The US and China are on a combustible escalation path that can end only when there is economic blood on the floor and the political pain threshold of one side or the other has been hit.

Both think they can withstand the longer siege. Neither can retreat easily.

Donald Trump has not put forward meetable demands in any case.


"I don't see any off-ramp. There is going to have to be a lot of pain before anybody backs away," said Patrick Chovanec from Silvercrest Asset Management, an ex-professor at Tsinghua University.

Trump boasts that "tariffs are working big time" and that it is easy to win a trade war against predatory rivals running a structural surplus. It is a false lesson drawn from the 1930s before the advent of global supply chains.

"The trade hawks around Trump seem to think that China's economy is now so wobbly that sanctions will push the country over the edge, and the Chinese will coming begging for mercy," said Prof Chovanec.

"They seem to have no idea what it would mean for the global financial system if they did succeed in taking down China."

In reality, Beijing would slam the door closed on capital flows, recoil inwards and flood its internal economy with stimulus. The state-controlled banking system would probably prevent a Lehmanesque "Minsky Moment".

"I am still looking for a credible explanation of how the mechanics of collapse might actually work in this unique political and economic system," said Bill Bishop, a China veteran and founder of Sinocism.

China is clearly digging in. Bishop said the secret Beidaihe "summer summit" of the Communist leadership in August saw a fateful shift in the strategic thinking of President Xi Jinping and the party hierarchy.

They concluded that the real goal of Donald Trump's trade war is to "thwart China's rise", part of a multi-pronged campaign targeting the military technology complex in a superpower struggle for hegemony.


"Xi has decided the US is intent on keeping China down," he said.

This goes beyond the Trump White House - an "unhinged" menagerie, led by a man with "the IQ of an inbred tanning bed", in the description of Bob Woodward's exposé Fear.

Hostility to China is becoming a "Washington view" reaching deep into both parties on Capitol Hill.

The Cold War character of this conflict is clear in the US National Security Strategy Report, which names China for the first time as a strategic rival that seeks to "challenge American power, attempting to erode American security and prosperity".

This theme has been picked up in the editorial pages of China Daily, the voice of the Politburo. It accuses America of trying to "suck the lifeblood" from the Chinese economy.

"Everyone is united against the common enemy. Everyone is clear: China has been forced to take desperate action," it said.

The immediate threat for China's leaders, however, is the brinkmanship of Trump himself.

Beijing will be aware of the passages in the Woodward book in which he talks of blowing up the world trade system, betting insouciantly that in "in six months, they'll come running back to the table".

But the Chinese also know that he watches Wall Street and judges his success by the US equity indexes. The "game theory" logic is for Beijing to retaliate pari passu and let a market correction unfold until he blinks.

This does not require active financial intervention. If Trump goes ahead with sanctions on US$200 billion ($307.3b) of Chinese exports this week, followed by the final US$267b already threatened, he will be shutting down the Sino-American nexus of Pacific trade.

The havoc for US corporate supply chains would lead to Wall Street contagion by mechanical effect.

It is a treacherous political backdrop for equity markets already at the Himalayan peak of the business cycle, against a background of quantitative tightening by the big central banks.

The Shiller price/earnings ratio for the S&P 500 is currently 32.96, higher than on the eve of Black Tuesday 1929.

Not everybody likes the Shiller ratio but Beijing tracks it. Fang Xinghai, a key architect of Chinese policy, theatrically waived a piece of paper in Davos this year showing a chart of the index. He warned that America will face its own reckoning sooner or later.

Exactly where Trump's pain threshold lies is anybody's guess. His behaviour is so erratic that one easily slips into thinking that there is no strategy at all.

But in the words of former White House chief of staff Reince Priebus, he is like a "dog with a bone" when it comes to China.

He instinctively sides with the hawks aiming to force US companies to repatriate their operations from China.

As Trump wrote in capitals on the margins of a G20 speech, 'TRADE IS BAD'.

For a while China's leaders sought to defuse the conflict, relying on the advice of yesterday's globalist luminaries: Henry Kissinger and ex-Treasury chief Hank Paulson.

Beijing went along with the idea that Trump is a "dealmaker" who uses threats to gain leverage, but can ultimately be assuaged by a publicity victory.

They hoped that pledges to buy fungible US grains, oil, and liquefied natural gas would be enough to address his idée fixe on the US$375b bilateral trade deficit. It was a dead end. The China 'doves' have been purged.

China has brought this diplomatic crisis on itself. The Party's "Made in China 2025" blueprint is an aggressive attempt to dominate 10 strategic sectors in violation of WTO principles, drawing on a nexus of subsidies and cheap state credit. Party agents are lodged on the boards of private companies.

A forensic 200-page report by the US Trade Representative accused the country of systemic cyber-theft and forced technology transfer.

It said the plan "calls on all facets of society to mobilise behind the plan". It is akin to a wartime structure.

Beijing has belatedly woken up to the dangers of such provocation. It has dropped its Amazing China propaganda documentary.

State censors have told the media to stop talking about the China 2025 plan.

This comes too late to mollify the child-president in the White House. China has in any case stated already that it will match each round of US tariffs with a riposte in kind.

Beijing must carry out this threat or lose face, and Trump has already vowed to escalate further when it does.

It is very hard to see how asset markets priced for perfection can ignore this deranged game of chicken for much longer. The mystery is that they have not crumbled yet.