25 June 2019
How did we get to this point in the US-China standoff?
The world’s two biggest economies have been locked in a heated dispute over trade for more than a year. Tensions flared further last September when the US implemented its first round of tariffs on Chinese imports and China reciprocated. Talks broke down in May and both sides escalated their respective tariffs, but Xi and Trump appear to have struck a more conciliatory tone over the phone in recent days. The US called off a potentially inflammatory speech on China by Vice President Mike Pence, and China called on “both sides to compromise”. But both countries want to sit down to a formal meeting only if an agreement is reached that can be signed. It is unlikely that a deal can be reached at this week’s G20 meeting, but the standoff could still be eased with a promise to hold further talks soon, and the US could halt its current plan to raise tariffs to 25 per cent on the remaining $300 billion worth of Chinese imports to the US.
Why did US-China talks break down last month?
The US accused China’s leaders of reneging on the provisions of a tentative trade agreement, including an enforcement provision. The US said the breakdown was based around China stalling on commitments to codify in law changes to intellectual property and technology transfer practices, saying China removed all references to changes in Chinese law. China responded in turn by blaming the US for the breakdown in talks, stating that US demands threatened Chinese sovereignty. News reports also suggested that China also may have balked at the number and depth of the concessions the US was requesting. Under the proposal previously in negotiation China would have acknowledged “forced technology transfer”, brought domestic subsidies further in line with the World Trade Organization and offered to import $1 trillion worth of US goods over the next six years. China perhaps felt as if it were the only side making concessions.
The many reasons why a resolution appears unlikely - a few sticking points on both sides:
- US officials have signalled that they are not prepared to engage in long, drawn-out negotiations with China. China for its part faces the challenge of integrating a state-directed economy with implicit and explicit subsidies into the global free trade system. Xi wants ‘bigger, better and stronger’ state firms, and policymakers have traditionally used them to smooth out the economic cycle in China by compelling these firms to spend when private companies are more cautious about outlays. China therefore has a fall-back plan of further stimulus if talks fail.
- A cynic would say the US is interested in containing Chinese growth, so why would China concede substantively when no concessions would ever be enough? Trump has openly stated that he doesn’t want China to become the No. 1 economy in the world “on his watch”.
- The US wants monitoring and enforcement of any trade agreements to be credible. China views implementing the US-sought changes to its domestic law as an unacceptable infringement on its sovereignty.
- Xi does not want to appear weak, especially after the dramatic escalation of the tensions surrounding Huawei. The Trump administration has called Huawei a threat to U.S. national security and has taken steps in recent months to curb US companies doing business with the Chinese tech giant.
- Trump does not want to appear weak, either, and can’t be seen to be making concessions and “going soft’’ on China ahead of a US presidential election year.
- China may well view the actions against Huawei as more serious than the previous round of US tariffs, in terms of damage done to its international credibility and legitimacy. The US seems more likely to repeal the planned next round of tariffs than to revoke the Huawei restrictions although Trump has suggested both could be up for negotiations.
- The US stock market has held up after the US Federal Reserve pledged to cut interest rates, so domestic pressure on Trump to reach an agreement with China has declined.
What would any of the potential outcomes of the G20 meeting mean for investors in the long term?
Overall, trade developments have proved near-impossible to predict, time and time again. The planned meeting could result in a handshake and agreement to keep talking that pauses the situation for six months - but it could also result in a breakdown and imposition of US tariffs on the remaining $300 billion of Chinese goods, or a deadline by which this will happen. The human element of Xi and Trump’s personalities will likely prove decisive.
We do not expect that a tariff agreement would have a large long-term impact on global growth, since trade tensions have so far been isolated between the US and China, and some other countries could benefit from the re-routing of supply chains out of China. Trade is also only a relatively small component of US gross domestic product.
We believe additional tariffs would likely just add to the downtrend that is already underway in the US, as its growth rates were previously high and out of sync with the rest of the world. Furthermore, any impact on China’s economy would probably be offset by further stimulus, potentially mitigating the impact on global growth.
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