Much Ado About Everything No 25: Trading Places?

Is the EU about to overtake China as Donald Trump’s top trade target…for now?

Love of ‘the deal’

It now appears to be a better than 50% probability that President Donald Trump’s love of ‘the deal’ will result in some sort of trade agreement being reached between China and the US as early as next month, possibly to be wrapped up at a summit in Florida.

For sure, there is still a distinct possibility that the whole process could end in disarray. Consider the issues on the table and the clear gulf between the two sides on at least some of them, as follows.

  • State Subsidies: At stake here is not just China’s long-standing growth model but also President Xi Jinping’s long-term economic (and political) strategy, which the US wants to see reined back, if not completely dismantled. Beijing will likely agree to some reforms but these are hardly likely to get anywhere close to the aspirations of the ‘China hawks’ in the US.
  • Market Access: Non-tariff barriers to third country businesses looking to operate in China remain considerable. Again, I expect Beijing to make some concessions (eg letting Visa and MasterCard into the market, which would be symbolically, as well as substantively, significant). But these are not likely to be far-reaching; and we may find that one barrier is removed only for another to spring up in its place.
  • Intellectual Property Rights: Part of the market access paradigm, this is a particularly important issue as far as business is concerned. Again, the extent to which China is prepared to change its current regime AND, just as importantly, enforce protection remains far from clear (especially noting that Beijing still insists that it does not force foreign companies to hand over its intellectual property in return for market access).
  • Prosecutions: Although not strictly part of the trade negotiations, China will clearly continue to press for charges against Huawei and its CFO, Meng Wanzhou, to be dropped — and Mr Trump seems inclined to pressure the Department of Justice to go along with this. But, if this does happen, the US President could face a considerable backlash at home for political interference in the rule of law.
  • Currency ‘Manipulation’: Even the US Treasury has never gone as far as to declare China formally to be a currency manipulator in its (supposedly) half-yearly reports on exchange rates. So, progress on this front is also likely to fall short of the wishes of the China hawks.
  • Tariffs: We can safely assume that any deal will include a commitment by the US not to follow through on the threatened tariff escalations. BUT China will also continue to press for the existing tariffs (25% on USD50bn of goods and 10% on a further USD200bn) to be annulled — which may be a bridge too far for Washington, at least until China demonstrates full compliance with other parts of the agreement. And see also ‘Enforcement’ below.
  • Trade Deficit: Undoubtedly, the easiest issue on which to reach meaningful agreement with Beijing clearly willing to commit to purchasing considerably more from the US, starting with farm products. Expect specific targets in any agreement. And do not underestimate the symbolic significance of this given Mr Trump’s obsession with trade deficits generally.
  • Enforcement: It appears possible that a mechanism will be included which would raise or lower US tariffs on Chinese goods depending on Beijing’s compliance with whatever final agreement is reached. But quite who will determine the degree of compliance and how it will be done are far from clear.

Based on what we have seen in the first two years of the Trump presidency, it is absolutely fair to assume that any deal which is struck will be hailed by the President as both huge and full delivery on one of his highest profile pre-election pledges. But, as I have already intimated, it is very unlikely to go far enough to satisfy many in the US on an issue, ie China/US relations in the broad, on which there is now not only bipartisan agreement in Washington but also support from much of business and the right-wing nationalists (ie Steve Bannon and his like) outside the formal political system.

[28 February addendum: Furthermore, giving evidence to Congress yesterday Mr Trump's USTR, Robert Lighthizer, made it clearer still that there are significant differences of perspective between him and his boss. Mr Lighthizer, who is leading the negotiations for the US, is firmly in the hardliner camp and is certainly looking for the sort of comprehensive and far-reaching deal which I very much doubt Beijing could accept. He may, of course, be overruled by Mr Trump at some stage — eg the proposed summit. But his testimony yesterday should nevertheless be something of a wake-up call for investors.]

Especially after the criticism he has taken from some of his erstwhile conservative supporters over the wall, one might imagine that Mr Trump will be wary of not meeting their expectations of him again. However, I reckon that his love of the deal plus what he (presumably) now clearly understands about how prospects for a trade war escalation versus the defusing of Sino-US tensions affects the stock market (and, potentially, the real economy) will win out. Furthermore, he will certainly understand that, come 3 November 2020, conservative voters will have nowhere else to go and are hardly likely to turn against ‘their’ man, even by abstention, to the extent that it would decisively ease the path to the Oval Office of the Democratic Party’s candidate.

Nevertheless, we should all — and perhaps over-enthusiastic investors in particular — keep firmly in mind that much can, and almost certainly will, happen in Sino-US relations between now and then; and that, even if the prevailing wisdom that there will be a deal in the next few weeks does indeed prove to be correct. it certainly will not all be good. As a sobering leader in the Financial Times (subscriber access only) this morning put it:

“In reality, any deal is likely to be a little more than a brief truce in a longer war. What markets, investors and many companies underestimate is the extent to which the US and China have entered a new epoch of strategic competition that will engulf all aspects of the relationship…. Attitudes on both sides have hardened beyond the point where relations can return to the status quo ante…. In coming years, the focus for both the incumbent superpower and its nascent challenger should be on containing conflict and maintaining, as best as possible, free and open global trade and markets. A deal now might help build confidence. But the biggest challenges still lie ahead.”


And then there is Europe.

Insofar as trade wars make sense at all, it is clear that fighting on two fronts at once is far from optimal. Concluding an agreement with China could therefore result in Washington turning its full attention to the EU.

The US Department of Commerce duly submitted its report to the White House by the 17 February deadline opining on whether auto and auto parts imports constituted a threat to US national security. Its findings have still not been made public; but it does seem likely that the report concludes that there is indeed a national security threat. If this is correct, Mr Trump has 90 days (starting 17 February) to decide what, if any, action to take; but he is already publicly stating that his decision will hinge on the extent to which there is progress in bilateral EU/US trade talks.

As things stand and acknowledging that the EU would certainly prefer to avoid a trade war with the US, I currently get no sense that Brussels is prepared to bend in the face of US pressure on autos. Indeed, all the signs were that the EU was digging in and preparing to retaliate in kind if Washington does impose tariffs even before the damaging clashes which took place between European leaders and US Vice-President Mike Pence at this month’s Munich Security Conference which further soured transatlantic relations.

There is certainly reason to hope that Mr Trump’s love of the deal and concern over the impact which escalating (bearing in mind that the EU is already suffering from US aluminium and steel tariffs) trade frictions would have on the US economy and the stock market will cause him to stay his hand on auto tariffs. However, it is at least equally possible, in my view, that the lesson he would take from cutting a deal with Xi Jinping, combined with his clear disdain for the EU, will encourage him down the tariff route in the belief that this would result in bankable concessions from Brussels.

In this event, I firmly believe that Mr Trump will quickly discover that, when it comes to trade, Brussels is an even tougher nut to crack than Beijing.

1 March Addendum

Going back to my 28 February addendum, writing in the Financial Times (subscriber access only but which should be readable at my posting on the Alavan Independent Facebook page) today, Edward Luce is clear in his belief that Mr Trump will overrule Mr Lighthizer and settle for a deal with China which addresses (at least to an extent and probably even then only temporarily) the trade deficit but which falls significantly short in other parts of the Administration's wider agenda.

Two things have happened this week which lead me increasingly to believe that Mr Luce is almost certainly correct, as follows.

  • Michael Cohen's testimony to the House Oversight Committee has probably not changed the mind of many — perhaps not even any — voters in the US. But it has opened the door wider still to further Congressional investigations into Mr Trump's conduct both before and since he became President. We can reasonably assume that the Allen Weisselberg, the Trump Organisation's CFO, will be subpoena-ed by the Committee shortly, putting Mr Trump under still more pressure. From which, on previous form, he will inevitably seek the distraction of a 'big' success.
  • The Kim Jong-un/Donald Trump Summit's ending in failure is certainly a blow to the latter's image (even though, having unwisely got himself into a mano a mano situation with North Korea's dictator, he did do the 'right' thing by walking away without a deal). He now needs a deal of some sort with China to try to make good at least some of the damage done — something of which Beijing will be acutely mindful. I guess it may be some consolation that, in the face of the inevitable criticism he will face over a mini-deal, that his detractors in this case must be wrong because he proved his willingness to walk away from a 'bad deal' in Hanoi.

I also believe that both these events increase the probability of Mr Trump slapping tariffs on auto imports from the EU (and, quite possibly, more widely).

2 March Addendum

Credit to Edward Luce who, in the article which I referenced in my 1 March addendum above, specifically argued that Mr Trump cares more about securing the votes of Mid-West farmers than he does about a comprehensive trade agreement with China. Later yesterday, the US President, on Twitter, called explicitly for Beijing to lift ALL tariffs on US farm products "immediately" as part of (or, possibly, even a precursor to) the proposed deal.

Also yesterday (which was 'deadline day' on this issue), Canada's Justice Department announced that extradition proceedings brought by the US against Huawei's CFO, Meng Wanzhou, could go ahead. Ultimately, the decision over whether to extradite her not will be made in Canada's courts. The US authorities do not have to demonstrate her guilt to trigger extradition, merely that their request complies with the terms of the Canada/US bilateral extradition treaty.

Alastair Newton