The Trump administration keeps upping the ante on its trade war threats, but markets haven’t reacted much.
Raghuram Rajan, who was India’s central bank chief from 2013 to 2016, may have pinpointed why: The risks are just too big.
“They don’t price some of these big risks because it’s hard to estimate probabilities,” Rajan said on Tuesday at the Nomura Investment Forum Asia in Singapore. “It seems like these are sort of unimaginable. A full-fledged trade war between the U.S. and China? Unimaginable and therefore we don’t price it in.”
To be sure, while the market may be viewing the possibility as unimaginable, the U.S. trade war, which has taken aim at China as well as long-loyal allies, has been escalating.
Trade war escalating
The U.S. has begun imposing tariffs on some imports and has already seen pushback and retaliatory tariffs in response. In a strategic blow, Canada has proposed tariffs on imports on maple syrup from the U.S., which primarily come from Maine.
Countries proposing, and sometimes already imposing, retaliatory tariffs are taking laser aim at states which voted for U.S. President Trump, or which have Republican lawmakers.
The Trump administration is also probing whether to impose tariffs on imports of autos and auto parts, a move likely to hurt profitability across the global auto industry, including in the U.S.
But Rajan said the eventual market losses when these risks are finally priced in were less worrisome to him than the potentially severe problems that could emerge in highly levered entities and emerging markets which depend on continued trade between the U.S. and China.
Never ending endgame?
Another issue that may be keeping markets from reacting much: The Trump administration’s eventual goals remain unclear.
“It’s not clear the president himself has a sense of where the endpoint is,” said Rajan, who is currently a professor of finance at the University of Chicago Booth School of Business. “It may be that these are bargaining tactics in order to get to a better position, but its not clear what the [desired] position is.”
Rajan also reiterated that another of the Trump administration’s policies — implementing large tax cuts — will also move the finish line on one of its occasionally stated goals of reducing the U.S. goods trade deficit.
Because the tax-cut stimulus came as the U.S. economy was already operating at full capacity, that stimulus will be spent on foreign goods, increasing the trade deficit, Rajan said.