Every day there’s a new shot fired in the global trade war of the U.S. vs. Everyone, Particularly China. The situation is even getting a bit ironically comical. Case in point, Treasury Secretary Steve Mnuchin attacked a flurry of reports on restrictions against Chinese investment in U.S. companies, calling it “fake news.” What was fake about it? Namely that the new restrictions wouldn’t be limited to China, but to “all countries that are trying to steal our technology.” So it’s actually even more extreme than initial reports let on.
This theater follows the Trump administration opening a new front against European cars, with President Trump threatening a sweeping 20% tariff on all European automobile imports on national security grounds. A consortium of car companies all from different countries including the U.S., General Motors (GM, Financial), Toyota (TM, Financial), and Volkswagen (OTCMKTS:VLKAY) have decried the move, saying that new tariffs this would tax U.S. consumers by a cumulative $45 billion. This is all aside from the already implemented and sweeping tariffs on $450 billion of the total $505 billion in Chinese goods imported to the U.S. annually as of 2017.
Let’s assume none of this gets resolved any time soon. After all, as long as the U.S. economy keeps doing well on paper, there will be little to no political pressure for Trump to reverse course. So where are we headed? Logically, if this continues, the answer is probably stagflation. Let’s reason this out systematically.
First, consider the $505 billion. That total was used to buy stuff from China last year and that number will decrease this year because of tariffs. This is simple supply and demand.
What is important to keep in mind though is that the number $505 billion is not paid to China by the U.S. government in any centralized way. It’s not like Washington is handing dollar bills over to Beijing and saying, “Give us $505 billion of your stuff this year.”
The total amount of imports flows from decentralized, uncoordinated decisions by American companies to buy stuff with dollars that they earned, from China. This is unplanned by governments, and is rather the cumulative effect of economic decisions made by individual firms and in some cases even individual consumers who, say, buy stuff on Alibaba (BABA, Financial) or some other Chinese retail site.
The dollars exported to China are used, partly, to pay for U.S. imports, so part of the dollar exports reenter the U.S. banking system and are added back into the circulating money supply. The rest, the so-called trade deficit, stays out of the U.S. banking system.
Whichever Chinese company has those dollars exchanges them for yuan at a Chinese bank, which sells the dollars to whoever wants to buy something in dollars internationally, like oil. Only dollars can be used to buy oil from OPEC, for example, which makes the dollar the world’s reserve currency de facto. The point is, the dollars stay out of the U.S. economy, wherever they end up going.
What about the trade deficit? Tariffs won’t put much of a dent in that because retaliatory tariffs that are already happening will decrease demand for U.S. exports for the same reason. In the end you have the same deficit, just with less overall trade. The net result is less demand for both dollars and yuan or whatever currency is being targeted, meaning prices for goods go up in all associated currencies and countries. This pushes up price inflation indexes globally faster than otherwise.
Higher inflation than otherwise means lower bond prices and higher interest rates, but not because of higher economic growth. The global economy is trade, literally so. Every single economic transaction ever made or that will ever be made is a trade of one thing for another thing, whether stuff for money or stuff for stuff or money for money. The less trade, the less economic growth, by definition.
Therefore, rising interest rates in this case would reflect a shrinking global economy, not a growing one. And in the end, we have a shrinking economy from shrinking trade, plus rising interest rates, plus higher inflation.
Those three together are stagflation. On that front, stocks are down today and oil is right back near 52-week highs. The good news? Only that if and when stagflation becomes obvious, trade barriers have a better chance of coming down again.
Disclosure: No positions.
