Four Trade War Scenarios: From ‘One-&-Done’ To ‘All Hell Breaks Loose’

On July 6th, President Donald Trump’s tariffs on $34 billion worth of Chinese goods are set to take effect. And, as Bloomberg’s Chief Asia Economist, Tom Orlik, notes, with an additional $16 billion coming close behind, and China threatening retaliation, it looks like the opening shots of a trade war are about to be fired.

We map out four scenarios:

Scenario One: $50 billion and done. The U.S. imposes tariffs, China retaliates. Financial markets shudder. Fearing panic, both sides send reassuring messages and hold fire on further measures. In this scenario there would be a negligible impact on the U.S. economy and a maximum drag on China’s growth of just 0.2 ppt next year. A broadening of tariffs to affect $250 billion of Chinese exports could drag on China’s economic growth by up to 0.5 ppt, we estimate.

Scenario Two: $50 billion, plus a slump in financial markets. The U.S. imposes tariffs, China retaliates, equity prices fall sharply, creating a second-round effect from falling wealth and tighter financing conditions. Fearing worse, both sides hold fire. In this scenario, growth in the U.S. weakens by 0.4 ppt next year, China is mostly unscathed by the decline in equities, thanks to insulation from global markets, but the 0.2 ppt drag from tariffs remains. And the world economy experiences a roughly 0.2 ppt drag to growth as well.

Scenario Three: The U.S. imposes 10% tariffs on all imports and the rest of world retaliates. In other words — we find ourselves in a global trade war. It would take time for the biggest impacts to be felt, but in 2020 the drag on annual GDP growth might be 0.4 ppt for the U.S., 0.2 ppt for China and 0.2 ppt for the world.

Scenario Four: The U.S. imposes 10% tariffs on all imports, the rest of the world retaliates, and financial markets slump. Layering on a tightening of financial conditions might raise the peak GDP growth impact to 0.8 ppt in the U.S. and 0.4 ppt for the world. China, being insulated from world equity shocks, might escape the additional burden of tighter financial conditions.

A global trade war combined with the interconnectedness of global financial markets means a shock to U.S. equities would be felt in most corners of the world.

Source: Bloomberg

To be sure, a trade war could unfold in myriad ways not captured in these scenarios. Tariffs could be set at different levels, on different products, and in different countries. The reaction of financial markets is also impossible to predict. U.S. investors could continue to focus on benefits from tax cuts rather than costs from tariffs. China’s “national team” could put a floor under the Shanghai Composite Index. Other policy instruments might provide an offsetting influence. China may opt to restart infrastructure spending to offset a drag from weaker exports, for example.

And, as Orlik notes, there is, of course, also a possibility the U.S, and China pull back from the brink. Trump threatened to wipe North Korea off the map but ended up sitting down for a summit with its leader. The wall along the Mexican border has not been built, let alone paid for by Mexico. If we see U.S. markets sliding ahead of the July 6 deadline, or more businesses lining up to criticize the impending tariffs, the chances of the White House seeking some kind of face-saving compromise would go up.

At this point though, that’s not the base case.

At least one round of tariffs looks highly likely. If China retaliates – and it surely will – and financial markets don’t provide a clear ‘stop’ signal, a second could follow.

In other words, the only way this stops is if markets crash… and if markets don’t crash – anticipating Trump folding – then he will double-down on his trade tariff attacks until it does.

This article appeared at ZeroHedge.com at:  https://www.zerohedge.com/news/2018-07-02/four-trade-war-scenarios-one-done-all-hell-breaks-loose