(Aug 21): News that China and the US will resume trade talks this week swiftly lifted markets. This follows the first meetings at the annual summer retreat of the Chinese Communist Party leadership at the beachside resort of Beidaihe. As might be expected, the main topic this summer has been the US-China trade war, where it might lead and what could conceivably be done to avert it without an unacceptable loss of political face.

While we won’t have any real indication as to the tenor of the Chinese discussions or their conclusions for awhile yet, it’s worth thinking through where this trade war could take us all in the absence of effective diplomatic intervention. History tells us trade wars are easy to start and hard to stop, just like real ones. There’s a reason for that. The material stakes become greater as hostilities continue. And the domestic political cost of backing down gets higher and higher.

Let’s start with trade. The traded sector represents some 38% of Chinese GDP and 27% of US GDP. If the current, small-scale dispute escalates to cover the entire US$650 billion ($890 billion) in bilateral trade, the world will have an objective economic problem on its hands, not just one of general market sentiment. Once growth numbers start declining, however marginally, it won’t take all that much for sentiment, and then the real economy, to head south. Falling sentiment and economic numbers will contribute to a mutually reinforcing spiral.

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