US-China deal likely but risks remain high

June 27, 2019

Former RBA board member Dr John Edwards says the US and China are likely to strike a trade deal rather than risk the consequences of ending four decades of successful globalisation.

However, Dr Edwards said the mood in Beijing had turned pessimistic about resolving the issue ahead of the two countries continuing negotiations at the G20 Summit in Japan this month. Meanwhile, equity markets had not priced in the possibility that the dispute may end badly.

“We are just at the point where this can get very, very much worse, very quickly,” Dr Edwards said at a session on global secular dynamics at Frontier’s annual conference.

“Equity markets are not positioned for bad news about the US-China quarrel, and they’re certainly not positioned for impact on the global economy of continuing deterioration in that relationship, perhaps involving other major economies as well.”

The US Chamber of Commerce has estimated that the tariffs imposed over the past year could cost the US economy $US1 trillion over a decade as President Trump considers extending those tariffs to a further $US300 billion of Chinese imports.

Nonetheless, Dr Edwards said both parties wanted a deal with the US participating in 11 rounds of negotiations and withdrawing other threatened actions, while China had made concessions such as passing laws to protect intellectual property.

A 150-page deal proposed by the US remains on the table although there are three main sticking points:

  • China wants the penalty tariffs imposed so far by the US to be immediately removed.
  • The amount of extra imports that China will buy from the US must be ‘realistic’.
  • The terminology of the agreement must recognise China’s dignity.

“I infer that these are all about enforcement. The amount that China buys from the US is it’s only negotiating coin at this point. It said it’s prepared to buy $US200 billion more each year and it’s said that the US wants $US300 billion – that seems to me to be negotiable.”

China was Australia’s largest two-way trading partner in 2017, accounting for 24% of total trade ($183 billion), according to Austrade. However, Dr Edwards said an end to the US-China trade dispute would disadvantage Australia with China likely to buy some farm product sales and LNG from the US rather than Australia.

“The agreement itself won’t be particularly advanced in our interest but what is in your interest is that this deteriorating relationship between US and China should be arrested.”

Dr Edwards, who is also a director of Frontier Advisors and Cbus Super, has been studying the US-China trade dispute in his role as Senior Fellow at the Lowy Institute.

Pendal Portfolio Manager, Amy Xie Patrick, said the US had national security concerns about its reliance on Chinese hardware but had taken its ‘Made in China 2025’ plan to upgrade the manufacturing capabilities of higher value goods and services far too literally.

“Therefore, now we’re getting these comments that this is not really a trade war, it’s a tech war. It could eventually culminate in a tech war but I think it’s a bit difficult for both sides to disentangle at the moment.”

The potential breakdown of the world’s multilateral trade system poses difficult questions for investors. UBS Head of Fixed Income and Investment Solutions – Australia, Anne Anderson, said monetary policy will remain supportive so investors should remain long real yields as protection against unexpected inflation over the next decade.

“I think equities will still do okay, because of the discount rate factor but you have to be mindful that the reason we’ve got to have pre-emptive policy responses is because of the downside risks and uncertainty that this trade de-globalization, extension of populism brings. So you have to be very mindful of earnings outcomes and there’ll be opportunities to buy and sell.”

For further analysis by Amy Xie Patrick click here.

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