Possible Trade War a Threat to Economic Recovery and Equity Markets

(MoneyWatch)  Just one bad policy decision can make the difference between a continuing economic recovery and slipping back into a recession or even worse. Unfortunately, government officials seem to be willing to make decisions in their own best interests, rather than the interests of the greater good.

One issue on which most economists agree is that free trade is good and trade wars are dangerous. Unfortunately, we've chosen to take steps down the slippery slope toward an escalating trade war. For example, the stimulus package contained a buy-America provision. As expected, we are seeing retaliation against U.S. exporters with similar buy local provisions.

On September 11, the U.S. announced a stiff tariff on Chinese tire imports, despite opposition to the tariff from U.S. tire manufacturers. The tariff was imposed despite requests from 33 U.S. agricultural companies and industry associations to refrain from tariffs on Chinese tire imports, concerned that China would retaliate against U.S. products. So the Chinese response that they're considering retaliating against U.S. exports of chicken was no surprise.

Even on a standalone basis, the rationale for the tire tariff can easily be questioned because Mexican and other low cost manufacturers will simply step in and replace cheaper Chinese imports, costing American consumers without saving any jobs.

Everyone is well aware of the dangers of a trade war, and no one wants to repeat the experience of the 1930s triggered by the enactment of the infamous Smoot-Hawley tariffs. For now, the financial markets are acting as if cooler heads will prevail. And there's reason for optimism. Chinese imports are growing rapidly, up 68 percent in the last five years to $608 billion, and now represent about one-third of their economy.

The rapid growth of Chinese imports is helping the global economic recovery. No one wants to risk taking actions that would threaten the recovery. While the Chinese have threatened retaliation, they have also signaled a willingness to negotiate a solution. The following quotes appeared in a Sept. 17 Bloomberg article regarding a possible trade war.

"China and the U.S. share extensive and broad common interests and we are ready to work with the U.S.," Jiang Yu, a Foreign Ministry spokeswoman, told reporters in Beijing when asked about the tire issue. China is ready to "strengthen communication, dialogue and cooperation in various fields and properly deal with our problems."

Yao Jian, another ministry spokesman, stated: "We don't want to see individual trade-remedy cases hurt the trade and economic relationship between China and the U.S." And President Obama, in an interview at the White House stated: "We're not going to see a trade war."

Given the awareness of the dangers, there's reason to hope that the President is right.