We have just days to avoid a painful new chapter in the US-China trade war

It may have been coincidence, but then again perhaps not. President Trump tweeted out of the blue his impatience with the stalling trade talks with China, and threatened to resume the trade war this coming Friday, putting an end to the momentary “ceasefire.”He chose to do so on the weekend that China was marking the centenary of the May the Fourth Movement.

This anniversary, carefully orchestrated by the Communist Party, and specifically excluding open and public displays, remembers the protest movement that railed against China’s treatment at the hands of foreign powers at the Versailles peace conference and from which the Communist Party emerged two years later. For the US to time its threats to China as Trump has done will not sit well with Beijing’s policymakers.

The current talks to ease trade tensions were agreed at the G20 Summit in Buenos Aires late last year, and were supposed to have been concluded after 90 days on 1st March, but they were extended as it appeared that progress was being made. The US agreed to shelve the proposal to raise punitive tariffs on $200bn of imports from China from 10 to 25 per cent, and to desist from recommending such tariffs on the half of imports not yet subjected to them. With that, and the longer the talks continued, the more the leverage shifted to Beijing.

For most of the last five months or so, there was never really much doubt about the low-hanging fruit in these talks. Namely that China would agree to step up purchases of US agricultural goods, energy and aircraft, for example, and confirm other existing broad agreements about opening up some financial services to US firms, and possibly lifting ownership caps in some firms or sectors where there was little challenge to Chinese firms. It’s in more contentious areas that meaningful agreement was always going to prove hard or impossible, and it seems like this is where we now are.

As a result, Trump has brought full-on trade tariffs back into play, and imminently.

Chinese markets certainly didn't like the turn of events. The Shanghai Composite stock market index fell by over 5.5 per cent, and the Yuan, which normally oscillates by minuscule amounts day to day, fell by over 1 per cent. All of this despite the announcement by the People’s Bank of China of a targeted lowering in bank reserve requirement ratios, designed to help spur more lending to small, private firms in particular. The US market reaction was more restrained, and after an initial 2 per cent fall, stock price losses were trimmed.

We can only speculate what this is all about and what happens next. A large and high powered trade delegation, lead by Xi Jinping’s economics and finance guru Vice Premier Liu He, is expected to arrive in Washington this week for what is thought to be a final round of talks before a presidential signing summit. Whether the delegation with Liu still comes was momentarily in some doubt but the latest information is that it will.

Given Trump’s threat, it might be difficult for Liu in Washington. If he comes regardless, we can surmise that China either thinks it has to give assurances that it is not reneging on agreements, as the US alleges, and/or that it really needs to tie up an agreement for fear of the consequences otherwise.

When negotiators on both sides had been speaking positively about the talks for so long, why the sudden shift in tone?

Perhaps President Trump was trying to put pressure on China for one last heave, to get the talks over the line with a last round of concessions. If so, openly threatening China doesn't seem like the way to do it. Maybe Trump wanted to sound tough again, having been criticised recently at home for appearing to capitulate to China on for example, cyber security and intellectual property issues, and settling for a purely political, soundbite type of agreement, rather than one that delivered true commercial benefits in line with America’s original demands.

It is also possible that China is playing hardball again, its confidence restored now that the economy seems to have stabilised. Remember that when China agreed to and then began trade talks in the fourth quarter of 2018 and early this year, its economy was in a bad way. In spite of the manicured GDP numbers, many other data sets at the time pointed to a sharp and generalised downturn in demand, necessitating renewed credit and fiscal stimulus.

Some speculate that China has balked anew at some US demands, such as using existing tariffs as a tool to determine and regulate China’s compliance with the terms of any agreement. China wants the US to dismantle punitive tariffs. Many observers have expressed consistent doubts as to whether China would ever agree to other important demands, entailing big and reciprocal concessions to foreign firms on sensitive issues like the rules and regulations in China governing industrial policy, technology transfer, intellectual property protection and cybersecurity. For China and the Party, these demands are a bridge too far as they go to the heart of China’s governance system, the codification of its laws, and the thrust of its core strategies for modernisation and technological development.

If the trade war does resume at the end of this week, it will go down like a lead balloon in financial markets, but I think it’s still the case that while everyone loses this kind of war, China has more at stake. The GDP impact of what Trump is threatening in China may be of the order of 1-1.5 per cent of GDP in a full year. It would require more policy stimulus, and send the Yuan and Chinese stock prices appreciably lower.

Having just realised a rather more stable economy, this is not what China’s policymakers want, especially ahead of another big anniversary in October, the 70th birthday of the People’s Republic.Then again, succumbing to foreign (US) pressure would negate the narrative about China's confidence and self-reliance, which is being pushed very hard this anniversary and by the Party generally. Deal or no deal, the US-China trade war of our time is still stirring.