You could have driven a truck through that gap.

No, it’s not the camera angle, there was daylight between the Chinese VP and all the President’s men last week when the so-called Phase One trade deal was signed.

Yes, VP Liu was there and so too was Nixon’s 1972 China envoy, Henry Kissinger (who recently cautioned against a mercantile approach) and a plethora of others, but U.S.S Mercantile was unashamedly on parade, with all gun ports open.

But gun ports are open on both sides of the Pacific.

The agreement is officially entitled: “ECONOMIC AND TRADE AGREEMENT BETWEEN THE GOVERNMENT OF THE UNITED STATES OF AMERICA AND THE GOVERNMENT OF THE PEOPLE’S REPUBLIC OF CHINA”.

It includes some big promises on currency exchange, opening up markets in China for financial services and other industries, relaxation of corporate ownership limits for foreign companies, some strengthening of patent, trademark and IP aspects, and other notable items.

It sounds peachy, but there are some issues in it which threaten to barricade the U.S-Sino bridge that Nixon, Kissinger and Zhou laid the foundations for, back in 1972.

First, the U.S. will maintain its stinging 25% tariffs on US$250 billion of Chinese imports, and has only agreed to reduce the tariff rate on the remaining US$120 billion of goods from 15% to 7.5%.

This US$360 billion blunt instrument (with an average tariff of just under 20%, or $72 billion) remains suspended over the negotiating table. China tariffs remain. No escalation, but neither side is a winner just yet with domestic industries in both countries feeling the sting.

Second, there does not appear to be any commitment from China to stop the subsidisation of its State Owned Entities. This gun port is potentially one of the most devastating, and is an older and bigger issue here than it is with Airbus and Boeing.

Third, the timing for further negotiations is yet to be decided. That is, no Phase Two until the parties agree that there will be a Phase Two.

Fourth, despite some progress on forced technology transfer and a more serious acknowledgement of IP, the agreement contains a dispute resolution mechanism which makes it easy to: (a) kick the can down the road via ‘consultations’; or (b) tear up the agreement if it gets too hot in the wheelhouse with no arbitration nor a multilateral court to preside over an orderly remedy.

In other words, it might be a ceasefire on further tariffs/retaliatory tariffs, but the jury is out on its longevity as an interim solution.

In addition, and somewhat hypocritically, it undermines free markets and free trade by stipulating that China must buy specific goods and services from the U.S. We are yet to see the full reaction from affected economies, but this may take time.

Here’s a few reasons why it’s probably not a ‘big and beautiful deal’.

• China’s $200 billion spend is mostly back-ended.

The agreement commits China to spend US$200 billion on U.S. goods and services over 2 years. I’ve seen a fair bit of press suggesting this is not possible from China’s perspective, however this is difficult to objectively quantify and above my pay grade.

What is apparent though, is that only 1/3rd of the amount is scheduled to occur in year 1, with the bulk, or 2/3rd of the commitment back-ended to year 2, which will be after the U.S. 2020 elections in November. Convenient?

• If the dispute process gets too hard, you can rip up the agreement.

There are a lot of promises in the agreement, and if a party thinks the other has broken one of them or is acting outside the agreement, it can appeal (Appeal). The complained against party considers the Appeal and then consults with the complaining party. If no resolution occurs, the Appeal is escalated from official levels to vice-ministers, and if still no resolution, to ministers. They then try to resolve a response to the losses and damages and implement it, but if they can’t the complaining party is free to adopt a proportionate remedial measure.

But wait, if an item cannot be resolved and the complaining party gets to impose some form of remediation which the receiving party thinks is bad form, Phase One goes to the shredder.

So, the default is ceasefire over, back to walloping each other.

• Dispute mechanism promotes Mercantilism, not free-trade.

Given stipulated purchases and the dispute resolution mechanism leading to termination (instead of consultation followed by arbitration and/or a judgement from a multilateral court made up of representatives from both countries and neutral parties) how does this deal promote open and free trade?

It doesn’t. It promotes mercantilism. This may prompt certain countries to react to a loss of returns from China exports.

• Either party can terminate it.

In any event, either party can terminate the agreement by notice in writing, with the termination effective within 60 days of that notice. That gives Plenty of time to load the tariff torpedoes.

Unless both sides are committed, this ceasefire could be a short one.

• Phase Two couched in an agreement to agree, maybe.

Article 8.4 states: ‘The Parties will agree upon the timing of further negotiations.’

What now?

The agreement comes into force once all domestic procedures are in place, or 30 days from signing, whichever is sooner.

Assuming that does happen, what then happens when U.S. big tech decides to go hard against China tech? Make no mistake, the tech war will continue to rage for many more years.

What about threatened U.S. export controls to protect national security interests (e.g., Huawei) and tougher foreign investment reviews? Will they be seen by China as separate to this, or part of the deal and potentially defined as bad form? Is there a risk that aggressive competitive behaviour might be deemed to be bad form? Yet to be tested.

As already mentioned, tariffs on US$360-370 billion of goods remain suspended above these proceedings, and in some ways these tariffs plus the pressure to implement and perform on Phase One might actually create more pressure and stress between the parties. We shall see.

And, here down under? Australia may lose some ground in the Other Agricultural and Iron sub-categories, together with the Energy category, given our export dependency on China - but that will depend on whether the China purchases actually occur.

Phase Two? At present, a bridge too far. We don’t even know whether Phase One will survive.

Equities markets and valuations? Short-term uncertainty lifted (rightly or wrongly) and markets lifting while interest rates are low and QE remains/grows, providing the U.S. reporting season finishes in a not too shabby manner.

Mike.

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