Trade wars thru a geopolitical prism

Markets are still trying to come to terms over what has been an extraordinary week, following Trump’s Liberation Day announcements of huge tariff increases as he attempts to put right what he views as years of exploitation of US generosity by the rest of the world. The rest of the world (ROW) might, and does, see things, a little differently.

The ROW would argue that U.S. exceptionalism, largely the modus operandi since WW2 - the state of affairs where the default settings of the global trade, financial, multilateral and to some extent the global security architecture, are set by the US, and to the advantage of the US. This exceptionalism gives the US huge leverage - soft and hard power - it gets to impose its values and interests therein - over the rest of tne world. It means, for example, that US sanctions matter. The quid pro quo is that the U.S. pays to extend security guarantees to key allies, maintains the dollar as the supreme global reserve currency and its Treasuries as the global risk free rate (benchmark in effect) and allows them some flexibility in setting terms for trade - to keep them allies, in effect.

The Trump presidency has obviously upturned that global status quo. It is taking US exceptionalism as a given, but because it sees the US as the dominant, still, global power, it is asking for allies, and trading partners, to pay for security guarantees, and for trading in its sphere of influence, in effect. The dollar as the reserve currency is no longer a given, for the world, but the U.S. is now almost attaching an annual credit card fee for its use.

The US initiatated global trade wars are the U.S. tool for resetting its relations with the world, in its favour.

They are also its sword, I think, for cutting its hegemonic rival, China, down to size, and to reinvigorate its own industry, and particularly its military industrial complex, to better counter what it sees as the increased military threat from China, and to prepare for what many in the Trump administration see as the inevitable and looming war with

China.

Markets have breathed a sigh of relief over the past 24 hours, as Trump seemed to blink in his trade war battle with the world, if not with China. He announced a 90 day pause on most tariffs, albeit but maintaining his new 10% universal tariff, with the exception of a now 125% tariff on China.

How to read all this?

Some in the markets will see this as marking an end to rising systemic financial sector risk, with some gaurdrails put around Trump’s actions on the tariff front. At least we know that Trump cares about the equity and bond markets, and understood that he had taken markets too close to the brink - where a systemic failure, akin to the global financial crisis (GFC) of 2008, was at least in the contemplation of markets, if not yet the base case. Perhaps that suggests he will not take it that far, that close next time around. But the concern surely is that we have seen an administration which does not always appear to be in control of what it is doing, to be unprepared and lacking in a systemic and well thought out approach - the Trump tariff formula is clear evidence of that, as it was laughable in its construct. The risk is of error, of Trump not knowing where the limits really are, and in the future of crossing them by mistake, to the point of risking then a GFC2, but without the guardrails of a coordinated global government response. On the latter G20 has been castrated by Trump, and unlike in 2008 where global governments worked together to produce coordinated responses, this time around we are far more vulnerable as the same governments now appear to be acting in competition.

There are those now, like Musk, arguing that the current tariff wars offer the longer term prospects of much better, and lower tariff, deals with key allies. Could the world come out from this with much freer trade settings?

Unlikely when Trump himself has put tariffs on such a pedestal as the tool to cure all global ills, and where tariff fees are seen as a key means of funding the US budget, and the Trump tax cutting agenda. And also unlikely because Trump’s actions over the past 24H, cutting back tariffs to the 10% universal tariff but then keeping the 125% tariff on China, suggests that China is the number one enemy, target of the US. And therein it is clear that the tariffs imposed on China are not just about economic nationalism, but changing US national security interests. China is seen as the existential hegemonic foe of the U.S., and tariffs are viewed as the one huge point of leverage the U.S. has over China given its huge trade surplus with the U.S.

So my take from all of this is that Trump’s actions will not see less, but more tarrrifs. We are entering a work of trade autarky, with less globalisation and global trade. That means fewer opportunities to take advantage of comparative advantage and economies of scale on a global scale. It means higher global production costs, lower growth, higher inflation, less jobs, declining global living standards and more poverty. And if we complained that globalisation failed to deliver inclusive growth, we absolutely cannot expect the new world to be any fairer. Back in the hey day of globalisation the inclusive growth argument was about how we divide up a bigger cake. In the new trade autarky world we will still be talking about how we divide up the cake, but the cake will be a lot smaller.

But we still have to get to the new autarkic trade world, a new status quo. And getting there could still be very disruptive. Business can learn to trade with higher tariffs, say going from 8% to 15% or whatever, but it is the uncertainty that kills. Is it 8% or 15%?The temptation when it is not clear is to halt trading across borders. And we have seen some of that this week, with a major U.K. car producer opting to halt sales to the U.S. until the tariff situation is resolved - not sure a 90 day pause is sufficient clarity therein. If the decision to stall trading is replicated globally that is a huge shock potentially to global supply chains. As Covid suggested that risks a big short term hit to growth and inflation which could be even more significant that the longer term impacts of global trade autarky.

Lower global growth means likely downward pressure on oil and commodity prices which will provide something of a counter to the bigger picture manufacturing inflation spurt from supply chains disruptions and then higher tariffs. But we will see oil and commodity exporters hit hardest - look at the Gulf and central Asian states with the highest oil price balance levels for budget and current accounts. There will also be winners though in terms of oil and commodity importers in Asia and central and

Eastern Europe.

Some of those Gulf states though that have been promising big investments into the US under Trump, might have to think again as they will likely see their own sovereign wealth windfalls drop, and will need all the reserves they at home to cover budget and BOP shortfalls and to fund their still ambitious Vision development programmes.

But key in what we have seen over the past 24 hours is that Trump’s beef is with China. He might have backed down on tariffs on allies and the ROW but he maintained the 125% tariff on China. And the Trump administration went further spelling out that their battle was not with allies and the ROW but with China.

Key now will be how China reads all this.

My take is that China will absolutely understand that it is in the US crosswires, it is the target, and not just from a trade perspective. It is an hegemonic battle for survival with the US. And this is not a win win negotiation but a zero sum game where the US actually wants to hurt China.

US Treasury Secretary Bessent tried to sell Trump’s 180 degree turn on tariffs this week as all part of the plan, and that China had misplayed its hand in going for tariff escalation unlike US allies and others in the ROW. I disagree. China will look at how the Trump administration took markets to the edge but then blinked as the US treasury market appeared on the brink of collapsing amid talk of Chinese selling of USTs. It will also look how GOP unity and Trump’s billionaire bros (they are mostly bros) began to break. They will smell weakness. And in a hegemonic battle for survival, with a U.S. bully in Trump (seen in the exploitative trade deal suggested to Ukraine), they will think that weakness will be exploited and there is then no way back in any future talks with Trump. They will have taken the subordinate seat to the US globally, or that will be the perception of others. I think they will now adopt a harder line, thinking that they can take Trump to the brink and he will blink.

For me China US relations are set to get worse.

Now Trump is pushing this line that he gifted his allies a tariff win on the assumption that they will now rally behind the US against China. I don’t think the U.S. can be so sure there. Indeed, after weeks of berating US allies, threatening to steal their land (Canada and Denmark/Greenland), and taking sides against their adversaries (Russia), and weakening the security backstop for Europe at least, I think many will be quietly hopeful that China will pull the US down a peg or two, and level the playing field for them. They will give lip service perhaps to the US, but I think will be slow to join the tariff barricades against China. If anything they will try and stay out of any trade wars between the US and China. For Europe the question will be what is in it for them? Is trade tariff moderation from the US enough? Or will they demand other assurances, for example, over their own defence - and back perhaps to asking the US what exactly are its plans with respect to relations with Russia and the war in Ukraine. Ironically lower global growth, and lower oil and commodity prices plays to European interests now by weakening the Russian economy, and perhaps forcing Putin to think about ending the at in Ukraine earlier, and perhaps more on the terms of Europe.

Now going back to US exceptionalism and the dollar’s reserve currency status, I think events this week have surely damaged that. The gyrations in UST prices have questioned their position as a risk free investment benchmark. China saw US vulnerabilities and surely will be minded to cut dependence on the U.S. - we might actually be seeing trade and capital account autarky herein play out. Countries looks to reduce dependency and vulnerability to each other. Deglobalisation might not just be about trade, it’s about supply chain security, autonomous defence capability, plus also perhaps capital account resilience. And the U.S. by even putting out there the concept that countries will need to pay for the benefit of using US dollar markets, Treasury benchmarks, and the dollar as a reserve currency, by for example, increased defence purchases from the U.S., might just conclude, nargh, we need our own automomy, and for US’ historical allies they might conclude that they no longer really share the same interests or values with a MAGA Trump presidency. So again they might give lip service to the US, while all the time trying to rebuild autonomy from the US. Liberation day might actually be Liberation Day for the rest of the World from overrelience on the US. Longer term this might mean lower US trade deficits, but counterbalanced by lower capital account inflows into the dollar, which might ultimately see the dollar weaker. We might see increased diversification away from the dollar into Euros, Sterling, CAD, Aussie, et al, anything but the dollar.