2008 or worse, as in the 1930s.

Smoot-Hawley Was a Big Factor in the Great Depression

The most egregious trade war in the 20th Century was the one caused by the Smoot Hawley Tariff Act of 1930, when tariffs went up to 60% (see chart, below). While there have been some tariff hikes in the recent trade skirmish between the U.S. and China, I think we’re far from a full-blown trade war; but one does have to wonder about the full name of the Smoot Hawley Tariff Act, as it reads like a Trump campaign slogan, namely: “An Act To provide revenue, to regulate commerce with foreign countries, to encourage the industries of the United States, to protect American labor, and for other purposes.”

Graphs are for illustrative and discussion purposes only.

I don’t think the U.S. President wants to collapse global trade, but I do think he wants to end the predatory practices of the Chinese government, which are to purposefully buy from their friends and neighbors to increase their political influence and purposely buy less from the United States. If the Chinese have been getting away with this clever trade maneuver for 20 years, I understand how they would want to keep getting away with it, but Mr. Trump is the new sheriff in town, and he is not respecting old arrangements.

What most investors miss is that under the Chinese brand of state capitalism there is a lot of government intervention in their economy. Because of the strong role of government control, there is an army of state buyers that are told where to source the necessary goods and services. It’s as simple as that. There is no such army of state buyers in the United States, or any other large economy in the world.

If the Chinese wanted to dramatically reduce their trade surplus with the U.S., which should be over $400 billion in 2019, all they have to do is direct those state buyers towards America. That would cause a big political problem of not buying from where they were buying before – which is why such a change should happen over 3-5 years and not relatively soon, as requested by the Trump administration.

Graphs are for illustrative and discussion purposes only.

We are probably not past the point of no return yet – as evidenced by looking at the performance of the Dow Jones Industrial average – but if we were past the point of no return in trade escalation, I don’t believe that any number of Fed rate cuts would stave off a global recession and a slumping Dow.

A lot is riding on this trade negotiation and brinkmanship between The Donald and his counterpart, The Sun Tzu Disciple from Beijing. Personally, I would welcome a mutually acceptable trade deal as fast as possible. But because I am not sure that the Chinese have negotiated in good faith so far in this process, I am worried that we may open a Pandora’s box with no clear way of resolving the obvious issues.

In other words, when the cat is out of the bag, it’s very hard to put that scratching beast back in.

Equities Contributor: Ivan Martchev

Source: Equities News

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