Trump’s Trade Follies Threaten Wider Fallout In Markets

11 May 2018 - Martin Shenfield
Trump’s Trade Follies Threaten Wider Fallout In Markets

As President Trump’s trade delegation returns from Beijing from preliminary discussions, we question how and when the US and China will be able to resolve their trade and economic disputes. Given not only the gulf that lies between the ultimate objectives of the two sides but also the difficulty in bridging it. Contrary to the expectations of the media and many analysts, we believe the starting point for serious negotiations between US and China is some way off and that considerable time may be needed to get there.

As a result, the risk of tit-for-tat trade actions is heightened because it is unlikely that formal negotiations will start ahead of the original deadline set for the US to make a decision on imposing tariffs, probably in late May or early June (public hearings on the tariffs end on 22 May). This deadline could be pushed back, perhaps repeatedly. Such a scenario of serial “deadlines” and rescheduling would likely be just as disruptive for markets as would be an outright trade war. In our view these risks have yet to be fully priced into markets. In the meantime Vice Premier Liu He goes to Washington next week apparently aiming to get talks on trade underway in order to buy time while China prepares for a longer-term stalemate on issues related to technology transfer and China’s “Made in China 2025” programme; these latter issues appear irresolvable from our perspective.

The path to the current discussions is already strewn with US actions that the Chinese side will undoubtedly demand be redressed before formal negotiations start. Among these was the US ban last month on American firms selling parts and software to China’s ZTE Corporation for seven years in connection with violations of the prohibition on shipping US goods to Iran. ZTE, the second-largest Chinese telecom equipment maker, paid a fine for the violation but the US alleges it did not comply with the terms of the settlement; ZTE is appealing the ruling but has meanwhile ceased operations. This was followed one week later by news that the US Justice Department is investigating China’s Huawei Technologies, the world’s largest manufacturer of telecom equipment, for similarly violating US sanctions related to Iran.

That these actions were designed “to soften up” the Chinese side before talks got under way is unproved but credible. US media sources reported that US Trade Representative Robert Lighthizer opposed a Beijing visit at this time, arguing that it should be postponed until closer to the threatened imposition of US tariffs in order to increase pressure on China. Trump overruled him and included White House China trade adviser Peter Navarro, “a frothing mercantilist trade warrior” (as he is described by the FT’s Alan Beattie), in the delegation along with Treasury Secretary Steven Mnuchin and self-professed free trader Larry Kudlow, Trump’s chief economic adviser. 

Faced with such an ideologically disparate group of individuals, Chinese officials may conclude there is little reason to engage with them in serious talks at this time. Moreover, China will remember its experience with Commerce Secretary Wilbur Ross, who apparently reached several agreements with Chinese negotiators last year only to have Trump throw them out when he returned to Washington. The Chinese side will want to know who speaks with authority on trade and economic issues for the US, so as not to repeat the Ross experience. Although Secretary Mnuchin is more senior than Lighthizer, who has ambassadorial rank, Trump’s instincts appear closer to the latter’s. Ultimately, the issue of who speaks for each side will likely have to be resolved between Trump and Xi Jinping; according to media reports such a conversation took place earlier this week and Xi reportedly said trade issues must be handled “properly”.

Another challenge for the negotiations ahead is that there has been no clear statement of US goals or what type of economic relationship the US wants to have with China in the future. Trump initially demanded a US$100bn reduction in China’s US$375bn trade surplus – since increased to US$200bn – and accused Chinese firms of stealing US technology and know-how in various ways, which he says must stop. For his part, Navarro has said the US goal is to prevent China from implementing its “Made in China 2025” guidelines, by preventing the transfer of high-tech equipment and expertise that China is seeking in order to meet the targets of that programme. It appears that Navarro’s aim is to frustrate and delay China’s acquisition of the latest technology and, by implication, its economic development. The sheet of demands the US put on the table last Friday in Beijing was unprecedented in its demands and suggestions of restrictive oversight of any agreement. This is clearly not an auspicious start to negotiations.

Faced with such open-ended and ill-defined demands, the Chinese leadership will want to hear the administration’s vision of the economic relationship it is seeking to establish with China. This is because there are areas in which the Chinese leadership is unwilling to consider any compromises, namely the high-tech targets outlined in the “Made in China 2025” document. In our view, the leadership will be willing to negotiate on trade and certain other market access issues, but not on any of Navarro’s goals. Since Navarro appears to be Trump’s alter ego, this could further delay getting to an overall agreement.

China’s first priority is likely to change the frame of reference. At the recent IMF Spring Meetings in Washington, a senior Chinese official pointed out that if US exports of services and the sales of China-based US firms are added to US exports of goods, they amount to roughly US$600bn, about the same as the combined total of China’s sizeable earnings from exports of goods, its much smaller service exports and the sales of Chinese firms in the US market. Under such a broad definition, each country’s “revenue” flows from economic activities are roughly balanced. This frame of reference contains an implicit threat that China will restrict the activity of US firms in its domestic market in retaliation for US restrictions on China’s exports.

The US delegation is likely to  emphasize China’s checks on market access and its alleged theft of intellectual property. These issues provided the basis for the USTR’s Section 301 investigation of China’s “Acts, policies and practices related to technology transfer, intellectual property and innovation”. It is unclear what Trump’s trade negotiators will seek as solutions in these areas. Trump threatened 25% tariffs on some US$50bn of Chinese exports to the US, but such actions impose a penalty for alleged damage done to US firms rather than offer solution to the problems identified in the 301 report.

Trump’s unilateral approach to addressing the larger problems associated with China’s restrictive industrial policies suffers from a major flaw. The US has policies for controlling people and goods crossing borders but it lacks the ability to similarly control proprietary company know-how. Thus, while it might ban Chinese acquisitions of high-tech goods in the US or investments in high-tech firms, China can likely find most of the technology it is seeking in Europe, Japan, South Korea, Taiwan and India. Shutting Chinese firms out of the US technology market will merely accelerate China’s involvement with technology firms from the rest of the world, possibly even with foreign subsidiaries of US-based companies. US firms operating in China could face a very disadvantageous future compared with their global competitors. By eschewing a multilateral approach to a widely perceived problem with China’s industrial policies, Trump has put US economic interests in the China market at risk.

Detailed trade and economic negotiations are unlikely to get under way soon. Mnuchin and others on the US delegation tried to put a positive spin on talks when they returned home. China meanwhile called for flexibility in the talks but refused to discuss Washington’s demand that it cut its trade deficit by US$200bn and curb its “Made in China 2025” initiative. We believe the most likely scenario for reaching serious negotiations will involve multiple deadlines and subsequent postponements, similar to what appears to be happening with the US-EU steel and aluminium talks, which have been postponed for another month. EU Trade Commissioner Cecilia Malmstrom has refused to engage in discussions with the US until the EU is given a permanent exemption from the threatened tariffs. We expect China to take a similar hard-line approach.  

Chinese officials will be very carefully watching the development of Trump’s dispute with the EU and drawing lessons for their upcoming negotiations. The US is currently demanding that the EU agree to quotas on its steel exports, a move that violates WTO rules. This issue is straightforward compared with those in the US dispute with China, which are intrinsically convoluted. Thus, when negotiations finally come, they are likely to be long and ugly.

#Donald Trump #Made in China 2025 #Protectionism #Trade War #US China Trade


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