After a considerable lead-up to the August 15th “initial review” of Phase 1 of the “greatest and biggest” trade deal between China and the U.S., the review was postponed just like someone hit the pause button on the remote.
Last Saturday – August 15th – China and the U.S. negotiators were all set to review the first six months of “Phase 1” of the new trade deal. The initial “review” of the deal which came into force on February 15th would determine whether China had fulfilled its obligations to purchase U.S. goods – particularly agricultural exports.
But surprisingly, over the weekend there was no cabinet level appearances on Fox Business or tweetstorms on Twitter as both sides instead agreed to delay the review citing scheduling conflicts and presumably adding more time for China to buy more U.S. goods.
And reportedly no new date for the initial six-month review was set between U.S. Trade Representative Robert Lighthizer, U.S. Treasury Secretary Steven Mnuchin and Chinese Vice Premier Lui He, leaving the compliance time frame open.
Plumbing the Gap
So, what happened on Saturday during a lull in the news cycle?
U.S. relations with the People’s Republic of China are at a low - perhaps the lowest since the period immediately following Tiananmen Square in 1989. It would, by all outside appearances, seem there are enough bullet points of disagreement between the two superpowers to fill the magazines of a dozen AK-47s. But in the midst of the rising tension between Washington and Beijing, someone seems to have hit the pause button and the question is why?
The issues between China and the U.S and the PRC are myriad but largely fall in the realm of either the strategic interests and trade. But in broad terms, trade, and specifically the US trade deficit, rises to the top as the major issue for the Trump Administration, especially with the President Donald Trump himself.
This is nothing new as it’s well established that the U.S. imports far more goods from China than it exports to China. Currently the trade gap between China and the U.S. is the largest of any trade partner - around $131.7 billion through June. In June alone the trade deficit with China was $28.4 billion and in 2019 topped $419 billion.
Among economists there is a great deal of debate over how important the trade deficit really is and how the numbers themselves are compiled. Most goods China exports to the U.S. are consumer goods like personal electronics or furniture while conversely the goods the U.S. exports to China are largely agricultural or energy such as soy beans, grain and hydrocarbon based-fuels.
From a bean counting perspective, it’s apples to oranges. A smartphone assembled at a factory in China might be worth $2,000 landed in the U.S. but the Chinese factory’s slice of the smartphone is worth just a fraction of that – maybe $200. The rest of the cash is spread around the value chain to many other parties - much of which finds its way back into the hands of stakeholders and shareholders that own the rights and patents to the smartphone – often domiciled in the U.S.
Conversely, bales of hay, tons of soy beans, barrels of oil or tons of LNG (Liquefied Natural Gas) are commodities whose worth, while subject to market whims, have few inputs – what ‘you see is what you get’ type of goods with no value chain to speak of.
Thank You China
Shortly after the deal was signed, President Trump tweeted, “The deal I just made with China is, by far, the greatest and biggest deal ever made for our Great Patriot Farmers in the history of our Country…In fact, there is a question as to whether or not this much product can be produced? Our farmers will figure it out. Thank you China!”
The President’s enthusiasm for the deal was based on China’s agreement to raise its agricultural purchases to $12.5 billion over 2017 this year and $19.5 billion over 2017 in 2021 [roughly bring the purchase totals to $37 billion and $50 billion respectively] agricultural exports coming from Midwestern states deemed key to the upcoming November elections. In turn, the U.S. side agreed not to raise tariffs from 25% to 30% in October. Overall the deal with China could amount to $200 billion by the end of 2021.
But the deal really hasn’t gone as planned. According to data compiled by the Peterson Institute for International Economics (PIIE), Chinese agricultural purchases at the end of June had reached only 39% of their semi-annual target, according to U.S. figures. Although by China’s reckoning the tally was 48%. Additionally, China only purchased approximately 5% of the energy products necessary to hit the Phase 1 goal of $25.3 billion.
And up to very recently, Beijing didn’t seem to be in any hurry to meet the goals outlined in the deal. A report by Bloomberg noted, China is buying more Brazilian commodities, such as soy beans, than it did before, accounting for 40.4% of Brazil’s exports in May. All in all, China bought 35.2% more from Brazil in May 2020 than it did in May 2019.
Such numbers are bad optics for the “biggest deal” and when asked whether the U.S. would pull out of the deal, President Trump noncommittally said, We’ll see what happens.”
What is happening right now is China, after months of tapping the brakes on U.S. purchases, is trying to make a good faith showing…or at least an attempt to alter the political trajectory. After buying around $8.7 billion in agricultural products through the first half of 2020, there has been a spate of ag export deals in recent weeks. According to the USDA, China has booked around 10 million tons of U.S. soybeans for shipment for the 2020-2021 marketing year starting Sept. 1st. China has also agreed to deals for 195,000 tons of corn for feed. The energy purchases have also stepped up as China bought an average of 4.2 million barrels of U.S. oil in May and June, after a five-month drought of no U.S. oil buys.
Ticky Tech Fouls
Even with an increase in U.S. imports there are still a number of outstanding issues that could foul up the U.S.-China trade deal. The biggest obstacle to keeping U.S.-China trade on even keel is likely to be the Tech war. Since the U.S. put sanctions on Huawei over a year ago, the war over tech has been heating up. The hostile situation isn’t just confined to the U.S. and China but is global in scope but as goes the world’s two economic superpowers, so goes the business. The latest salvo came when Trump issued an executive order (August 14th) that would ban social media app Tik Tok and WeChat in 90 days if they weren’t divested by their Chinese-owned parent companies. Since the order was issued Microsoft and Oracle have jumped in to bid on the app. The President has subsequently indicated that he’s considering banning online retail giant Alibaba and others.
Whatever the (de)merits of the case against Tik Tok, the executive order may have the unintended consequences of entangling Tech issues with trade in ways the Trump Administration hadn’t foreseen. While Huawei’s connection to the Chinese military hierarchy is well documented and the company’s 5-G business is intrinsically tied to national security interests (as the UK recently decided) the same does rise to the same threshold for Tik Tok.
By forcing a divestiture, the U.S. is treading down a path that capitalistic economies generally oppose and could destabilize agreements like the recent trade deal with China.
China, Hong Kong and the US
When Beijing announced the new National Security Law for Hong Kong, it triggered a rapid response from Washington. The Trump Administration announced that Hong Kong goods will need to be labeled as made in China instead of Hong Kong after September 25. Although the goods at this juncture still remain outside the U.S. tariffs on China.
The Administration also took the step of freezing the U.S. assets of 11 Hong Kong officials including Chief Executive Carrie Lam and criminalizing their financial transactions within the U.S.
Part of the controversy over the security legislation is the extraterritorial reach of the new law – basically allowing the law to be applied to a person of any nationality whether residing in Hong Kong or not – an unsettling prospect for the business community.
While most economists believe the security law’s short-term impact on Hong Kong’s business will be immaterial for the moment, as Covid-19 and other local issues are of greater import – Hong Kong’s economy contracted by 9% in the 2nd quarter compared to the same period in 2019 and the forecast for the year are contraction of 6%-8%. Nonetheless there are worries about how international business will be impacted going forward. Will Hong Kong be able to continue as a premier international trade and financial center?
Amcham (American Chamber of Commerce) in Hong Kong recently ran a survey among its members: “To gauge how these developments have impacted business, AmCham asked its diverse set of member companies for their views in a temperature testing survey, to which 154 members (13% of overall membership) responded between August 7 and August 11.”
Almost more interesting than the actual results were the many comment on the situation.
Most of the comments were directed at the impact of the rift on financial services should the U.S. and China begin a dollar decoupling: “Funding requirements could be affected if US financial institutions are prevented from doing business in HK or US banks pull back on their own initiative,” as one AmCham commentator wrote.
Ultimately, the issues like Hong Kong or Huawei may be just side issues to the greater movement of trade but with Phase 1 on pause will we ever see Phase 2?
