The old news is that there is a trade war between the US and China. Some people pretend it’s a “skirmish” and that a real Trade War — capital “W” — can still be avoided.
We prefer to live in the real world. And in this real world, a full-fledged trade war has been underway since early May of this year and continues to intensify. Our belief is that this process is likely far from over.
The key question for players and financial markets is this: How long can both sides hold out and maintain or ramp up their mutual game of hardball? That question has received a great deal of input over the past 5 days, first in the form of Fed Chair Jay Powell’s press conference on Wednesday of last week, then in the form of the White House’s move to threaten escalating tariffs on the near horizon, and finally in the form of China’s willingness to let its currency drop below a widely watched threshold in foreign exchange rate versus the US Dollar.
The big point here is this: Because the Fed cut interest rates and cited “trade uncertainty” as a driving force in future policy discussions, the Fed has effectively put the White House in charge of monetary policy. So much for an independent Fed. Now, even if the Fed is not taking direct commands from Mr. Trump, they have signaled they will respond with more accommodation if the White House chooses to step up its tariff actions against China. The very next day after hearing this message, that’s exactly what the White House did.
As a result, traded futures contracts demarking bets on future policy changes from the Fed have shifted to imply more cuts on the way. In other words, the Fed is being bullied into more rate cuts by Trump’s actions, giving Trump de facto control over monetary policy.
At the same time, China’s reaction to the specter of increased tariffs has been to let its currency sag meaningfully. This is important because it alleviates the ultimate impact of the tariffs — tariffs are important insofar as they add to the price of goods from China on US store shelves. But if China’s currency falls in value, then, because those goods are first sold from Chinese producers to US retailers, the price tag of such goods in the US is decreased in step with the weakening of the Chinese yuan because fewer dollars are needed from US retailers in the inventory stocking phase to acquire those goods.
To make a long story short, both the US and China are now using policy tools to mitigate the impact of the Trade War on US consumers and the economy of both nations.
When someone is involved in some sort of self-destructive behavior, it is often the case that the best thing that can happen to such a person is that the behavior has immediately unsustainable destructive implications on his or her quality of life. Imagine if you started smoking cigarettes, but found out that cigarettes made you unable to eat for 48 hours. It would be an easy habit to quit. But if you didn’t have much of a problem smoking and living your life, you might go on smoking two packs a day for years until dying of cancer.
The fact that both sides are finding ways to more easily “live” with the Trade War in a weakened but not desperate state suggests they are both ready to stick with this issue in an unresolved form for the long haul.
That’s why the stock market is crashing and policy analysts are scrambling. Because both Washington DC and Beijing have managed to mobilize the Fed and PBOC as respective enablers, the Trade War will likely be with us for a long time to come.