US-China trade talk

Posted By Darren Winters on Jan 29, 2019


US-China trade talk

Stocks are back in the “the neutral zone” with major stock indices going nowhere in the past year, but US-China trade talks scheduled to take place mid-week (30-31 January) could be about to change all that.

Pending US-China trade talks could lead to three likely scenarios which could determine the trajectory of stocks and perhaps even impact the Fed’s monetary policy going forward

So here is the good, the bad and the ugly range of scenarios to consider that might result from these pending US-China trade talks, according to a recent piece in Bloomberg

The best case scenario for US-China trade talks would be where China makes “a game-changing offer”. In this breakthrough case, US Trade Representatives (who are primarily made of hawks) would need to be convinced that China’s Xi’s one-party one rule communist party has liberalized its access to the world’s second-biggest economy. In short, the US is demanding no less than “structural changes” to China’s economic model.

The US Trump administration argues that China is not an open economy which is in lock-step with what the International Monetary Fund (IMF) thinks.

“We are looking at China and comparing it with other G20 countries … in terms of service trade and investment, the Chinese economy is still very restrictive,” Alfred Schipke, IMF’s chief China representative, said at a symposium in Beijing.

But in previous US-China trade talks, China refuted the view that its economy is restrictive and lacks openness. China’s Xi one party one rule announced earlier in 2018 structural changes to the economy which would allow foreign control of financial and auto joint ventures, increase access to its capital market. China has also agreed to narrow the list of sectors in which foreign investment is restricted.

US China trade talk

The US still demands more changes from China. “The U.S. wants broad changes to China’s corporate governance,” said David Loevinger, a former Treasury official who is now a managing director at TCW Group Inc. “It’s just very hard to do.”

Put simply, don’t expect US-China trade talks to yield “a game-changing offer” from China. This best case scenario would play out with China’s Xi and US’s Trump standing side-by-side, positive body language, genuine smiles and shaking hands and making a joint announcement confirming a breakthrough agreement and an end to the trade war. Stocks would go into a frenzy, hot money on the sideline would stampede into stocks and a massive short squeeze would fuel the mother of all rallies.

Whether US-China trade talks yield the best case scenario for the markets would probably depend on how the hawks in the administration react to China’s offers

The Trump administration is overwhelmingly hawkish. Trade Representative Robert Lighthizer, White House adviser Peter Navarro and Commerce Secretary Wilbur Ross are all hawks. In other words, China is viewed by the US trade delegates as a strategic rival which is eye to eye with US President Trump labeling China as a strategic competitor.

So US-China trade talks could be viewed by the US trade team as a zero-sum game where the best case scenario (from the US perspective) is China submitting to US demands. Collaboration, partnerships and the theory of comparative advantages of trade which led to the proliferation of global trade and relative peace is being substituted with the politics of survivalism. But competition leads to rivalry which leads to enemies and eventually that  leads to wars.

“What worries me is that over the course of the last year the balance of power has shifted toward the China hawks,” said Loevinger. “It’s still not clear what will take the U.S. to say yes.”

What then is a more likely scenario coming from the US-China trade talks?

A likely scenario would be vague official statements about the progress made from US-China trade talks. That is precisely what happened following the last meeting in Beijing when the two sides put out separate statements. The US acknowledged progress on issues such as purchases of US products, but added that any deal would need to include “ongoing verification and effective enforcement.” The Chinese referred to the talks as “extensive, in-depth and detailed.” The joint separate statements did help to calm fears of an escalating trade war. But with a lack of details in both statements traders/investors optimism soon turned to the unknown factors surrounding future US-China trade talks.

There are many unknown factors regarding US-China trade talks

“Everybody’s divided because President Trump is so unpredictable,” said Reinsch, now a senior adviser at the Center For Strategic and International Studies based in Washington. While the announcement of a final deal isn’t expected this week, there’s a reasonable chance that negotiators will draft package of proposals to present to both presidents, “It’s probably 50-50 whether he’ll (Trump) accept it,” reckons Reinsch.

Should the worst-case scenario unfold, following US-China trade talks then we could see an escalation in trade tensions.

Moreover,  a shut down of the South China Sea could be the end game if the trade war goes hot. US Trump administration is expected to raise the tariff rate on $200 billion in Chinese imports from 10 percent to 25 percent. The darkest clouds of a trade war would hang over the global economy, financial markets and (if history is a good indicator) a shooting war would soon break out.

But US President Trump has aligned his success with the stock market performance so will we see the art of the deal? Hope for the best but plan for the worse, after all, failed US-China trade talks would provide the perfect smokescreen for the Fed to ramp up its quantitative tightening. It would also provide a scapegoat if a market crash is on the cards

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