Trade wars always lead to deflationary conditions, and this current American trade war with China will prove no different from those in the past. Early signs are becoming apparent that deflation will worsen as the Trump Administration digs its heels in and the signals that they are “in no rush” to make a deal.  Granted, the higher tariffs will lead to an initial spike in the prices of imported goods from China. But once the prices adjust to new levels, demand will drop off. It is this weakened demand that characterizes a deflationary world.

We are already seeing clues to the deflationary impact of the trade war: witness,

•  Global growth on the decline. The IMF and other large international bodies have reduced their forecasts for world growth significantly; the IMF is currently projecting only 3.3% global growth this year, the weakest expansion since 2009 when the world’s economy shrank due to the severity of the financial crisis in 2008.

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• International trade is slumping. Internationally trade forecasters are also downgrading their projections for 2019; the IMF expects the trade in goods and services to fall back from 3.8% achieved in 2018 to 3.4% in 2019; revisions later this year could see further reductions;
• Monetary policy is on a holding pattern. In line with the changed outlook on an international scale, all central banks including the US Fed are keeping their policy interest rates on hold; citing the trade war and related domestic weakness, many analysts are placing their bets that we could see a rate cut as early as year’s end;
• US agriculture is under duress. The US agricultural sector is reeling from price declines for major food exports in the wake of the  Chinese retaliatory tariff  measures; the loss of farm income, and more importantly, the possible permanent shift by China to other markets, such as Brazil, weigh heavily in many regions of the country; discussions turn now to how long farmers can continue to survive as harvests pile up unsold; and
• Long term interest rates are on the decline.US long term rates started to tumble in late 2018 as it became apparent that the trade war was heating  up; now, long term rates are approaching lows not seen since 2017 ; moreover, with an inverted yield curve --- in which short term rates exceed long rates----  the bond market is sending a  strong signal that a recession is in the making.  

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The equity markets seem to ebb and flow with each sound bite about US-China trade talks. But make no mistake, this trade war is going to be protracted--- both sides are giving every indication this will be the case. They have set the table for deflationary conditions.