The view still prevails that the two sides will eventually sign a comprehensive agreement and life will revert back to the good old days of 2015. Investors have been longing for news of a deal, almost any deal, just to feed the natural desire for evidence of a de-escalation.
In a false quarrel there is no valour1
That news headline has finally arrived, in the shape of a “Phase I” deal, presented to the world on December 13th by the US Trade Representative Robert Lighthizer2; unconventionally, however, the trade deal was not made public, only a limited number of headlines:
- China has committed to import an additional $200 billion of goods from the US over two years
- Importantly, Beijing did not confirm that number in its equivalent press conference on the deal
- The base year used is 2017, when China imported $150 billion of goods from the US (WTO3)
- There are four categories of exports covered:
- Manufactured goods
- Food and agriculture
- The US side has stipulated specific sub categories, such as oil seeds, cereals etc, but will not publish these numbers, because they believe that the information might move market prices
- The first three lists of imports from China, mainly intermediate goods, remain at the current 25% tariff
- The fourth list, which was hit with 15% tariff in September, will be reduced to 7.5%, probably in March 2020
- The fifth list, covering goods that would directly impact the US consumer, will be cancelled – it was due to be hit on 15th December.
Without further detail, its practically impossible to thoroughly analyse the deal, but an overall evaluation is relatively straightforward: It’s Much Ado About Nothing, just like the title of Shakespeare’s comedy.
Why do I say this? Because the numbers currently don’t add up
In food and agriculture for instance, China tends to only buy raw materials, not processed food. 2017 was close to a record year for US agricultural exports, as they amounted to $140 billion4. China was the largest buyer, accounting for $22 billion, followed by Canada ($20 billion) and Mexico ($19 billion). Total US exports of corn, wheat, pork, soybean and cotton were $52 billion. This deal claims that China will buy $40 billion in each of 2020 and 2021. Will US farmers cut off their other export customers? Can they literally grow $36 billion worth of agricultural goods in time for export in 2020 and 2021?
In this, as in every negotiation, there are some relatively ‘easy’ wins, as the distance between the two sides’ starting positions is relatively minor. Conventional negotiating strategy suggests that you don’t focus on the low hanging fruit to start with, because it simply leaves the tough stuff till later.
That is exactly what this Phase I deal represents. It’s a deal on the ‘easy to agree’ stuff. This is poor negotiating technique, because naturally the gulf between the two parties on the ‘tough issues’ is wider, thus rendering any agreement significantly harder to deliver.
So, what happened?
For the White House, the electoral calendar beckons and the President’s voter base seems to have been hit the hardest, so a deal is an imperative. For Beijing, there is no electoral calendar, only a pervasive fear of conceding too much to an opponent who appears as untrustworthy an interlocutor as he is belligerent.
Essentially, what the US had originally asked China to do is to dismantle its centrally planned economy and to, bluntly, stop being China; furthermore, it demanded the right to unilateral judgement and enforcement. Unsurprisingly, that has not worked so far and remains highly unlikely to work. Interestingly, this is effectively a very old fashioned, government to government agreement on trade – a classic example of ‘managed’ or ‘directed’ trade.
This Phase I deal may well be evidence that this is an accepted reality, since the new deal looks an awful lot like managed trade, anathema to the US built free market system. I guess that doesn’t matter, but the bottom line for investors is this: Enjoy this rally, for it will not last. The world will not go back to 2015, this is not so much Phase I, pending a fantastic Phase II. It is more likely a pause in the escalation.
Capital markets will prefer to enjoy the ride and not to focus on this for as long as possible.
1(Shakespeare’s Much Ado About Nothing, Act 5, Scene 1, Benedick)
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