Friday, 15th of February 2019
“When you surround an army, leave an outlet free. Do not press a desperate foe too hard.”
― Sun Tzu, The Art of War
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Markets have returned to form this week, after a brief wobble at the end of last. The shine has come off a bit since US retail sales data released yesterday showed an unexpected contraction in Q4, but the general uptrend appears to have returned. The reversal coincided with rising investor optimism that incremental progress is finally being made in the US-China trade negotiations. Markets swooned last Thursday when President Trump poured cold water on the idea that he would be meeting Chinese President Xi Jinping by March 1. (The final date for an agreement to be struck to avoid a doubling of US tariffs on $200bn of Chinese goods.) However, the resumption of high-level talks in Beijing between Chinese vice-premier Liu He and US Trade Representative Robert Lighthizer suggests that negotiators may have found some common ground at least.
Whether it will be enough to form the basis of a trade deal is as yet unclear and investors were disappointed to learn this morning that the latest round of talks has ended without a memorandum of understanding between the parties. The two remain at odds over whether China’s complex web of industrial policies – from subsidies to soft bank loans and loose patent enforcement – is even up for discussion. The US argues that such policies create damaging market distortions and diminish global competition, while giving Chinese exporters an unfair advantage in international trade. US negotiators have also taken issue with both China’s direct and indirect efforts to steal US intellectual property through a mix of state-sponsored hacking and byzantine investment policies that limit access to domestic markets and force foreign companies to work with and transfer technologies to local JV partners. China believes that its state-directed economic model has been crucial for maintaining high rates of growth and innovation and there has been no movement on their side towards making changes to its core pillars. Moreover, many officials are sceptical that in making these structural demands the US wants anything other than to prevent China’s rise as a geopolitical peer competitor and to cage the Middle Kingdom within a set of rules that the incumbent superpower wrote. As such, Chinese negotiators are holding out hope that President Trump will eventually agree to a more limited deal that boosts purchases of US commodities and goods and tweaks market access for US firms. These promises could be sold to the American public as wins, but do not challenge China’s fundamental policy architecture. One area where Chinese negotiators may prove more flexible is on subsidy disclosure, a requirement under WTO rules which they have flaunted since joining the organisation. If China agrees to reveal its myriad government and local subsidies this will provide the US with specific targets for attack in future trade disputes. Even if no changes are made before month-end, this could conceivably satisfy the hawkish US Trade Representative for now, or at least win China a reprieve from the next round of tariff hikes in March.
The big news overnight was Trump’s decision to go nuclear over his beloved border wall, declaring a National Emergency to bypass Congress and redirect crisis and defence funds to build it. He will also sign a bipartisan federal spending bill which has passed both Houses in order to avoid another government shutdown; however, because the budget only contained a fraction of the $5bn that the President requested for border security (and, in a further humiliation, less than a previous proposal that he rejected), Trump has decided that ‘process be damned’. Most Republicans are putting on a brave face, but many are concerned about the harmful precedent this sets for future administrations, particularly with the Democrats tacking much further to the left than in previous cycles ahead of elections in 2020. He can also expect to get sued by groups who believe the move is unconstitutional. Another legal headache for a President that loves bold action and hates constraints, just as speculation mounts that Mueller will soon deliver his verdict on Russian interference in 2016. There will be sparks.
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