China’s US Investment: A State Of Attraction

With the ‘Phase One’ US-China trade deal due to be signed on January 15, our man in Tokyo alerts us to a timely article in the Nikkei Asian Review. It examines the continuing Chinese investment in US agricultural and manufacturing states that could be considered Trump heartland, despite Washington’s general chilling of inbound direct investment from Chinese firms.

These are ‘Red’ states where the US president was successful during his 2016 election campaign in blaming China for their economic ills, but equally where Beijing’s retaliation to his tariffs on China’s exports have caused the most pain and thus where Trump’s bid for re-election in November risks coming unstuck.

The article highlights a disconnect between attitudes towards China at the federal and state government level. Many state governors, including Republican ones, have pursued inbound Chinese investment on the basis that any jobs, even Chinese-owned ones, are better than none. They have made a pragmatic peace with the Trump administration’s economic hawkishness towards China and its continuing appeal to the president’s electoral base.

The other lessons from the article are that it provides a further example of how difficult decoupling the US and Chinese economies is, and of why domestic US electoral politics weigh heavily in Trump’s trade calculations — as they always have done.

Options Narrow For A China-US Trade Deal

SUMMITS ARE FOR signings. US President Donald Trump’s second summit meeting with North Korean Leader Kim Jong-un in Hanoi should never have taken place. Or at least not until after officials had worked out what the agreement between the two countries was going to be. President Xi Jinping is not prepared to put himself at risk of the sort of fall-out that followed Trump walking out on Kim and that summit ending prematurely with no agreement.

The presidents meeting at Trump’s Florida resort Mar-a-Lago pencilled in for the end of this month to sign-off on a China-US trade agreement remains no firmer that, with Terry Branstad, the US ambassador in Beijing confirming to the Wall Street Journal that a date had not been finalised. The boosterish talk a couple of weeks back that a deal was near enough to completion to suspend the introduction on March 1st of 25% US tariffs on $200-billion-worth of Chinese exports is heard no more.

The sticking points of the agreement are proving as intractable as this Bystander has suspected all along that they would be, particularly over state subsidies, market access and forced technology transfers. No country readily changes its economic development model without either good cause or great pressure.

However, even the mechanism for monitoring and enforcing an agreed timetable for China to remove tariffs is proving difficult to nail down, as is getting the US side to agree to a schedule to withdraw its tariffs. The enforcement mechanism must be “two way, fair and equal,” Vice Commerce Minister Wang Shouwen said this weekend.

The US president is pushing for an early conclusion to a deal for political reasons. He needs demonstrable benefits from it to take into his 2020 re-election campaign. Xi also needs a deal that avoids him looking as if he has come off second best to the United States or has done anything to exacerbate the current slowdown in the economy.

For both, a narrow trade deal with enforcement mechanisms around only tariff-removal regimes seems more and more likely. Beyond that, Beijing will agree to buy more US produce and industrial goods and codify economic reforms that it is already planning to introduce. The more significant structural issues will be kicked down the road.

Xi And Trump Provide Temporary Relief

CHINA HAS BOUGHT itself some time in its trade dispute with the United States, paying in farm goods, energy products and other industrial imports.

After a two and a half hour meeting over a steak dinner at the G20 summit in Buenos Aires, President Xi Jinping and US President Donald Trump called a time-out in the two countries’ tariff war. The United States agreed to suspend for 90 days the hike in tariffs to 25% from 10% on $200 billion of Chinese imports due to take effect on January 1 and not to introduce any new ones in return for purchases of unspecified but ‘substantial’ value of the above-mentioned goods.

Beijing and Washington will also step up talks on addressing broader structural issues the Trump administration has with China’s economy and body politic, although on those, Foreign Minister Wang Yi was somewhat ambiguous when he said these would cover ‘legitimate’ US concerns, leaving open a vast definitional loophole of what would count under that term.

It also looks as if Beijing has agreed to reverse its regulatory blocking of a proposed $44 billion takeover bid by Qualcomm, the US semiconductor manufacturer that is the world’s largest, for the Netherlands’ NXP Semiconductors that torpedoed the deal. However, Qualcomm has since said the proposed merger is dead.

Perhaps the most impactful part of the deal will be China’s agreement to designate Fentanyl as a controlled substance. The Chinese-made pain-killer is behind much of the opioid crisis in the United States, and one that disproportionately affectsTrump supporters.

In hailing the agreement as ‘incredible’, regardless of the fact that China had given up little if anything, Trump highlighted the positive impact it would have on US farmers, pointing up the most acute political pain point he is feeling at home from his tariffs.

But in truth, he is providing only temporary relief.

Ninety days is not much time to make any progress even on talks about talks on the intellectual property and market access issues. And all the time the threat of a re-escalation of the tensions will hang over discussions.

There might be some opportunity to revive (and rebrand) the agreement Xi struck with President Barack Obama that China would refrain from commercial cyber-espionage, which has, to all intents and purposes, collapsed. However, China will not abandon its ‘Made in China 2025’ industrial policy and will need to acquire foreign technology in support, by whatever means.

In short, the Buenos Aires agreement resolves none of the underlying issues of the economic let alone geopolitical rivalry between the two countries.

We are still in a position in which Trump is addicted to tariffs and Xi has no clear idea on how to treat him.

Update: Trump has tweeted that China has agreed to cut its 40% tariff on US car imports, which were anyway due to be reduced before the tit-for-tat tariffs started. Neither side had mentioned this in public while in Buenos Aires and China has yet to comment on the tweet.

US Democrats’ Midterms Success Will Not Change US-China Relations

OUR MAN IN Washington writes that the success of the US Democratic party in retaking control of the lower house of Congress in this week’s US midterm elections will not make much difference to the bipartisan consensus in Washington in favour of being tougher on China, certainly in the short-term and probably not for the duration of the Trump presidency.

In the unlikely event that Beijing was expecting American voters to deliver a stinging rebuff to their president at the polls, it will have been disappointed.

The new Congress, which does not convene until January, will let the Democrats play the spoiler in the House, where they now have a slim majority, but not advance their agenda. In the Senate, Trump’s Republicans increased their majority, and thus strengthened President Donald Trump’s nominating power, should he need, for example, to put in place a new Defense or Treasury Secretary who is more of a ‘China hawk’ than the incumbents.

The Democrats will not come to office unified in their position over trade, over which Congress, not the White House technically has ultimate authority as it writes the laws regarding trade deals and tariffs, and authorises the President’s remit over individual trade negotiations..

The Democrats old House leadership (in terms of both incumbency and age), which is likely if not certain, to continue in the new Congress, still reflects the interests of labour unions and has traditionally been sceptical of free trade. Some of new, younger, progressive Democrats have expressed pro-free trade sentiments. Elizabeth Warren, a possible if unlikely Democrat presidential nominee for 2020 and a veteran leader of the Democratic left, has complained that Trump’s punitive tariffs on China do not go far enough.

Two key figures to watch are Massachusetts Rep. Richard Neal, who is likely to become chair of the Ways and Means Committee, which gives him influence over budget allocations, and New Jersey Rep. Bill Pascrell, who is expected to chair the House trade subcommittee.

Neal is on record as a supporter of robust and enforceable labour and environmental provisions in trade deals, a position followed by many Democratic legislators, while Pascrell has opposed a putative free trade deal with the Philippines on the basis of the Duterte administration’s human rights record.

Pascrell has also hounded the Trump administration over its steel and aluminium tariffs and made rhetorical points about how Congress is trying to lower trade barriers in contrast to an administration that seeks to raise them. However, scoring political points by demanding the administration clarifies its tariff strategy and insisting it does not harm U.S. exporters or importers, is not the same thing as trying to force Trump’s hand over China trade in a direction it does not want to turn.

One area where there might be some momentum, because there is also support for it among House Republicans, is to rein in the president’s ability to unilaterally raise tariffs without consulting Congress, an attempt to wrest back some of Congress’s authority over trade that it has traditionally wielded.

In the current Congress, bills to that effect have failed to make it out of committee. However, were they to do better in the new Congress, they still face being killed off in the Senate, where there is a supportive Trump majority that Senate Majority Leader Mitch McConnell has signalled would be used to that end.

The Senate will likely be less fertile ground for those hoping to lower the tensions between Washington and Beijing. Many Democrats there, including Senate Minority Leader Chuck Schumer of New York, have spoken in support of the administration’s protectionist policies. Senators in Rust Belt states, where Trumpism has taken particular root, also look favourably on tariffs that could shield their local industries. Senator Sherrod Brown of Ohio, who leads the protectionist wing of the Democratic Party, recorded one of the most emphatic Democratic victories of last Tuesday.

There are issues other than trade between the two countries, of course, notably North Korea, the South China Sea and Taiwan, as well as the general one of Trump’s ‘America First’ stance at home and abroad, with China now categorised a strategic adversary of the United States.

The Congressional gridlock that he will face in the final two years of his first term may tempt him to become more active in foreign affairs in the run-up to the 2020 presidential elections. If there is one thing that is certain about the Trump administration is its unpredictability.

China And Japan Warm Commercial Ties As A Matter Of Convenience

CHINA-JAPAN RELATIONS have blown hot and cold since the two resumed diplomatic ties in 1972, and there is self-evidently history as to why that is the case.

Japanese Prime Minister Shinzo Abe’s current three-day visit to Beijing is the first by a Japanese prime minister for seven years, an indication in itself that the bilateral relationship is coming out of a chilly phase. The ‘historic turning point’ lauded by the official statements is over-egging the pudding at this point.

There is a geographical logic to the trade deals agreed during the trip ($18 billion worth). This has been given additional fillip by the US administration’s imposition of tariffs on both Chinese and Japanese exports. Both neighbours need to diversify their sources of supplies and their markets as a result. They are both already among the biggest trading partners of the other and the $30 billion currency swap agreed during Abe’s visit will underpin that.

However, Japanese carmakers have not yet got the all of the better access to the Chinese market they want, and Tokyo has not provided as ringing an endorsement of the Belt and Road Initiative as China would wish.

Abe also needs to secure a better seat at the table in the discussions over North Korea, which are becoming increasingly a quadrilateral affair between Pyongyang, Seoul, Beijing and Washington, sidelining Tokyo, which has a particular issue over Japanese citizens kidnapped by North Korea that is not shared by the other four.

The key point of conflict between Beijing and Tokyo remains their territorial dispute over islands in the East China Sea known as the Diaoyu to China and the Senkaku to Japan. Anti-Japanese riots broke out in China just six years ago following moves by Japan to extend its sovereignty over the islands. Cars made by Japanese manufacturers and other Japanese products were vandalised in China. Tourism, trade and investment between the two countries fell off a cliff. Beijing froze high-level contacts.

Anti-Japanese nationalist sentiment remains a switch that Beijing can flip on or off at its convenience.

Asia’s two largest economies making common commercial cause in the face of the challenges posed by the Trump administration is one thing; resolving long-standing political differences will be another. The challenge will be greater for Japan than China, as it now has two ‘frenemies’ to deal with not one.

Latest China GDP Figures Show Stable But Challenged Growth

IF THERE IS a scintilla of concern for authorities in the third-quarter GDP growth figure, covering July-September, it is that the tariffs imposed by the United States have not had much time to have a material impact.

At 6.5% year-on-year, the third-quarter number represents the slowest quarterly growth rate since the first quarter of 2009 in the immediate aftermath of the 2008 global financial crisis. However, it is still in line with the official growth target for the year. For the first nine months, GDP grew at an above-target 6.7%, according to the National Bureau of Statistics, which generally portrays the economy as “running within reasonable range in the first three quarters, and [continuing] to stay stable with good growing momentum”.

However, as the economists like to say, all the risks are on the downside: Trump’s tariffs; the ticking debt time bomb; and the pains of rebalancing.

In particular, with the Trump administration ramping up its tariffs in the current quarter and no resolution to the trade frictions between the two countries in sight, further policy support for the economy is going to be needed. However, policymakers’ scope to stimulate the economy is limited by high debt levels, in part taken on to finance the infrastructure investment boom that was the stimulative response to the 2008 financial crisis.

Giving banks more freedom to grow their loan books, trusting their credit judgements are better — or less politically swayed — than they have been in the past, will be preferred to increasing direct government spending. There will some of that, though, too, if growth is seen as slowing uncomfortably fast once the current round of US tariffs takes effect, or is followed by another.

Investors are less than convinced. Hence the raft of bullish statements from President Xi Jinping’s top economic adviser and the heads of the securities regulator, the combined insurance and banking watchdog and the central bank urging investors to stay calm as the main stock market index neared a four-year low.

However, the important words are yet to be spoken. Those will exchanged between Presidents Xi and Donald Trump when they meet at the G20 leaders’ summit in Buenos Aires at the end of November and may give an indication of which direction the trade disputes between the two countries are headed in.

When Elephants Fight, It Is The Grass That Suffers

 

THE WHITE PAPER on China’s membership of the World Trade Organization (WTO) since it acceded to the world trade body in 2001 released by the State Council Information Office on June 26 implicitly acknowledges how much China has benefited from its membership.

This is all couched in terms of how China has lived up to its membership obligations and is now championing global free trade — an unabashed riding on the coattails of the global backlash against the United States’ protectionist turn.

The latest step in that come today with US tariffs of 25% on $34 billion worth of Chinese goods from ball bearings to lithium batteries coming into effect and China retaliating by imposing a similar 25% tariff on 545 US products, also worth a total of $34 billion, and likely to focus on agricultural products.

US President Donald Trump had previously threatened a 10% levy on an additional $200 billion of Chinese goods if Beijing’s trading practices remain unchanged, and raised the stakes on Thursday by saying that more than $500 billion of Chinese exports could be tariff targets.

Should that happen, Beijing may resort to non-tariff retaliation in forms such as more expensive and lengthy customs inspections and consumer boycotts of US products, as it did last year to South Korea’s Lotte Group.

That would be a display of patriotic citizen loyalty that the United States would be unable to match and may point to the Achilles’ heel of Trump’s belief that he can push hard on trade because the U.S. holds the strongest hand and thus the rest of the world will, ultimately, back down.

Two days before the imposition of these latest tariffs, the WTO reported that in the seven months to May, trade restrictions imposed by the G20 had doubled over the previous reporting period. These include tariff increases, stricter customs procedures and imposition of taxes and export duties.

In a nod to its purpose, the WTO noted that during the seven months reported on (so they do not include the latest tariffs), trade liberalisation measures taken by G20 members covered $82.7 billion of trade, versus the $74.1 billion affected by trade restrictions. But the gap is narrowing rapidly.

The WTO’s report is blunt in saying that further escalation of protectionism — measures and rhetoric — could carry potentially large risks for the global trading system itself:

At a juncture where the global economy is finally beginning to generate sustained economic momentum following the global financial crisis, the uncertainty created by a proliferation of trade restrictive actions could place economic recovery in jeopardy. The multilateral trading system was built to resolve such problems and it has the tools to do so again. However, further escalation could carry potentially large risks for the system itself. Its resilience and functionality in the face of these challenges will depend on each and every one of its Members. The G20 economies must use all means at their disposal to de-escalate the situation and promote further trade recovery.

Trump’s antipathy for the WTO — beyond a general belief that all multilateral organisations exist to do down the United States — is that it has provided China with a mechanism to create the vast trade surpluses with the United States on which he is now waging trade war.

Our man in Washington tells us that in private Trump repeatedly says that United States should get out of the WTO because it is anti-American and recalls the president on the campaign trail in 2016 calling the WTO a “disaster”.

Perversely, because the US-created the system and has lots of effective lawyers at the WTO, it does better than most when it comes to dispute resolution at the WTO. According to this year’s Economic Report for the President, the US has had an 85.7% success rate in cases it has initiated before the WTO since 1995, compared with a global average of 84.4% and China’s 66.7%. And it wins 25% of the cases brought against it, compared to the overall average successful defence rate of 16.6%.

Whether Trump would push the destruct button on the WTO remains an open question, though he is constrained to an extent in that the US Congress would have to pass legislation for the United States to leave the organisation.

Doing so would send both world trade and world financial markets into a tailspin. Stockmarket indices are scoreboards that get Trump’s attention. A deal to ‘fix’ the WTO might appeal more to him, especially if markets react badly to this latest round of tariffs.

For all the rightful concern, the US tariffs so far are tiny in the global scheme of things, affecting the equivalent of 0.6% of global trade and accounting for 0.1% of global GDP, according to Morgan Stanley.  The collapse of the WTO would be on an altogether greater scale.

Meanwhile, Beijing will continue to play its long game and to occupy the moral high ground over the WTO, its belief in its ability to outlast Trump as unshakeable as Trump’s belief that it cannot.

 

China’s Economy: Normal Slowing Will Resume in 2018

THE ECONOMY STORMED along in the second half of last year, taking growth for the year to 6.9%, comfortably outstripping the official target of ‘around 6.5%’.

It was riding the coattails of the fiscal stimulus introduced in the first half of the year and also the pick-up in global trade, partly helped by the robust growth in the United States and some recovery in Europe, which boosted China’s exports. At 8.7% of China’s GDP growth, net export volumes made their largest contribution to growth since 2008.

Policymakers have been managing a slowdown from the giddy decades of double-digit growth. The overall lesson from last week’s figures is that economy is fitfully rebalancing and that there was some slowdown in credit growth as official efforts to cool the property market, deleverage and upgrade industrial capacity gained some traction.

That last year turned out to be the first acceleration since 2010 should prove to be an anomaly. Normal slowing will resume this year. And especially if policymakers push ahead with measures to control financial risks.

The most recent forecast from the World Bank, which recently upped its estimate of GDP growth in 2017 to 6.8% (a 0.3 percentage point increase from its forecast a year ago and reiterated in June) says it expects 6.4% growth this year (a 0.1 percentage point increase from its previous number).

Beijing has plenty of headroom in meeting its 2010 target of doubling aggregate and per capita growth by 2020. The economy needs to average no more than 6.3% growth to achieve that.

That headroom will also let Beijing tackle its most pressing economic-related problems: curbing escalating debt; cutting excess heavy industrial capacity; becoming environmentally cleaner; and dealing with the risk of unemployment as the economy is rebalanced towards domestic consumption and higher-value-added manufacturing.

Where the margins of safety are considerably thinner is if there is a trade war with the United States.

As we noted recently, US President Donald Trump is itching to impose tariffs on Chinese steel and aluminium imports into the United States. More recently Washington has said that an investigation into intellectual property transfers to China has been launched, with Trump warning that China is in for “a very big intellectual property fine”.

His self-restraint because he needs Beijing’s help with North Korea is wearing thin. Nor will it have been helped by the revelation that an ex-CIA officer arrested in New York this week may have been the mole responsible for passing information to Chinese intelligence that led to the dismantling and death of the CIA’s intelligence network in China between 2010 and 2012.

China Trade Does America A Service

US PRESIDENT DONALD Trump lambasted cheap Chinese imports for destroying American jobs when he was on the campaign trail last year.

A National Bureau of Economic Research working paper by Robert Feenstra of the University of California, Davis and Akira Sasahara of the University of Idaho, which  recently came across our desk though published in August, suggests the damage may not have been as extensive as previously thought once the gain in jobs from US exports to China are taken into account.

Looking at the impact of trade on employment in the United States from 1995 to 2011, the authors say:

For merchandise exports and imports from China, we have found added demand of 3.7 million jobs and reduced demand of 2.0 million jobs, respectively, giving a net gain of 1.7 million jobs.

Including services trade, Feenstra and Sasahara count a much larger net gain of 4 million jobs.

Different modelling approaches give some variation of results, showing that in merchandise trade the net job gain from the China trade could have been as low as 730,000 jobs or as high as 2.7 million and for trade in all sectors from 4 million to 5.1 million jobs. But all show a net gain in jobs.

At least some of that growth will have been as a result of China’s growth stimulating global growth and thus world trade.

Previous studies have estimated that since China’s accession to the World Trade Organization in 2001, unleashing the ‘China shock’ on world trade, Chinese imports accounted for one-quarter of the decline in U.S. manufacturing employment and have contributed to the unusually slow employment growth following the 2008 financial crisis.

Imports from China — or anywhere — else have twin effects. They create import competition and labour-market dislocation, but also benefit domestic consumers through lower prices. Trump concentrated on the former.

But what Feenstra and Sasahara highlight is the importance of services in the United States’ global trade. Thus Trump’s emphasis on restoring manufacturing jobs, if politically salient, is economically misplaced.

China-America First

DONALD TRUMP MARKED his first meeting as US president with the visiting President Xi Jinping with a display of naked American power, Cruise missile strikes against an airfield in Syria in retaliation for the Assad regime’s chemical attack on a hospital. The timing was coincidental, if opportune, but it was an act of defining and defending national interest of which only one of the two superpowers is currently capable, let alone comfortable, in undertaking.

The signalling was palpable. Moreover, it was an action that also had many observers quickly connecting the dots to North Korea, a country Trump had threatened unilateral US action if China did not start to exert the control over its ally that Washington believes it can and should.

Xi’s visit was always going to be scrutinised for the subtle signs of a power play between the two men. The ‘optics’ would be as important as the outcomes. However, it also carried considerable domestic political risk for Xi, making the trip to the United States early in Trump’s presidency (and to a golf course resort, at that) with all the risk of Trump’s unpredictability providing a loss of face for no very certain reward. The deflection of much of the world’s attention elsewhere would not necessarily have been unwelcome.

It is hard, though, to imagine the trip was undertaken without assurances there would be some return. The pre-trip speculation was of an agreement, if longer on affirmation than detail, on a joint reset of tackling North Korea’s nuclear ambition and some public US affirmation to Beijing over arms sales to Taiwan and the ‘one China’ policy.

In the event, the publicly announced outcomes were more modest, though likely of Beijing’s design, a 100-day plan to discuss trade talks directed at boosting US exports and reducing Washington’s trade deficit with China, and an invitation to Trump to make a state visit to China, which the US president accepted for a date to be arranged.

Trade is the lowest-hanging fruit for restoring relations between the two countries to an even keel. The direction of travel favours more US exports to China, especially once the rebalancing of the economy to more domestic consumption takes hold, while the One Belt, One Road initiative, to which the United States has now been asked to join, offers the prospect for more business and investment than China can handle alone.

Difficult issues — North Korea, Taiwan, the South China Sea — offer scant prospect of early harvesting.

The agreement to trade talks is positive, in the sense that it shows Trump can be steered away from his fiery anti-China rhetoric of the campaign trail last year. Further evidence that the reality of office is taking hold over the rhetoric of candidacy is that the Trump administration has so far declined to carry through on pre-election threats to brand China a currency manipulator or impose punitive tariffs on Chinese exports to the United States.

That the US president said that he was willing to further strengthen cooperation with China in economy, military affairs and people-to-people exchanges and support China’s efforts in pursuing corrupt officials who had fled China with ill-gotten gains will all be taken as evidence of success by Xi’s team, whose overarching goal was to restore stability and order to the relationship so they can manage it. Trump’s description of his personal relationship with Xi as “outstanding” will have been a bonus, though Trump will likely find eventually that that friendship will come with trappings.

State media have been quick to present the Florida summit as continuation of policy between the world’s two leading nations. “Expanding win-win cooperation” and “managing differences” and developing “dialogue and cooperation between China and the United States in such areas as diplomacy and security, economy, law enforcement and cyber security, as well as social and people-to-people exchanges” represents a good outcome for Xi, even if it is not the language of concrete gains for American manufacturing workers that reverse trade deficits and job losses that Trump had previously told his blue-collar economic nationalist supporters he laid squarely at China’s door.

The harsh truth is that it is not that group that stands to benefit from growing US trade with China. The winners will be the same ones that were the winners from globalisation.

The longer-term win for Xi is that summit has steered one of the world’s most important relationships, that between China and the United States, further in the direction of an arrangement of international affairs that is based on bilateral relationships between great powers than the post-World War Two system of international rules — something Xi has previously described as “a new model of great power relations” and which aligns with China’s efforts to construct a parallel architecture for global governance with itself in the centre.

The US president, who seems to prefer to focus on winning battles rather than wars, may well not realise what his guest has walked away with.