Trade War 2.0: The Reckoning

Hold onto your portfolios, folks! The spectre of a second Trump term is looming, and China watchers are scrambling to assess the fallout for the world’s second-largest economy. The big question: What happens if the former president and his new running mate JD “I Don’t Like China” Vance decide to turbocharge the trade war?If Trump trumps Biden in the upcoming election, expect a frenetic rollout of tariff hikes and other measures. Think of it as Trade War 2.0.The Reckoning. A 60% US tariff could slash China’s GDP by a whopping 2 percentage points. Some forecasts are even gloomier, predicting a 2.5 percentage point hit over a year. Meanwhile, the US economy could take a body blow, too, with GDP dipping and inflation spiking—talk about a one-two punch suggesting the global economy will take a head-first dive into the plunge pool!

Economists at Goldman Sachs calculate a roughly 2 percentage-point hit to China’s GDP from a 60% US tariff. Their counterparts at UBS this week tallied a 2.5 percentage-point wallop to growth over a year.

A hardcore tariff assault would likely lead to a massive subdivide not only between the US and China. Still, it would likely accelerate global economic fragmentation faster than you can say “supply chain disruptions.”Washington remembers the last trade war fondly—or at least, they remember surviving it without too much pain. Inflation didn’t skyrocket, jobs weren’t lost in droves, and Wall Street didn’t collapse. With memories like that, who needs a deterrent?The fact that the Biden administration left most of the tariffs in place and the US economy took off like a SpaceX Starship, with 32 engines roaring, will only incentivize the political hawks who will likely fill the White House steering committee.Trump’s promised tax cuts will need funding. Enter tariffs, stage right. “Is this a real threat? We think so.” Trump has floated a 60% tariff but hasn’t committed. In classic Trump style, he’s keeping everyone guessing. In a recent interview, he dodged specifics: “I had it at 50% and I’ve never heard the 60.” Analysts, start your engines.If Trump imposes a 60% tariff on Chinese imports, combined with a 10% baseline tariff on all other nations, the US could see its highest average tariff rate since the Smoot-Hawley Act of the 1930s. This would be a historic high—and not in a good way. Trump insists tariffs are significant leverage for negotiations. Could a deal be in the cards? Maybe, but don’t bet the farm on it.Remember the Plaza Accord of 1985? I’m dating myself a bit here; I was trading USDCAD then. Today’s currency maneuvers by China and Japan are a whole different ball game,  . Plus, because “the US is a large, relatively insulated economy that trades almost exclusively in its currency, a cheaper dollar won’t work wonders for the US economy like it used to.” ( Isabella Rosenberg Goldman Sachs)China and Japan have been intervening in the FX market to halt their currency slides, but their efforts are in vain. FX markets and their sophisticated models are exceptionally efficient at calculating forward interest rate arbitrage and assessing risk versus reward from spot to 6 months. Despite the interventions, the relentless march of market forces will continue unabated until underlying interest rate differentials shift to cave the carry and the economies take a much more favourable turn. Right now, folks are still looking at the harvest they carry in a relatively low-volatility environment. Still, as I suggested in my weekend blog, “Turning Point For The Yen,” the uptick in VIX volatility could rock the carry trade boat.Trump’s message to Chinese companies is clear: “Build it in America and only in America.” Shades of the 1990s when Japanese automakers set up shop in the US to dodge tariffs. But don’t hold your breath—today’s geopolitical chess game is much more complex. Even a 30% tariff would be devastating, causing a freefall in China-US trade from $575 billion to possibly under $100 billion. That’s a cliff dive no one wants to see.So, traders, investors, and economic enthusiasts, keep your eyes peeled and your hedges handy. Trade War 2.0 could be coming to a market near you.More By This Author:Nosedives, Blue Screens Of Death, And A Turning Point For The Yen?
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