US-China trade war: both sides have reason to compromise, but their differences remain intractable

China has its hands full with pork price inflation and Hong Kong unrest while Trump needs happy investors and farmers ahead of the presidential election
But as long as China can’t commit to structural economic reforms and the US won’t ease its tech war, any compromise will be limited

Andy Xie

Published: 1:00am, 19 Sep 2019

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China and the United States are taking steps to de-escalate the trade war. It has raised hopes for a breakthrough at the scheduled talks next month. While there could be an agreement to ease some of the tit-for-tat punitive measures, a complete solution is unlikely.

Indeed, the trade war is likely to continue for many years. The auxiliary tech war will only escalate. Full-scale military competition may not be far off.

US President Donald Trump is backing off to a degree because the stock market cannot absorb further blows. Americans depend on the stock market for their retirement. If it crashes, it is adios Trump. Right after the market crash in response to his announcement of a 5 percentage point increase on tariffs, he admitted to having second thoughts.

The market took that as a sign that no more was coming. He has taken more conciliatory steps since, such as postponing some of the tariffs to December from September.

China’s incentives for reconciliation are multifaceted. The top concern is to have a smooth national day celebration on October 1. Events and dates drive Chinese politics. This is a matter of face. Second, inflation is rising in political importance.

The surge in pork prices is driven in part by lower imports of both feedstock and pork, so increasing imports can ease the all-important food inflation. Third, bad sentiment in asset markets, partly because of the trade war, is endangering government finance and tech ambitions.

Local governments are experiencing difficulties in collecting fiscal revenues, even for rich cities in the Yangtze and Pearl River deltas. As most cities depend on the property sector for half of their revenue, bad and lasting sentiment can cause havoc in local government finances.

Even China’s monolithic political system is vulnerable to a downturn in sentiment. This is a consequence of the financialisation of the Chinese economy since 2008. When debt is 300 per cent of gross domestic product, room for manoeuvre is limited.

How the trade war is disrupting China’s economic reforms

While the stock market is small, relative to the banking system or debt market for capital raising, it plays an important role for tech companies. The Chinese government likes tech bubbles. Most ideas will not succeed but some may, and this is positive for the country’s tech ambitions.

The recently opened Star Market board at the Shanghai Stock Exchange is the latest attempt to get a Nasdaq lookalike going in China. After a roaring start last month, it is fizzling out. If the trade war keeps escalating, forget about making a tech bubble at home. For better or worse, the Chinese government is betting on tech bubbles to catch up with the US in tech. That needs good vibes.

The fear of unintended consequences seems to be rising in China. The pork price doubling is one. It has huge social consequences. What has been happening in Hong Kong is a stark reminder that you never know what may happen.

When real public opinions are hard to ascertain, any negative development could trigger a social crisis. This fear of the unknown is likely to drive China to compromise in the coming months.

When both sides have strong incentives to compromise, a breakthrough should come soon. Unfortunately, the window of opportunity has closed and the trade war has mushroomed into a clash of societies.

First, China will not make structural changes to satisfy the US, which was asking for such reforms back in May. The Communist Party has been increasing its role in controlling and supervising the economy. Subjecting a big chunk of the economy to outside supervision would defeat the political changes made over several years.

How legal differences tripped up US-China trade talks

What China can do is buy agricultural or energy commodities, subject to government approval, which is consistent with the current political system. The US originally thought this was not enough so it would be a big climbdown if it were to accept that now.

On the US side, the tech war has emerged as a more important tool in containing China. But things are getting out of hand – for Trump. The Senate can easily block any attempt by the Trump administration to compromise on the technology ban, the lifting of which happens to be more important to China than any tariff reduction.

The yuan has depreciated by 15 per cent to counter much of the impact of the tariffs. A trade deal excluding tech is not worthwhile for Beijing. As China cannot commit to structural reforms and the US cannot commit to easing its tech war, any compromise would be limited in scope.

One possible outcome is for China to purchase American agricultural products in return for cancelling or postponing the tariffs imposed since May, when tariffs were raised from 10 per cent to 25 per cent on US$200 billion of Chinese goods, then 10 per cent tariffs were imposed on another US$300 billion of goods, followed by the latest 5 percentage-point-increase on top of it all.

Trump has already agreed to a two-week delay in return for China buying US agricultural goods. That formula could be repeated or amplified.

This sort of compromise may revive market sentiment and keep bubbles alive. That may be good enough for both sides for now. But if Trump is re-elected in November 2020, he may exact his revenge. Trump is a “credible” madman who has threatened to do so – and just might, when he has nothing to lose.

This raises the question of whether it is wise for Beijing to help Trump’s re-election chances. If China buys enough agricultural commodities, Trump may win over the Midwestern states and therefore, secure his presidency again. But perhaps Beijing has too much to worry about now to think so far ahead.

Andy Xie is an independent economist

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