China Markets trade

The Great War Of Attrition: 5 Reasons Why The US-China Trade Conflict Won’t End Soon

"Stay tuned".

With the exception of intermittent Twitter tantrums, the last two weeks have been characterized by what counts as “trade optimism” these days.

To be sure, “optimism” is a relative term at this point. Escalation after escalation, tweet after tweet and tit after tat, have left markets war-weary to the point of exhaustion. But even as a kind of fatalism sets in, traders (both carbon-based and otherwise) can’t help but get sucked in on ostensibly positive headlines.

And so, “news” that the two sides are still in touch and plan to meet both at the working level (this month) and the principal level (some time early next month) helped bolster risk assets and push the VIX back to a 15-handle. It’s been a wild ride.

Everyone has their own framework through which to assess the odds of a Sino-US trade deal. Suffice to say optimism around the prospects for a pact ahead of the US election are “not good, not good”, to quote Trump.

For BofA’s Aditya Bhave, five lessons from a “war of attrition” game-theoretic model help inform a rather grim take on the likely evolution of the dispute.

First, Bhave writes that “the bigger the prize, the longer the fight”. Clearly, the prize is about as big as prizes come in this case.

“Over time it has become increasingly clear that the trade war is part of a much broader conflict between the US and China over technological and military dominance, and geopolitics”, BofA says. “Accordingly, both sides are likely to remain patient, pursuing this costly conflict for an extended period of time”.

Second, the bank doesn’t think fatigue is a factor – or at least not yet. “The length of the conflict to date has basically no bearing on how much longer it is expected to last”, Bhave cautions, adding that while “the costs of the conflict add up for both sides over time, the intuition is that past costs are sunk, so they do not affect decisions about the future path of the conflict”.

Third, BofA postulates that although Trump may have the upper hand, the fight is nowhere near as one-sided as trade disputes between, for instance, the US and South Korea, Mexico and Japan.

“The economic cost to China of fighting the trade war might be only modestly higher than the cost to the US [and] it is possible that China is able to bridge the cost gap by inflicting more pain on the US than other countries can”, Bhave says, on the way to noting that “when the two sides are similar in their willingness and capacity to fight, our framework suggests that the total cost of the conflict tends to be similar to the value of the prize that they are fighting for”.

That increases the odds of a “Pyrrhic” victory. More simply, the bank says that by the time this is over, the “damage done [may] exceed the winner’s gains”.

Fourth, BofA suggests that Trump might not be the only one playing the “crazy” card. The bank says that even if China is woefully outgunned, as a non-market economy, Beijing may be able to take the pain indefinitely. “Consider a scenario in which China has a higher cost of fighting the trade war than the US, but US policymakers are concerned that their Chinese counterparts might be ‘irrational’ [or that] they might have an infinite pain threshold”, Bhave says.

As the trade war drags on, Washington may become more worried about the possibility that China is economically irrational. Indeed, Trump has repeatedly suggested that China might try to wait him out until the 2020 election, despite the enormous economic costs. The US president has, at times, sounded incredulous that Xi continues to hold out in the face of what the administration insists are “millions” of lost jobs and factories “fleeing China”.

Of course, if China knows the US is concerned about this, they may keep fighting in an effort to demoralize Trump. As BofA puts it, “China might continue to fight for longer than it otherwise would have, even if it does care about the costs it is incurring”.

Finally, Bhave says the Trump administration’s decision to delay tariffs on consumer goods, the farmer bailouts and the incessant effort to convince voters that China is “paying for the tariffs” even when that assertion is manifestly untrue, may be perceived by Beijing as a sign of weakness. Here’s BofA:

From a strategic perspective, however, this move should make China more confident that the Trump Administration is responsive to economic incentives. In fact despite its somewhat out-of-the-box approach, we see plenty of evidence that the administration is sensitive to the costs of the conflict. It has issued subsidies to farmers to offset the pain from Chinese measures against the US agricultural sector, and President Trump often justifies the trade war by reiterating his view that China, not the US, is paying for the conflict. Our framework suggests that the knowledge that it is up against a “rational” opponent would make China more patient in terms of extending the conflict.

All of that (and the full note is obviously much longer, including an appendix outlining war of attrition games and elaborating on the framework), to come to a conclusion which is broadly similar to that adopted by other desks.

“Our game-theoretic analysis reinforces our view that the US-China trade war is unlikely to get resolved in the foreseeable future”, BofA laments, before admitting that “things probably have to get worse before they get better” and advising investors to “stay tuned”.


9 comments on “The Great War Of Attrition: 5 Reasons Why The US-China Trade Conflict Won’t End Soon

  1. Lobo tosoro

    The boy crying wolf, all night long, is a game that no longer carries water:

    Moreover, the fact that the United States held out the possibility of escalating the conflict to at least an air strike indicates that the initial blockade decision was not considered final – that is, the United States considered its strategy choices still open after imposing the blockade.

    As a consequence, this game is better modelled as one of sequential bargaining, in which neither side made an all-or-nothing choice but rather both considered alternatives, especially should the other side fail to respond in a manner deemed appropriate. In the most serious breakdown in the nuclear deterrence relationship between the superpowers that had persisted from World War II until that point, each side was gingerly feeling its way, step by ominous step.

  2. Neither the US nor China are so critically dependent on bilateral trade, and the respective degree of dependence is not so dramatically different, so neither actually has a decisive upper hand.

    Both have many still-unused weapons against each other, and both have defenses to those weapons. For example, China has yet to seriously target US companies’ operations in China, the US has yet to actually cut Huawei off from supply, China can depreciate the CNY to offset tariffs, the US can move from tariffs to outright import prohibitions, etc.

    There are two crucial differences.

    First, the US President has only 16 months left in office, and is openly and aggressively opposed by major elements in the government and in the society at large. The Chinese leader has unquestioned power and authority with no end date.

    Second, most Americans are at best lukewarm about the trade war; they think it is a good idea in theory but it was never high on their list of things they wanted to sacrifice for. Their support, such as it is, will fade as the war grows. Most Chinese see their country as the innocent party fighting for survival and identity, encouraged by the state-controlled media, and their latent resolve has hardly been tapped.

    I see the US as the weaker party. Trump and his advisors were extremely naive to equate relative trade flows with relative power, and to think that everyone is transactional with short memories.

    Trump has also acted like a player trying to bluff a weak hand. How many times has he postponed a tariff and otherwise veered away from a decisive action? Blinking is a big fat “tell” in any game.

    Keep looking at this from China’s point of view. It should look very “winnable” to them.

    • Alarmclock2020

      Re: “US President has only 16 months left in office”

      Considering the Democrats still have no viable candidate for voters, the very real possibility of The Idiot returning for a second term is still very high. Te Democrats are re-running the 2016 election playback, running sure-fire fighting Joe, who will be about 80 years old, dragging massive political baggage behind him, while Pocahontas finds a way to connect with anyone — and then the rest of the pack of 20 who are all meaningless and inconsequential — leaving the GOP totally unified as the Democrats fragment into smaller pieces of chaos. You may recall that 90 million eligible voters sat out the 2016 election because they hated all the choices — do you really think anything has changed?????

      • Hmmm, Warren is infinitely better that HRC. She has mid-west appeal. Joe quasi-senile is DNC sacrificial lamb game to be offered up to shift relief to Warren and avoid donor-killer Bernie at all costs. They are stupid but not stupid enough to push Biden up against Trump. That would be one sorry ass event that would threaten the entire corrupt DNC structure. Biden’s consolation will be an expanded bank account balance.

        • Alarmclock2020

          The sooner the Democrats wake up the better, in terms of investing in the right candidate, but this problem today is all too familiar, with who has the official party blessing, i.e., Hillary was the money magnet in 2016, because she apparently deserved all the money and all the respect, because she was the most qualified person and so well connected to the whole base, except for the 90 million eligible voters who saw her as a negative liability, even though trump was disgusting. Bernie was poison, as he is now and Warren has never broken away as a legitimate champion — she may have had a better chance in 2016. What needs to happen is a spark from some new candidate, something (someone) unexpected that lights a fire — and then like a magnet, that person draws in voters and money ASAP and they take out the entire GOP. Unfortunately, the GOP is united, well funded and in a position to protect themselves, while the Democrats explore new ways to express how nice they are in a slow motion touchy feely kinda way, as they stumble over how to make Socialism into a new exciting product that makes America better again. They need a miracle to fix the mess they created!

  3. I can see the tariffs being withdrawn on non-strategic goods if the democrats win the election fairly quickly. If the Chinese also relax their restrictions to match and we sit down with them and the Europeans and get trade up and running again hopefully the world’s peoples will start breathing easier. We’re all in this together. There are some bullies in the neighborhood but we all have to work together on the major crisis’ to survive. Or we won’t.

  4. Get this straight from the horse’s mouth. Mexico is paying for our big beautiful erect wall, and China is paying for the cost of his studly tariff war. Other interpretation are anti-American. MAGA! MAGA! MAGA! f***in MAGA!

  5. I agree Trump has some advantages come election time – incumbency, electoral college math, vote hacking, maybe a so-so Dem candidate – but if the trade war escalates for 16 months, he’s going to be in a world of hurt as far as getting a second term goes.

  6. Harvey Cotton

    Bank of America seems needlessly nationalistic. China is the country with the positive balance of trade, a shrinking but still positive current account surplus, and huge foreign currency reserves. China has geopolitical sway over a host of countries in Asia and Africa that American-based multinationals could move their supply chains through. China has the ability to pivot their export-led growth model to enhance domestic consumption as they attempt to raise the standard of living in their interior regions.

    The United States has a massive and growing trade deficit with China, a current account deficit, huge and growing annual public deficits, a large and growing public debt, corporate debt, and household debts, unfunded public liabilities, bubblicious asset classes, and a looming near-term recession.

    Even our advantages are being diminished. Our independent agencies are being politicized. Technocratic expertise is systematically being eroded and replaced with literal political correctness (Our very own King Canute, backed up by the N.O.A.A., changed a hurricane forecast with a stroke of a sharpie). The sinews of our democratic institutions are withering and our civic discourse is fraying. The attack on all forms of immigration will make our country older and less socially dynamic. Wealth concentration will make social mobility ever more rigid. All of the social and financial dislocations China bears have been predicting for decades for China now apply at least equally as much to the United States.

    For all of these reason, I believe it is China that has the advantage at least in the near- to middle-term.

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