The toll of protectionism

When President Trump arrives in Britain later today, we will all know about it. This is no hand-baggage-only city break, with both Air Force One 747s likely to be required to transport most of his family across the Atlantic plus up to 1,000 assorted hangers-on, aides and security staff. Last year’s non-state visit required 750 rooms to be booked in advance and we haven’t even started to talk about the two armour-plated Cadillacs and fleet of helicopters that will arrive ahead of the main party.

The cost of just the extra policing required for the President’s trip has been estimated at £18m, making the visit both disruptive and expensive. Which is not a bad description of Trump’s impact on financial markets at the moment as he escalates and broadens his trade offensive to burnish his ‘don’t mess with me’ credentials ahead of next year’s Presidential election. The market rally between January and April ran out of steam in May as investors started to view the President’s actions as politically and economically damaging.

At the end of last year, markets were concerned about three things: trade war, government shutdown and over-zealous monetary policy. Since Christmas two of those worries have eased but trade tensions have intensified. The markets have so far held their nerve, weighing up the cost of individual initiatives and reassuring themselves that the likely hit to economic activity will be manageable. But last week’s opening up of a second front in the trade war on the US’s southern border with Mexico has some asking whether investors are right to be so relaxed.

The decision to threaten a staircase of incrementally rising tariffs on America’s southern neighbour between June and October is worrying on a couple of fronts. First and foremost, the unexpected move underscores the unpredictability of the White House. The imposition of tariffs came as Trump’s replacement North American trade deal was set to pass through Congress. We have become used to the President ripping up his predecessor’s agreements; now it seems we can’t even trust him to stand by his own deals. Second, the use of an emergency economic act from the 1970s to provide legal cover for the tariffs is a clear abuse of the delegation of Congressional trade powers to the President. He is over-reaching the rightful powers of his office.

The escalation of trade tensions in the past week shows that there is much more to Trump’s strategy than simply reining in Chinese mercantilism. The US is engaged in an existential battle with China for dominance in the unfolding 21st century. It is a classic battle between an emerging and a status quo power and history does not paint a reassuring picture of how these tend to be resolved. The imposition of tariffs on essentially all Chinese trade with America is just the start of it, as the extension of the dispute to Huawei’s 5G technology confirms. Britain will be told in no uncertain terms this week what America expects of us on that front.

China’s response to Trump’s bluster is instructive and will be key to whether an early resolution of this growing dispute can be achieved. Thus far the Chinese have endeavoured to maintain the moral high ground, hitting back at the US without rupturing ties. The imposition of retaliatory tariffs has been proportional and threats to withhold the supply of rare earths that America needs for the production of, for example, smartphones have been vague enough not to paint China into a corner. But references to the Long March when China’s communists trekked into the mountains to regroup during their 1930s civil war against nationalist forces confirm that President Xi is preparing for a long fight.

There are differing views on how serious an extended period of protectionism would be for the US, China and the broader global economy. A recent note from Morgan Stanley said that continued stalling of talks could push the world towards the first recession since the financial crisis. Goldman Sachs thinks the hit to economic output would be less than 1pc in both countries and could be contained. But it admits that how markets react to that kind of slowdown would be unpredictable. The performance of a wide variety of assets in May suggests that investors are becoming increasingly jittery. The yield on US government bonds is falling as investors gravitate towards this safest of safe havens. The MSCI World index has fallen 5pc since the end of April. The odds on a cut in US interest rates this year are now above 80pc. The price of copper and oil is falling.

The optimistic view is that this market weakness may be what finally puts the trade talks back on track. The one thing we can predict with certainty about President Trump is that he will have half an eye on the markets during his three days in the UK. He obsesses about the level of the Dow, seeing it as the scorecard of his Presidency. He knows that re-election in 2020 demands a US stock market higher than it is today and he can be expected to do what he has to in order to deliver it. This is the ‘Trump put’ argument that says the President will throw his weight around only as long as the markets give him cover to do so and will step back if he loses the support of Wall Street.

The concern for investors is that he may not be so in control of the situation. He may have underestimated China’s deep-seated aversion to being pushed around by foreigners. Many Chinese think, probably correctly, that America is less interested in trade than in keeping China in a state of permanent inferiority. In light of the humiliations China suffered during the hundred years before the Communist victory in 1949, that is a risky strategy.