Enclosed is an executive summary from a new paper that we have published on the changing probabilities in the trade war:

  • Coolabah Capital Investments previously assessed that a myopic and mercenary President Trump would want to strike an expedient trade deal with China well in advance of the 2020 election to maximise his economic momentum heading into that crucial cross-roads.
  • After extensive due diligence with Chinese and US intelligence, defence, and political experts around the world, we have recalibrated our probabilities to a much more finely balanced outcome.
  • This reflects an internal struggle within the White House between the market-friendly “Goldman Sachs consensus” (our phraseology), led by Treasury Secretary Steve Mnuchin, that want a deal to be done to staunch market fears of a catastrophic decline in global trade and those who adhere to a much more realist (or “hawkish”) strategic view that judges China on its actions and internal ideology. This latter camp, which we refer to as “Bannon’s Hawks”, believes that China is a fundamentally malign actor seeking global economic and military supremacy in order to sustain President Xi’s dynasty. This cohort includes Trump’s influential chief negotiator, Robert Lighthizer, who has been dealing with the Chinese on trade for decades, and Trump’s economic adviser, Peter Navarro.
  • As China has reneged on, and remains resistant to, an all-encompassing trade deal that would—through strict monitoring and regulatory reform—finally force it to compete on a level playing field with other nation states, we sense that the balance of power is swinging back towards Bannon’s Hawks, who are winning bipartisan support across the US polity and indeed the West at large in favour of giving China a binary choice: either belatedly adhere to the terms of the Western liberal-democratic free and fair trading order, or be actively excluded from it via US led “de-coupling”, which would involve migrating supply chains out of China through the imposition of punitive tariffs.
  • We currently believe that there is a circa 50% probability that either (1) Trump folds and does a weak trade deal to satisfy financial markets and take a superficial win to the 2020 election or (2) President Xi relents and signs-up to a comprehensive trade deal that he has no intention of complying with in the long-run, but which would buy China more valuable time to strengthen its geo-political leverage. We believe this latter option is Xi’s best current solution given the awkward situation he finds himself in where he has both lost face through his bruising entanglements with Trump and ostracised China from much of the developed world via his heavy-handed foreign policies.
  • Alternatively, we think there is a circa 50% probability that no deal is struck, and wittingly or unwittingly, China and the US economically “decouple” via the application of 25% tariffs to all Chinese exports, which would fatally undermine its historic cost and trade advantages. Low cost competitors and Western firms would then have an incentive to shift their supply chains (and trade) to more benign counterparties around the world. This might induce more short-term market volatility, but would ultimately be positive for long-term geo-political and financial system stability by preserving the Western liberal democratic model, which has maintained peace and prosperity since the Second World War.
  • We think that markets will respond positively to any deal being struck given this cauterises short-run geo-political risks. While markets might react very negatively to the failure of Presidents Trump and Xi to reach an accord at the G20 summit, and to Trump carrying out his threat to apply 25% tariffs to all Chinese exports by mid July, it is also possible to conceive of mitigants. Trump could seek to soothe markets, which do appear to be experiencing trade fatigue, by claiming he is committed to doing a deal, which he could signal was still being negotiated. The Fed also has ample room to cut rates and inject stimulus into the economy with a trade stale-mate potentially providing the perfect reason to doing so.

Read our full paper here.