The real problem with the phase one accord announced on October 11 is the basic structure of the deal into which it presumably fits. From trade to currency, the approach is the same – prescribing bilateral remedies for multilateral problems.
Dealmakers always know when to cut their losses. And so it is with the self-proclaimed greatest dealmaker of them all: US President Donald Trump. Having promised a Grand Deal with China, the 13th round of bilateral trade negotiations ended on October 11 with barely a whimper, yielding a watered-down partial agreement: the “phase one” accord.
This wasn’t supposed to happen. The Trump administration’s three-pronged negotiating strategy has long featured a major reduction in the bilateral trade deficit, a conflict-resolution framework to address problems ranging from alleged intellectual-property theft and forced technology transfer to services reforms and so-called non-tariff barriers, along with a tough enforcement mechanism. According to one of the lead US negotiators, Treasury Secretary Steven Mnuchin, the Grand Deal was about 90% done in May, before it all unraveled in a contentious blame game and a further escalation of tit-for-tat tariffs.
But hope springs eternal. As both economies started to show visible signs of distress, there was new optimism that reason would finally prevail, even in the face of an escalating weaponization of policy by the United States: threatened capital controls, rumored delisting of Chinese companies whose shares trade on American stock exchanges, new visa restrictions, a sharp expansion of blacklisted Chinese firms on the dreaded Entity List, and talk of congressional passage of the Hong Kong Human Rights and Democracy Act of 2019. Financial markets looked the other way and soared in anticipation in the days leading up to the October 11 announcement.
And yet the phase one deal announced with great fanfare is a huge disappointment. For starters, there is no codified agreement or clarity on enforcement. There is only a vague promise to clarify in the coming weeks Chinese intentions to purchase about $40-50 billion worth of US agricultural products, a nod in the direction of a relatively meaningless agreement on currency manipulation, and some hints of initiatives on IP protection and financial-sector liberalization. And for that, the Chinese get a major concession: a second reprieve on a new round of tariffs on exports to the US worth some $250 billion that was initially supposed to take effect on October 1.
Far from a breakthrough, these loose commitments, like comparable earlier promises, offer little of substance. For years, China has long embraced the “fat-wallet” approach when it comes to defusing trade tensions with the US. In the past, that meant boosting imports of American aircraft; today, it means buying more soybeans. Of course, it has an even longer shopping list of US-made products, especially those tied to telecommunications equipment maker Huawei’s technology supply chain.
But China’s open wallet won’t solve America’s far deeper economic problems. The $879 billion US merchandise trade deficit in 2018 (running at $919 billion in the second quarter of 2019) reflects trade imbalances with 102 countries. This is a multilateral problem, not the China-centric bilateral problem that politicians insist must be addressed in order to assuage all that ails American manufacturers and workers. Yet without resolving the macroeconomic imbalances that underpin this multilateral trade deficit – namely, a chronic shortfall of domestic saving – all a China fix could accomplish would be a diversion of trade to higher-cost foreign producers, which would be the functional equivalent of a tax hike on US consumers.
Promises of a currency agreement are equally suspicious. This is an easy, but unnecessary, add-on to any deal. While the renminbi’s exchange rate against the US dollar has fallen by 11% since the trade war commenced in March 2018, it is up 46% in inflation-adjusted terms against a broad constellation of China’s trading partners since the end of 2004. Like trade, currencies must be assessed from a multilateral perspective to judge whether a country is manipulating its exchange rate to gain an unfair competitive advantage.
That assessment makes it quite clear that China does not meet the widely accepted criteria for currency manipulation. Its once-outsize current-account surplus has all but disappeared, and there is no evidence of any overt official intervention in foreign-exchange markets. In August, the International Monetary Fund reaffirmed that very conclusion in its so-called Article IV review of China. Although the US Treasury recently deemed China guilty of currency manipulation, this verdict was at odds with the Treasury’s own criteria, and Mnuchin is now hinting that it may be reversed. Far from essential, a new currency agreement is nothing more than a feeble grab for political bragging rights.
The real problem with the phase one accord is the basic structure of the deal into which it presumably fits. From trade to currency, the approach is the same – prescribing bilateral remedies for multilateral problems. That won’t work. Multilateral problems require solutions aimed at the macroeconomic imbalances on which they rest. That could mean a reciprocal market-opening framework like a bilateral investment treaty or a rebalancing of saving disparities between the two countries that occupy the extremes on the saving spectrum.
The saving issue is especially critical for the US. America’s net domestic saving rate of just 2.2% of national income in the second quarter of 2019 is far short of the 6.3% average in the final three decades of the twentieth century. Boosting saving – precisely the opposite of what the US is doing in light of the ominous trajectory of its budget deficit – would be the most effective means by far to reduce America’s multilateral trade imbalance with China and 101 other countries. Doing so would also take the misdirected focus off a bilateral assessment of the dollar in a multilateral world.
A macro perspective is always tough for politicians. That is especially true today in the US, because it doesn’t fit neatly with xenophobic bilateral fixations, like China bashing. With new signs of Chinese resistance now surfacing, the phase one accord may never see the light of day. But if it does, it will hurt more than it helps in addressing one of the world’s toughest current economic problems.
Stephen S. Roach, a faculty member at Yale University and former Chairman of Morgan Stanley Asia, is the author of Unbalanced: The Codependency of America and China.
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