Refresher.

When we left Lighthizer, Liu and their intrepid negotiators in January, the so-called Phase One trade agreement between the U.S. and China had been signed.

You may recall the Chinese were pushed into the deal to avert new tariffs being imposed on all remaining Chinese exports to the U.S.

Phase One outcomes:

• US$370 billion blunt instrument (with average tariff of just under 20%, or $75 billion) remains.

• No commitment from China to stop subsidising its State Owned Entities.

• No arbitration or multilateral court de-escalation mechanism, with termination allowable.

• China to spend US$200 billion on U.S. goods and services over 2 years, with 2/3rd back-ended to year 2, after the U.S. 2020 elections in November.

• In return, new tariffs on US$160 billion of Chinese goods shelved indefinitely, with no increase to existing 25% tariffs to a 30% rate.

• Timing for Phase Two undecided, and only relevant if parties agree there will be a Phase Two.

Since then, the Phase One agreement has been lost in the crowd.

Why?

Nationalism, imperialism, mercantilism and protectionism, in pursuit of capitalism.

These are not all that well camouflaged in the U.S. trade representative’s March 2020 report to congress, that I finished reading recently.

It’s called “2019 USTR Report to Congress on China’s WTO Compliance”.

But perhaps a more appropriate title would be: “The voyages of U.S.S Mercantile, March 2020.”

Phase One is deficient and the U.S. knows it.

In the March report, the words are clear.

“Because the Phase One agreement does not cover all of the United States’ concerns, the United States will turn to Phase Two of its trade negotiations with China in order to secure resolutions to important outstanding issues.”

So, what didn’t Phase One adequately cover?

“These discussions will focus on intellectual property, technology transfer, and services market access issues that were not addressed in the Phase One agreement as well as critical issues in areas such as excess capacity, subsidies, state-owned enterprises, cybersecurity, data localization and cross-border data transfers, pharmaceuticals and medical devices, competition law enforcement, regulatory transparency, and standards.”

OK, so pretty much all of the key concerns outlined by the U.S. in its previous reports to congress on China’s WTO compliance.

How many beefs does the U.S. have?

There are 48 U.S. concerns specified in the WTO compliance report. These are significant and wide ranging guns pointed specifically at China.

So far, diplomatic methods have failed, and tariffs/retaliatory tariffs have been the weapons of choice.

Most of the tariffs remain, while Covid-19 spreads. Countries are becoming economically and socially insular and distanced, as a result.

I don’t like the odds of resolving these - not even sure they will get past row 1 of the checklist.

The language of U.S.S Mercantile.

There is a common language throughout.

“Since last year’s report, our assessment of China’s record in terms of complying with WTO rules and observing the fundamental principles on which the WTO agreements are based has not changed. China’s record remains poor.”

“China has been a particularly bad actor when it comes to trade remedies.”

“China’s retaliatory use of trade remedies highlights another unique issue that WTO members face when dealing with China – the threat of reprisal.”

“It is clear, moreover, that the trade policies and practices generated by China’s non-market economic system have caused serious harm to China’s fellow WTO members. As it currently operates, China’s non-market economic system is not compatible with economic systems that operate on market principles, and significant and far-reaching adjustments are, therefore, critically needed.”

It’s a manifesto to assemble a fleet of economic gunships, behind U.S.S Mercantile.

The U.S. feels the WTO response is doomed to fail.

U.S.S Mercantile is seen in action in much of the report. Here’s a couple of examples.

“No matter how many cases are brought at the WTO, China can always find a way to engage in market-distorting practices. Furthermore, given the extent to which China has benefited from the current state of affairs, it is not likely to agree to effective new WTO disciplines on its behaviour. Indeed, China has been using its WTO membership to develop rapidly. In 2001, when China acceded to the WTO, China’s economy was the sixth largest in the world. China’s economy is now four times larger than it was in 2001, and it is the second largest economy in the world. In addition, China rose to become the largest goods trader among WTO members. There can be no doubt that China has benefited enormously from its WTO membership even though it has not sought to transform its economic system, or its trade regime as had been expected, and it has never fully complied with WTO rules. Given these facts, it seems clear that relying solely on the WTO and its mechanisms to address China’s unfair trade practices is a recipe for failure.”

 And,

“In the United States’ view, existing proposals by various WTO members for WTO reform seem only marginally focused on the China problem. While these reform proposals potentially could address some behaviours that make China an irresponsible member of the WTO, they do not directly address the serious threat that China and its state-led, mercantilist trade regime poses for individual WTO members and the multilateral trading system. Going forward, it is the United States’ hope that China will continue to take our concerns seriously and engage with us on a productive basis. If China does so and the two sides are able to finalize and implement a comprehensive Phase Two agreement, it will benefit not only the United States, but also China itself and the rest of the WTO membership. It may also generate a willingness on the part of China to take on similar new disciplines at the WTO.”

A ‘mercantilistic’ trade regime - that’s rich!

That’s a big gun.

China’s open market economy-facing interface is opaque, and does little more than wallpaper over a more familiar and older ideology - but the real problem is that the many changes demanded by the U.S. requires fundamentally large tweaks to Xi’s Chinese characteristics.

What’s also acting against Phase Two is that each have adopted stances which are highly mercantile in nature - albeit they both deny it under the cover of seeking some element of ‘mutual respect’.

So far, U.S.S Mercantile is larger and outguns C.C.P Mercantile, and that’s why the Phase One agreement looks the way it does. Protectionism, nationalism, and imperialism on steroids.

That’s also why a Phase Two, if there is one, will more likely be born out of a ‘deterrent’ rather than a positive catalyst (as was Phase One).

What’s in the way of Phase Two?

Frankly, there’s no real sign of Phase One working, let alone a Phase Two coming into the cross-hairs in the short-term. There’s plenty of reasons why:

• Covid-19, which as I write has just been classified as a global pandemic by the WHO.

• Doubt over China’s ability to honour its commitment to buy requisite level of U.S. output in the face of Covid-19.

• Trump’s 2020 election campaign, with the Phase One ceasefire providing enough of a ‘win’ for Trump, and at the same time representing in some minds a reason to return him to the White House for four more years.

• Democratic primaries and caucuses.

• Stock and bond market corrections, with the CBOE volatility index (VIX) oscillating between 40 and 59 since last Friday and signalling a heightened state of fear in equity markets.

• I’ll say it again - the Phase One agreement can be torn up if the parties can’t agree - there is no arbitration clause.

Converging storms.

Meanwhile, the convergence of the Covid-19 global pandemic, populism, nationalism, imperialism, mercantilism and the icy lakes of almost valueless money courtesy of QE infinity - has created a level of fear that’s not been seen since the GFC.

It’s like acid rain on global markets, and printing more money or lowering rates may simply confirm the markets’ worst fears of recession.

Still, aid packages in the billions are being announced in the U.S. and the UK and even today in Australia. These will help households, but will they bolster real demand or productivity? No. They are band-aids. Only a trade resolution and an end to the 301 and subsequent tariffs (and retaliatory tariffs) can create fundamental demand for energy, materials and outputs.

Now would be a great time for the U.S. and China, and the UK and the EU (and its other trading partners), to bite the bullet and pump out some sensible trade agreements.

Unfortunately, this will be more difficult to achieve during a global pandemic, particularly while Donald Trump occupies the wheel house of U.S.S Mercantile.

Economically, what now?

The play book is probably going to be the same as before, i.e., too big to fail bail outs (not just banks), plus further rate cuts and more money printing - globally.

Predictions?

With volatility comes opportunity.

So, today, the only thing I am predicting is that you and I will wake up in a few months from now and marvel at how a few brave and smart businesses used this volatility to grab a competitive edge.

Hopefully as well, we might all end up making a few good investment decisions, and of course remain healthy and well.

Keep safe.

Mike.

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