Wall Street and the New Cold War
The stock market seems to rise or fall almost daily based on the latest news from the frontlines of the trade war.
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 US.
US markets sold off last 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 it 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 US, so a trade war was always bound to have more impact on China than the US.
And if China tries to match the US in tariffs dollar for dollar, it runs out of headroom at US$150 billion. Meanwhile, the US can keep going up to US$500 billion and inflict far more pain on China.
Rare earths just a distraction
Other forms of Chinese retaliation are mostly nonstarters.
The Chinese cannot dump US Treasuries without hurting their own reserve position and risking an account freeze by the US.
China cannot turn up the pressure by stealing intellectual property because it’s already doing that to the greatest extent possible.
China’s latest threat is to ban exports of rare earths to the US and its allies. Rare earths are essential for the production of plasma screens, fibre 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 of rare earths, which makes them a potent weapon in the US-China trade wars.
It should be noted that ‘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 US will win the trade war and either China will open its markets and buy more US goods or the Chinese economy will slow significantly.
But while the trade war is important, it’s not the main event.
The main event
The trade war is part of a much larger struggle between China and the US 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 US is responding with arms deals and bilateral trade deals to counter Chinese influence.
Even if a modest trade deal is worked out with China in the US 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 war 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.
All the best,