Fresh negotiations are again underway between the U.S. and China to try to resolve the deepening trade conflict between the world’s two greatest economies. Prospects of a comprehensive deal are no nearer, however, because the fundamental conceptions of the two sides are so far apart. U.S. pressure has tended to confirm Chinese leaders’ urgency for more autonomous national development, making it even less likely that China will concede on issues like reducing government subsidies for high-tech development, as once touted in the Made in China 2025 plan. Continuing U.S. threats of trade and investment constriction make economic decoupling more likely, not less.
Furthermore, Chinese leaders know time is on their side. As the U.S. election year approaches and there is more and more talk of a trade-induced financial crash, President Trump alternates between pushing harder with further tariff increases, and backing off when the Wall Street reaction is strongly negative. Trump’s reelection prospects are already looking dodgy in a relatively good economy. If a recession and financial crash hits during the coming year, his reelection prospects vanish. China knows this too.
It is often said it is better to deal with “the devil you know” instead of facing the uncertain prospect of what a Democratic president might demand. This witticism fails with Trump since he is such a difficult devil to know. Three times a draft trade agreement has seemed at hand: May 2018, December 2018, and May 2019, but each time it was shot down by the White House. The first time Trump directly nixed it. The second time the arrest of Huawei CFO Meng Wanzhou, apparently instigated by John Bolton, Trump’s recently fired National Security Advisor, killed the deal. Last May, the American media largely blamed China for walking away, but ignored Trump’s provocation by tweeting that he might retain tariffs on Chinese imports even after a trade agreement to insure Chinese “good behavior.” China must have thought if the extraordinary tariffs do not come off, then what is there to negotiate about? Even U.S. ally Japan is facing a similar conundrum because Trump rejects a written pledge against future auto tariffs as a quid pro quo for Japanese concessions. Trump demands; he does not deal.
Now we are told progress is again being made toward a China deal, but take that with a grain of salt. Both sides have the incentive to project optimism: the U.S. to avoid spooking Wall Street and China to keep up the appearance of reasonableness, both to maintain domestic business confidence and to dissuade Trump from ever harsher trade penalties. However, it seems from the available evidence that China has put little new on the table since May 2018, in part because it has only so much it would be willing to offer without compromising its own vital national plans. Furthermore, Trump seems unwilling to sweeten the deal with any attractive quid quo pro that might induce further Chinese concessions. After setting up China for years as the consummate exploiters of weak American leadership, he can hardly afford a weak-looking deal.
Influential Democratic donor George Soros threw down the gauntlet to Trump recently, signaling that the demonization of China has advanced so far that Trump will be attacked as “soft on China” if he cuts a trade deal little better than what he rejected several times already. Trump himself has raised expectations of a comprehensive deal with China to such heights that it is difficult for him to now cut his losses and compromise. He cannot accept whatever China could reasonably offer.
Thus, the most likely prospect is another round of failed talks, followed by another round of punitive Trump tariffs, provoking Chinese retaliation. Another failure is likely to hasten a global recession, already beginning even without further bad news.
Yet further bad news is likely. The world economy is already showing serious signs of strain. The competitive pressure of internet-based retail companies like Amazon has undermined the prospects of hundreds of large conventional retail companies, leading to scores of bankruptcies, especially among those who loaded up on low-interest debt for expansions that never panned out. Part of the reason Germany’s largest bank, Deutsche Bank, is now drastically downsizing is its heavy exposure to failing retail companies in the U.S. Another vulnerability is the big British-Hong Kong banks, HSBC and Standard Chartered, rooted in dodgy real estate and commercial lending and the disproportionate effects on Hong Kong of the trade war and now months of pro-democracy protests. Finally, in the midst of the “retail apocalypse” Trump is threatening big tariff increases on Chinese imports that supply much of the retail sector. This could accelerate the retail and real estate crisis, spilling over to the broader economy.
Finally, Trump seems determined to fight with Wall Street over the value of the dollar. Trump has long campaigned for a weaker dollar. His charge that China is a currency manipulator is driven by his desire for the Chinese RMB to strengthen relative to the dollar so Chinese exports will cost more and U.S. imports less, perhaps helping somewhat to reduce China’s massive trade surplus with the U.S. However, the exchange rate not only affects the relative value of traded goods, but more significantly the value of outstanding loans that are denominated in each currency. More than $60 trillion in bonds and bank loans would be devalued along with the dollar. That is why big banks and other investors with portfolios of full of dollar-denominated assets demand a strong dollar.
Trump’s latest campaign to weaken the dollar includes his persistent attacks on the Federal Reserve and its chairman, Jay Powell, appointed by Trump himself. Although the Fed seemed to accommodate Trump’s desire for easier credit by its recent modest quarter point interest rate drop, Trump was not impressed. He tweeted that the Fed Funds rate should be zero or even negative instead of around its current 2% target. Such low yields on dollar assets could significantly weaken the dollar, leading to an outflow of capital, a drop in private credit, and a financial crash as the credit-fueled asset boom collapses. Many economists believe that Fed rate cuts automatically stimulate credit, but this is not true if private creditors lose confidence at such low rates. Nobody is forced to lend. As if to confirm my point, Wall Street greeted the latest Fed rate cut with a modest sell off, the opposite of its usual reaction. Bearishness is rampant.