Trade: More uncertainty ahead

Current Sino-US relative calm (albeit surrounded by confusion) should not distract from transatlantic trade tensions

“By the time American negotiators wrapped up high-level talks with a visiting Chinese delegation [on 20 May], President Trump’s ambitions for a multibillion-dollar trade agreement had, for the time being, shriveled into a blandly worded communiqué without any dollar figures. It was not clear that the talks set a path to success.”

Mark Landler and Ana Swanson, The New York Times, 21 May 2018

At present, the US’s push against China on trade appears to be on ‘hold’. Commerce Secretary Wilbur Ross is due to lead a US delegation to Beijing on 2-4 June, following on from Treasury Secretary Stephen Mnuchin supposedly reaching a framework agreement with China’s Vice-Premier Liu He on 20 May. Initial reaction to the 20 May deal was that President Donald Trump had settled for a ‘quick win’. But within 72 hours this was far from certain as USTR Robert Lighthizer in particular made it clear that the Administration was anything but united on the deal; and Mr Trump himself said that any deal would need “a different structure” (whatever that means!). So, it is hard to be optimistic about Mr Ross’s chances of a ‘successful’ (whatever that means!) visit, especially given the manner in which Mr Trump dissed him when he returned from Beijing with a proposed deal on steel last year. This despite Mr Trump’s continuing efforts to help China out over ZTE (on which we are still probably far from the final word to judge from recent press reporting). And despite the US likely still needing China’s help over North Korea.

Lack of unity in Washington stands in stark contrast to the situation in Beijing where there appears to be a single agreed strategy which Keith Bradsher summed up in the 21 May edition of The New York Times as follows.

“China’s success partly comes from its ability to stick to a single strategy in trade. Even as Beijing has shown a willingness to talk and make peace offerings in the form of multibillion-dollar import contracts, it has held fast to its refusal to make any commitment for a fixed reduction in its trade gap with the United States. The trade imbalance between the countries has actually widened since Mr. Trump visited Beijing in November and oversaw the signing of import deals on everything from beef to helicopters.

Beijing also has not bent on its Made in China 2025 initiative, an industrial modernization program that Washington and American business groups complain forces foreign companies to share their best technology while potentially creating state-sponsored rivals.”

As if this were not sufficient to underline how uncertain the forward trajectory of China/US trade is, just last week Mr Trump sprung another surprise by announcing a Section 232 investigation, ie ‘national security’ focused as was the case for steel and aluminium, into auto imports (again pandering to his base in the ‘rust belt’). As with steel and aluminium, China would not be the country which suffers the most in the event of heightened US tariffs on auto imports — Europe, Japan and South Korea being significantly more at risk; but this move still raises tensions further.

Nevertheless, to judge from his tweet lauding the supposed outcome of the Mnuchin/Liu exchange as far as America’s farm product exports to China are concerned, Mr Trump — well aware that come 6 November the Republicans need every vote they can get in the corn belt as well as the rust belt — is likely to remain cautious about escalating trade disputes with China in the next five months or so. However, this is not really good news for investors who will almost certainly have to put up with weeks of contradictory utterances from not only Mr Trump himself but also those around him in the Administration and, in all probability, periodic substantive u-turns such as we have seen with ZTE.

Furthermore, the risk of a serious escalation, sooner or later, is far from diminished. Trade remains one of Mr Trump’s two highest personal commitments (the second being immigration); and China remains his number one target. Furthermore, just as North Korea may have helped stay Mr Trump’s hand to date, China’s activities in the South China Sea and the likelihood of rising tensions between Beijing and Taiwan could easily spill over into trade, especially as far as the targeting of sectors central to President Xi Jinping’s Made in China 2025 initiative is concerned.

The bottom line? I remain firmly of the view that trade may yet turn out to be the 21st century equivalent of Thucydides’s trap.

[Note — added 29 May. The surprise announcement that the US is, after all, going to impose 25% tariffs on USD50bn of imports from China with effect from 15 June (and announce fresh restrictions on Chinese acquisitions in the US wef 30 June) underlines two things. First, the sheer unpredictability of the current US Administration which not only unsettles equity markets but also, and more importantly, is going to make reaching agreement with third parties all the harder as fewer and fewer negotiating partners are prepared to take Washington at its word. Second, the trade hawks in Washington appear to have the upper hand when push comes to shove. Of course, we could see another Trump u-turn before 15 June; but if we do this could quite conceivably be reversed too.]

A ‘second front’?

“If any trading partner is going to stand up to Mr Trump, it is likely to be the EU. Suggesting talks about talks is a perfectly reasonable response at this stage. But offering anything that looks like a concession is simply liable to make the president sniff weakness and come back for more.”

Financial Times, 20 May 2018

No doubt coincidentally, Mr Trump may be about to launch what could be described as a ‘second front’ on trade — with Europe — more or less on the anniversary of D-Day (ie 6 June) if the current exemption from steel and aluminium tariffs, which expires on 1 June, is not extended. At the time of writing, it was totally unclear (in the public domain at least) whether there will be an extension or not, again leaving investors uncertain as to which way they should jump (if at all). Furthermore, as things stand, simply extending the exemption, rather than granting a permanent one, would not be sufficient for the European Commission, left to its own devices (but see below), to agree to substantive negotiations.

Acknowledging that reaching consensus is seldom straightforward in the EU, I nevertheless consider that the Europeans are making life more difficult for themselves by not, as yet, having a united position behind the European Commission’s firm refusal to negotiate with “agun to the head. Indeed, Germany in particular (no doubt out of concern for auto exports) is looking very wobbly. And yet, if there is one lesson the EU should certainly take from Sino-US trade tensions, it is that (as the quote above from the FT makes clear) having a clear and united position is essential in dealings with Washington; and on trade at least the EU certainly has the muscle to stand up to the US, as well as being able to claim the moral high ground and help defend the WTO against Mr Trump’s disdain if it does so.

For what it’s worth and as I suggested in my 22 May article, my sense is that Mr Trump may have damaged transatlantic relations sufficiently overall for Europe (led by a very determined President Emmanuel Macron) to stand firm on this issue. If I am correct, as things stand there appear to be three likely forward trajectories as follows.

  • The tariff threat is dropped completely by the US, in which case the two sides quickly engage in what the EU has projected as “mutually beneficial” trade talks covering a wide range of sectors and, probably, cooperation (to include Japan too) dealing with some of China’s current practices.
  • The exemption simply expires and the full proposed tariffs are put in place with consequent EU retaliation to the tune of around EUR2.8bn in tariffs targeting politically sensitive sectors (notably farm products), goods from politically sensitive states (eg Florida, Kentucky, Wisconsin) and iconic American brands (eg Harley Davidson). Press reporting (eg in the FT) suggests that this is Mr Trump’s preferred next step. But, the Section 232 investigation notwithstanding, it is anyone’s guess whether he would then double down by immediately slapping stiff tariffs on auto imports from Europe.
  • The US imposes the ‘halfway house’ of applying a tariff-rate quota (TRQ) under which punitive duties would only come into force once imports from Europe reached a pre-specified level — an approach which appears to be favoured by some American officials. How the EU would respond would likely be determined in part by the level at which the TRQ kick-in was set; but even then the Commission would likely still want to take the US to the WTO over what it believes would be an illegal unilateral trade measure. Nevertheless, it would probably still reduce the probability of EU retaliation which risked firing up a series of escalating tit-for-tat measures.

As with China, Mr Ross will be in the front line this week as he attends the OECD ministerial where he is expected to have talks with European Trade Commissioner Cecilia Malmström; similarly Mr Mnuchin if he attends the 31 May G7 finance ministers meeting. However, experience over the past few months suggest that anything seemingly agreed in the margins of those events may not subsequently survive the rigours of what currently passes for inter-agency process in Washington.

Alastair Newton