This might not end well.
Last week, during what's become a routine Friday night bad-news dump (for Democrats and Republicans), the Obama Administration announced it would slap 35% tariffs on imports of Chinese tires as an anti-dumping measure.
Over the weekend, Beijing accused Washington of "rampant protectionism" and announced plans to investigate "allegations" the U.S. was "dumping" chickens and auto parts.
As of 7:00 a.m. EDT, Asian markets are down sharply over fears a trade war could follow this initial exchange of fire. Wall Street seems likely to follow.
In and of themselves, the U.S. action and China's strong hint of reaction are not all that significant and are unlikely to lead to an immediate trade war. What is very significant is the context and what it could portend.
It's a bad omen.
The timing couldn't be worse. The world economy is struggling to get back on its feet without the need of a multi-trillion-dollar crutch, and the U.S. is counting on exports (the American consumer lies in a debt-laden coma and Washington may be running out of other people's money). The U.S. "recovery" is being kept afloat, for the most part, by exports and government.
President Obama is scheduled to lead the G20 summit in a few days at a session that was supposed to be devoted to serious, difficult reform of a global financial system to prevent or at least mitigate a future financial crisis. This is just two months after the U.S. led the G8's joint declaration not to engage in protectionism.
Measures to move global free trade forward have been stalled for years, most recently during the Doha Round, with many countries opting for simpler, but less efficient ad hoc bilateral agreements. In physics, what goes up must come down (unless it escapes the earth's gravitational pull). When it comes to trade, what does not move forward, eventually regresses and moves backward...especially in a recession. That's what's happening now and what happened before around the start of the last century -- with deadly consequences.
The U.S. move only adds more momentum to a reversal from freer trade, following similar stealth and not-so-stealth protectionism by India, Russia, other countries and China itself over the past year's slump (click here and here).
The global slump continues, regardless of what cheerleaders are saying. The Baltic Dry (Goods) Index, a key real time barometer of trade, after showing signs of recovery from its collapse earlier this year, has started declining again.
This trade spat is a bad sign because joblessness will only get worse in the U.S. and elsewhere for the foreseeable future absent a miraculous shift in Washington toward business-friendly economic policy and real private-sector growth. That means protectionist pressures will only intensify.
A virtual beggar-thy-neighbor policy has already taken hold in DC. The White House and the Federal Reserve are accommodating a sharp drop of the dollar -- a drop that's siphoning demand from trading partners. Note that New Zealand, among the top economic and currency performers of the past year, is now seeing its second straight drop in retail sales. The dollar's drop against the local currency plays a big role. Japan is experiencing similar travails.
The Smoot-Hawley tariffs of the 1930's and the subsequent trade war were critical ingredients that helped turn the stock market crash and early economic downturn of the 30's into the multiyear Great Depression.
In taking this move, it is surely the Obama Administration's hope that this might stave off or relieve some political pressure. In retaliating it is no doubt China's hope that it can also relieve popular pressure on Beijing and discourage the U.S. into taking any other protectionist measures.
In reality, in the context of deepening economic pain and growing political pressure in the U.S., China and worldwide, there is a great risk that one or both countries will miscalculate and other countries will bow to their own internal pressures and pile on.
The pressure to further restrict trade is only going to get more intense in the U.S. and elsewhere as hard times stay hard or get harder for more of the American electorate and electorates abroad. By allowing this early crack in the dam against protectionism, Obama risks unleashing a flood in the U.S. and abroad.
China is one of America's biggest trading partners and one of the country's biggest creditors. If this spat or a future spat somehow leads to even a mere slow down in the pace of American imports and its purchases of U.S. debt, China can hurt the U.S. where and when it can least afford to be hurt.
Consider this latest spat a warning of something much worse that could lie down the road as bad times and political pressures among all major trading partners intensify. Expect a sharp drop in stock market, a rise in U.S. interest rates and greater inflation if this exchange of fire is indeed a preview of what's to come and eventually turns into a circular firing squad.
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