US – China negotiation reality TV show

Markets expect that the threat to raise tariffs on Chinese goods to 25% by March 01st is off the table. But what if this is not the case?

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President Xi briefing the US negotiators on the importance of a win-win solution aka. don't lose face.

Financial market participants interpreted the headlines which came out when the latest round of negotiations between the United States and China which concluded on Friday to mean that the gap between the two world superpowers was narrowing, or at  least not widening. The Wall Street Journal screamed “Chinese, U.S. Trade Negotiators Inch Toward a Broad Agreement” when the South China Morning Post had only a day earlier likened the negotiations to “pulling teeth.”

The markets had gone into the negotiations hoping for a breakthrough but in the end was happy to settle for anything that appeared vaguely positive. Surprisingly, the markets looked the other way when two crucial economic data points which were released over the week was decidedly bearish: the collapse in US Retail sales in December, which was the largest on record since the great recession in December 2008 and the contraction in US Industrial production. Last week was all about trade and the markets decided that a deal was in the offering and tariffs will not increase to 25% come March 01st.

On Friday, President Trump himself gave the markets too much optimism when he gave an upbeat assessment at the conclusion of the latest round of trade negotiations. Speaking at a Rose Garden news conference about his national emergency declaration, he mentioned “We’re a lot closer than we ever were in this country with having a real trade deal.”  He also conceded that the current proposed deal was very limited and far below what he had hoped for.

The obvious question is whether market participants were correct in their understanding? After all, the President himself seemed to hold out some hope of a negotiated settlement. Going into the latest round of negotiations, he seemed to give every indication that this was the final round and he wanted to see a settlement.

Judging by the speed asset prices rose since the start of this year, it is not wrong to suggest that hundreds of billions are at stake. Not only in asset prices but in supply chains and logistics as well. If the US goes ahead to escalate tariffs on Chinese imports to 25% on March 1st, it will disrupt global supply chains and the globalists will argue it will cause a collapse in the stock market.

However there is a risk to those who trade on Trump’s state of mind today risk being disappointed tomorrow because as Malaysian Prime Minister, Tun Dr Mahathir Mohamed, famously said of Trump that he changes his views even in a manner of hours.”

And true enough, President Trump’s off the cuff remarks over the outcome of the trade negotiations was followed by the only authoritative source of US National Policy: The Presidential Tweet.

Official US Foreign Policy as of Feb 17, 2019 @ 8:17 am (New York Time) was …..

Official US Foreign Economic Policy as of Feb 17, 2019 @ 8:17 am, followed by:

 

So what the official US Foreign Economic Policy as of Feb 17, 2019? The Presidential tweet gives market bulls optimism because he characterized the talks as “very productive.” But the Presidential tweet was silent on whether or not he has decided to extend the Mar 01st deadline. And the Presidential tweet was supportive of tarriffs.

This was followed later on with a change in language – from Trade negotiations to trade deal.

So now we are at a crucial point with three options, with only 13 days left before Trump’s 25% tariffs are set to be imposed :

a) Will the US agree to a deal in principle and cancel all tariffs?
b) Will the US leave tariffs as it is and give the negotiations a bit more time? or
c) Will the US increase tariffs on Chinese imports to 25% come March 1, 2019 ?

Currently, this is what the market is pricing. The market thinks option a) is possible and option b) is probable. Trump tweets recent announcements do strongly hint at option b) so there is rational expectation of that.

Rembau Times however thinks going by our propietary Trump model option c) is possible to happen closer to the deadeline because Trump may change his mind again, we call it the STARCH ( Simplified Trump Autoregressive Conditional Heteroscedatic model) aka Trump changes his mind . With Vice Premier Liu He due to visit Washington Trump may hardened his stance this week. For example, Trump could issue a Presidential order banning Huawei’s 5G network infrastructure from US followed by renewned threats to escalate the duties on Chinese imports to 25%. That should catch China by surprise!

This is because China has offered virtually nothing substantive to the United States. It is perhaps a bit good to understand the context of this negotiation so as to understand what will be ultimate outcome.

China’s approach to Trump dealing

The Chinese approach is governed by traditional Chinese philosophies of Confucianism, Taoism, and war stratagem. In this case, China views the tariffs as an act of aggression and has taken a purely defensive stance. So far China has been very careful not to escalate the situation and has been playing a game of strategic patience thinking that President Trump’s fervor for a fight is merely for political theater and that he will have to settle as the Presidential elections are only 20 months away. For China is all about not losing face to Trump by agreeing to anything that gives the impression that China was pressured into making concessions.

President Xi for his part has always stressed on a “win-win solution” and so far has offered nothing in light of the US tariffs. For China, it is all about saving face. If President Xi gives the impression that he had caved in to US demands then he will have lost face among China’s elite. China, which was initially taken back by President Trump’s aggressive style of negotiations may have figured that Trump’s Achilles heel was the financial markets. If tariffs rise to 25% then the US Stock Market crashes, public disapproval with President Trump increases so there is no point in conceding anything and losing face because Trump will weaken his stance as he is afraid that markets will crash. Alternatively, if Trump does increase tariffs to 25%, the Chinese reason thar US markets will crash and then Trump will weaken his stance and settle for a face saving agreement. In the meanwhile Chinese consumers are helping the cause by boycotting US made goods, leading to disappointing sales by Coca-Cola and Apple.

How Trump actually works

However, currently it is possible for US to impose the 25% tariffs rather than agree to a big negotiated settlement. This is also contemplated by China as being possible but not probable. However, the financial markets view this as not conceivable given that prices are so high with the deadline only 2 weeks away.

This is perhaps possible as Trump works on the principle of who speaks to him last will likely influence his views. Until Friday morning, Trump was talking to the negotiation team, namely Robert Lighthizer and Steve Mnuchin, so they had a chance to influence the President’s views.

The US Trade Negotiators may appear to be weak in the eyes of the US economic nationalists like Wilbur Ross and Peter Navarro.

Both individuals had a vested interest to show some progress and to strike a deal as that is what negotiations are all about. If not they will look bad because President Trump had dispatched them with orders to win a deal, or any sort of deal to sell to the stock market.

In this regard, they accomplished their mission as the Dow Jones Industrial index, which is the only index which matters to President Trump, rallied a massive 777 points this week, from 25,106 at the close on Friday 8th Feb, 2018 to 25,883 on Friday 15th Feb, 2019.

However President Trump does not work in a reflexive way with respect to market expectations. The financial markets expect President Trump to not escalate tariffs to 25%, but will he play along?

The counter view goes like this: When markets are strong, it gives him optimism to pursue a hawkish trade policy. When markets are weak, it gives him the fear to pursue a negotiated settlement.  President Trump is a made for TV President and settling too early before the March 01st deadlines takes trade away from the national consciousness and thus TV ratings.

Moreover, The Economic Policy team advising the US President consists mostly of avowed economic nationalists like Peter Navarro. Since China has offered the US nothing, and since the markets have been doing well recently and the Federal Reserve is under control, this gives Trump all the support he needs to accomplish the above objectives.

The objectives of the hawks at the US economic team at the is

  • a) do as much economic damage to China as possible and
  • b) make Trump look good by winning as much concessions as possible, and
  • c) repeat a) and b) as much as possible to the US public.

And one of the few benefits the US President can do without having to get support from Congress is the ability to unilaterally impose tariffs.  After all, the US has a further fight with the EU on vehicle imports and defense spending, so right now it will be way too easy to give in without accomplishing any of the above objectives. That is why President Trump could at least give the impression that the 25% tariff increase is still on the table and will be imposed. Perhaps markets reacted too early to Trump’s mood on Feb 15th, which could change dramatically by Feb 23rd.

By the way, the US official policy on the media was as of Feb 17, 2018 was

 

 

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