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Economic Insights

We see three points in the earlier trade talks between China and the U.S. that could form the basis of a reasonable trade agreement going forward.

It’s easy to be skeptical of the Trump administration’s claim that progress is being made in trade talks with China. Especially when the most recent discussions came to an abrupt halt on May 29, 2019, after U. S. negotiators made a particularly onerous (to China) demand. U.S. negotiators insisted on being the sole determinant of whether or not China has met the terms of any future agreement as well as the sole arbiter of what penalties to be imposed if China violates those terms.

China’s response was immediate: Unilateral-like adjudication of violations is not acceptable. China then countered with demands of its own:

  • Any agreement must include the removal of all tariffs and no new ones imposed.
  • The amount of additional goods that China is being asked to import from the United States must be “reasonable.”
  • Any agreement signed must be “equitable” in its terms—a reference, in part, to the adjudication dispute just mentioned.

Nonetheless, with a break in the trade talks and a consequent lowering of tensions, the G20 summit in Osaka, Japan (June 28-29) offered both nations an opportunity to recommit to the process. And they did.  In our first-run analysis of the G20 summit, we viewed this as a positive outcome, simply because it avoided the worst-case scenario of a refusal to come back to the table.

It is often said that China has the greater incentive to return to trade talks because exports and imports from China have slowed. But the moderation is much slower than the headline data would suggest. The headline data, typically reported in U.S. dollar terms, are depressed by the depreciation of the Chinese yuan—approximately 6% over the past year, according to Bloomberg. The overall picture is of more-or-less steady export gains and sharply lower imports, adding up to a rising trade surplus, including the bilateral surplus with the United States.  

Moreover, conventional exports have held up better than lower value-added “special regime re-exports.”  The latter refers to semi-finished goods that are shipped to China for the final stages of assembly, often under special customs arrangements, and shipped to third countries after modest further processing.  A slowdown in these “special regime” exports has less of a negative impact on economic growth in China than a slowdown in “ordinary” exports.

In short, we believe China has ways to cushion the blow from weaker exports, if that is indeed what takes place in the second half of 2019.

The United States, on the other hand, has a large trade deficit with China—reaching $419.2 billion in 2018—which President Trump believes is the result of bad trade agreements. (In our opinion, the U.S. trade deficit with China is more a matter of macroeconomic imbalances, particularly the fact that the United States saves less than it invests each year and must make up the difference by generating capital inflows.)

Source: The Balance, Lord Abbett.  Data as of December 30, 2018


Face to Face With a New Regime
It’s fair to say the trade agreements we have today were created at a time when global trade was envisioned as a system in which private enterprise would compete against private enterprise, not against state-sponsored entities. At least that was the premise of agreements sanctioned under the regime of the World Trade Organization (WTO). China was welcomed into the WTO on December 11, 2001, only after significant steps were taken to open its markets and lift restrictions on foreign investment. And, for a while, China seemed to be fulfilling that promise.  

But after the Party Congress in 2017, Chinese President Xi Jinping made it very clear that theirs is a state-controlled economy, with a Communist Party at the top of the system, and that’s the way it’s going to stay.

Over the past 25 years, a very integrated global economy had been built on the assumption that China was going to become more like the West over time.  No one makes that assumption today, and trade conflicts have been the inevitable result.

The Trump administration believes that participation in the WTO has not been advantageous for the United States. Rather than engage in the multilateral agreements favored by the WTO, the administration prefers the bilateral agreements of the prior trade regime, the General Agreement on Trade and Tariffs, which governed world trade prior to World War II.

Never the Twain Shall Meet?

 Oh, East is East, and West is West, and never the twain shall meet,
Till Earth and Sky stand presently at God's great Judgment seat;
But there is neither East nor West, Border, nor Breed, nor Birth,
When two strong men stand face to face, though they come from the ends of the earth!

–Rudyard Kipling, The Battle of East and West

Trade negotiation is not a pursuit for the faint of heart. And clearly, with two leaders of such opposite persuasion, one can be forgiven for doubting that anything productive will result. But U.S. negotiators see value in going back to the kind of deal that seemingly was being discussed in May and, although there is a lot of disparate opinion on both sides that needs to be arbitrated, we don’t disagree.  In fact, we see three points in the earlier trade talks that could form the basis of a reasonable trade agreement and could be claimed as a “win” for the United States, an important consideration for the Trump administration as it makes its pitch for re-election in 2020:

1.  Increased exports to China from the United States. In the discussions earlier this year, China had agreed to roughly an additional $200 billion in imports of such U.S. products as soybeans and natural gas.

2.  A clear policy addressing the issues of forced technology transfer and intellectual property protection. Both parties seemed to be making considerable headway on these issues, but progress came to a halt following the U.S. insistence on unilateral arbitration on disputes.

3.  Rolling back existing tariffs and avoiding new ones.  Despite their value as a negotiating tactic, a lot of research—from the International Monetary Fund, the New York Federal Reserve Bank, and academia— is showing that existing tariffs are being paid for by U.S. consumers and U.S. businesses and could prove damaging to sectors of both the U.S. and Chinese economies.

There are a huge range of opinions within this administration as to how China should be dealt with—from those who just want to see a trade deal done to those who would relish a more intense strategic conflict, extending as far as a policy of “containment.”  So, it’s difficult to handicap the likely outcome.  But we believe the self-interest of both nations will lead to a trade deal sooner or later, and the three components mentioned above will be a part of it.

 

Forecasts and projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee.

This article may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.

The Group of 20, also called the G20, is a group of finance ministers and central bank governors from 19 of the world's largest economies, including those of many developing nations, along with the European Union. Formed in 1999, the G20 has a mandate to promote global economic growth, international trade, and regulation of financial markets.

The information provided herein is not directed at any investor or category of investors and is provided solely as general information about our products and services and to otherwise provide general investment education.  No information contained herein should be regarded as a suggestion to engage in or refrain from any investment-related course of action as Lord, Abbett & Co LLC (and its affiliates, “Lord Abbett”) is not undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity with respect to the materials presented herein.   If you are an individual retirement investor, contact your financial advisor or other non-Lord Abbett fiduciary about whether any given investment idea, strategy, product, or service described herein may be appropriate for your circumstances.

The opinions in the preceding commentary are as of the date of publication and are subject to change. Additionally, the opinions may not represent the opinions of the firm as a whole. The document is not intended for use as forecast, research or investment advice concerning any particular investment or the markets in general, and it is not intended to be legal advice or tax advice. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information.

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