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[...]In surveys, business executives point to trade tensions and the uncertainty they generate as their single biggest concern. Stock markets have become extraordinarily sensitive to trade news. And the weakness in activity persists despite negative real interest rates. Trade tensions have not only slowed growth but have also preempted the normalisation of monetary policy.
Many were initially complacent about the effects of tariffs, since they were only applied to a small part of world trade, and their impact on GDP is known to be small. But this calculus was wrong. Tariffs affect specific sectors in a big way and trade disputes can turn into trade wars. Investors struggle to anticipate where the axe might fall. The cause of the slowdown is not the tariffs themselves, but the fear of regime change. In this case, regime change is the passing of the rules-based trading system and its replacement by the struggle for power.
When policymakers talk seriously about decoupling from China, about imposing 25% tariffs on automobiles, about the collapse of the WTO’s judicial function because of the United States’ refusal to replace its judges, that is the start of regime change. [...]
Everyone wants a deal, but it would be naïve to believe that, even after Trump, Americans will lose their fear of a rising China.
Beijing is ready to liberalise more and do a better job of protecting intellectual property, but it would also be naïve to think that China is willing to abandon its highly successful state-driven model. Meanwhile, Europeans, who often claim that they are the virtuous exception, are instead among the most impervious to change.
So much is at stake that I believe compromises can be found, allowing the rules-based trading system to survive. But a lot will have to change for that to happen, and it is far from certain that the political will exists. Growth has slowed because investors have taken notice.