China trade tensions rise without end in sight

 May 20, 2019

The prognosis for China-U.S. trade negotiations is not good.  Gallup polls last summer indicated that 62% of Americans think trade is unfair with China. U.S. Commerce Secretary Wilbur Ross and President Donald Trump are resolutely acting on this sentiment, seemingly willing to do whatever it takes to level the playing field and achieve “fair trade.”  The protectionist policies coming from the White House are concerning politicians and business leaders everywhere, even those who support Trump.

Trump’s unpredictable negotiation strategy is consistent with his real-estate past, but he may be operating in uncharted waters with Chinese leaders

Trump certainly has a unique method for negotiations, a style developed over his long career in commercial real estate. He is determined to live up to his campaign promises and is deploying all of his usual tactics in service of the defense of the U.S. manufacturing and technology sectors.

“He has put allies, rivals and … enemies right on notice that they are going to reduce their trade surpluses and trade reciprocally,” said political historian Victor Davis Hansen in an Interview with the Stanford’s Hoover Institution.  “Because he is unpredictable and they have no idea what he is going to do…I don’t know what he would do and neither do they. Unpredictability is an advantage in diplomacy…  If you read The Art of the Deal books it is [his preferred practice] to act unconventionally. To scream and yell, but to always have in the back of your mind that you are going to ask for 70, 80, 90% of a deal and then take 55% then praise your interlocutor.”

This negotiation style is unconventional for a U.S. President and is proving unpleasant for stakeholders across the globe. Markets are hair-trigger sensitive and react to the President’s every tweet. What is yet to be determined is how China will react. It is critical to note that China is not negotiating based purely on short-term financial interest like many of Trump’s previous business partners. China is a country with a long view.

By 2049, the 100th anniversary of Mao’s revolution, China aims to have a dominant position in global markets. To attain this goal they have set forth a series of short-term plans with lofty aims. Recently, the “Made in China 2025” plan sets specific targets, such as “70% self-sufficiency in high-tech industries.” A report from the European Union Chamber of Commerce in China subtitled their report on the China 2025 plan, “Putting Industrial Policy Ahead of Market Forces.” The race for industrial and technological superiority is clearly a priority for both governments, and it seems that President Trump is willing to mimic the Chinese use of state power in order to sustain industrial development.

Trump believes both deregulation and tariffs are essential tools for growing the U.S. economy, China’s tariff response has been forceful and calculated

Trump’s economic policies have been an appeal to America’s working middle-class, those who feel that they were lost in the swirling competition of globalization. Executive Branch diplomatic visits to coal, oil and steel towns have promised revitalization. Promises to industry have been accompanied by executive orders lifting regulations that had previously made it difficult for these businesses to thrive in the U.S. and compete against foreign interests. This deregulation, coupled with a tax overhaul, has helped to fuel some of the best domestic stock performance ever and drive unemployment to the lowest it’s been since the 1960s. 

Yet, deregulation has not been enough to satisfy the U.S. Executive Branch. Under grounds of National Security, Trump launched the Section 232 Tariffs on Steel and Aluminum in March of 2018 after a yearlong investigation. The tariffs quickly extended to $50 billion worth of goods and then $200 billion in the fall of 2018, broadly impacting both intermediate and consumer goods. China retaliated with tariffs on $60 billion of U.S. goods.  In mid-May of 2019, Trump promised to hike the tariff rate from 10% to 25%, China quickly promised to respond.

What is interesting is what U.S. goods China has chosen not to retaliate on. Aircraft ($13.3b), Semiconductors ($10.2b), and Crude oil ($3.2b) have been left untouched by tariffs. This is a clear message that China is not willing to put its growth at risk. Transportation, technology, and energy are critically important to meeting long-term Chinese growth plans and have been treated as such.

Both countries have engaged in frequent negotiations over the last year without a major breakthrough. Beijing has been quick to criticize President Trump’s actions as not in the interest of either country but has remained firm in their tariff response. 

Keeping political promises for both President Trump and President Jinping will be difficult and painful, there is no clear end in sight for the trade war

While the tariffs have been received fairly well by Trump’s political base, they face heavy criticism from investors and most business trade organizations. The tariffs have managed to help some companies, such as United States Steel Corporation, that had closed plants from mounting Chinese competition. Mostly, the costs of the trade war have been passed on to businesses and the American consumer.  With the 2020 election in sight, China may hope that the American people will feel the pain of higher prices and unseat Trump and his tariffs.

“Sometimes referred to as the “chairman of everything,” [Chinese President] Xi Jingping is widely regarded as China’s most powerful leader in decades. He cleared a path to remaining in office indefinitely last year when he amended the constitution to remove presidential term limits,” noted Christopher Bodeen for the Associated Press. This concentrated political power has allowed China great maneuverability that a free market lacks and will allow the Chinese to embark on a “Long March against U.S. trade sanctions.

The success of either President in these negotiations will be rooted in their ability to retain legitimacy as leaders, despite risks of worsening financial situations. Jinping has the advantage of total political control compared to Trump’s many vocal adversaries in the U.S. government and his tenuous position in the second half of his term.  However, Trump has the advantage of the Chinese expectation for growth and the leverage of the United States’ buying power. The Chinese people have given up many freedoms to their government in exchange for promised rapid increases in economic development and quality of life. The threat of substitution from other emerging economies and the U.S.’s own manufacturing base could kill Chinese momentum and create political unrest.

Regardless of the specific effects, it should be excepted that the trade negotiations will get much worse before the situation improves.

20 May 2019