US-China trade war – Armageddon?

Armageddon: “the prophesied location of a gathering of armies for a battle during the end times… The term is also used in a generic sense to refer to any end of the world scenario” – Wikipedia

If you let your imagination run wild, and you try to picture where this trade conflict could be going, what the absolute worst-case scenario could be, you get Armageddon, WWIII, the end of the world as we know it.  After all we are talking about a conflict between the 2 largest nations on earth, and world wars have been started for less (Japan, for one, got involved in WWII because of a trade issue).

But why would we do this? What benefit is there to think such dark thoughts?  Two reasons:

1. Overcoming fear.Fear of the unknown can be paralyzing. Do not be intimidated; the best way to counter fear is to come to terms with reality.
2. Planning: By actively studying a situation we can obtain knowledge that prepares us. We already know the beginning, if we can imagine a likely end, then we can deal with the space in between.

Assuming that nothing good happens when the leaders meet on June 20^that the G20,

What is the worst-case scenario? There are 3 components to consider:

1. The level of tariffs, i.e. from 0% to 100%;
2. The volume of imports subject to tariffs, i.e. $0; $200bn or the whole c.$540bn?
3. And time: How long will the tariffs last?

Armageddon, WWIII, is a valid theory, but in the current environment, it is highly unlikely.  We will not even get close to that.  So, we can stare this scenario down and move on to something more useful: A plausible worst-case scenario.

That could be an all-out trade war; fierce, but stopping short of an armed conflict.  Some say such a thing is plausible. We have not been in a real trade war since the 1930’s  (Smoot-Hawley; protecting American jobs; Tariffs on everything  – followed by the Great Depression) and it useful to remind ourselves of that possibility. Just because events are forgotten does not mean that we cannot repeat them. But I think an all out trade war is overly pessimistic and not plausible.

I say this not because I have faith in the wisdom of our times, but rather because such a grim scenario is too simple: it ignores both the context and the drivers of current events. Not only has America evolved since the 1930’s, but so has the world and so, of course, has China.

To determine plausibility is hard work and it is fiendishly complicated. Not only does it require one to ask the hard questions about current realities and to relentlessly test assumptions, but that process must be applied to numerous related, but uncertain factors, including:

• The US Economy: The reaction of the stock market, impact on employment and consumers; likely revolt by the business community if things go really bad
• The US Government: Congress’s willingness to cooperate; intervention by the judiciary
• International: The reaction of other governments and trade partners, the global opprobrium factor.

Keeping this in mind, let’s circle back to simplicity and focus on the essential elements of the scenario: the two protagonists, Trump and Xi Jinping.  All we need to do is to figure out what they are thinking, how they would deal with the above complexity, and we would get a realistic understanding of what course they will take.

I know what you are thinking: neither Trump nor Xi Jinping are easy to figure out.  But we actually know quite a lot about them, namely:

• They are both powerful, stubborn, and quite intelligent.
• They don’t understand each other.
• They are determined to succeed.
• They got a chance to test their assumptions during the last few months. They will therefore adjust.
• It does not matter what they say in their bombastic public pronouncements, what matters is what they want.

So lets focus on what they want:

• Trump: “Make America Great Again”
• Xi Jinping: “The China Dream”

Given the above, the conclusion is one word: consensus.  The two leaders will have to cooperate and achieve some consensus to succeed in their individual objectives. Trump could not achieve his dream without a stable trade deal with China and Xi Jinping could not make China great again without a harmonious relationship with America. And this reasoning brings me to the most likely conclusion.

Conclusion:  We will not get Armageddon.  We will not have an all-out trade war. The most plausible worst-case scenario is that there will be an escalation of hostilities until an agreement is reached say by June 2020, that the 25% tariffs will be maintained until that time and that additional tariffs of up to 10% will be levied on the balance of China imports.

Hopefully it won’t be as bad, and hopefully it will not take that long, but get ready for more tweets, threats, saber rattling and statements of outrage. It is all part of the process.

 

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