A Great Deal Of Nonsense

Submitted by Michael Every of Rabobank

A US-China trade deal was announced to chaotic fanfare late Friday Asian time – and we are sceptical. First, we still don’t have details other than that December tariffs were postponed by both sides, the 15% US tariffs imposed on 1 September are to be reduced to 7.5% as a sign of goodwill, and the 25% tariffs on USD250bn stay in place. Second, we aren’t going to get a signing ceremony between the US and Chinese leaders, which does not send an encouraging signal. And third, what we see is close to the terms we previously criticized for being unrealistic in reports such as ‘A Great Deal of Nonsense” and “LOL-A-PLAZA”.

The US Trade Representative (USTR) says the final text of the phase one agreement is still being finalised, and he will sign it early next year for a likely incept date of end-January 2020. The areas covered include: Intellectual Property (IP); Technology Transfer; Agriculture; Financial Services; Currency; Expanding Trade; and Dispute Resolution. Each of these promises much…and yet potentially delivers little.

China has pledged to address issues of geographical indications, trademarks, and enforcement against pirated and counterfeit goods. That’s just after a Chinese court ruled that Japanese retailer Muji doesn’t own its own name in China and a local rival started years afterwards does. Enforcement matters, not promises: more on that in a moment.

China has agreed to end forcing or pressuring foreign companies to transfer their tech as a condition for obtaining market access or administrative approvals. Again, enforcement is all that matters here. China also “commits to refrain from directing or supporting outbound investments aimed at acquiring foreign technology pursuant to industrial plans that create distortion.” That is China’s reason for outbound investment! For example, Sweden’s Defence Research Agency just released a detailed survey of Chinese corporate acquisitions in their country showing at least half are correlated with the “Made in China 20205” plan.

China will “support a dramatic expansion of US food, agriculture and seafood product exports, with the USTR stating the target is to jump to USD40bn in 2020, a USD16bn increase over the pre-trade war level of USD24bn, and to aim for USD50bn. Part of that reflects China’s decimated pork herd, so is hardly a concession. Yet it is hard to conceive of how the total figure can be achieved without China using the US to displace agri imports from other nations, e.g., Argentinean and Brazilian soy, and perhaps Aussie and Kiwi farm goods. That also increases China’s economic exposure to the US at a time of rising geopolitical tensions between the two (see news of the US’ secret expulsion of two Chinese diplomats), and US’ farmers exposure to China in kind. For its part, the Chinese press are not mentioning these US hard targets, and are talking about WTO trading terms, which bodes poorly.

The financial services chapter pledges China to an opening up already underway as it searches for new sources of USD inflows, so again is not a concession. Interestingly, it also says US ratings agencies will get access – which will be fun given the evident credit stresses emerging in China just as US banks will be trying to sell China as an investment destination. .

On currency the US is requiring “high-standard commitments” to refrain from competitive devaluations and targeting of exchange rates. Everyone knows the CNY is not freely-traded – but also that China is doing its best to prop it up, not to try to push it lower. The key message is CNY is not going to be allowed to do what it ought to be doing, i.e., weakening, as China is pledging new fiscal stimulus in 2020 that will decrease its external surplus. That runs counter to market forces, and smacks of a kind of Plaza Accord. Of course, as long as this US-China agreement holds that might be sustainable due to the promised higher capital inflows...

…except the expanding trade chapter implies the opposite. The USTR says China is pledging to boost its 2020 imports of US goods and services by USD100bn over the level in 2017, and by USD100bn again in 2021, for a total increase of USD200bn. Given 2017 was pre-trade war and US exports to China dropped off a cliff in 2019, this means around a 110% y/y increase in purchases in 2020 – and agri is only a portion of that. The problems should be obvious. How can a slowing Chinese economy (imports are down y/y from most sources), see this kind of increase without substituting US for world exports or local goods? How can a China with a USD liquidity shortage serious enough to be driving said lowered import bill, and ‘1USD-in/1USD-out’ de facto capital controls, cope with the net reduction on the trade side? As of November, the 12-month rolling Chinese global trade surplus with the US it was USD330bn and globally was USD440bn. We are talking about reducing that US figure by 2/3 and the global total by 1/2!

Which brings us to the last chapter: Dispute Resolution. Getting China to comply is far harder than getting it to sign. The USTR notes the agreement “establishes strong procedures for addressing disputes related to the agreement and allows each party to take proportionate responsive actions that it deems appropriate.” In other words, each side can unilaterally do what they want when they want! So much for the unilateral US control of the process.

So how to see this in summary? The reduction in tariffs from 15% to 7.5% is a positive, albeit far less than the Wall Street Journal had promised. (NB, the USTR took the extraordinary step of publicly chastising the WSJ journalists who wrote that story – regular readers may recall I have also called them out more than once in the past.) Indeed, if China really has agreed to all that is stated here then further incremental tariff rollbacks can be seen – though the USTR has said the 25% tariffs will stay as collateral for a phase two deal that nobody really expects to happen. Yet the terms of this phase one still seem to be A Great Deal of Nonsense. How can China stop buying foreign tech? How can it buy as much US stuff as pledged? How can it do so and not undermine the WTO? How can it do so and not weaken CNY? And how can it do so with a strong CNY without increasing its USD debts, its strategic reliance on the USD, and to US goods? In short, if China does as the USTR claims, the US is a huge winner here (and there are lots of losers); if China does not comply with what look an impossible import targets, then the US can frame China as the bad guy and the tariffs can go back up again. Arguably, the question is not if that will happen, but when.