China and the US did not address key issues

Macro Highlights - 11/04/2017

The constructive attitude reigning over the recent US-China summit is encouraging. Although question marks remain over Mr Trump’s intentions and priorities regarding trade policy, he should however not adopt a staunch protectionist stance. China’s economic activity continues to stabilise. While manufacturing dynamics are likely to ease, the country should still reach its 2017 GDP growth target of 6.5%.

The summit between US President Donald Trump and his Chinese counterpart Xi Jinping on 6–7 April led to few tangible results. The main breakthrough was probably that the two presidents agreed to adopt a new framework for negotiations and dialogue on a range of issues. This constructive attitude was reassuring following Mr Trump’s bellicose rhetoric on China and its trade practices. The two heads of state agreed on a 100-day plan to narrow America’s trade deficit with China, but the details of the plan are still being hashed out. This plan echoes the executive order that Mr Trump signed on 31 March giving his administration 90 days to assess the effects of trade abuses on US trade deficits. And US newspapers are saying that Mr Trump will probably issue another executive order penalising countries accused of dumping steel onto US shores. While few specifics have filtered through so far, China would most likely be targeted by this measure.

US Treasury Secretary Steven Mnuchin also kept up the pressure on China, stating that his department would soon make a decision on whether to brand China a currency manipulator. Under the 2015 Trade Enforcement and Trade Facilitation Act, the US government can apply that label to a country that meets the following three criteria: it has a trade surplus with the US of over USD 20 billion; it has a current account surplus of over 3% of GDP; and it has carried out net foreign currency purchases amounting to more than 2% of GDP over a 12-month period. With a goods trade surplus of USD 347 billion, China meets only the first of these three criteria. What’s more, since 2014 the Chinese government has drawn down some USD 1 trillion of its foreign exchange reserves to support the yuan.

Under the 2015 Act, designating a country as a currency manipulator doesn’t automatically trigger direct sanctions but kicks off a year-long negotiating period aimed at correcting the country’s undervalued currency and current account surplus. If, at the end of this period, the US considers that the country still hasn’t taken the appropriate measures, the US president could:

  • Forbid the US Overseas Private Investment Corporation from approving new funding for projects in the country. But this sanction has already been in effect against China since 1990, when it was adopted in response to the events in Tiananmen Square.
  • Forbid the federal government from entering into new agreements or continuing existing agreements to purchase goods and services from the country.
  • Ask the International Monetary Fund to keep a closer eye on the country’s macroeconomic and foreign exchange policies.
  • Ask the US trade representative to take these factors into account when considering bilateral or regional trade agreements with the country.

Although no country currently meets all three criteria, the Trump administration could conceivably change the definition of a currency manipulator. The US Secretary of Commerce has put forth the idea of designating the practice of currency manipulation as an unfair subsidy. This less-quantitative definition would apply to more countries that are running a trade surplus with the US.

So while the spirit of cooperation and mutual respect that reigned over the recent summit is encouraging, it shouldn’t overshadow the differences that persist between the world’s two largest economies. The balancing act we are now seeing will remain fragile as long as the Trump administration has not made its intentions clear and stressed its priorities for trade policy. As we highlighted earlier, Mr Trump has little to gain from adopting a staunch protectionist stance that would lead America into a mutually-destructive trade war. He would be wise to take the middle ground, and the executive order on steel exporters could be a good opportunity. That order would satisfy his Republican electorate yet have only a minimal impact on the economy, since China accounts for just 4% of US steel imports and 2% of domestic consumption. Similarly, any concessions that China could make on US beef exports, which have been subject to restrictions since 2003, would be only symbolic in nature. These exports make up just 0.3% of America’s total exports and would do nothing to shrink its trade deficit with China. We can expect to see more such measures in the near future targeting segments that are marginal in terms of Sino-American trade. That means trade relations between the two countries would likely remain as they are but the precarious trust they now enjoy could erode.

In addition to trade, geopolitical issues are the other source of tension between China and the US. The two countries’ divergent standpoints were thrust to the fore by North Korea’s nuclear missile tests which led America to show China its firm stance by sending an aircraft carrier.

On the economic front, official manufacturing PMIs for March provided further evidence of a buoyant Chinese economy in the first quarter; all sub-indices showed encouraging trends (see left-hand chart). The input prices sub-component ticked downwards, indicating a moderation in manufacturing activity and suggesting that producer price inflation in the country may have peaked (see right-hand chart). And although manufacturing output may ease in the coming months, momentum should remain strong enough for China to reach its GDP growth target of 6.5% for 2017, barring any unpleasant protectionist surprises.