The Trade War Escalates

The trade war with China is heating up. Yesterday the Trump Administration threatened to put tariffs on 1,300 more Chinese exports. China has threatened 25 percent tariffs on 106 U.S. products. The stock market promptly dropped 500 points when it opened today.

Conventional wisdom says the stock market is over-reacting.

Paul Krugman:

I think it’s worth noting that even if we are headed for a full-scale trade war, conventional estimates of the costs of such a war don’t come anywhere near to 10 percent of GDP, or even 6 percent. In fact, it’s one of the dirty little secrets of international economics that standard estimates of the cost of protectionism, while not trivial, aren’t usually earthshaking either. …

…Yet there is a reason why stock prices might overshoot the overall economic costs of a trade war. For a trade war that “deglobalized” the U.S. economy would require a big reallocation of resources, including capital. Yet you go to trade war with the capital you have, not the capital you’re eventually going to want – and stocks are claims on the capital we have now, not the capital we’ll need if America goes all in on Trumponomics.

Or to put it another way, a trade war would produce a lot of stranded assets.

Basically, we’re calibrated to be really good and efficient at producing X, and a trade war could push us into producing Y instead, which would require a lot of shifting and re-tooling and moving around of assets. We end up putting resources into producing things we used to be able to import at less cost, and that’s a drag on the economy overall. This also is a big hit on existing corporate assets. So, while a trade war might not bring on the Great Depression, if I had money in the stock market I might be thinking of pulling it out, too.

And then there’s this:

Trump, Navarro et al are showing that they really are as unhinged and irresponsible as they seem, and markets are taking notice. Imagine how these people would handle a financial crisis.

That might be the bigger factor here. The investor class has been happy with Trump, thinking he’d give them the tax cuts and deregulation they wanted. But now it may be dawning on them that they’ve been backing an angry, dimwitted child who has no clue what he’s doing.