Thoughts on the “Trade War” and why I’m not worried.

The press has been busy warning about the devastation that is coming if there’s a trade war. References to Smoot-Hawley and the Great Depression are hauled out to terrify people. There’s just one problem with this scenario: size matters. America remains by far the world’s largest economy, the world’s wealthiest nation and the world’s largest market. As a result, it has the most leverage and our trading partners have the most to lose.

The U.S. GDP (Gross Domestic Product) is approximately $20 trillion.

Our largest competitors:
• European Union $12.5 trillion.
• China $12 trillion
• Japan $5 trillion
• Germany $3.7 trillion
• The U.K. $2.6 trillion
• India $2.6 trillion
• France $2.6 trillion
• Brazil $2 trillion
• Everybody else is under $2 trillion – for example:
• Canada $1.6 trillion
• Russia $1.5 trillion
• Mexico $1.1 trillion

Some thoughts by Gil Weinreich that put these numbers in perspective:

“Accusing the U.S. of ‘launching the largest trade war in economic history to date,’ Beijing has implemented retaliatory tariffs on 545 items worth $34B in response to the comparable U.S. duties that were enacted at midnight. Another $16B in tariffs are expected to go into effect in two weeks, and President Trump has warned of additional levies on $500B in Chinese goods.

“Trade War”

So opens the lead news story in today’s Wall Street Breakfast. The trade war is indeed intensifying. China is apparently getting angry. So is Europe, which is preparing its next retaliatory round, this time targeting ketchup. The Europeans like symbolism – be prepared to hear lectures on the different dressings into which Europeans can dip their pommes frites. As I’ve written and podcasted numerous times, I oppose trade protectionism on principle and see the current process as one that will slowly chip away (with or without ketchup) at economic growth.

But trying to be objective about this, I don’t think that China, the EU, Canada, Mexico or anyone else will prevail against the U.S. in the trade war. To the contrary, I think the U.S. simply has far more leverage, and far more staying power, than any of its trading partners.

Look at the last sentence quoted above from the Wall Street Breakfast story: “…President Trump has warned of additional levies on $500B in Chinese goods.” The total volume of U.S. exports to China is just a fraction of that amount ($170 billion), so China could simply never retaliate on an equal basis. The trade balance between the U.S. and the EU is far more balanced. But the reality, which the Europeans know all too well, is that Europe is militarily dependent on the U.S. and America’s European allies don’t carry their weight when it comes to the financing of the NATO alliance. The U.S. can quite easily find ways of turning up the pressure if it wants to.

For a demonstration of how this works, take a look at a Tweet from earlier this week on the president’s Twitter page:

‘The OPEC Monopoly must remember that gas prices are up & they are doing little to help. If anything, they are driving prices higher as the United States defends many of their members for very little $’s. This must be a two way street. REDUCE PRICING NOW!’

Saudi Arabia understands that the U.S. underwrites Gulf security. I think we will see oil prices coming down just as soon as they can ratchet up oil production.

Whether or not the folks in Foggy Bottom prefer this method of diplomacy, it does give expression to the leverage the U.S. genuinely possesses vis-à-vis other nations. That suggests two possibilities: Either China, the EU, OPEC and others will find a face-saving way to yield to U.S. demands before they get hurt even more in this trade war; or they will accept more pain out of national pride.

But as some of the numbers above indicate, there’s room for much more pain. Economic policy is not carried out according to principles as laid out in textbooks. Behind the human conduct of business is usually a fair amount of monkey business, including and especially domestic sources of market distortion. Sometimes the rational thing to do is to lose a little in order to avoid losing a lot.”

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