McLARTY TRADE UPDATE: Tariff threats raise tension in China trade talks

May 8, 2019

KEY POINTS:

Chinese chief negotiator Liu He rejoins trade talks tomorrow, leaving President Trump less than a day to evaluate whether Beijing’s concessions are enough to justify a halt in tariffs hike.
China has promised “necessary countermeasures” if new US tariffs are imposed.
Potential for failure has been highlighted by end-game brinksmanship.

USTR FR Notice

After President Trump’s Sunday tweets and Amb. Robert Lighthizer on Monday blaming China for “an erosion in commitments,” USTR filed a draft notice in the Federal Register, due to be published tomorrow (Thursday), announcing that tariffs on $200 billion worth of Chinese goods will be raised from 10% to 25% starting 12:01am Friday, citing “the lack of progress in the additional rounds of negotiations since March 2019.” We will look for any changes to the draft notice when the final version is published. USTR said it will publish a separate notice describing the exclusion-request procedures. We understand that goods already in transit will be subject to the original 10% tariff rate.

Trump tweeted this morning: “The reason for the China pullback & attempted renegotiation of the Trade Deal is the sincere HOPE that they will be able to “negotiate” with Joe Biden or one of the very weak Democrats, and thereby continue to ripoff the United States (($500 Billion a year)) for years to come…Guess what, that’s not going to happen! China has just informed us that they (Vice-Premier) are now coming to the U.S. to make a deal. We’ll see, but I am very happy with over $100 Billion a year in Tariffs filling U.S. coffers…great for U.S., not good for China!”

Lighthizer said on Monday that USTR probably will also release for public comment this week a proposal putting new 25% duties on the remaining $325 billion worth of Chinese exports.

Beijing prepares for escalation of trade war

Beijing initially reacted in a restrained way to the threats of a major escalation of the trade war, and still decided to send Vice Premier Liu He for talks in Washington on Thursday and Friday, but on a slightly delayed and shortened trip. We can speculate that there have been diplomatic communications between the two governments that led Beijing to conclude that the negotiations have not collapsed.

However, after the USTR’s filing on a tariff hike was posted this morning, China’s Ministry of Commerce quickly issued a statement expressing “deep regret” over the US plan and vowing to take “necessary countermeasures” if the new tariffs are implemented.

This shows Beijing has prepared for an escalation in the trade tensions, raising the stakes for the negotiations starting Thursday. The exchange of tough words also increases the risk that the trade talks may eventually fall apart.

Thursday key time window

After Lighthizer attacked Beijing on backpedaling, China’s Foreign Ministry spokesman Geng Shuang responded earlier this week: “it is natural to have differences in a negotiation.” Their different characterization on the issue suggests that the potential for misunderstanding can be significant given the distinctions in work style, language, and decision-making mechanism on the two sides.

Thursday will prove to be the key time window to assess whether the planned tariffs hike could be put on hold. Liu He will have to convince the US that it has not backtracked in the talks, either by re-inserting previously agreed upon language or presenting an alternative proposal to meet US demands. Assuming both sides can get over this hurdle, they will then need to turn to the remaining outstanding issues, including industrial subsidies, cloud computing, enforcement mechanisms and existing tariffs. Accomplishing this within such a short time will be difficult.

Chance for “cease-fire” remains

Amid the drama, at least one thing looks quite certain: the US tariffs already put in place over the past year will unlikely go away altogether even if the two sides reach a deal.

The last-minute, public threats have added a new dimension of uncertainty to any predictions, but we still believe there remains a chance for a trade deal to be reached. It is possible that Liu He may delay his return to Beijing so that the bilateral talks can be extended to the weekend and possibly beyond. Trump may agree to postpone the imposition of tariffs to enable the talks to continue.

Messages from Congress are mixed. Senate Minority Leader Chuck Schumer (D-NY) urged Trump to “hang tough on China” while Finance Committee Chairman Charles E. Grassley (R-IA) expressed “some sympathy for Trump’s lack of patience with the Chinese,” saying “It’s time to strike a strong, enforceable deal”. But Senate Majority Whip John Thune (R-SD) said he was worried about the potential consequences of higher tariffs against China, which certainly must include retaliatory measures by China.

More tariffs mean more trouble

If Trump’s threatened new tariffs are implemented, China has many retaliatory options.

China could raise existing tariffs on $110 billion worth of US products and impose new tariffs on the remaining $10 billion of its annual imports from the United States yet untouched. Beijing could also halt approvals on biotech products, investment, and licensing for US firms, step up inspections of US plants in China, and even encourage domestic consumers to boycott US brands. Politically, Beijing also has the option of moving beyond economic actions and undermining US policy on geostrategic issues important to the United States.

Against the backdrop of an evolving, broad-gauge strategic rivalry between the two countries, the importance of resolving the many economic friction points in US-China relations through these negotiations is looking to be increasingly urgent. The consequences of failure are daunting to contemplate.