On his return from the US, Zhenbo Hou sees no end game for China tariffs as the bilateral relationship loses its pro-trade anchors.
I had one key takeaway on returning from a Washington DC and New York research trip in mid-September: There is no end game for Trump’s tariffs on China.
- Trump’s war with China is not about trade. It’s about hegemony.
- 25% tariffs on USD200 billion worth of Chinese goods is inevitable, although it might come via a phased approach.
- I see a 50%+ probability of tariffs on all China’s USD500 billion exports.
- There’s bipartisan support for the US to be tough on China. Democrats winning the House would only aggravate the pressure on China – trade conflict could spill over into no-trade arenas.
- Bilateral dialogues at a senior level are broken.
I was bearish on Chinese tariffs before my trip, but returned with an even stronger conviction that this is the best time for the US to strike.
Why? Three reasons:
- The populist, protectionist agenda has wide support across the political aisle.
- The US economy is boringly strong and the Federal Reserve is on autopilot until at least Q2 2019.
- There’s wide bipartisan support to change China’s behaviour
The strategic aspects of China/US relations are in trouble.
The word that most accurately captures US policy towards China right now is ‘disengagement’. Recognising the interdependent nature of the two economies, the US appreciates that dealing out tariffs on China inevitably causes itself harm.
In order to minimise that pain, the US aims to eventually begin to decouple from China.
Broadly speaking, China and the US have gone from ‘co-operating rivals’ from 1978 to 2017, to ‘competing rivals’ in 2018. This new, abnormal relationship will likely last beyond 2020, regardless of whether Trump is re-elected.
Traditional anchors of the China/US bilateral relationship have gone.
Historically, the Chinese government would stabilise its relationship with the US by buying more Boeing jets, or agricultural and energy products. Hence, the traditional anchors of relations have typically been the pro-trade, corporate business lobbyists.
These lobbyists have largely disappeared as the Trump administration shifted to a tougher stance in order to change China’s behaviour.
Because of this, China keeps getting it wrong when negotiating with the US.
Senior Chinese officials are known for having forged long-lasting relationships with the likes of Maurice Greenberg, Hank Paulson and Stephen A Schwarzman. But these legacy contacts are often a part of the globalist establishment, who are either out of office, lacking a voice in the current administration, or have turned against China.
Dialogues at a senior level are broken and dual track diplomacy is dysfunctional.
The failure of Chinese diplomats to communicate with China hawks in the Trump administration explains why the Chinese are struggling to understand what is going on in the White House.
Another reason the Chinese are not officially communicating with the US is that they don’t know or cannot satisfy American demands. Despite offering concessions three times – April 2017, November 2017 and June 2018 – the Trump administration continues to demand more from China.
To reiterate, there is no clear end game in sight for Trump’s tariffs on China. What is more concerning though is that the traditional public line of past US administrations that ‘ a strong, stable and prosperous China is good for the US’ is now rarely heard.
We continue to view monetary policy as largely on autopilot on both sides of the Atlantic, though research meetings in the US over the past week only reaffirmed the underlying strength of the economy and the perception that medium to longer-term rate expectations remain well underpriced.
Multilateral agencies in Washington appear sanguine about China hitting economic growth of 6.5% in 2018. However, if 25% tariffs on USD200 billion worth of goods go ahead on 1 January 2019, this could shave 0.5–1.0 percentage points off growth next year, by shrinking net exports and investment, as well as undermining business confidence.
The main worry for China is whether Chinese policy makers will undo the good deleveraging work it has carried out the last 18 months in response to the downside growth risk due to the trade war with the US.
In any case, China’s current account surplus is expected to switch into a deficit in the next three to four years but this should be viewed as natural evolution.
The US Treasury could label China as a currency manipulator.
I heard mixed views on this topic during my trip, but it’s important to bear in mind that the US wants CNY appreciation, not depreciation.
The reality is that China does not qualify as a currency manipulator under the US Treasury’s definition.
The Bennet Amendment within the 2015 Trade Facilitation and Trade Enforcement Act sets out three criteria for currency manipulation:
- Intervention (here I assume purchases) in the foreign exchange market in excess of 2% of GDP.
- A current account surplus in excess of 3% of GDP.
- A bilateral goods surplus with the US of more than USD20 billion dollars.
As it stands, China is only guilty of the third point. Interestingly, the country that comes closest to meeting all three criteria is Thailand.
Nevertheless, such decisions can easily become politicised. With departures of key career US Treasury technocrats who served for over 20 years on Asia, the existing Treasury team is less experienced and maybe less likely to resist political pressure to penalise China.
It is even possible the Treasury could change the criteria so that it can label China as a currency manipulator. But would the Treasury then start spending their Exchange Stabilisation Fund (approximately USD100 billion) to make the CNY appreciate? I seriously doubt it.