Why the trade war will continue - It is a not a trade war, it a battle of economic models

The purpose of war according to Clausewitz is simple, "...compel our opponent to fulfill our will" and "war is the continuation of politics by other means."  It may be a last resort, but it is an extension of diplomacy even financial and trade diplomacy. 

These quotes are very applicable to the current trade war between the US and China and represents a part of the diplomatic strategies of each country. Nevertheless, there needs to be a focus on the deeper strategies being played by each country and the implications for investing. The simple view is that the tariffs were increased to change the balance of trade, but this fight is now being played at a much deeper level and is the reason why this conflict may be more protracted. This has become a contest of competing systems; consequently, it is less likely to be easily resolved.

The simple view is that tariffs are a fundamentally new policy response and that the pre-Trump period was absent of import restricting policies. That view is simply not true. Policies such as anti-dumping and countervailing duties have been on the rise since the entry of China into the WTO. The current policies, albeit ratcheted to a much higher level, are an extension of ongoing trade skirmishes, albeit not in the headlines. The amount of tariffs levied has been small but not absent. (See the PIIE working paper from Chad Brown for a good overview #19-7 "The 2018 US-China Trade Conflict After 40 Years of Special Protection")

This is a battle between western economic liberalism and a corporate state mercantilist system; however, liberalism is in the perverse position of imposing tariffs as sanctions on the anti-competitive behavior of state enterprises and state growth policies. These tariffs are not to gain revenue or just make US businesses seem more competitive and bring manufacturing back to the US. The tariffs are attempting to place a wedge in market structures and change state behavior for doing business in China which includes patent and copyright work as well as the transfer of technology that move beyond sharing between business partners. 

The mechanisms of the WTO may not address or have the enforcement powers to change overall business structure in China. The tariff club is ham-handed, but a choice within the tools of financial diplomacy. It may not be the right choice, but frustration with state behavior has made this a tool. Corporations by themselves do not have the market power to ignore or change China, so the state apparatus is necessary. China's will is to maintain the political status quo and continue to achieve high growth through global trade policy.  

Unfortunately, there is no international organization that has the power to change a large dominant player for the benefit of the global community. The end of economic liberalism is tied to the lose of faith in using international organizations and law to mediate these disputes. Currently, no one trade player or group that can impose their will on another, so there is an escalation of policy and rhetoric that will not go away

There are some key themes that should be applied to any portfolio construction:

• Global growth was driven by the growth in China and the US. This trade war will continue to weigh on growth. As China diversifies its exports, the rest of the world will face margin pressure.
• Revenue growth from selling across borders will decrease. The absolute level of trade will decrease even if tariffs are dropped. The threat of future sanction is real. We are see a significant drop in trade that is beyond a growth slowdown and that will not reverse in the short-run.
• Margins for companies with China supply chains will compress. Even with an agreement, companies will diversify suppliers which will increase costs.
• Cross-border investments between China and US will decrease. The environment is too uncertain. This will apply to real estate as well as companies.
• For China, dedollarization will be a long-term policy goal which will only cause further constraints on economic liberalism and cooperation.

The net global loss from trade and finance frictions will be based on each country being driven by their self-interest based on what they believe is good for their citizens. Global liberalism and cooperation is a hard sell when viewed through bilateral policy views in both the US and China.