I want to talk about the trade war again with China, because the Chinese have made a retaliatory strike. In the past I have predicted that the talks between China and America would break down, and that is exactly what happened. America instituted tariffs on Chinese goods, then added and increased the tariffs, and China said Monday that they will institute tariffs in retaliation as well. And from an economic perspective, there’s a few points to ponder, because it really does affect all of us, both here and in China.

First, tariffs imposed by America on Chinese goods may help American competitors in the short run. So too, Chinese imposed tariffs on American goods may help Chinese competitors in the short run. Emphasis on the word may, because there is no guarantee it will help.

Second, regardless of who imposes a tariff, it always results in the diversion of good capital to inefficient investments.  Bad investments will temporarily look good, but in the medium to long run, this will hurt both sides as good capital is diverted away from truly good investments.

Third, a tariff is looked at as a cost of doing business, and therefore a Chinese producer of yarn, for example, will pass that cost onto the buyer of his products, as will the American producer of products with tariffs imposed by China.  The guy who is really punished in this scenario is the final consumer, you and I and all other buyers of any product with a tariff.  And that will ultimately raise the cost of living without a commensurate rise in wages, leaving less cash on hand to consume other stuff, pay down debts, or save for the future.

Fourth, politics aside, President Trump may be right that the Chinese are being ruthless predators on the economic front by violating international trade rules and treaties and the like, but where he is wrong is that he thinks they’ll cooperate and we should play nice while they are playing playground bully. What has happened here is that the playground bully threw the first punch, and rather than punch back, Trump has gone to tell the playground aide. After all, there’s a reason this is called a trade war, and not a trade event. There is no playing field with referees here.

Fifth, what most politicians on this side of the Pacific don’t realize or even fully comprehend, is that China has a much much longer timeline of 100 years to our election cycle of 4 years.  The Chinese are willing to sacrifice the next 5 years of this battle, as long as they keep their eye on the prize of winning the war. That prize is taking over America’s place in international trade and banking as well as who gets to play police (think military strength). They just don’t care about the near term optics of the American consumer who reads the New York Times or Wall Street Journal, or what will be said on CNBC.

Finally, as I have said before, the Chinese have many tactics they can employ besides retaliatory tariffs.  Such as not rolling over treasuries, not buying more treasuries, selling treasuries, imposing additional tariffs on products that come from key election states (they're threatening this and I predicted that in January), holding political prisoners, restricting American businesses in China (another current threat to Apple), requiring higher wages in factories that produce for American companies, and much more.

In fact the mainstream media has the trade war all wrong, and so does the president.  This article about the tariffs, which explains why Trump thinks America will win a trade war with China if the Fed could just cut rates, is but one of many articles parroting the same points.  Personally I think the Teflon Don is just looking for another excuse to get the Fed to cut rates, which he is desperate for the Fed to do.

And there are a couple additional points to ponder here:

Again, let’s remember that Trump enacted tariffs, and when trade talks broke down a week ago he upped the ante with higher and more tariffs on Chinese goods.  China then retaliated by enacting tariffs on American goods, and they are threatening to just stop buying about $15B worth of agricultural products from the USA, like soy beans, and also placing restrictions on American businesses. 

But there are other retaliatory measures the Chinese can take as well, short of a military conflict, and Trump can tweet until he’s blue in the face that we’re winning when in fact the Chinese will just laugh at him. One of those measures would be to devalue their currency called the Renminbi, or the Chinese Yuan.  Depending on how far they are willing to devalue, the end result is that the tariffs on their goods would be partially or fully nullified.

And when it comes to devaluing the currency, our own Fed will never do that so overtly.  The status quo for decades has been 2-3% devaluation (read: inflation) per year. Uprooting that status quo would remove the reserve status of the dollar, thereby destabilizing the entire world economy and ruining all post WWII prosperity.

Further, the Fed would never consider an explicit devaluation, and they won’t lower rates and buy assets like Trump wants because that will benefit any countries and foreign companies that borrowed money denominated in USD, including…China and Chinese companies.  As the dollar weakens, those loans get easier to repay.  Potentially China would actually see more prosperity from any of these actions than it will lose on tariffs.

And finally, if the Fed does what Trump wants, Americans will also have a lower cost to loans, but it will also cause more misdirection of good money towards bad investments like Uber or Lyft, and the crash and ensuing recession will be far worse than necessary.