It has been quite a week in trade. President Trump’s announcement on 3 May that he had lost patience with China caught most by surprise, particularly because the President and his administration has been signalling optimism for weeks and months. One week later there is no trade deal, and tariffs on Chinese goods worth USD200 billion have been raised from ten percent to 25 percent. Negotiations have been “candid” and “constructive”, which is actually not that great in diplomacy lingo. No one got hurt, and they are still speaking. But that is about it.
President Trump lost patience, because China – according to the US narrative – reneged on a series of commitments made earlier in the negotiations. The US thought the two sides had agreed China would work commitments into actual legislation. The Chinese edits to the 150-page document deleted all such references.
The question is whether China walked back on firm commitments or the US misintepreted the commitments made. When two sides are engaged in good-faith negotiations with mutual benefits, chapters on different subjects can be closed along the way and are normally not opened again. But nothing is final until everything is agreed. That is also the lesson from the Brexit negotiations.
Matters became even more confusing during the week as a flood of presidential tweets pointed in different directions. President Trump referred to a “beautiful” letter from China’s President Xi and continues to stress the personal strong relationship between the world’s two most powerful men. But tweets about tariffs in general do not indicate any rush to reach an agreement.
Tariffs are paid by US consumers and businesses
President Trump often points to the increased government revenue from duties, which is likely to surpass USD100 billion this year, if the trade war continues. But Trump wrongly claims they are paid by China. Tariffs – whether you agree or disagree with the policy itself – are paid by US businesses and consumers. When tariffs were introduced on washing machines in January 2018, prices for consumers went up. Construction costs for builders are up due to steel and lumber tariffs. Earnings in the auto industry are already hurting from a series of tariffs and will be further hit by the latest increase in tariffs.
However, President Trump can point to consumer prices and claim that there has been no major impact on total goods prices so far. Yes, prices have stopped declining, but they are also not increasing overall. The higher costs in the auto industry have also not shown up in consumer prices, partly because auto sales already have been hit by saturation and are declining.
Tariffs are likely to become more visible, when goods with 25 percent tariffs begins to enter the US. The new tariffs are only added to goods leaving China after midnight on 10 May, so higher prices will not be a reality until this summer. That also leaves negotiators time to find an agreement. However, for businesses the new tariffs – and threats of further action – increase uncertainty. Not only about Chinese imports, but also about the situation for US businesses in China. Beijing is likely to respond in kind to the latest tariffs, raising tariffs that were introduced in autumn. Purchases of soybeans and crude oil could also be halted. Bilateral relations on crude oil are further complicated by the US sanctions on Iran. China has been adamant to continue purchases from Iran despite the increased US pressure.
The situation is most worrying for the US agricultural sector. Chinese tariffs are not the only headache. Mexico – the second biggest market for US products – introduced tariffs on many US agricultural goods last year in retaliation for US steel tariffs. Furthermore, catastrophic floodings have hit the Midwestern states. Prices on US soybeans have plummeted in recent days.
On 10 May, the US Secretary of Agriculture announced plans for another aid package for farmers. An initial USD12 billion package was introduced last year. President Trump has tweeted about buying USD15 billion worth of “….agricultural products from our Great Farmers, in larger amounts than China ever did, and ship it to poor & starving countries in the form of humanitarian assistance.” An interesting idea.
More to come
On 10 May, US Trade Representative, Robert Lighthizer, initiated the formal procedure to introduce tariffs on the remaining imports from China worth roughly USD300 billion. Introduction of tariffs involve a period of public hearings and comments to assess whether some products should be exempt. While the actual application of tariffs is only decided at a later stage – and would entail a massive escalation of the trade war – the step is a good reminder that President Trump’s campaign promise of tariffs on all Chinese goods should have been taken a lot more seriously at the time.
China would not be able to answer in kind to such an escalation since the US does not export enough goods (that is the trade deficit). However, China could inflict serious pain. Boeing airplanes could be targeted, which would not only benefit Airbus, but also support the Chinese ambition of building a domestic airplane industry. Financial services and other service providers could be targeted, and US businesses could find the Chinese market a lot more hostile than before.
Don’t hold your breath
Tariffs are not the only issues affecting the US-Sino relationship. The situation surrounding Huawei remains uncertain. This week, China Mobile was blocked from selling phone services in the US on national security grounds.
China has utilized the truce in the trade war to boost domestic demand and has managed to turn the economy around with both industrial sales and consumption picking up. The main thrust is another massive credit expansion and credit growth was the highest ever recorded in Q1. The turnaround has probably tipped the political scale from short-run growth worries to preserving the long-term development strategy.
Trade negotiations between the US and China are likely to continue, but while economists are quick to conclude that economic pain = speedy resolution, the utility functions are probably different in both Washington and Beijing. Rhetoric has so far been cordial, but that could change, when China rolls out countermeasures. Both leaders are loathe to lose face and both would face significant political headwinds if they compromise.
China wants to preserve its industrial ambitions and is also unwilling to surrender to Western demands.
President Trump has yet to demonstrate that he is a master dealmaker. Despite all the noise, very little concrete has actually been achieved. A deal that allows for a lengthy implementation period for Chinese commitments (if they can be put in writing) would unleash attacks from both left and right.
Moreover, Trump’s fondness for tariffs should not be underestimated. Tariffs on washing machines, solar panels, lumber, steel, aluminum and many Chinese goods are not going anywhere. Canada refuses to ratify the updated Nafta-agreement while steel tariffs are still in place; many Senate Republicans agree with Ottawa. President Trump may have to announce withdrawal from the current Nafta-agreement to force action.
U.S. Steel’s recent decision to invest USD1 billion in new production facilities is seen as proof that tariffs, slowly but surely, bring production and jobs back to the US. While Trump’s tweets are incorrect on so many parameters, they have a coherent and easy-to-understand narrative. Running in 2020 on a platform of trade restrictions and tariffs could be a winning strategy. The question is, whether the strong political support for a tough line on China can be maintained, when the higher tariffs are felt more broadly in households and businesses.
I am not sure the US-Chinese trade war is resolved any time soon.