Tariff Wars and Nuclear Brinksmanship: The Psychology of Economic Mutually Assured Destruction
Like games of brinkmanship, trade conflicts are largely driven by perception, not precision. Seeing trade wars as reactionary standoffs masquerading as strategy clarifies the investment map.
The concept of tariff wars as a form of economic nuclear brinksmanship should not be a foreign concept by now as the parallels become not just apparent but unavoidable in recent developments. What we're witnessing in global trade today has deep psychological underpinnings that mirror the Cold War standoffs of decades past—only now the weapons are economic rather than thermonuclear.
The Psychology of Economic Deterrence
Consider what happens when Country A imposes a 25% tariff on Country B's exports. The immediate response isn't economic—it's psychological. Pride is wounded. Status is threatened. The lizard brain activates. Country B doesn't carefully calculate the GDP impact before responding; it reaches for the most potent weapon in its arsenal—reciprocal or escalating tariffs—driven by the same psychological forces that powered nuclear standoffs during the Cold War.
At its core, this is a "competition in risk-taking" where each actor aims to demonstrate higher resolve—a greater willingness to tolerate the risk of mutual economic damage—to compel the other side to concede. This behavior makes perfect sense when viewed through the lens of evolutionary psychology. Our brains evolved in small tribal environments where relative status and the perception of strength were often more important than absolute welfare. We are wired to respond to perceived slights with demonstrations of power, even when those demonstrations may harm us in absolute terms.
The irony should not escape us: rational actors engaged in profoundly irrational behavior.
The Game of Chicken on the Global Stage
Thomas Schelling, the Nobel-winning economist who developed much of our understanding of nuclear deterrence strategy, recognized that nuclear brinksmanship wasn't just about weapons—it was about psychology. The same holds true for trade conflicts.
Both scenarios can be modeled as a "Game of Chicken," where each side wants the other to "swerve" (concede) but tries to signal its own unwillingness to do so, risking a mutually damaging collision if neither yields. The fascinating psychological puzzle here is how "chance" generates leverage when leaders technically retain the "choice" to escalate or not. The uncertainty surrounding human decision-making under pressure is itself a source of risk.
When we examine the current US-China tariff situation, we see all the classic elements of nuclear deterrence psychology:
Credible threats: Both sides must demonstrate willingness to endure economic pain to make their threats believable
Signaling resolve: Public statements about "winning trade wars" serve the same function as missile parades
Saving face: Creating off-ramps that allow both sides to claim victory becomes crucial
Fear of appearing weak: Domestic political considerations often override economic rationality
Manipulation of risk: Leaders deliberately introduce uncertainty to enhance bargaining power
What makes this dynamic so treacherous isn't just the rational calculations, but the emotional undercurrents. Anger, fear, pride, desire for revenge, and shame powerfully influence decisions, potentially leading to actions that seem irrational but serve deep psychological needs.
Leadership Dynamics: The Human Element
The personalities and agendas of key leaders intensify the psychological dynamics at play:
In the United States, we've witnessed the deployment of tariffs as an aggressive tool, with unpredictability seemingly leveraged as a tactic. The stated aims include reducing trade deficits and boosting domestic industry, though economists debate the effectiveness of these measures. What's clear is that this approach has triggered retaliatory actions and global trade friction.
China's leadership under Xi Jinping has reacted by emphasizing resilience, portraying China as a defender of multilateralism, and actively seeking alternative partnerships, particularly with Europe and developing nations. There's a fascinating psychological countermove here—while the US projects unpredictability, China positions itself as the stable, reliable partner. The Chinese leadership's emphasis on "eating bitterness" signals a high tolerance for economic pain, a critical component in any game of chicken.
Europe finds itself in a profound dilemma, caught between US pressure and its desire to engage with China. The internal EU divisions on strategy reveal how complex psychology plays out not just between nations but within political blocs. Some European leaders have explored closer ties with Beijing, seeing alignment against unilateralism, while the EU collectively seeks a reformed, fair global trade system.
The Current State of Play: A Costly Signaling Equilibrium
As of today, we're witnessing what game theorists would call a "costly signaling equilibrium." Major economies have established tariff barriers that function not as optimized economic policy but as signals of resolve. The actual economic impacts—which are substantial—have become secondary to the signaling value.
What's particularly fascinating is how cognitive biases distort the decision-making landscape. Leaders on all sides exhibit the "illusion of control" (overestimating their influence over events), overconfidence, and systematic misperception of adversary intentions. National narcissism can exacerbate these tendencies, leading to dangerous miscalculations.
The data here is unambiguous: according to studies from the Federal Reserve, tariffs have led to higher input costs, reduced manufacturing output, and hurt U.S. consumer purchasing power. Evidence suggests past tariffs have often failed to achieve goals like significantly reducing trade deficits or reshoring jobs, with costs borne primarily by importing country businesses and consumers.
The psychology of loss aversion traps us in this suboptimal equilibrium. The pain of "backing down" feels more acute than the diffuse economic costs, even as those costs compound annually through reduced investment and innovation.
Prescribed Remedy: The Investment Implications
So where does this leave me as an investor navigating this landscape?
First, I have resigned to not seeing tariffs as temporary phenomena that will quickly resolve through rational negotiation. The psychological forces at play suggest these barriers will persist longer than economic models predict.
Second, I'm looking for what I call "tariff-resilient" businesses with these specific characteristics:
Supply chain redundancy: Companies that have already diversified production across multiple countries
Pricing power: Businesses that can pass increased costs to customers without destroying demand
Regulatory navigation expertise: Management teams with demonstrated ability to work within complex trade environments
Third, I'm maintaining a long-term focus while employing diversification strategies that reflect the new realities of trade friction:
Geographic diversification: I'm balancing exposure across different regions, with particular interest in businesses that have global presence but domestic-focused with less exposure to direct tariff impacts.
Sector diversification: I'm thoughtfully mixing cyclical positions with defensive sectors like utilities, healthcare, and consumer staples that typically weather economic uncertainty better.
Risk management tools: I've increased allocations to traditional hedging instruments, such as gold and turned to deep out of money equity option premiums to amplify income yields, while maintaining higher liquidity.
Fourth, I'm watching for signalling inflection points—moments when the psychology shifts from escalation to de-escalation. These aren't found in economic data but in the language and positioning of political leadership. When leaders begin creating face-saving narratives that allow for de-escalation without appearing weak, that's when the investment landscape will fundamentally shift.
I'm also identifying opportunities emerging from structural shifts like nearshoring, new trade alliances, or long-term growth trends in AI and automation. These areas may benefit regardless of or even because of continued trade tensions.
The most crucial insight I've gained is that tariff wars don't end when they become economically painful—they end when they become psychologically unsustainable. Understanding the difference is essential for positioning capital effectively.
Breaking the Cycle
The path forward requires creating what psychologists call "new choice architectures" that allow for de-escalation without triggering loss aversion. History shows that direct bilateral negotiations often fail because they frame trade as zero-sum. More effective are multilateral frameworks that diffuse the psychological binary of winner/loser.
The mechanisms of risk in trade conflicts mirror those in nuclear brinksmanship, though at a different scale:
Accidents: Unintended consequences from tariffs that spiral beyond control
Self-control issues: Leaders who become trapped by their own rhetoric
Control of others: Unpredictable reactions from allies, adversaries, and markets
What I find most concerning is that our institutions haven't evolved to manage these psychological dynamics. Central banks have sophisticated models for managing inflation and employment but lack frameworks for addressing the psychological fallout of trade conflicts. This institutional gap represents perhaps the greatest systemic risk in the global economy today.
For my own portfolio, I'm proceeding with the humility this complexity demands. I'm increasing allocation to businesses with demonstrated tariff resilience, considering inflation hedges like local T-bills and gold, and watching carefully for those psychological inflection points when the narrative begins to shift from strength-signalling to cooperative problem-solving.
It is likely that the investors who will navigate this environment most successfully won't be those with the best economic models, but those with the deepest understanding of the human psychology driving these seemingly irrational yet entirely predictable behaviours.
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Great job with this. Very pro!