The on again off again trade spat with China seems to be peaking this week. Tonight is when the new tariff regime is supposed to go into effect if the two sides do not come to a different accommodation. There is of course some question of whether President Trump (or Xi) will blink and business can continue as usual. If we learned anything from the government shutdown over the holidays, it is that DJT will not hesitate to do a Thelma & Louise and take us collectively over the cliff. In his bare-knuckles negotiating style, the other side has to believe there is no bridge too far to get what you want.

And, there is a very strong case that has been made over decades that China needs to bend. They have benefited from overly generous policy for decades now that allowed them to build their economy while Western markets used them as a cheap outsourcing factory. Part of the price paid was a systematic forfeiture of intellectual property and inability to truly participate in their market. The benefit was, in two words, cheap stuff. With low wages, few environmental controls, and a myriad of other reasonable and questionable policies and practices, we enjoyed a tremendous arbitrage between their ability to make and our ability to consume that gave us everything from full shelves at dollar stores to affordable smart phones and other consumer electronics.

China is no longer a marginal emerging economy. As the second largest economy in the world, with plenty of sophistication, it has arrived. It is true that their markets lack the access, transparency and governance one would desire in a developed market, but that does not change the fact they are approaching economic preeminence in the world. America has carried them and America has benefited, but it certainly is time for that balance of trade to evolve and mature.

It is time for them to participate in and respect international trade norms and enter into fair and equitable trade accords. This is structurally necessary for an integrated global economy to continue to thrive in the decades to come. The method to get there seems to be on what the market is choking. Tariffs are taxes, and most free market thinkers agree that more, or excessive, taxes, particularly punitive taxes, do long term harm to markets and economies. The market is understandably worried that Trump’s rhetoric and actions around tariffs will stall or crush domestic and global growth. From where we sit, when you sift through the bellicosity, it does not seem that the White House wants permanent trade barriers. They want to win, and they are using the sledgehammer of tariffs to get the Chinese to moderate on market access, IP protections, and other fair developed economy attributes that would make them a better trading partner.

Maybe more importantly as an investor, we think that the repeated bouts of short term volatility we have been experiencing are the side effect of a new experience in trade protocol. Historically we have observed that most of this is done behind closed doors, and the public square is only used in the extreme to flex public muscle to win a point. Instead, we have a street brawl spilling into the virtual public square on Twitter, and market participants do not know how to handicap that. Would Trump’s team levy the tariffs? In our view, very likely. Will they do so indefinitely at the demonstrable cost of growth and jobs? Our view is no. As with the government shutdown, there will be an endpoint when, if the Chinese do not budge, the cost is too high, particularly coming into an election cycle.

The Chinese are also not on a fool’s errand. They still desire free trade with the world’s most productive economy. The current era of engagement and trade effectively opened with Nixon, and they will not let it close with Trump. They likely understand that they have to reform, but of course they want to do so as slowly as possible. For this reason we think standing our ground on our market exposures is prudent, even through this latest round of volatility. We would be strongly inclined to get more defensive if we do enter a period of punitive bridge-burning and wait for the parties to come closer together before ramping up risk again. But if this is the two sides having a staring contest across the Pacific and they quickly get back to business, trying to trade the noise would be difficult if not impossible.