The stock market seems to rise or fall almost daily based on the latest news from the front lines of the trade wars.
When Trump threatens new tariffs and China threatens to retaliate in kind, stocks fall. When Trump delays the tariffs and China agrees to resume negotiations, stocks rise. And so it goes. It has been this way since January 2018 when the trade war began.
The latest dust-up came late last week when Trump threatened tariffs against Mexico if it doesn’t do more to curb illegal immigration to the U.S. Markets sold off on Friday as a result, bringing a terrible May to an end. Largely due to the trade war, the stock market had its worst May in seven years.
From the start, Wall Street underestimated the impact of the trade war. First they said Trump was bluffing. Then the analysts said that Trump and Xi would put their differences aside and make an historic deal.
All of these analyses were wrong. The trade war was problematic from the start and is growing worse today.
China will lose the trade war. The reasons are obvious. Foreign trade is a much larger percentage of Chinese GDP than it is for the U.S., so a trade war was always bound to have more impact on China than the U.S.
And if China tries to match the U.S. in tariffs dollar for dollar, they run out of headroom at $150 billion while the U.S. can keep going up to $500 billion and inflict far more pain on China.
Other forms of Chinese retaliation are mostly nonstarters. They cannot dump U.S. Treasuries without hurting their own reserve position and risking an account freeze by the U.S. China cannot turn up the pressure by stealing intellectual property because they’re already doing that to the greatest extent possible.
China’s latest threat is to ban exports of “rare earths” to the U.S. and its allies. Rare earths are essential for the production of plasma screens, fiber optics, lasers and other high-tech applications. Electric vehicles, mobile phones and telecommunications systems would be impossible to build without them. China is responsible for 90% of global production, which makes them a potent weapon in the U.S.-China trade wars.
“Rare” earths aren’t actually that rare. They are plentiful in quantity. The problem is that they are found in extremely low concentrations. This means a huge amount of ore and expensive mining processes are needed to extract even a small amount of these vital substances.
So rare earths are one weapon China possesses.
But over time, Western powers can replace rare earths purchased from China. There could be major manufacturing disruption in the meantime, it’s true. But it would not be the end of the world.
The U.S. will win the trade war and either China will open its markets and buy more U.S. goods or the Chinese economy will slow significantly.
But while the trade war is important, it’s not the main event.
The trade war is part of a much larger struggle between China and the U.S. for hegemony in Asia and the Western Pacific.
They are locked in a new cold war being fought on many fronts. These include trade; technology; rights of passage in the Taiwan Strait and the South China Sea; and alliances in South Asia, where China’s Belt and Road Initiative is promising billions of dollars for infrastructure development.
The U.S. is responding with arms deals and bilateral trade deals to counter Chinese influence. Even if a modest trade deal is worked out with China this summer, it will not put an end to the larger struggle now underway.
What are the implications?
If the Chinese view the trade war as just one step in a protracted cold war, which I believe they do, then we’re in for a long period of contracting growth that will not be confined to China but will affect the entire world.
That seems the most likely outcome for now. Get set for slower growth and perhaps stagflation. It could be like the late 1970s all over again.
Slowly, Wall Street is taking the trade wars seriously. But it is still missing its larger implications of a new cold war.
This new cold war could last for decades and it will affect the entire global economy. Let’s just hope it doesn’t turn into a shooting war.
Below, I show you why it could. Read on.
for The Daily Reckoning