• The US-China trade talks in Washington ended on Friday with what looks like a deadlock. The two sides both sent signals of cautious optimism but the underlying development suggests a bigger crisis in the negotiations.
  • The trade teams have agreed to meet again in Beijing but not when. The US has given China a month to make concessions or otherwise face tariffs on all imports. In this case the tariffs could come into force in early August.
  • We see an increasing risk that the trade talks drag out into H2 and that it will get worse before it gets better, see also China Weekly Letter – Chicken game is back on, 10 May 2019

Signals of cautious optimism after talks in Washington…

First the cautious optimism: US Treasury Secretary Stephen Mnuchin saying talks had been ‘constructive’ and China’s top negotiator Vice Premier Liu He said it went ‘fairly well’. Trump tweeted later that the conversations had been ‘candid and constructive’ and that ‘the relationship between President Xi and myself remains a very strong one, and conversations into the future will continue. In the meantime, the United States has imposed Tariffs on China, which may or may not be removed depending on what happens with respect to future negotiations’. The moderately positive signals led to a rebound in equity markets and strengthened the belief that maybe things are not so bad after all.

… but actual developments reveal a bigger crisis in the talks

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However, the actual developments suggest something different and that the two sides were trying to play down the real difficulty of the situation in order not to stir up too much concern. Here is what we know happened during the two days based on media reports.

  • The talks on Thursday were very short. They lasted for only one and a half hours and sources close to the negotiations said there was little to no movement. The sources said that China’s top negotiator Liu He had delivered the message that China was not willing to give the concessions the US wanted.
  • On Friday 12:01am US tariffs come into force and China immediately vows retaliation.
  • On Friday morning Trump launched a series of tweets among other things saying that the US is in no rush to make a deal and that the US economy will speed up while China’s economy will greatly slow down. He also stated the ‘the process has begun to place additional 25% on the remaining USD325 billion dollars’ (for some reason, the tweets were removed for a short period and then put back on).
  • Trade talks continued on Friday but again lasted for only one and a half hours. The Chinese trade team leaves on a flight out of Washington at 4pm. The two sides agree to keep negotiating and meet in Beijing but with no set date.
  • Supposedly the US gives China a month to make a deal or they will start the process of taxing the rest of imports from China, see Bloomberg, 10 May.
  • After returning to China, Liu He for the first time revealed some of the sticking points in the negotiations in an interview with the national television CCTV where he spoke in an unusually frank manner, see Reuters 11 May and SCMP 11 May: ‘Right now, both sides have reached mutual understanding in many things, but frankly speaking, there are also differences. We think these differences are significant issues of principle… We are very clear we cannot make concessions on matters of principle. We hope our US colleagues understand this’ [our highlight].

On the key differences between the two sides he mentioned three points: ‘China believes tariffs are the starting point of the bilateral trade disputes. If a deal is to be reached, the tariffs should all be eliminated. This is the first point.’

The second point regarded the size of Chinese purchases of US goods where an initial agreement was reached in Argentina in December but where the two sides according to Liu now have differing views on the volumes.

The third point was over how balanced the text of the draft agreement should be. ‘Every nation has its’ dignity, so the text ought to be balanced’. Liu He also denied that China had reneged on promises saying it was normal to make changes before a final deal. Both sides had differing views on how to phrase it, he said. He expressed hope the issue could be resolved so it was unnecessary to ‘overreact’.

Why things are getting tough again

While it is positive that the two sides express a desire to continue negotiations and view the talks as ‘constructive’ the fact that the two days only had 1½ hours of talks on each day is a sign that there was no movement on the Chinese side and that throwing tariffs at China is not making it easier for China to make concessions.

Although Liu He also expressed optimism that a deal would be reached, the interview suggests that there are some crucial differences between the two sides and some red lines for China that they will not cross.

The most important one is most likely the issue of whether Chinese law has to be changed. This seems to be what Liu He refers to when it comes to not making concessions on ‘matters of principle’. Changing Chinese laws is not a straightforward thing and forcing China to do it would be felt as a loss of sovereignty and loss of dignity. The so-called unequal trade treaties from the period of the Opium Wars in the 19th century also play a role here. A Chinese concession to change its laws would be viewed domestically as China bowing to US bullying. An opinion in Global Times, the most nationalistic state media, said that ‘China has always promoted trade negotiations with the US with highly responsible attitudes and utmost sincerity. But China will never yield to the US’ extreme pressure and will never compromise on issues concerning the country’s principles.’

However, for the US side it is seen as a fundamental issue because the US doesn’t trust China to live up to the agreement and sees implementation into Chinese law as a requirement for a deal. The risk is that China does not move enough and that the US takes the decision to go all in and put tariffs on all Chinese goods to use maximum pressure. This could be the last straw that broke the camels back and triggered a consumer boycott of US goods in China. Some Chinese netizens have already turned to social media to ask whether the Chinese should not just start boycotting US goods?

If the US starts the process of putting on tariffs on the rest of Chinese goods it will take around two months from the formal announcement. Since the US team has indicated it will wait a month with starting the process to see if China makes concessions, the earliest the tariffs could come into force would likely be three months from now. That takes us to early August.

Rising probability a deal drags out into H2

The concern is that the further escalation we have, the more hard liners seem to gain ground on both sides and the more nationalistic views get strengthened in both countries. Which makes it harder to make a deal.

Ultimately we do believe in a deal as the alternative of continued escalation is too painful. But the path to a deal is now be more difficult than is currently acknowledged in markets. We now see a rising probability that we will get into H2 before a deal is done and that we get more escalation before it is done. There is a rising risk that the only thing that will get serious talks going again is more pain in financial markets and the respective economies that adds the needed pressure to get the deal done.

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