Much Ado About Everything No 35: Trade — “You Can’t Always Get What you Want”

Relief over a, now seemingly imminent, China/US trade deal will be overdone and short-lived.

Introduction

"We have almost an $800 billion a year trade deficit with other nations. Unacceptable. We are going to start whittling that down and as fast as possible."

President Donald Trump, 15 November 2017

The world in general and, arguably, the investor community in particular is firmly focused on the ongoing negotiations between China and the United States pretty much to the exclusion of several other ongoing trade-related issues which could go seriously array. This article aims briefly to recall some of the problems which a China/US deal will not resolve between the world’s two largest economies, as well as one very serious one which it stands to exacerbate significantly; and to update on three other important trade-related ‘fronts’ on which the Trump Administration is currently engaged.

China/US: A lot of ‘bull’ in the China shop

“We’re getting into the final laps.”

US Treasury Secretary Steve Mnuchin, 28 April 2019

Following this week’s short visit to Beijing by Mr Mnuchin and USTR Robert Lighthizer, a very large Chinese delegation led by Vice Premier Liu He is expected to arrive in Washington on 5 May and, probably, finalise a trade deal between China and the US. Mr Mnuchin’s characterisation of his and Mr Lighthizer’s two days of meetings this week as productive will have boosted such expectations.

It could, of course, all still go horribly wrong, if not through failure to reach agreement on one (or more) of the thorny issues at the heart of the negotiations — details of which are to be found in my 27 February update — then through other less central but, arguably, still related issues. One which has been around for some weeks now revolves around the ongoing efforts by the Trump Administration to have Huawei Technology’s CFO, Meng Wanzhou, extradited from Canada to the US to stand trial for alleged violations of sanctions against Iran, which in the mind of China’s leaders is intertwined with Washington’s efforts to close Huawei off from exporting 5G technology to US allies. A second more recent one is the US threat to sanction China if it continues to buy oil from Iran after 2 May (which I believe it will). Although both parties have pledged not to let other disagreements impinge on the trade talks, the risk that they will remains.

Nevertheless, let us assume that agreement will be struck. Even putting to one side the hyperbole we shall inevitably see on Mr Trump’s Twitter feed, the deal will undoubtedly be greeted with considerable acclaim — or at least with relief as far as investors are concerned. Indeed, although it should hardly come as a surprise in the light of the determination of both Mr Trump and President Xi Jinping to strike an agreement (which both need for domestic political reasons), we are still likely to see a relief rally in equity markets in both Asia and the US.

Given the serious implications for the global economy of a breakdown in talks and consequent escalation in trade frictions, such relief may be justified, at least in the short-term. But acclaim, in my view, is certainly not. Consider.

As far as the agreement itself is concerned, it will certainly result in more US exports to China — thereby easing, at least temporarily, Mr Trump’s obsession with the bilateral trade deficit — and it will likely remove some barriers confronting US investors and potential investors in China (but not vice versa where Washington is actually making it harder for Chinese companies to invest in the US, especially in technology sectors). However, it is increasingly clear that there will remain at least largely unresolved a great many issues on the US’s original ‘wish list’ (again, see my 27 February update) — and, no doubt, still on that of the hardline Mr Lighthizer — not only relative to broad Sino-US geopolitical rivalry but also more trade-specific issues such as intellectual property (and major concern among US multinationals). I am, therefore, not alone in believing that any reprieve in China/US trade tensions could prove to be short-lived.

Indeed, if anything, I am even more concerned today than I was at the outset now that more information about the proposed enforcement mechanism is emerging. Edward Luce, writing in the Financial Times on 28 April (subscriber access only), put it thus:

“The radical part [of the overall deal] is the way in which they have agreed to hold each other to account. Unlike trade deals signed under Mr Trump’s predecessors, this one calls for no third parties to be involved. Each country will be licensed to decide when the other is in breach. Having sought a reset with China, Mr Trump would be enshrining a diet of endless tit-for-tat. If ever there was a blueprint for bilateral instability, the coming US-China deal would qualify.”

I find myself in complete agreement with Mr Luce.

Torpedoing the WTO

“When the world’s two largest economies agree to settle disputes between themselves, the World Trade Organisation is instantly sidelined.”

Edward Luce, Financial Times, 28 April 2019

The summary at the head of my 19 December 2018 article on where the US is going on trade read as follows:

“Donald Trump's wilful torpedoing of the WTO dispute settlement mechanism is even more dangerous than China/US”.

The main focus of the article was (not for the first time) the Trump Administration’s deliberate attempt to destroy the World Trade Organisation’s (WTO) dispute settlement mechanism by blocking the appointment of judges to its appellate body. I recommended an article from the 17 December edition of The New York Times by Professor Jennifer A Hillman from which I lifted the following:

“Rather than waiting for the impasse over the judges to be resolved, countries will take trade disputes into their own hands, engaging in retaliation and counter-retaliation that could escalate indefinitely. It also signals a desire by the Trump administration to return to an unsustainable might-makes-right system.”

We are now almost at this point since, although the WTO is still accepting new cases, the appellate body has, as the Trump Administration has long intended, ceased to function.

Mr Luce again:

At face value, the looming trade deal will probably look like a victory for Mr Trump. Further reflection reveals how much damage the deal would do to the rules-based order that America created.”

EU/US: Not Plane Sailing

“The EU has taken advantage of the US on trade for many years. It will soon stop.”

President Donald Trump (on Twitter), 9 April 2019

My 5 April update on EU/US trade relations was headed by a 4 April quote from Mr Trump to the effect that the whole ballgame is cars”. Less than a week later, the President himself made it clear that this is patently not the case as the US threatened to impose tariffs on USD11bn of EU products after the WTO found against Europe in a case brought by the US over subsidies for Airbus. [Note: although Washington is entitled under the terms of the ruling to impose tariffs, the value of EU products which can legitimately be hit by tariffs will be determined by the WTO and may not match Washington’s USD11bn claim.] Just a week later, the EU announced its intention to tariff USD12bn of US products in respect of a previous WTO ruling on tax breaks for Boeing with which Washington has failed to comply.

Writing in the FT on 9 April, James Politi and Jim Brunsden noted as follows:

“The big concern for Europe will be that Mr Trump will take an even more aggressive posture towards Brussels once the negotiations to resolve the US trade dispute with China are wrapped up, to maintain his image as a tough president on trade.”

Regular readers may recall that I have been flagging this risk for many weeks now. Furthermore, they will hopefully have in mind that Mr Trump has decide whether or not to impose auto tariffs on the EU (and, possibly, others including Japan and South Korea) no later than 11 May following the submission of recommendations under Section 262 of the US Trade Act by the US Department of Commerce on 17 February. As I wrote in my 5 April article:

“Although we can be reasonably confident that the consequences (at least initially) of imposing auto tariffs on the EU would not be as serious as an all-out Sino-US trade war despite inevitable EU retaliation, this would still not be good news for either the global economy or investor confidence”.

And I wrote this without taking account of the long-running transatlantic dispute over large civil aircraft or the consequences of Mr Trump’s determination to undermine the WTO.

Japan/US: Ploughshares to swords?

“The president was very clear in reminding the prime minister . . . that his goal is to achieve a more reciprocal relationship with Japan.”

William Haggerty, US Ambassador to Japan, 28 April 2019

The apparent major sticking point to advancing the proposed Japan/US bilateral trade agreement is Prime Minister Shinzo Abe’s refusal to budge on imports of US farm produce at his 26 April meeting at the White House with Mr Trump. However, lying behind this is Mr Abe’s determination to extract concessions from the US which would more or less match the hard-won ones in the Trans-Pacific Partnership (from which Mr Trump walked away as one of his first acts in office) and the total removal of the threat of auto tariffs (see above) as well as the lifting of the tariffs on aluminium and steel imposed last year. Yet, Mr Trump appears to be offering nothing in return for his demand even though (possibly financial services aside) it is hard to imagine a domestically more sensitive trade issue for Mr Abe and his party than opening up Japan to imports of farm products.

It seems very likely that talks will therefore drag on for months (and certainly well beyond Japan’s upper house elections in July) with no guarantee of agreement ultimately being reached. Why is this? Well, the real problem may have been summed up by a Japanese official speaking (anonymously) to the FT after the White House meeting, as follows:

“[Mr] Trump still has not given [Mr Abe] anything to work with. With TPP, the US would have modestly reduced some tariffs to make the deal two-way. [Mr] Trump won’t do that or reduce new tariffs he slapped on steel and aluminium. It is classic Trump win-win negotiations — [Mr] Trump expects to win twice.”

If this assessment proves to be correct, rather than make concessions Mr Trump’s determination to open up markets for Midwest farmers whose votes he needs in 2020 could well drive him to escalate a dispute over agri products into something closer to a trade war.

USMCA: DOA?

“Donald Trump’s Nafta represents at best a minor update to Nafta, which will offer only limited benefits to US workers.”

Senator Ron Wyden (D), April 2019

When he was a Representative for the State of Indiana in the US Congress from 2001 to 2013, Mike Pence was a doughty defender of free trade. But as Vice President he seems to have swallowed the Trumpian view of trade hook, line and sinker. As such, he is a good choice as de facto cheerleader to try to rally Congressional support for Mr Trump’s trade deal with Canada and Mexico, the USMCA. Nevertheless, he may be doomed to fail. Quite apart from their (unworthy but inevitable) desire not to gift Mr Trump any victories, Congressional Democrats, who have a critical say in the ratification process, have plenty of substantive reasons for rejecting the deal.

Their scepticism over the deal has been deepened by the 18 April report of the International Trade Commission (ITC), an independent government agency, which found that the USMCA would boost US GDP by only 0.35% and even then mainly because of the alleviation of uncertainties which were triggered in part by Mr Trump’s reopening of Nafta in the first place. Furthermore, the ITC concluded that USMCA measures relative to autos and auto parts would actually raise the price of vehicles in the US thereby hitting consumer demand.

Congressional failure to ratify the deal would call into question Mr Trump’s threat to withdraw unilaterally from Nafta in such circumstances (if, indeed, the US constitution allows him to do so — an issue I explored in 2 September 2017 article). Failure to secure ratification would certainly be a blow to Mr Trump’s claims about his dealmaking skills, which were a cornerstone of his 2016 election campaign (with, it should be underlined, special reference to trade). On the other hand, withdrawing from Nafta would likely seriously damage support for him in key states such as Michigan.

As trade expert Phil Levy (quoted in the 25 April edition of the FT) states, as we get closer to the 2020 election “the ‘kill-Nafta’ option is becoming less credible". Furthermore, such a move would certainly run heavily contrary to the importance which the President places on the performance of the stock market. Nevertheless, this is the mercurial Mr Trump we are talking about and, as is the case with other trade-related issues, investors would do well to take nothing for granted with the USMCA.

Alastair Newton

www.alavan.biz

Footnote: The title of this article is taken from a song on the Rolling Stones' 1969 album Let It Bleed.

Image credit: www.businessinsider.com

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