Trade Deal Closer Than Ever or Never Coming

Several years ago I read “The Rise of China vs. The Logic of Strategy” by Edward Luttwak and posted a review here: The Logic of Strategy: Yuan Devaluation and the Road to Trade War. The condensed version is nations have a choice: sovereignty or GDP. Trading with China will accelerate its rise and aid its military modernization. Military conflict or at least much higher defense spending will be needed to protect sovereignty. China's incursions into the South China Sea drove this point home. There is an alternative policy, one that became a potential reality when Donald Trump won the 2016 Presidential Election: slow China's economic ascent. If China's economy slows by even a percentage point or two, it will take many decades before it converges with the U.S. economy. A natural alliance between national security and Main Street to combat State, Treasury and Wall Street was needed and it came if the form of "Trumpism."

In March 2016 I wrote: Trade Will Be Key Component of New China Containment Strategy

In 2018: China Enters the Trade Trap
Logic of Strategy: New Crisis as U.S. Identifies China as #1 Threat
Bannon on China: We Can Take the Whole Thing Down, Total Victory for USA

Reuters now tells us China fell deep into the trade trap, assuming it's goal is not an economic blockade or steering the U.S. into WWIII in the Pacific: Exclusive: China backtracked on nearly all aspects of U.S. trade deal - sources

The diplomatic cable from Beijing arrived in Washington late on Friday night, with systematic edits to a nearly 150-page draft trade agreement that would blow up months of negotiations between the world’s two largest economies, according to three U.S. government sources and three private sector sources briefed on the talks.

The document was riddled with reversals by China that undermined core U.S. demands, the sources told Reuters.

In each of the seven chapters of the draft trade deal, China had deleted its commitments to change laws to resolve core complaints that caused the United States to launch a trade war: theft of U.S. intellectual property and trade secrets; forced technology transfers; competition policy; access to financial services; and currency manipulation.

U.S. President Donald Trump responded in a tweet on Sunday vowing to raise tariffs on $200 billion worth of Chinese goods from 10 to 25 percent on Friday – timed to land in the middle of a scheduled visit by China’s Vice Premier Liu He to Washington to continue trade talks.

The stripping of binding legal language from the draft struck directly at the highest priority of U.S. Trade Representative Robert Lighthizer - who views changes to Chinese laws as essential to verifying compliance after years of what U.S. officials have called empty reform promises.

Much more at Reuters.

First, this is Chinese negotiating tactics. If they believe President Trump wanted a deal by Friday and this was a harder deadline than before, then it was time for them to pull the Chinese pressure tactic of offering a terrible deal at the 11th hour. Second, Trump responded in the best way possible: walk away. China will either come back with a far better offer or there isn't going to be a trade deal because none is possible. One way or another, we'll know soon.

Many people have various reasons to dislike Trump's negotiating strategy, including turning off potential allies with other trade spats, but from a purely realpolitik view, the past two years were far more valuable for China than for the U.S. China's win scenario was run out the clock or sign a deal that China could renege on after Trump left office. The U.S. win scenario is a trade deal or a collapse in global trade because as the largest economy, relatively isolated from global trade and with a global military presence, it is best positioned to benefit from chaos.

As for the fallout of no deal, the U.S. is more than simply isolated from falling global trade. It's costs are politically beneficial. The U.S. is a major importer of consumer goods. Consumption imports can be shifted from China to other countries. If to domestic goods or services, U.S. GDP growth will rise. Costs may rise, but substitution may mean the dispersed rise in costs will not match the concentrated benefit to American companies and workers. The fall in trade mirrors the rise in trade. It will be inflationary. Main Street and the national security apparatus want a good deal or no deal.

President Trump's opponents have louder voices in the media. After three years of the Russiagate hoax, the media isn't doing any soul-searching. The goal is still trash Trump by any narrative possible. Reality is this isn't an ordinary trade war. If Trump goes to war with Canada or the European Union and it causes major economic pain, businesses and consumers will ask, "Why?" There's nothing going on except an economic calculation. With China, this is not only an economic argument, but geopolitical. It is more akin to an actual war in that Americans accept economic losses in the same way they accept losing men, materials and wealth in a shooting war. As long as President Trump is "fighting the war" in America's interest, he will have surprisingly strong support. Politicians, economists and media who counter on economics alone will come off as unpatriotic or worse, Chinese agents or traitors.

Finally, on the markets. I don't believe the trade deal matters that much. Most people are overestimating the economic cost. In the markets, perception is more important than reality most of the time. However, I'll go one step further and point out the December rally, which was not predicated on trade, exhausted right where at the last point for a bear market scenario. If this is a bear market, a trade deal won't save it. If this is not a bear market, a trade war won't sink it.