Trump has declared war on China. It’s a trade war, not a shooting war. But the fallout will still be devastating and it will reach every corner of the globe.
The markets rallied on the news that Trump had blinked. He had reduced everyone’s tariffs to a blanket 10 percent—plus 25 percent for cars, aluminium and steel—except China.
Then tariffs on Chinese goods went up. China retaliated. They went up again. As of this writing tariffs on China stand at 145 percent. And Chinese tariffs on US goods are at 84 percent.
That effectively means that the world’s two biggest economies, who between them control 49 percent of global trade, have locked themselves out of each other’s markets. American farmers who rely on China for their sales will be left with crops rotting in the fields. And American shops that sell everything from t-shirts to I-phones will be left with the choice of either empty shelves or more than doubling their prices.
Trump promised to bring inflation down. It will go up. So will interest rates as the Federal Reserve Bank tries to control spiralling prices. Which means that mortgages and business loans will rise. As business costs rise so will unemployment.
These problems will extend far beyond American shores. There is more than a grain of truth in the saying “when American sneezes the rest of the world catches a cold.”
But there is more. If America can’t sell to China and China can’t sell to America then where will all the soybeans, wheat, steel, cars, computers… go. The answer is Europe, the UK, Japan, Australia, New Zealand, South Korea and India. This means that those countries goods will have to compete against Chinese and American businesses forced to dump their surplus output on third country markets. And, of course, all those countries will have to pay tariffs to export to America.
And there is more. Trump claims that the tariffs will increase foreign investment in America. Companies, he says, will build factories in the US in order to avoid US tariffs and sell to Americans. But will they? Most major businesses these days think in global not national terms. America is sealing its market off from the rest of the world and, anyway, it is quite likely to be in recession. Finally, foreign businesses crave economic stability. Trump’s up, down, in, out, unhinged shoot-from-the-hip economic policies are creating chaos rather than stability.
Perhaps most worrying of all, is the bond market. Bonds are effectively loans. US Treasury bonds are loans made to the US government to finance America’s trade deficit. At the beginning of the month America’s foreign debt stood at $7.9 trillion. Half of the debt is held by governments. Japan, China and Britain being the top three.
Japan was number one at about $1 trillion. But nipping at its heels was China with holdings worth about $860 billion. These figures seem high. They are and their size is what worries Trump. But the fact is that people buy American debt because they are investing in the American economy and the American economy is seen the best bet on the planet. Or at least it was.
After Trump announced his tariffs, American bonds started to be sold. No one knows who was selling them, but they were being sold. They are still being sold. This means several things: For a start the sell-off is the market’s massive vote of no confidence in Trump and the American economy. Furthermore, the dollar will reduce in value. Trump says he wants this because it will make American goods more competitive, but a drop in the value of the dollar will increase inflation which Trump doesn’t want. And then there is the danger that the dollar will cease to be the global reserve currency which is used for most international trade.
There is also the possibility that if China is pushed far enough by sanctions that it will go for the “Samson Option”. That is, it could opt to dump its American debt on the American market which would likely crash the dollar. It will also damage the Chinese Yuan which is why it is called the “Samson Option.”
On Thursday night, former Treasury Secretary Janet Yellen, said: “This is the worst self-inflicted wound that I have ever seen an administration inflict on a well-functioning economy… Trump has taken a wrecking ball to it.”
Former US Treasury Secretary Janet Yellen said on Thursday: “This is the worst self-inflicted wound that I have ever seen an administration inflict on a well-functioning economy… Trump has taken a wrecking ball to it.”
* Tom Arms is foreign editor of Liberal Democrat Voice and author of “The Encyclopaedia of the Cold War” and “America Made in Britain".
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15 Comments
One of the restraints on China acting to re-establish Chinese control over Taiwan was the economic cost in terms of likely US sanctions. Perhaps the Chinese government may assess the situation and decide that the time for military intervention is now? I would not expect a full invasion of the main island but perhaps a move on Kinmen to show China’s resolve and to test international reaction…
The instability in the US bond market is the achilles heel for the entire Trump economic agenda and unfortunately for UK public finances.
It appears that financial speculators were having to sell large volumes of US treasuries as bond prices declined this week and margin calls for repayment of loans came in from banks lending to these speculators.
The Trump administration pointed to a successful $22bn auction of 30 year bonds during the week as a sign that there was still strong demand for US bonds from overseas investors. However, over 20% of purchases were made by dealers i.e. a group of big banks responsible for absorbing any bonds not bought by investors and it has been reported that Japan had been unable to sell US bonds at an acceptable price overnight on Wednesday.
Although US bonds have historically been considered the premier risk free safe haven investment many overseas investors, including central banks, appear to have been diversifying their portfolios/reserves away from US dollar holdings in response to the perceived instability of the US government.
The republican administration has previously flirted with the idea of defaulting on US loan repayments (something Trump has made a careeer of ) and is floating the idea of a Mar-a-Lago accord. This accord involves swapping existing treasury liabilities for 100 year bonds paying no interest. That amounts to an effective default Mar-a-Lago Accord, Schmar-a-Lago Accord.
In the meantime, Trump may try to replace Jerome Powell, the current respected chair of the US Federal reserve, and replace him with a Trump loyalist willing to lower official interest rates despite spiralling inflation.
“…. replace him with a Trump loyalist willing to lower official interest rates despite spiralling inflation.”
This makes a lot more sense than applying tariffs. The relationship between interest rates and inflation is far from straightforward. When rates are high the government is spending more into the economy to service its debts. Any other form of government spending of this magnitude would be regarded as inflationary.
The reason to have higher interest rates is to encourage an inward flow of capital which pushes up the value of the currency. The US$ in this case. This will worsen the current account. A higher dollar will reduce export competitiveness and make imports more affordable.
We all may dislike Trump, but the US does have a valid underlying point. Many countries, including Germany, Japan, Singapore and China, are asking the US to continue doing what they would never consider doing themselves in providing an easy open market for everyone else’s exports and so be a growth engine for the world economy.
Germany can’t even manage to be a growth engine for the EU.
Trump’s big mistake is on the tariffs and to try to change the pattern of world trade far too quickly. He should have held fire for several months and at least until after he’d been seen to be trying to resolve any grievances by negotiation.
Might it be possible that Germany’s economic problems be affected by a lack of Russian gas and the use of American gas at some four times thé price?
If what Steve Trevethan says is true, there is a simple answer. Speed up the discontinuation of gas and move to solar power and possibly hydrogen. Germany would not then need gas from anyone.
@Mick – Following the logic, provided the cost of US gas is sufficiently high, the market should naturally migrate to local energy sources such as solar. However, we should not forget Germany still has significant coal reserves…
@Peter – “… are asking the US to continue doing what they would never consider doing themselves in providing an easy open market for everyone else’s exports”
From years of exporting, I’ve never found the US an easy or open market to access for non-US businesses.
@Steve For 28 years my wife and I drove to both Denmark and Italy through Germany. The incredible increase in solar panels and wind turbines are a credit to efforts by the Germans to get off oil and gas fuels. The downside has been the cost but they are in a better position with the climate crisis here. Trump’s madness extends further than tariffs into energy uses.
@ Roland,
I’m not sure why you think that. It’s not been my experience in the electronics industry.
In any case, putting anecdotal evidence to one side even when we were in the EU we had a huge trade deficit with them (£100bn +) whereas we always had a large, but not quite so large trading surplus (£60bn) with the USA.
The cost of funding the US Debt and deficits has been rising despite interest rate cuts by the Federal Reserve Why 10-year yields are rising despite Fed rate cuts Federal Reserve rate cuts will not reduce government spending in these circumstances.
The federal funds rate is the interest rate that US banks charge other institutions for lending excess cash to them from their reserve balances at the Fed on an overnight basis.
Bond yields indicate long-term lending rates for consumers. While bond yields have been rising, so have mortgage rates. US 30-year mortgage rates have been increasung steadily in recent months.
Higher long-term bond yields are also a problem for the government, as Treasury bonds fund the federal deficit. Higher bond yields make it more expensive for the government to borrow and refinance its debt.
The Fed Funds rate may have a more immediate impact on short-term lending and borrowing such as the rate savers can earn on deposits or the credit card interest that more directly impacts consumer spending levels and hence inflation.
Trumps tariffs are fixated on trade in manufactured goods. This ignores the fact the USA has a massive trade surplus in services with the rest of the world This key American business sector has a massive trade surplus with the rest of the world. Its jobs are at risk in a trade war. This will now be threatend by the loss of large numbers of International students and tourists to the USA.
“Trumps tariffs are fixated on trade in manufactured goods. This ignores the fact the USA has a massive trade surplus in services…..”
The adjective “massive” is somewhat misleading in this context. The surplus in services isn’t as “massive” as the deficit in goods. The US current account deficit which includes the trade in services is therefore still in significant deficit.
https://www.bea.gov/news/blog/2023-12-20/us-current-account-deficit-narrows-3rd-quarter-2023
“Higher long-term bond yields are also a problem for the government, as Treasury bonds fund the federal deficit. Higher bond yields make it more expensive for the government to borrow and refinance its debt.”
The US government, and the UK’s too, have chosen to have the interest rates which we see in the “market” currently. Short term rates are set by a decision of a committee in the the central bank. effectively a part of government despite any denials. Longer term bond rates are set by the activities of the central bank, or its agents, in the bond market.
If the central bank wants lower rates and yield, which implies higher bond prices, it acts as a net buyer. If it wants higher rates it acts as a net seller.
There may be very good reasons for these central banks to have rates as they are, but this doesn’t change the fact that they are aren’t totally driven by external markets.
Central banks are in practice driven by external markets.They make policy choices in reaction to movements in the bond markets.The current increase in US borrowing costs has not been driven by actions of the Federal Reserve, but rather by market expectations of higher inflation and an economic slowdown as reflected in bond markets.
The US federal reserve has a dual mandate that targets stable prices (inflation target of 2% ) and maximum employment consistent with its inflation target. These two goals can clash in a stagflationary enviroment as is currently the case in the USA.
When inflation is high, the Fed may raise rates to cool the economy—even if that slows down hiring. When the economy is weak, the Fed may lower rates to boost jobs—even if inflation ticks up a bit.
Central Bond yields reflect investor expectations about growth, inflation, and future interest rates.
Central banks watch yield curves (like the 10-year vs. 2-year spread) to gauge market sentiment. Rising yields can tighten financial conditions. If yields spike too quickly, central banks may slow rate hikes, pause, or intervene to prevent destabilizing the economy.
Central banks set short-term rates, but rely on bond markets to transmit those rates through the economy (e.g., mortgage rates, corporate borrowing costs).
If markets aren’t “cooperating,” central banks may adjust communication or use QE/QT (Quantitative Easing/Tightening) to influence longer-term yields
If there’s dislocation (e.g., the UK gilts crisis in 2022), central banks may intervene to ensure market functioning, even if it’s at odds with their inflation goals.
Central banks influence the bond market via policy and guidance. Bond markets influence central banks via expectations and reactions. Both are watching each other constantly—it’s a dance.
“Treasury bonds fund the federal deficit. Higher bond yields make it more expensive for the government to borrow and refinance its debt”
An alternative view is that the sale of Treasury bonds forces up the value of the currency which gives more purchasing power to consumers and so creates a deficit in the current account. We both agree that this will be linked to a deficit in the Govt budget. I’d say it is explicable from the sectoral balances. You might quote the principle of the twin deficits.
“the Fed may raise rates to cool the economy”
They may intend to do that; but, as they are causing the Govt to spend more into the economy, as you have correctly indicated above, than they would otherwise need to, they could be warming it up! I’d say they definitely would be in the longer term although there is probably a short term effect which corresponds to your conventional view.
We should show flexibility in limiting dumping by applying our own temporary tarrifs if it is necessary to protect our economy. Our economy might benefit if we become less reliant on China and American exports and forge trade deals with other countries. Successful businesses know that it is unwise to become too dependent on a few markets however attractive they might seem.