The Trump Trade War Recession? By: John Mauldin | September 28, 2018
“A conservative is someone who stands athwart history, yelling stop, at a time when no one is inclined to do so, or to have much patience with those who so urge it.”
—William F. Buckley, Jr., 1955
I will never compare myself to Bill Buckley, as a writer or anything else. He was one-of-a-kind and a personal hero who I am disappointed to say I never met but who I read a lot. The response to my recent tariff comments gives me a small hint of how it must have felt to “stand athwart history” and launch the modern conservative movement. Many of you support the tariffs. And I understand your reasons. I really do.
Free trade used to be a core belief of the conservative movement. Hayek, Friedman, Mises, Rothbard, and numerous other economists eloquently explained why. Several liberal economists agree. Conservative politicians spent the last few decades moving us in that direction, albeit imperfectly and with some big mistakes along the way. But few disagreed with the ideal.
Let me be clear on this: I do not think the tariffs on China are going to cause a recession. But if we have a recession, that is precisely what the Democrats will say. Democrats will not run against the Fed, investor sentiment, markets, Italy, or anything else that actually causes the next recession. They will be running against Trump and everything will be his fault. It will be the Trump Trade War Recession. Whether or not it is true is immaterial.
That is neither here or there because a trade war with China introduces too many variables into an already difficult situation. Let’s look at what is actually happening on the ground.
Hoover, Smoot & Hawley
We all wonder if Trump’s trade actions are as random as they appear or if there is a broader strategy. Some of my contacts argue that the relatively strong US economy allows the administration to take a harder line than would normally be advisable. We can ride out a trade war better than China can, the thinking goes.
This only works if the US economy keeps prospering long enough for the tariffs to make China bend. We can postpone a recession for another year or two if the trade war doesn’t intensify and Europe holds together. Since it is intensifying—with a new round of 10% tariffs taking effect this week and more to come in January—we may not get that time.
In other words, tariffs could end the conditions that justified them. Something similar happened before, during the most famous trade mistake in US and global history: the 1930s Smoot-Hawley tariffs.
Similar to today, the Roaring 1920s saw rapid technological change, specifically automobiles and electricity. This created a farm surplus as fewer horses consumed less feed. Prices fell and farmers complained of foreign competition. Herbert Hoover promised higher tariffs in his 1928 presidential campaign. He won, and the House passed a tariff bill in May 1929. The Senate was still debating its version of the bill when the stock market crashed in October 1929. Today, we use that event to mark the Great Depression’s beginning, but at the time, people didn’t know they were in a depression or even a recession. Most economists expected a quick recovery. Stocks did recover quite a bit in the following months, though not back to their prior highs.
So, when the Senate finally passed a tariff bill in March 1930, the thinking was not that different than we see today. They thought they could preserve and even extend the good times. But conditions worsened quickly and by 1931, unemployed men were standing in soup lines.
In 1932, both Smoot and Hawley lost their seats as Franklin Roosevelt beat Hoover in a landslide—57% of the popular vote. That history won’t necessarily repeat this time, but it’s surely not a good omen.
Multiplayer Game Theory
John Nash (one of the world’s great mathematicians, Nobel laureate, and centerpiece of the brilliant movie A Beautiful Mind) developed multiplayer game theory. Essentially, an equilibrium develops around the rules as they are at the moment. If somebody changes the rules, no matter how rational the rule change may seem to be to the person who’s making the change, it makes everybody else change their response.
Trump’s actions, especially in regard to China, may be perfectly rational. China is not playing fairly. But his actions change the rules and everybody else is forced to react.
Throw in NAFTA, Europe, and all the other trade negotiations, and things get complicated. Yes, we have a new trade deal with Korea. The US is marginally better off. Trump is trying to do a one-off trade deal with Japan. Abe is cautious because Trump wants to open up Japan’s markets to US agriculture.
We pulled out of the Trans Pacific Partnership (TPP) because it had flaws—clearly. But it served the purpose of isolating China.
Trying to do bilateral trade agreements with every one of those partners is going to be extraordinarily difficult and time-consuming, if not impossible. And so, everybody reacts to try to change the circumstances to their own benefit. This is multiplayer game theory on a scale so vast that it is almost impossible for a human being sitting in the middle of the United States working at his job, just trying to get through the day, to understand. And so, they get angry and say we need more tariffs to protect America. Just like every other voter in every other country is trying to figure out how to protect their markets.
Trade Sandpile
Something else I keep hearing is variations of, “China is cheating, and we have to do something.” This comment from reader Justin McCarthy is typical.
I get all the handwringing and pearl clutching about trade wars. But it really appears that true free and fair trade is an illusion. China cheats. Why? Because it can. Everyone pretty much acknowledges it. But where are the projections and analyses of the long-term consequences of permitting the status quo to continue? What are the consequences of letting the balance of power shift in China's favor? I see a lot of angst about trade wars but no discussion about the effects of no action.
Justin said this nicely, but I have to disagree. He’s right that “true free and fair trade” is not what we have, nor have ever had. But trade isn’t a binary condition. Today, we see near-total isolation on one extreme (think North Korea) or at the other end extensive trade freedom, as nominally exists within the European Union. There’s lots of room in between.
China cheats in many and various ways, which I have stated are problematic. I’m not happy with the status quo, and I want to change it. The question is, are tariffs the best way to accomplish this? A second question is, even if tariffs accomplish the goal, will there be side effects that reduce or eliminate the benefits? I see a lot of unintended consequences.
A few weeks ago, I described how a sandpile can slowly grow in size, apparently stable, but in reality, it has many hidden fingers of instability. At any moment, something could trigger an avalanche.
The global trade system is something like that. Of course, it’s not perfect or even optimal. Countries erect barriers to their advantage. I can point to several countries whose economic policies are mercantilist, but at least everyone knows about them. We see the fingers of instability and leave them alone, lest we trigger an avalanche whose victims are impossible to predict. It is a kind of equilibrium. Everyone’s incentive is to avoid catastrophe and make incremental improvements. That makes trade talks extraordinarily difficult.
The Trump administration doesn’t seem to care about equilibrium. Whether the president himself or those around him, the strategy appears to be “kick apart the sandpile and make everybody rebuild it.” And whether we like it or not, many of Trump supporters actually like the concept of throwing a wrench into the system.
So, it is not the case that the US has no choices. We have many choices. Tariffs are the wrong one. But then, that is just me and I am one lone voice and vote.
Victim List
Commerce Secretary Wilbur Ross is a brilliant businessman. He is proving less than effective as a public advocate for administration policy. Earlier this month, he appeared on CNBC to tell us the latest tariffs won’t be so bad.
News 
Market Data 
Discover 
