The first real shots in the trade war between the US and China were exchanged on Friday. Despite the obvious risk of escalation, markets were generally unmoved.

That may change, indeed probably will change, if Donald Trump follows through with his threats to impose tariffs on more Chinese imports even if it means expanding the range of tariffs to include the $US500 billion ($670 billion) or so of all imports from China.

aChinese President Xi Jinping with Donald Trump in 2017.  Photo: AP

The US stock and bond markets, and currency markets, digested the $US34 billion of new tariffs the Trump administration announced on Friday, and China’s quick matching response, with ease.

The US stock market closed slightly up and the US dollar was essentially unchanged against its major trading partners. The Shanghai exchange, which has had a very rough few weeks, was also up slightly and the renminbi held its ground against the US dollar.

With Trump outlining the path of future tariff imposts – “first 34, and then you have another 16 in two weeks and then as you know we have 200 billion in abeyance and then after the 200 billion we have 300 billion in abeyance. Ok? So we have 50 plus 200 plus almost 300” – the extent to which the US is prepared to go has been made clear.

China’s capacity to directly retaliate is more limited because it imports only about $US130 billion a year from the US. Its responses so far, however, have been more tightly targeted for political impact and it does have a range of non-tariff measures it could use to damage US companies within China and their supply chains.

Trump started the war but it is unclear how he envisages it ending without China volunteering to both significantly damage its own economy and its leadership suffering humiliation in the process.

So far the rhetoric, and action, from China has signalled that it will continue to respond proportionately to anything the US does.

Trump has said that trade wars are ‘’good and easy to win.’’ The reality is that trade wars are damaging to everyone, not just the participants, and no one will ‘’win.’’

The US might ultimately prevail against China – it can do more damage to China’s economy than China can inflict on the US – but the US economy will be damaged, probably significantly, if the war continues to intensify.

Even a “victory’’ could be pyrrhic. If Trump were to realise his ambitions there would be more domestic plants producing goods that China or Europe used to provide, and more jobs created in those plants. The products would, of course, be significantly more expensive and the range probably more limited.

bThe 10 per cent fall in the Shanghai stock market over the past weeks might not be wholly attributable to the trade war.  Photo: Bloomberg

There are already signs within the US that companies are pausing decisions on investment and hiring and input costs flowing from the earlier increase in duties on steel, aluminium and washing machines are flowing through to higher end-prices.

In China the impact of the dispute is harder to discern, with the sharp fall in the value of the renminbi and the 10 per cent decline in the Shanghai stock market over the past few weeks at this stage probably attributable more to domestic issues – the authorities’ attempt to reduce leverage in their financial system – than to the trade dispute.

Trump’s decision to trigger a trade war isn’t confined to the tit-for-tat exchange with China. The US has also slapped tariffs on imports from Canada, Mexico and the European Union and Trump has threatened/tweeted that he might impose higher tariffs on auto imports from the EU. The EU has said it will impose its own tariffs of about $US300 billion on US imports if he follows through.

 “ The markets are clearly signalling that they expect sanity to prevail but that could change quickly.”

Thus, the core of the global trading system progressively built up over the past 70 years and the global supply chains and financial system developed over recent decades to facilitate global trade and investment are under threat, along with the still-fragile recovery in the global economy from the financial crisis.

The impacts and the uncertainties any further worsening of the situation would generate for global economic and financial activity could be devastating for economic activity and would also have a very significant, and very negative, impact on financial markets.

It is unclear whether the Trump administration appreciates how integrated the global economy has become or have properly thought through the consequences for the US if Xi Jinping and the EU leadership refuse to blink and subsequently cave in to the US demands that they sell less to the US and buy more from it.

It is also unclear whether they considered how their actions might encourage closer trade relations between China and the EU (which are being discussed), or China and other Asia Pacific economies (also being negotiated).

Had Trump confined the trade assault to China, the EU and other traditional allies would probably have ganged up with it. They all have their own issues with China. Instead he has isolated the US by the US actions against the EU, Japan, Korea, Canada and Mexico.

The markets are clearly signalling that they expect sanity to prevail and the various parties to the disputes to come up with compromises that don’t involve massive concessions to the US.
If the war were to end today, the impact on economic activity in the US, or China, or the EU would be minimal.

That could change materially and quickly – and be reflected within financial markets – if all the parties continue to hold the ground in which they are already becoming quite entrenched. The signs aren’t good.