The era of free trade is over. Tariffs and trade restrictions that only a decade ago would have seemed unthinkable are now embraced by lawmakers on both sides of the aisle and certainly by both men vying to be the next President.

In less than six months, voters across the United States will select the next President of the United States. Between now and then, we will hear from Former President Trump about the need for across-the-board import taxes of 10% and for the imposition of 60% tariffs from all goods from China. Not to be outdone, last week the WSJ reported the following regarding the Biden administration,

“Officials are particularly focused on electric vehicles, and they are expected to raise the tariff rate to roughly 100% from 25%, according to the people. An additional 2.5% duty applies to all automobiles imported into the U.S. The existing 25% tariff on Chinese electric vehicles has so far effectively barred those models, often cheaper than Western-made cars, from the U.S. market. Biden administration officials, automakers and some lawmakers worry that wouldn’t be enough given the scale of Chinese manufacturing.”

In addition, the Biden administration appears likely to add tariffs to steel and aluminum imports from China.

In fairness to this wave of protectionism, China has given western countries little choice. In autos for example, China has built the capacity to build as many as forty million cars a year with domestic demand at less than half of that figure. As China continues to suffer from the implosion of a woefully overbuilt property market, Chinese leadership has embarked on an effort to export their way out of the current malaise by heavily subsidizing strategic industries. In fact, the EU is also in the process of figuring out the best way to keep subsidized Chinese products from EV’s to solar panels out of their markets to protect local manufacturing and local jobs.

Of course, these actions will not be unilateral. China’s trade representative said last week, “China will take all necessary measures to defend its rights and interests”. China has leverage on several fronts: the country dominates the processing of metals from lithium to graphite, both of which are critical to industries involved in the energy transition. China continues to grow more belligerent in the South China Seas around Taiwan and the Philippines. China has shown some level of restraint in their military assistance of Russia, but that could obviously change.

So what does all this mean for markets? Probably more inflation. The world’s economy is transitioning from economic cooperation to trade wars. Trade wars are inflationary for the simple reason that the cost of the tariffs are largely passed on to the end consumer. Perhaps it goes without saying, but trade barriers also reduce competition.

As we have been saying for some time now, US economic trends remain strong benefitting from unprecedented fiscal spend, massive accumulated savings, and strong income growth, but the risk to all that is the growing risk of secular inflation and the transition from free trade to trade wars is eventually going to get priced in to markets.

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