Tensions from Trump's trade war have reached dangerous levels. Photo: AFP / Nicolas Asfouri

Markets continue to more or less shrug off the prospect of a dramatic escalation in the US-China trade conflict, with major US stock benchmarks in the green on Thursday as of early afternoon. But a realization is finally taking hold that the leaders of the world’s two largest economies have little political room to back away from doubling down.

Many analysts’ base-case scenarios have already shifted from a short-term resolution to the US-China tariff war to an expectation that the current stalemate will be the new status quo for the foreseeable future.

But Ray Dalio, founder of one of the world’s largest hedge funds, said he is worried about a worst-case scenario, one that sees Washington and Beijing slide into a disastrous export control war aimed at crippling sectors of each other’s economies.

“As someone in these negotiations wisely said, history shows that countries in conflict have seen that such conflicts can easily slip beyond their control and become terrible wars that all parties, including the leaders who got their countries into them, deeply regretted,” Dalio wrote in a LinkedIn post.

“What is now most important at this time of brinksmanship is seeing what actually happens next—i.e. whether we see the “tariff war” slip into an “export embargo war” intended to shut parts of the other country down,” he warned.

That has already begun in the case of Chinese telecommunications firm Huawei, which has been cut off from key US components and services that it relies on for important sources of revenue, including its booming smartphone business. Huawei handsets overtook Apple to become the world’s second-best selling mobile devices last year, and the company was poised to leapfrog Samsung in short order.

Huawei has already ascended to become the world’s dominant provider of telecommunications network equipment and services, relied on by mobile providers in Europe and much of the rest of the globe outside the United States. In China’s ambitious drive to become a leader in high-tech industries, Huawei is far and away the most important chess piece.

The question then is whether China will respond by cutting the US off from exports it needs from China, such as rare earths.

So far, Beijing has held off, presumably in hopes that trade negotiations can be restarted, or at least that the attack on Huawei, which could spread to include other Chinese tech firms, could be mitigated.

But as Dalio says, “Building independence will happen regardless of what is negotiated because both sides have learned that they need to be protected against being squeezed … That is a big deal because it is a major, multi-year undertaking that will take resources away from other development.”

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