China: Negotiating the “Phase-One” Deal

Published on November 4, 2019
SGH Insight
** In looking ahead, the message went on that if the two sides reach a phased trade agreement, China, will “consider removing” (meaning they will remove) extra tariffs on most US agricultural products, and “both sides” (meaning more importantly the US side) will give up additional rounds of tariffs threatened on each other for December 15.

** Not anticipated by markets, Beijing is also asking that in return for its lifting of the extra tariffs on US agricultural imports that it imposed in tit-for-tat escalations with the US, the US should consider removing equal amounts of tariffs that it imposed on Chinese products. That would be above and beyond a simple ceasefire on the December 15 tariff threats.
Market Validation
(Dow Jones 11/7/19)

Stocks Open Higher on Signs of Progress in U.S.-China Talks

Stocks rose Thursday in early U.S. trading after China said Beijing and Washington agreed to lift some existing tariffs if a deal is struck, signaling that trade talks are progressing.
The Dow Jones Industrial Average index climbed 0.5%, while the broader S&P 500 rose 0.2% and the Nasdaq Composite Index added 0.5%. Earlier, the pan-continental Stoxx Europe 600 gauge had risen 0.2%.
Following negotiations over the last two weeks, China and the U.S. agreed to remove tariffs at the same time and by the same amount when they sign the initial accord, a Chinese Commerce Ministry spokesman said Thursday. The yield on 10-year Treasurys rose to 1.879% from 1.814% on Wednesday.

China’s President Xi Jinping, from what we understand, provided Vice-Premier Liu He with a detailed message to deliver to Washington on behalf of the Fourth Plenum Session of the 19th Central Committee of the Communist Party of China.

That message was the basis for Liu’s call last Friday with US Trade Representative Robert Lighthizer and Treasury Secretary Steven Mnuchin, and it included important negotiating guidelines, and on the phasing of agricultural imports in particular.

*** The Fourth Plenary Session was said to view the development of “normal” China-US trade relations “positively”, and it confirmed Beijing is willing to sign an agreement “if the US does not introduce new issues into the text of the “first phase” of the China-US trade agreement. China further expressed it is willing to work with the United States to complete the proofreading and confirmation of the text of the first phase of the agreement by November 15, and to prepare for President Donald Trump and President Xi Jinping to sign a formal agreement at any time after November 15. ***

*** From what we understand as of today, the lead negotiators indeed agreed on Friday’s call not to add any new topics to the existing text, and to continue to exchange and discuss both the Chinese and English language versions of the text of the first phase of the trade agreement. That means Xi and Trump are almost certain to sign a phased bilateral trade agreement, despite the two countries remaining “far apart on some of the thorniest issues in their bilateral trade relations.” ***

“Try Its Best” on Ag Purchases

** As to the agreement itself, regarding agricultural purchases, China’s position was that it will “try its best” to raise imports in what is left of this year to somewhere close to the (low) levels from last year, and then step up and “try its best” to import about $25-30 billion worth of agricultural products in 2020.

** This number “will be expected” to increase to about $35-40 billion of agricultural product imports in 2021, after which China will “strive to” import $40-50 billion of agricultural products by 2022.

** Even as this proposed phase-in gets to President Trump’s touted $50 billion mark, it may not meet that target in the time frame demanded and advertised by the White House. Furthermore, it maintains very conditional language rather than hard commitments by Beijing to meet those targets.

** And notably, five senior sources from Beijing emphasized in the wake of the Plenary Session that China will not make “unrealistic commitments” in import targets in a trade agreement with the United States. Perhaps most to the point, the purchase of massive agricultural products represents Beijing’s most significant political and economic leverage point over the White House, and not one to be traded away easily, when Beijing’s ultimate objective is a full rollback of tariffs.

** While these key and highly political differences appear to remain on agricultural imports, it appears they will be glossed over or negotiated away in this last leg, perhaps to run into subsequent “phases” of a trade accord, if they have not been agreed to already.

** In looking ahead, the message went on that if the two sides reach a phased trade agreement, China, will “consider removing” (meaning they will remove) extra tariffs on most US agricultural products, and “both sides” (meaning more importantly the US side) will give up additional rounds of tariffs threatened on each other for December 15.

** Not anticipated by markets, Beijing is also asking that in return for its lifting of the extra tariffs on US agricultural imports that it imposed in tit-for-tat escalations with the US, the US should consider removing equal amounts of tariffs that it imposed on Chinese products. That would be above and beyond a simple ceasefire on the December 15 tariff threats.

Currency and IPR

** Regarding the currency agreement, there is little to add to what we believe is in essence political fluff provided by Beijing to Washington to justify a climb down from the somewhat silly designation of China as a “currency manipulator,” while Beijing, which has long touted its desire for a basically stable currency, agrees not to manipulate FX for trade advantage.

** And while the White House would, for political reasons, prefer to draw parallels of this “currency accord” with China to the FX language included in its own, yet to be ratified, USMCA deal, for similar bland and toothless language one could also refer to the last decade of G20 and G7 communiques.

** An agreement on intellectual property rights is also purportedly part of the agreement, but interestingly, it is barely mentioned in leaks or public comments, except in the briefest of passing remarks, by either US or Chinese officials. That is because as Washington and Beijing rush to sign a deal, on IPR protection, at least, there appears to be less than meets the eye.

** Here, China will point to a new foreign investment law that will take effect on January 1, 2020. The new law, Beijing maintains, will contain “very detailed definitions and provisions on intellectual property rights protection.” Perhaps in an acknowledgment that this may not be enough to satisfy the US, Beijing has indicated it will be willing to continue further discussions with Washington on the IPR issue, most certain to slip into a “phase two.” However, Beijing will not, from what we understand, add a US proposal on IPR into its new law.

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