Conflicting Signals: USTR Ups Pressure on China Ahead of Talks and Treasury Talks Lifting Tariffs

Messaging is everything in international diplomacy, especially around high-level negotiations. After the latest round of U.S.-China trade talks in Beijing, all signs pointed to a successful outcome. An extra day was added beyond the planned two days of talks. Vice Premier Liu He made a short appearance at the lower-lower-level gathering of deputies. The U.S. Deputy Agriculture Secretary had glowing words after the meeting (though curiously no one from USTR spoke during the coveted press briefing.) Trump even tweeted shortly afterwards that the talks had gone very well.

And then the messaging changed, at least from USTR. 

Lighthizer said last week, according to Sen. Grassley who had met with him Friday, that he hadn’t seen the structural changes he was looking for from China. That’s a major sticking point for the White House and something Trump has repeatedly said must be addressed to avoid raising tariffs from 10% to 25% on Chinese goods.

It is an odd complaint since China would likely only agree to the far more difficult issues face-to-face at Cabinet-level negotiations with either USTR Lighthizer or President Trump. The Beijing meeting was a the Deputy level, a.k.a. not the decision makers.

Lighthizer also announced that if talks don’t work out, U.S. companies could apply for exclusions to the 25% tariffs on $200 billion of imports from China that are set to take affect in March.

That’s a weak nod to the U.S. business community who were directly affected by the 10% tariffs and are likely lobbying hard for a resolution to the trade impasse. The promise of exclusions provide cold comfort since the aim of the next round of tariffs is to put even more pressure on China. Any exclusions would weaken that influence. Approvals would likely be slow-rolled by the administration. 

USTR now appears to be trying to get out in front and push their hardline agenda ahead of the Jan. 30-31 talks. Sen. Grassley commented in a briefing to the press that since China’s economy is ailing there’s a chance to get more progress on these harder issues, which include IP protection, forced tech transfer, and stealing trade secrets.

These issues aren’t going away. The Department of Justice is now looking into whether Huawei stole robotic technology from T-Mobile.

To further complicate the administration’s signaling, Treasury Secretary Mnuchin has been discussing lifting tariffs as an incentive for China to make an equally bold move, though it’s unclear what that could be considering the depth of structural changes needed to satisfy U.S. concerns.

Since China isn’t going to agree to the U.S. list of over one hundred issues raised, and Trump isn’t going to accept some token purchases of U.S. goods and nothing else, some kind of compromise is necessary. What Grassley and other White House hardliners may not fully accept is that Trump’s approval ratings are plummeting, major U.S. companies are feeling the effects of the tariffs, and Trump himself may be itching for a settlement.

While compromise isn’t really in Trump’s winner-take-all approach and his impulsiveness can lead to unexpected outcomes (e.g. the Wall shutdown), time is on no one’s side here. The U.S. and China have been locked in a mutually reinforcing death spiral of tariff-raising for the past year. 

While USTR should certainly push for everything they can get, the most likely outcome, if cooler heads prevail, is some sort of short-term relief, continued tariffs on some Chinese goods, and a plan to tackle the harder issues over time.

While both sides might not get exactly what they what, it’s certainly better than the global economic carnage of a prolonged trade war where everyone loses. Trump really looks like he could use a win right now.

Deal or No Deal in U.S.-China Trade Talks

U.S. negotiators are heading back after an extended trade negotiation with their Chinese counterparts in Beijing. While there’s been no formal agreement yet, both sides are expected to make public announcements on Thursday. If talks had gone badly something would have come out in the official Chinese state-run press by now, so all signs point to some kind of deal. Will it, however solve any of the more difficult challenges in the relationship?

Trump wants to see markets rebound. Chasing the sugar high of a stock jump is hardly a trade policy, and a terrible negotiating position. This essentially gave China added negotiating leverage knowing he is eager to settle. That doesn’t bode well for any substantial movement on the most difficult issues facing U.S. exporters — forced tech transfer, non-tariff barriers, and intellectual property theft. That was the whole reason Trump launched his ill-thought out trade war in the first place by ratcheting up tariffs on Chinese goods.

If there’s no movement on those hard issues, what was the point? China announced they’re going to be buying U.S. soybeans again, but China was already buying U.S. soybeans before Trump’s tariffs. That’s not a concession. 

China also announced that U.S. rice would be allowed into their market. While this is new, market access isn’t likely to dent the trade deficit as U.S. rice prices are significantly higher than other suppliers to China, most notable from Southeast Asia.

Other Chinese government moves included reduction in auto-tariffs, already offered to the rest of the world. While some legal reforms have been mentioned, enhancing IPR protection for example, changes in law are often not fully implemented. Given the inherently political nature of China’s judicial system, companies have little recourse.

These “structural” reforms tend to be the most difficult, often edging too close to issues that party hardliners in Beijing hold dear (e.g. favorable government and financial support to state-owned enterprises.) They’ll most likely kick the can down the road like they have for years and wait out what’s left of the Trump presidency.

That’s the crux of these negotiations. Are Chinese officials convinced that Trump will hold his line or will he cave to his own domestic economic pressures? It’s looking like Trump’s eagerness for a win will trump his own hardliners who are pushing for China to fundamentally change the way they do business. While that’s a laudable goal, they’ve used the wrong tool for this kind of heavy lifting.

Adding to the uncertainty, no senior-level negotiator was present for the talks. This was more of a working level negotiation and all of the familiar figures in Washington need to give their input including U.S. Trade Representative Lighthizer, Treasury Sec. Mnuchin, and Advisers Navarro and Kudlow. Interestingly it was mainly the Agriculture Deputy Secretary who spoke to the press, not the USTR Deputy Secretary, who ostensibly led the negotiations.

So what did Trump get out of all this turmoil? Hard to say until tomorrow, and there’s still three weeks to the March deadline, but there will be plenty of spin about the great, great, concessions that no U.S. president has ever gotten from China before. 

Expect an announcement highlighting all the U.S. goods China is going buy as a result. For comparison, from Jan. to Oct. 2018 China bought $102.5 billion in U.S. goods. Over the same period in 2017 the number was $104.5 billion (U.S. Census data for 2018 is currently available through Oct.) If the structural issues aren’t resolved, don’t expect too much difference in overall U.S. exports, especially as China’s economy slows down.

Markets react quickly to news, and then adjust to facts. Trump might still get his temporary stock bump, but a sugar high never lasts. China is playing the long game and a fickle market movement is about as small a win as it gets. 

Trump Has Few Options on Huawei Sanctions Trouble

Time is running out on the U.S. extradition request for Huawei’s CFO, Meng Wanzhong who was arrested in Canada in December. This follows an investigation on sanctions-busting by the firm related to business ties with Iran. Trump said that he might intervene in the case if it helped with the China trade impasse and for national security reasons.  As much as he’d like to use the Huawei case for political purposes he actually has few options. 

Intervening creates a dangerous linkage between national security issues and trade politics. China routinely engages in this type of politicization, and is part and parcel of their attempts to influence other countries over a variety of perceived slights. In 2017 South Korea’s Lotte department store chain shut its China operations after a concerted government effort to thwart their business (stores were suddenly hit with fire hazard violations,) when the firm gave up land to the South Korean government for a U.S. THAAD missile defense system installation. In 2011 the Chinese gov’t banned Norwegian salmon after the Nobel Prize was awarded to Liu Xiabo, a Chinese dissident who later died while in custody.

State Department Issues China Travel Warning for Americans

The U.S. is not China, and a Trump intervention would signal that the rule of law is no longer the rule of the land. The political backlash from left, right, and what remains of the center would be swift and significant.

Political intervention would make Trump look weak on China, again. Trump already gave Xi Jinping a huge gift when he lifted a ban on ZTE after its own Iran sanctions trouble. The company would have gone out of business without that commercial “pardon” to continue purchasing U.S. technology. Xi Jinping did not return the favor and blocked Qualcomm’s $44 billion purchase of NXP. China was the only country standing in the way. 

Canda Warns U.S. Not to Politicize Extradition Case (Reuters)

That’s not to say Trump won’t try, but a criminal case is harder to interfere with than the ZTE sanctions case. Politically, Democrats have the majority in the House and will hit from the left. Hardline Republicans, who want a more forceful policy on China, will strike from the right. And any meddling in the Department of Justice while Mueller’s investigations remain open would be a huge red flag for those considering impeachment hearings.

The only option is to let the legal system run its course. While this may inflame tensions with China in the short term, it reduces the chances of a U.S. political backlash.

Don’t be surprised though if Trump surprises us all and defies the collective wisdom with an impulsive response if Canada agrees with the extradition request. While he has the power to free Huawei’s CFO, promising more than he can deliver ahead of time may prove that a Trump promise made, is a promise easily broken. That would significantly weaken his trade negotiating position vis-a-vis China.

U.S.-China Trade Deal Already in Doubt

 

Trump Chaos Rattles China Trade Negotiations Before They Even Begin

Just days after President Trump claimed success in trade disputes with China, disagreement over the details have emerged. That rings with a familiar tune.

The Trump-Kim Summit this past June in Singapore raised similar doubts about what, if anything, was actually accomplished. It turns out that even with a loosely worded document we now know that nothing was formalized after that highly touted success.

While North Korea continues to develop missiles and possibly more nuclear weapons, Trump complains he hasn’t been offered the Nobel Peace Prize for his efforts. 

The Saturday Trump-Xi dinner in Buenos Aires didn’t even offer anything in writing and journalists were left guessing why applause erupted from behind closed doors as the dinner ended. There was no press conference or photo op to clear up the issue as Trump & Co. headed for the airport.

After landing, Trump claimed Chinese auto tariffs were being lifted. The White House has now walked that back. Trump claimed China would spend over $1 trillion on U.S. goods. His economic advisor Larry Kudlow said that was more aspirational than specific and would be determined by private entities and economic conditions. Trump said if China doesn’t make bold moves in ninety days, he’s Mr. Tariff, and then suggested the timeline might be extended.

No one knows what success looks like three months from now, and that’s a serious problem.

Now China has expressed its discontent with the White House version of winning it all. Yet again, Trump excels at undiplomatic posturing while others are left to clean up his mess.

The pattern here is clear. Trump’s erratic words cannot be trusted, only managed, even by those closest to him. It’s another episode of “Promises Made, Promises Broken.”

U.S. markets didn’t like that kind of uncertainty, and along with other negative financial news on Tuesday, they shed over 3% in one of the worst days in their history. 

Making matters worse, US Trade Representative Lighthizer replaced Treasury Secretary Mnuchin as lead negotiator. Lighthizer is a known China hawk, and while having someone strong-willed and skeptical at the table is an advantage, if the lead isn’t considered to be negotiating in good faith that will not end well for bilateral relations or the international trading system.

The biggest risk at the end of February will be China claiming they did everything they said they would do and the U.S. saying whatever they did wasn’t enough.

Chinese state media has already started making the list and announced increased punishments for firms found guilty of IP theft, but will they be implemented?   

If Trump really wants to reduce the trade deficit, protect intellectual property, and remove investment barriers, he and his team are going to have to be far more disciplined than they have been to date, and that seems highly unlikely.

Playing loose and fast with the facts, tweeting exaggerated wins, and painting Chinese negotiators into a corner will not make this relationship work. Both sides have to be able win.

 

What the China Stock Market Crash Really Tells Us (and What It Doesn’t)

Monday morning headlines were more sobering than a double shot of espresso, adding anxiety to an already tumultuous few weeks in China. The Shanghai index dropped 8.5%, in one day, again. This after a see-saw struggle to regain momentum with similar drops from mid-June’s dizzying peak of over 5,000.

The consequences of such a serious correction, with a Monday close at 3209.91, are neither dire nor surprising and the ensuing panic will likely bring out a host of incorrect linkages.

Here are three misconceptions of what the crash seems to mean, but doesn’t.

1. The China market crash will destroy the U.S. economy

U.S. exports to China totaled a mere 7% of total U.S. exports year to date. Canada and Mexico represent a combined 34%.

Exports in general make up an extremely small percentage of the U.S. $18 trillion economy (about 8%) and exports to China represent an even smaller amount.

Over two-thirds of all U.S. economic activity is driven by consumers. The biggest impact on that activity is whether people feel they have more money to spend today than yesterday, not on whether day traders in Pudong are pulling their money out of Sinopec shares.

2. Shanghai and Shenzhen stock markets represent the broader Chinese economy  

Usually a broad-based stock market sell-off represents a belief that the underlying economy isn’t going to do as well going forward as it has in the past. That’s the rational explanation assuming near perfect knowledge of economic conditions. Even the U.S. market doesn’t work that efficiently (there are sell-offs even without new negative economic information.)

In China, knowledge of the broader economic slowdown has been around for a while. If the markets were rational they should have been dropping when the government announced lower growth targets back in March. They should have dropped as alternate economic measures hinted that the official 7% growth rate might not be reached.

Instead they continued to climb based primarily on two non-economic beliefs. The self-fulfilling prophecy that the market could only go up and that the Chinese government would prop up any market weakness. Win-win.

Since domestic savers have very limited choices of where to put their money, once the real estate two-step dance was over (buy one to live-in, buy one to hold) the stock market became the only game in town attracting a flood of capital. That rush caused prices to rise which attracted even more investment, much of it borrowed on margin. Thus the illusion of a perpetually rising market.

The Shanghai composite has now dropped below the magical 3,500 level where many believed the Chinese government would step in with massive buying to push prices back up. The illusion of invincibility appears to be faltering. Meanwhile online sales in the real economy continue to expand.

In this market there is no irrational exuberance with Chinese characteristics, just irrational exuberance as rationality returns to the market.

3. The China sell-off is similar to previous Asian financial crises   

In 1997 the Thai Baht came under heavy pressure resulting in large scale contagion throughout the region. A heavily reliance on trade with a market-determined exchange rates drove this spread. China has neither.

China’s yuan, despite recent changes, remains a managed currency. The government still decides on its opening daily price. That means speculators cannot significantly alter its value beyond a government imposed trading band of +/- 2 percent per day.

China’s economy is also far less reliant on trade than in the past as government investment in infrastructure as well as real estate development have become main drivers of growth. Of those industries dependent on trade China’s recent devaluation made Chinese exports cheaper (a dollar or euro buys more today than in the recent past).

What does the recent sell-off really tell us?

The Chinese government is going to have an increasingly difficult time trying to stop the carnage. Despite conventional wisdom, it does not have unlimited power. By even trying to manage the sell-off, policymakers have placed themselves in an extremely difficult situation.

If they can’t right the market as people expect the government looks weak. If they impose even more draconian rules to stop sellers from liquidating they may kill interest in the market as a whole. Lose-lose.

Apple’s Tim Cook, for one is not that concerned about purchasing habits in China. Let’s hope that the nascent middle class has more cash stashed at home that they’re willing to spend than most people think.

Meanwhile the China market crash has caused a flash sale on a host of solid U.S. equities.

China Devaluation Latest Sign of Market Weakness

The People’s Bank of China (PBOC) devalued the renminbi yesterday in the latest sign that market forces continue to weaken in the world’s second largest economy.

Exports have fallen. Growth is likely far slower than the official 7% rate. Electricity usage is down. Steel production has declined. Infrastructure investment yields less impact. Even demographics highlight a shrinking workforce (enter the robots). And then there’s the stock market, largely divorced from the underlying economy and gyrating like hips at a hula hoop competition.

Currency devaluation will do little to reverse these trends.

As a short term fix it may help exporters whose goods are now cheaper to buy abroad, slow capital flight (it costs more to convert renminbi into other currencies) and potentially attract more foreign investment into the country (a U.S. dollar today buys more renminbi than a dollar yesterday).

But the underlying economic uncertainty in China’s partial transition to domestic led growth will continue to weigh heavily on the minds of international investors and policymakers alike.

If China truly wants to make the renminbi a global reserve currency the PBOC will have to reverse itself and let the currency float freely like the yen, euro and pound. That requires giving up managing a trading band around a fixed daily rate. Economic conditions would have to improve significantly before moves in that direction resume (almost certainly a gradual step-by-step process).

None of this means a hard landing for China’s go-go economy, but resorting to a currency devaluation highlights the limited policy options left for a government navigating increasingly choppy waters.

Remaining moves (and ones largely ignored to date) include government heavily investing in a social safety net, improving health care coverage and promoting more affordable housing. That will allow households to free up some of their savings to spend and spur new business creation.

Until this happens expect more partial solutions and continued volatility.

Does Anyone Really Know What Time It Is In North Korea?

Update 2018 – Relations between North and South Korea have improved over the past year to the point where North Korea has now re-set its clocks to be in sync with its southern neighbor.

World_Time_Zones_MapIn yet another bizarre move by North Korean dictator Kim Jong Un, official time in Pyongyang will officially roll back 30 minutes on August 15th. While not unheard of in the annals of geopolitics (New Delhi and Islamabad diverge by half an hour as well), the move is a decidedly cold war maneuver that matters little to the rest of the world.

Re-jiggering airport information will be relatively easy with so few flights in and out of the capital. Train schedules need little adjustment considering the extremely limited service with China, its only ally (loosely defined).

Why is Kim asserting his right to bend the space-time continuum above the 38th parallel north to the Yalu and Tumen rivers? After executing high ranking leadership and family members it appears that he still needs a symbolic boost to assert a Kim 3.0 leadership. Harkening back to a World War II propaganda cliché he’s freeing North Koreans from the legacy of Japanese imperialism.  Little else seems to have changed in the isolated and perpetually dark-after-dusk hermit kingdom.

If waking up to best of 1960’s-styled patriotic music on the government-controlled radio station weren’t enough, the capital’s citizens now sacrifice a ceremonial 30 minutes so the country can exist in a time zone of Kim’s own making.

Unfortunately this will do little to counter endemic poverty, international isolation and the ignominious title of being the only country left in the world still fighting a last century war (if the Iran nuclear deal actually goes through).

Arm-chair criticism aside some change is in the air. Reuters has an official Pyongyang bureau and even the North Korean embassy in Beijing, once a mysteriously inaccessible outpost, has opened its doors to journalists (no questions allowed during press briefings, however).

It looks like Kim wants to engage with the outside world, if only on his own terms and largely with the same missile-rattling and provocations marking over half a century of mistrust. Most recently North Korean soldiers planted wood cased landmines on the South Korean side of the demilitarized zone resulting in two serious injuries to ROK soldiers.

And yet the Kaesong Industrial Complex keeps churning out near slave labor-produced goods where workers, despite agreements to the contrary, receive wages only from the North Korean government and not their South Korean employers.

Manic engagement remains the norm. Hard currency continues to flow north while the DPRK attacks one of its only business partners, no matter what time it is.

In homage to the title of this blog post here’s the 1969 hit by Chicago.

U.S. Needs an Asia Re-Pivot

Legacy must be on Obama’s mind these days as his two-term presidency nears an end. It might seem early, but the approaching 2016 election cycle starts in earnest as soon as Hilary Clinton announces her candidacy. That could be only months away. Then the media cycle fills with coverage of every presidential hopeful’s latest utterance and Congressional paralysis settles in.

Little can be done in twenty months that hasn’t been accomplished in six years save for some much needed focus on longer-term policy. This positioning was supposed to include an “Asia Pivot”, loosely defined and broadly conceived. So far it has lived up to its conception.

Enter news of a China-led3-23_aiib_2 Asian Infrastructure Investment Bank (AIIB) featuring participation of major allies the UK, France, Germany, Australia, South Korea and now Japan*. Glaringly absent, the U.S.

What’s stopping U.S. involvement? Partly an inherited pride from post-World War II institution-building that created the IMF and World Bank. Opponents highlight the risk of the bank becoming a potential instrument of Chinese regional soft power, a potential lack of transparency and less stringent lending standards that may erode development criteria created over the past several decades. These include social imperatives, environmental standards and labor protections.

While these remain reasonable concerns, China already lends heavily throughout the region. No amount of outside pressure has influenced how this aid has been disbursed or under what terms.

Only involvement with this new multilateral institution opens the door to engagement with China and the region on development issues.  With little cost, potentially none at first except for some diplomatic formalities, the U.S. could play an influential role in the first round of serious regional economic institution building since the 1966 formation of the Asian Development Bank (ADB).

Foregoing a role, even a limited one, pivots the U.S. further away from Asia signaling that the U.S., while espousing support for regional integration, does little to back-up those ideals.

As regional trading patterns increasingly revolve around China’s economy a new constellation of partners will define the regional development agenda, with or without U.S. involvement. Avoiding the AIIB risks forfeiting hard won gains. Asia will then see the U.S. primarily through a narrow security lens.

Refusing to work with China and the rest of Asia, even when the terms are not ideal, is not a legacy worth leaving.

* Note: After publication Japan changed course and announced it would not be joining the bank at this time.

@brianpklein

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Image: Xinhua/Li Xin

India Poised to Gain as China Troubles in South China Sea Escalate

The recent Philippine-Vietnam announcement on a coordinated response to China’s latest ocean drilling marks a significant shift in regional relations. Strains have been growing for some time. An unenforceable territorial dispute process has failed to resolve competing claims and anti-foreign sentiment is on the rise (in both Vietnam with riots against foreign factories and changing attitudes in China against buying foreign-made goods.) Any natural gas discovery will only exacerbate tensions.

This unprecedented level of public cooperation highlights a growing regional consensus. Years of China’s “peaceful rise” have ended and Southeast Asian countries appear to be gaining less and less from their trade-and-appease policies of the past.

Enter India, long the economic giant in waiting. While still a good two decades behind China in terms of overall development, the recently elected Modi government has pledged business reforms that could transform the country into a regional power. Re-kindling GDP growth rates of 7-10% could be a boon to resource rich southeast Asia eager to offset a slower-growth China.

With a near super majority Modi’s control over parliament can push change in ways that previous administrations could not. If he delivers, then significant trading and investment opportunities will follow. Average trade growth between Asean and India has already accelerated faster than Asean-China trade (25.5% vs. 15.1% from 2007 to 2011, the latest year available via Asean).

Still there are pitfalls along the way. Modi will need to steer the BJP party clear of its ultra-nationalist tendencies and historical anti-Muslim and anti-minority sentiment. His unresolved response to the slaughter of Muslim Indian citizens in 2002 while he was State Minister of Gujarat will surely be on the minds of Indonesia’s leaders. Competition may also hinder some opportunities where firms go head-to-head with each other (e.g. Thailand’s auto industry vs. southern India’s).

If India’s leaders can finally overcome decades of inertia and liberalize the economy they will find a region eager for a trade partner that doesn’t threaten their territorial integrity.

 

What Does Xi Want?

South China SeaFor so many years now the rhetoric coming out of China was “peaceful rise” and “non-intervention”. And then by stealth, diplomacy and economic might a shift occurred turning a policy of biding one’s time into action. This new muscular foreign policy, under President Xi Jinping’s leadership, increasingly fractures a status quo that has maintained stability in Asia for over half a century.

Gaining control over the Spratley Islands and laying claim to the greater South China Sea have re-drawn long established boundaries and defied international norms. This is the new China order.

While countries throughout the region, including the U.S., continue to express their diplomatic discontent in press releases and regional gatherings, an unimpeded land and sea grab expands. Other nations talk. China takes.

Water cannon volleys between Chinese and Vietnamese ships have now escalated to hard objects and ramming hulls (water cannons were also used by Chinese “enforcement” ships against the Philippines back in February). An oil rig planted its drill within Vietnam’s internationally recognized economic zone without consequence. Chinese construction has begun on a hotly contested island chain also claimed by the Philippines.

All of these actions contradict in word and deed the pronouncements of the Xi government through APEC speeches, bilateral conversations, and international gatherings that no unilateral actions would upset the status quo. Consultation, not force, was meant to guide resolution of historical tensions.

What does the Xi government really want? — A reckoning with history to re-write the past and lay claim to what was “taken” decades and even centuries ago under a selective reading of China’s place in the region and the world.

And yet China has developed at remarkable speed, largely because of this very international system that provides it access to the world’s resources and markets. In a different time, a country would have needed to field a global military presence to keep the peace, maintain the shipping lanes and facilitate international trade.

These latest confrontations and a weak international response sets a dangerous precedent for the system that has long been welcoming China’s rise. President Xi doesn’t want to embrace a world not of his own making. He wants to re-write the world’s terms to reap even larger benefits at the expense of his neighbors. That includes re-drawing boundaries of influence throughout Asia.

Until countries take heed and begin working with concerted action, China will continue to free ride and impose its considerable economic influence to mold the world in its own image. A region not united will eventually be divided.

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