Last week’s meeting between the US and China’s Presidents did not produce much
fireworks or headlines. The missile strike on Syria and the North Korean missile launch tended to overshadow the
first meeting between the leaders of the two largest economies.
We understood that both Japan and China have
similar strategies for dealing with a mercurial and, perhaps, unpredictable US
President. Make small concessions, giving Trump a
“victory,” which buys some good will. And most importantly,
outlast Trump. Recent rule changes in Japan’s LDP will allow Abe be Prime
Minister for three terms. Some suspect that President Xi, the first core
leader since Deng Xiaoping, may also be angling to serve a third
term.
Earlier this year, Trump and Abe struck
an agreement to hold new trade talks led by US Vice President Pence and Japan’s
Finance Minister Aso. We anticipated President Xi would agree to
similar talks. It is, after all, a low-cost
concession. Sure enough, a cabinet-level
talks were agreed with an eye toward
reaching an agreement in 100 days.
Press reports have discussed likely
concessions by China, but nothing concrete from the US. However, the
Chinese concessions are low hanging fruit. For example, China may lift
the ban on US beef imports. They were
imposed in 2003 during a mad cow scare. China could have lifted
the ban years ago. Before the Xi-Trump meeting, a group of nearly 40 US
Senators encouraged the Trump Administration to get China to lift the ban on
American beef. The US runs a substantial agriculture surplus with
China. China is the largest export market for US agriculture produce,
absorbing about a fifth of US agriculture exports.
The other concession China likely makes will allow foreign firms to have a
majority stake in banks and brokers. Previously, under the Obama
Administration, China seemed to have been moving in this direction, as a
bilateral investment treaty was being negotiated.
The outcome of the
election froze the talks, and it is not clear that the Trump Administration
will allow their resumption.
It is also may not be such a significant
concession either on ground Chinese financial institutions have become quite large, and their role as national champions
will be difficult to break. At the same time, foreign participation
may bring the country best practices and take some pressure off some domestic
institutions.
The US may seek another concession.
China levies roughly a 25% tariff on US vehicles. China’s auto market
competes with the US to be the largest in the world. The high tariff and
large domestic market encourage foreign producers, like GM, Volkswagen, and
Toyota incentives build cars and factories inside China.
It is not clear what the US is offering in
exchange. China would like to have access to more high-tech goods;
China is also concerned about its direct investment in the US.
China would, of course, like to avoid being
cited as a currency manipulator in the US Treasury’s semi-annual report
that is due in the next few weeks. Treasury Secretary Mnuchin as
indicated that there is a process that will be
followed. The recently introduced quantitative definition includes
a large bilateral surplus with the US ($30 bln+), a substantial overall surplus
(3%+ of GDP), and persistent intervention to weaken the currency.
The only criteria that China meets are the large bilateral surplus. Its
current account is less than 3% of GDP.
It has been intervening but to strengthen the currency. Several US
presidential candidates, including Bush, Obama, and Romney talked about citing
China as a currency manipulator. The US has not done so since 1994. At first, being cited would require
bilateral negotiations.
Separately, media reports suggest that
President Trump may sign an Executive Order that calls for a formal
investigation into the trade in two or
three industries (steel, aluminum, and household appliances). The
concern is the extent of subsidies. While China is a likely
suspect, it is not alone. Moreover, some of the household appliances may be assembled in Asia by US
producers.
One of our interpretative points about the
Trump Administration is that there are two wings.
A wing that is linked to Bannon, which is
the populist-nationalist element. The wing is more traditional, accepting
the multilateral trade and security system that has been erected since the end of WWII. Commerce Secretary
Ross appears to be driving the trade agenda at least until a Trade
Representative is appointed. It is difficult to know for sure, but it
looks if Ross is most interested in more robustly enforcing existing rules than
defecting from the multilateral trade regime.
On the other hand, there does seem to be a
naive view of trade among many officials. There seems to be an implicit assumption that if currencies
float, then large trade imbalances cannot be sustained. Therefore to the
extent that the US has a large chronic deficit, someone
must be taking advantage either in trade practices or the foreign exchange market.
However, these ideas do not stand up to scrutiny. Consider the terms of
trade. For these purposes, the terms of trade can be thought of as the manufactured goods and raw materials. As
we noted, agriculture produce is among the largest US exports to China. Among China’s largest exports to the US are electronic
goods. Of the US overall deficit with China, electronics and
electrical equipment account for a little over half.
The US dollar and the Canadian dollar are as free floating as any currencies. Canada enjoys a persistent goods trade
surplus with the US. For more than 30 years, the US has had a bilateral
deficit with Canada. Between 2010 and 2014, the goods trade imbalance
averaged a little more than $30 bln a year. The drop in the price of oil
seems to be a key consideration that halved the deficit in 2015 and 2016.
The 2016 deficit was $11.2 bln, which is
the smallest since 1993.
The US goods deficit is set to widen.
The US data is not seasonally adjusted, and in January and February combined
the US recorded a $5.5 bln goods deficit with Canada. In the first two
months of 2016, it was a $3.5 bln
deficit. Relative price changed and grew
differentials, rather than malfeasance, likely
explains the change.