The Pretend Trade Deal

On Friday afternoon, the United States and China proudly announced a partial trade deal that was heralded as moving toward a more comprehensive agreement. The only problem is that there is no actual deal there.

To be sure, there’s pressure to strike a deal. For some time, news reports have indicated that the Trump administration was not anxious to continue ramping up tariffs, and it was also seeking to lessen the pain of Chinese tariffs on U.S. agricultural products. Since the trade war started in earnest, rumors and regular variations of tariff delays by the United States in return for incremental purchases or policy changes such as a reduction in fentanyl exports circulated. There has been little progress, ultimately resulting in incremental escalation as Washington accused Beijing of not honoring their agreement by not buying soybeans or stemming the flow of fentanyl.

In the lead-up to the visit by China’s lead trade negotiator, Vice Premier Liu He, numerous reports indicated both sides were seriously considering a partial trade deal. The thinking went that this would allow for an easing of tensions as more substantive deeper agreement was hammered out between each side.

Each side is under significant pressure due to domestic politics to strike a deal. Despite rosy headline numbers of GDP growth, the Chinese economy is under enormous pressure. Chinese imports in U.S. dollars fell 8.5 percent year on year last month—having fallen consistently throughout 2019, indicating broad weakness. Consumer goods sales are flat or falling significantly, and unreported capital outflows have reached their highest level in years as people move their money out of China. With the threat of an impeachment inquiry into U.S. President Donald Trump and election season ramping up simultaneously with a decelerating economy, the Trump administration is looking to go into 2020 with some movement on its signature trade policy issue.

The fundamental problem with the deal, however, is that it doesn’t seem to actually exist. As of Monday in Asia, there was no official text of the agreement between the United States and China. Officially, Chinese state media would only say that “substantial progress” had been made. Even U.S. officials still said they would be papering over the agreement, and it remained unclear how big any agricultural purchases would be, over what period, and whether any currency or intellectual property commitments would be included. In short, while a more material deal may spring forth in the coming days, there is nothing substantive at present.

The bigger problem is the United States and China agree on almost nothing. They do not agree on the problems, how to solve them, or even what the broad objectives should be. China does not accept the U.S. position that domestic subsidies and industrial policy are negotiable topics, while the United States does not accept the Chinese position that Huawei is a trade issue. Nor do they agree on the general objective. While openness and liberalization are generally taken as the foundational motivating objective of trade negotiations, China has not and does not accept the premise.

Each side spent significant time recently removing key issues from the negotiating table. Reports indicated that China refused to discuss industrial policy and subsidies, a key complaint from Washington. The Trump administration refused to discuss Huawei, other Chinese firms on the entity list, or the companies sanctioned over their involvement in Xinjiang. A major driver of the significantly smaller deal is that each side has drawn a series of red lines around many issues, leaving relatively little to discuss.

Given the ambiguous nature of the agreement and its limited scope, there’s little reason to have confidence this will result in a more lasting basis to move forward. Multiple times within the past 15 months, supposed agreements have emerged—including a supposed delay of U.S. tariff increases and Chinese purchases of agriculture—only to fall apart. Even if there is ultimately an agreement on the basics, it is important to set realistic expectations for successful execution.

Looking at currency management, the outlook darkens further. Though the Trump administration may not appreciate the falling renminbi, there is not strong evidence that China has been politically manipulating the currency to offset tariff increases. The currency is pegged to a basket of currencies effectively replicating a U.S. dollar index, so the decline in the yuan in 2019 has been driven by the increase in the U.S. dollar, not political manipulation.

Washington, however, still wants a stronger yuan to decrease the trade imbalance. The problem for China is that it cannot commit to credible changes to currency mechanisms without incurring major risks to its economy. Arbitrarily raising the yuan through such measures as a change to the basket, as the Trump administration is likely pressuring Beijing, risks negatively impacting any surplus. Easing currency flows is likely to leave the Trump administration even more unhappy given the strong probability it would push the yuan down as capital flowed out. Any agreement on currency pricing in this situation will need both specific valuation description and a pricing mechanism to be credible. Otherwise it will be little more than flowery words.

There is a similar Gordian knot on intellectual property. Despite years of pressure from the United States and decades of promises from Beijing, China continues to engage in a variety of practices ranging from the problematic, such as forced technology transfer, to the outright illegal, such as the theft of U.S. companies’ intellectual property rights. To combat this, the Trump administration has given law enforcement and regulators wide latitude to pursue economic and security espionage cases, hacking, and forced technology transfer cases. Given the scope of the problem, they have sought an agreement with China on intellectual property protection, something Beijing has and continued to refuse. Any inclusion of intellectual property is like currency—little more than toothless reiteration of general talking points about the importance of respecting intellectual property.

Both sides have talked of future agreements being signed in December that would include a wider range of issues. But there’s little reason for optimism. Any deal means nothing without serious enforcement mechanisms—a difficult, perhaps impossible, step for China, which ardently resists any oversight of its practices. When trade negotiations fell apart the first time it was due to the Beijing side, reportedly under direct orders from Chinese President Xi Jinping, stating that it would accept no tangible enforcement mechanism.

Trade wars are unpredictable, as is the Trump administration. It’s certainly possible a deal will still emerge in the end. But the Chinese Communist Party’s stance against openness, against oversight, and against liberalization is predictable—and that may be the best thing to bet on here.