The G20 High Stakes Dinner between the US and China
- The United States and China have agreed to stop imposing new tariffs for a period of 90 days
- The financial markets welcomed the US-China trade truce – but there is far less certain and positive than meets the eye
- It is a can-kicking at best, and arguably puts the US in an even stronger position going forward
What was agreed between Trump and Xi?
On Saturday 1 December, US President Trump and Chinese President Xi Jinping sat down for a pivotal steak dinner in Argentina: it was seen as either trade war or peace. The steak was undoubtedly very good; but the ‘trade deal’ that came out of it was not. Initial press releases were from the Chinese side: the dinner had gone very well, run longer than expected, and had ended with a group photo. Then we saw these headlines:
“Xi, Trump agree not to impose more tariffs after Jan 1”;
“US, China agree to open markets to each other”;
“China agreed to increase imports”;
“Legitimate US concerns to be resolved as China opens”.
That all seemed remarkably positive given American hard-liners on China Peter Navarro, Robert Lighthizer, Mike Pompeo, and John Bolton all flanked Trump. And the delayed US interpretation of the dinner was indeed very different (Table 1).
Those are two radically alternative interpretations of the dinner discussion.
According to China’s reflections on the meeting, the US will not raise tariffs, will open up its market to China further, will allow China to gradually address the trade issue, and start negotiations to withdraw the tariffs already in place. This could be interpreted as a positive for Beijing. However, given the White House interpretation of the meeting’s results, it is questionable how realistic these expectations are. Especially if one takes into account China’s performance on reform pledges so far.
From the US perspective, a hike in tariffs on USD 200bn of Chinese imports to 25% is delayed by two months (from 1 January 2019 to 2 March 2019), China will immediately start buying large quantities of US agricultural, energy and industrial products, and will concurrently have to address US concerns over the structure of the Chinese economy: if it does not do that, then 25% tariffs will still be imposed.
The outcome of this high stakes dinner does not fundamentally change our views regarding the US-China trade war. In many ways, the deal currently in place does not differ much from the ‘Mnuchin deal’ dating back from May 2018, when China also promised to buy more US agricultural and energy products, lower the trade deficit with the US and step up protection of US intellectual property rights in China. Despite the room for further negotiations, fundamental differences between the two countries still exist and we expect that China will not be able or willing to meet all US requirements in the short term. And if the US finds that China progress on that front is too limited within that period of time, the US will press ahead with the implementation of the tariffs of 25% on 200bn, which is still in line with the most realistic scenario (scenario 1) in our trade war scenario analysis that we have published last week. In this most realistic scenario we include a tariff increase from 10% to 25% in 2019Q1.
The current outcome also implies that for China to reach a final deal with the US, on many fronts it will have to accept structural reforms and open up its economy. The question is whether it is feasible to initiate the proper policies within 90 days, and whether it is realistic at all to expect China to fulfil these demands. If China does follow up on its promises to announce structural reforms during their Economic Work Conference in December, this will be a victory for the US administration, but China will probably frame this as a planned domestic reform strategy. Further down the road, any final deal will most likely include US dictated terms that will protect intellectual property rights of Western firms operating in China and expose Chinese state-owned enterprises to foreign competition. This would undermine China’s ‘Made in China 2025 strategy’ which aims at global technological dominance in high-tech industries, such as the aerospace industry, ICT, robotics and clean-energy cars. China would certainly not be keen to abandon that strategy, and we can therefore expect the trade war to flare up again.
Geopolitics part of the deal…
Once again, President Trump has tied geopolitical interests to his trade agenda, as is reflected by the fact that the White House added: “President Trump, together with President Xi, will strive, along with Chairman Kim Jong Un, to see a nuclear free Korean Peninsula,”. This suggests that China will keep on supporting the rounds of strong sanctions against North Korea imposed by the UN Security Council. China’s does play a key role here. We previously have shown that without China’s economic lifeline, the North Korean economy would go off a cliff.
One could argue that actually the US gains much more than China from this truce in a tactical direction. In the near-term, China will almost certainly have to buy more US soy, for example, allowing US farmers (key Trump voters) to clear their accumulated stores and bring in cash, while the 90-day tariff window allows them to plan what next year’s crop should be in line with geopolitical developments. In the next 90 days, the US defines the terms of a structural trade pact that undermines the ‘Made in China 2025’ industrial strategy, weakening China’s global position. If China refuses to signs it, Trump can blame China as the bad faith party and put tariffs up to 25%.
Or, Trump can roll the 25% tariff threat every 90 days to dissuade new foreign direct investments into China and allow US firms more time to redirect supply chains elsewhere. This is important, as currently US firms are still heavily integrated in the Chinese supply chain. Such a ‘rolling’ strategy of imposing strategic uncertainty without additional tariffs has the advantage that it inflicts no additional inflation-boost/tariff-pain for the US consumer, as the remainder of US imports from China consist of a larger share of consumer goods (Figure 1). If this analysis is correct, the US would feel emboldened to remain on the trade offensive against China ahead. Within the ‘war’ part of a trade war and Cold War analogy this would imply a truce for rearmament and redeployment, not an armistice towards lasting peace. In short, it seems highly unlikely that the G-20 steak dinner trade deal has any real meat on its bones.
For the coming period it seems that at least some period of calm has returned in the bilateral trade war. But the big question of course is how long this will last. The results of the dinner negotiations are interpreted quite differently by both sides. Ultimately there is a realistic chance that the 90 days period is used to buy some time for any further escalation. We already have some indications that both countries seriously take such a scenario into account. China, for instance, has recently announced a stimulus package to offset the domestic cooling down, but this package could also be viewed as mobilisation operation in anticipation of a further trade war escalation.