Hold Your Fire – For Now

The United States and China agreed on a limited framework to manage tensions in the bilateral relationship at the G20 summit in Argentina, tentatively deferring escalation in trade disputes. The US will stay the previously threatened tariff increases from 10% to 25% for 90 days in exchange for immediate demonstration of Chinese import commitments and other steps such as control of fentanyl exports. Four observations stand out to us:
Limiting escalation is constructive enough for now. The foremost implication is that both sides are willing and able to pull back from escalation: continued disengagement is not inevitable nor either side’s first best option. In light of fears that the US might not believe a constructive outcome is worth exploring, on the theory that Beijing ultimately has no intention of converging with market norms, this demonstration by itself is meaningful and can reduce political and macroeconomic risks in 2019. But the basic structure of the outcome was as expected and represents a major reframing of future expectations for a constructive relationship: Washington will keep in place the already significant level of tariffs and pressure unless China is committed to fundamental reforms.

Beijing’s cooperation will probably be limited, and negotiations could easily break down over the 90-day period. The Argentina framework puts the burden of meeting expectations on China, and thus is agreeable to the hawkish, skeptical voices on the US side. The outcome will be applauded by commercial interests worldwide, particularly in financial markets, and will raise hopes that tariffs delayed might not be implemented at all. But a sustainable resolution still depends on fundamental reforms from China that require more painful adjustments than Beijing is probably ready for at this point.

US non-trade action directed at China-related security threats, industrial policy and external influence will continue to mount unabated. In addition to continued Section 301 actions and anti-dumping cases, law enforcement activism against Chinese firms over intellectual property will expand. Anti-espionage and influence work will redouble. Discussions of subsidies, reciprocity imbalances in government procurement, competition policy and myriad other structural concerns will grow louder, and more multilateral. To the extent Washington has now agreed to strengthen the WTO architecture, a much harsher treatment of China’s views on that forum will be offered.

China’s currency can still weaken before March 1. There was strong evidence China’s central bank had prevented the currency from weakening through the 7.0 level ahead of the G20 summit. The extension of the deadline for tariff implementation does not mean that the currency will stay supported during that timeframe, as the yuan is under pressure for fundamental reasons, and capital inflows are slowing down. Currency-related discussions were not mentioned following the Trump-Xi bilateral, but the items that were mentioned likely did not fill the entire meeting, which lasted over two hours.

Posted December 5, 2018
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