How The Trade War Ends

The quote “When goods don’t cross borders, soldiers will,” is frequently attributed to 19th century writer and free market economist Frederic Bastiat. While these specific words, strung together with this specific syntax, cannot be found in Bastiat published catalogue, their sentiments are of the type he would have likely endorsed.

The point is that free trade not only increases the wealth of different societies, but it may also be essential for peaceful relations. The breakdown of free trade has often coincided with wars. These wars start as currency and trade wars and then escalate into shooting wars. This is something to be mindful of as President-elect Trump amps up forthcoming import tariffs.

Global trade has expanded without interruption for so long that only senior citizens remember anything different. But global trade hasn’t always expanded. In fact, there have been long episodes of global trade contractions that have played out over long secular trends for thousands of years.

The Silk Road, for example, was established by the Han Dynasty of China in 130 BC. This ancient route allowed for continuous trade between east and west for nearly 1,600 years. The Silk Road was not only a conduit for the exchange of goods. It was also a conduit for the exchange of culture and knowledge – and plagues and diseases – among its network of civilizations.

Like other features of civilization that once appeared to be permanent, this trade route eventually came to an end. When the Byzantine Empire fell to the Turks in 1453 AD, the Ottoman Empire closed the Silk Road and cut all ties with the west. Geopolitical trends between the east and west turned inward towards isolation.

Declining Global Trade

Global trade these days is conducted by shipping cargo across the international waters of the high seas. Trade cycles over the last 200 years have often expanded for such lengthy durations that several generations will come and go while only knowing the expansionary half of the trend. These extended expansionary episodes compel people to believe that increased global trade is a linear phenomenon.

You have to go back to pre-1960 in the United States, Japan, and Western Europe to find someone with living memory of a global trade contraction. China’s latest trade expansion began in the 1970s. Eastern Europe’s began in the early 1990s.

Those willing to look back to the first half of the 20th century will discover something that goes counter to their life experience. Global trade, as a proportion of total economic activity, went down between the onset of World War I and the 1960s. That’s a nearly 50-year run of declining global trade.

We posit that the breakup of the classical gold standard at the onset of the Great War had something to do with this. Eastern Europe suffered rampant hyperinflation in the 1920s while in the USA the inflation manifested in an epic stock market bubble.

When that went kaput, and the world spiraled into the Great Depression, the Smoot-Hawley Tariff Act of 1930, and tit for tat retaliatory tariffs, took an axe to what remained of global trade. It also presaged the start of World War II.

It wasn’t until well after WWII that international trade picked back up. This trade, while hesitant at first, blossomed during the latter part of the 20th century. Nonetheless, that doesn’t mean trade will continue to expand indefinitely.

Political Intervention

Geopolitical shocks have periodically disrupted or reversed overall long-term trends in expanding global trade. The World Trade Organization publishes a World Trade Report each year documenting the state of international trade and offering various facts and anecdotes. If you peruse through them, you can find interesting insights. For example, the World Trade Report 2013 included this nugget:

“Politics [at times] has intervened – sometimes consciously, sometimes accidentally – to slow down or even roll back the integrationist pressures of technology and markets. It is this complex interplay of structural and political forces that explains the successive waves of economic integration and disintegration over the past 200 years; and in particular how the seemingly inexorable rise of the ‘first age of globalization’ in the 19th century was abruptly cut short between 1914 and 1945 – by the related catastrophes of the First World War, the Great Depression and the Second World War – only to be followed by the rise of a ‘second age of globalization’ during the latter half of the 20th century.”

There are times when extrapolating from the economic past and projecting into the future are exceedingly thoughtless and blind. Right now, maybe one of those times. By our estimation, the potential for multiple geopolitical shocks, including wars and currency chaos, to interrupt or reverse the global trade expansion that has been in place since the 1960s is extremely high.

At the moment, it’s very well possible that we’re near the start of another long-term global trade contraction. The impetus of the trade contraction is a politically motivated trade war.

Trump campaigned on a promise to impose at least a 60 percent tariff on Chinese imports. The intended purpose is to correct the ghastly $300 billion annual trade deficit the U.S. has with China and to remake the USA into a manufacturing powerhouse.

Somehow, trade tariffs will make it possible for factory jobs to return to America’s rustbelt so the country can experience the nirvana of full MAGA. Moreover, in doing so, the forgotten workers of America will be able to kick their fentanyl addiction.

This all sounds great. But will a full-on trade war attain the desired result for the USA. We may soon find out in real time…

How The Trade War Ends

A trade war, in simplest terms, will result in a trade contraction. Shrinking trade means less imported and exported goods. Less imported and exported goods means smaller economic growth. Smaller economic growth means less wealth creation.

In short, a trade war means a smaller economy. It also means a reduction in choices, and a shrinking of global wealth.

For American consumers, with their heavy dependence on imported goods, it means higher prices. It also means fewer choices.

As the trade war escalates, all sorts of strange and dysfunctional things will happen. American visitors to China may discover high quality Electric Vehicles, made by companies they’ve never heard of, selling for just $10,000 a pop.

These brands and bargain prices will be effectively excluded from American markets. At the same time, American workers will earn $20 per hour to make socks, which will quadruple their price.

Regardless, Trump is committed to sticking it to other countries with across-the-board tariffs of 10 to 20 percent as part of his America First economic policy. For China, he’s reserved a special 60 percent tariff.

The purpose of these tariffs, in addition to potentially increasing Made in the USA goods, is to generate revenue to offset Trump’s tax cuts. Import tariffs in combination with domestic tax cuts would drive import volumes down while household and business spending would increase. This is a recipe for rising consumer price inflation.

There’s also the potential of this politically motivated trade war leading to a world war. What then? Can the consequences be undone before it’s too late?

Alas, the historical precedent is less than cheerful.

Once a global trade war starts in earnest there really isn’t a quick end. Like a California wildfire, once the conflagration starts it cannot be stopped.

Only the complete devastation and destruction of a world war, and a full reset to the power balance, will bring a trade war to its bitter end.

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Sincerely,

MN Gordon
for Economic Prism

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