The Looming Trade War.

US stock markets have had a very wobbly opening last Monday as fear spreads that the Obama administration has fired the first salvo in a trade war with China.

President Barack Obama made a long-awaited decision on previous Friday about imposing sanctions on China over alleged"dumping"of low-cost tires on the American market. Obama sided with trade unions and imposed stiff duties on $1.8 billion worth of Chinese tire imports.

The United Steelworkers brought the case against China back in April, claiming that more than 5,000 tire workers had lost their jobs since 2004 because of cheap Chinese tires flooding the US market.

Obama's order raises tariffs on Chinese tires for three years -- by 35% in the first year, 30% the second, and 25% the third.

The Chinese government hit back fast, and on many fronts.

On Sunday, Beijing announced it would investigate complaints that American auto and chicken products are being dumped in China or that they benefit from subsidies. China says the US imports have "dealt a blow to domestic industries" and you can be sure Beijing won't have much trouble arguing that US farmers and automakers are heavily subsidized.

On Monday, Beijing escalated its action with a complaint to the World Trade Organization (WTO). The Chinese complaint in Geneva triggers a 60-day process in which the two sides will try to resolve the dispute through negotiations. If that fails, China can request a WTO panel to investigate and rule on the case.

With unusually swift and coordinated action, the official Xinhua new agency quoted the government as saying, "China believes that the action by the US, which runs counter to elevant WTO rules, is a wrong practice abusing trade remedies."

So far, it's a trade spat, not a war. But it's an irritant as Washington and Beijing prepare for a summit of the Group Of 20 leading economies in Pittsburgh on Sept. 24. Obama is set to visit Beijing in November, and his reception could be very frosty.

Amazingly, American tire companies had begged the president not to go ahead with sanctions against China. "By taking this unprecedented action, the Obama administration is now at odds with its own public statements about refraining from increasing tariffs" said Vic DeIorio, executive vice president of GITI Tire in the US. "This decision will cost many more American jobs than it will create." GITI Tire is the largest Chinese tire maker, and a US retailer of low-cost imports.

Although investors are not yet facing World War III between the two economic superpowers, it's enough to make the markets very nervous. The Chinese ADR Index tumbled heavily at the markets' opening, but recovered swiftly as cooler heads prevailed.

Alarmists are worried that China, which holds about a trillion dollars worth of US financial instruments, could declare a real economic war. The tools Beijing could use are worrisome. China could: -

1. Sell dollars it holds faster than it already is

2. Not buy at the treasury auctions in the near future

It's a little too early for China to exercise the nuclear option in this trade dispute, but the events have spread fear in otherwise buoyant markets. Investors in US stocks should exercise caution and consider diversification as worries about the US dollar's devaluation, inflation, and trade wars continue to loom.

Holders of Chinese ADRs should ride out this rough period if they're confident that the shares they hold are from companies which continue to grow profits by double digits.

And, more importantly, they shouldn't be invested in companies dependent on foreign exports.