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| By Juan Villaverde |
Few things give investment markets a worse nervous breakdown than the prospect of full-scale trade war. This wasn’t entirely clear on Monday or even Tuesday.
But by Wednesday, reality was sinking in.
Many cheered President Trump’s tariff announcements last week. They were seen as a way to force reluctant countries to the negotiating table. The hope was to abolish all trade barriers between America and its trade partners.
And indeed, the White House says requests for trade negotiations are pouring in from more than 70 countries.
But one key nation moved in precisely the opposite direction: China.
Initially, Trump threatened Beijing with a 34% tariff on all imports — bringing the total up to 54%. Later this week, he promised that if China retaliated, he would come back with even more tariffs.
But instead of trade talks, Beijing fired back with a 34% tariff of its own. Plus, a slew of other measures targeting key U.S. industries.
And so, the latest chapter in the great Sino-American trade war began.
Trump then doubled down with an additional 50% tariff on all Chinese imports, bringing the total to over 100%. Which, of course, will rock the globally interconnected economy to its very foundations.
A lot of commentators misread this situation.
They say China is just “calling Trump’s bluff” — with a bluff of its own. After all, Beijing didn’t exactly back down when Trump threatened tariffs during his first term as President.
Do tariffs hurt China? Of course.
Beijing’s strategy was never to bow down. Party bosses are too well-versed in Chinese classics like Sun Tzu’s The Art of War, which advises: Know your enemy. Attack his weak spots. Adapt accordingly.
During the first Trump administration, Beijing faced a similar situation. At the time, it chose to fight back and adapt. And it worked!
In 2020, after months of painful negotiations ended with little more than a Chinese promise to import more U.S. goods — which Beijing never really followed up on. What a surprise.
By 2021, the very next year, Chinese exports hit all-time highs!
Five years have now gone by. But Beijing’s strategy likely hasn’t changed. Especially since it worked so well last time.
In other words, China is prepared to fight the Trump administration tooth-and-nail, hammer-and-tong. Only this time, the stakes are much higher.
China’s economy is facing a massive deflationary wave, courtesy of an epic housing bubble gone bust. This puts downward pressure on the Chinese yuan, whose value Beijing is determined to preserve.
But America isn’t in a very strong position either. After the COVID catastrophe, the only thing keeping the U.S. economy afloat has been record government spending. Which the new administration aims to reverse.
And now, Beijing and Washington are set to clash like two great dragons in an epic battle — with the rest of the global economy held hostage. As one blow after another further damages already beaten-down supply chains.
I don’t think Washington is more likely than Beijing to back away from this conflict. Both are determined to sever their interdependency — no matter how painful and protracted the resulting adjustment may be.
Will there eventually be a deal? Probably.
Both sides, for example, want a stronger yuan. That would offset the massive money printing Beijing needs to stave off catastrophic deflation.
And by making Chinese products more expensive, a rising yuan would help rebalance trade between the two countries in favor of the United States. Which would be immensely welcome at the Trump White House.
Sadly, that isn’t likely anytime soon, especially since bluster and bravado seem to be the order of the day. We can only hope that open trade aggression goes no further.
In the meantime, the most likely outcome is a global recession.
Indeed, warning signs were already visible before Trump announced his tariffs. If the global economy looked weak before, it’s outright sick now.
And yet …
Crypto and Wall Street Explode Higher
In the pullback, Bitcoin (BTC, “A-”) tested $75,000 before Trump announced a 90-day pause on “reciprocal” tariffs on non-retaliating countries (which excludes China).
This news ignited explosive, across-the-board rallies in world markets. Bitcoin shot up above $83,000. The S&P 500 jumped 9.3% and the Nasdaq, 12.3%.
Even before this, however, dollar liquidity was already on the rise. And the effects have yet to be fully reflected in risk assets, including crypto.
Moreover, as the deflationary impact of the Sino-American trade war sets in, both the Federal Reserve and the People’s Bank of China will surely try to counter with the only tool they know: printing money.
Now, this does not mean the coming rally will be a rocket ride to the moon.
When deflation comes knocking, it’s rarely offset by central bank action, at least initially. The resulting drain in global liquidity will probably drag crypto down along with the stock market and everything else.
In the fullness of time, however, central banks will eventually be compelled to roll out the heavy artillery. Risk assets will rebound. The world will climb back on the path of growth.
And because this is also the path of monetary debasement, it’s going to be like mana from heaven for Bitcoin and other leading crypto assets.
Investors will have to be agile and patient until then.
Best,
Juan Villaverde
