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Phase One Trade Deal Seems Totally Dependent On China

Does this China phase one mini-deal inspire any confidence? The way U.S. Trade Representative Robert Lighthizer is putting it, the success of the deal is all dependent on Beijing.

Lighthizer hinted over the weekend and again on Monday that if China hardliners took over the process and reneged on portions of the deal, phase one was a goner. He’s signaling to the market that if this thing goes south, blame China.

Xi Jinping is in charge here. If he wants the hardliners to rule the day, they will. If he wants a more moderate or reform-minded group within the Communist Party to rule, then they will.

In the meantime, China trades on hope.

“We don’t actually know what’s up yet with this trade deal,” says Morgan Harting, a fund manager for Alliance Bernstein. “My inclination is to pay attention to the actual announced policies. Until I see it in something like the Federal Register, then I won’t know what the facts of this deal are.”

Some of the key facts in the deal include promises not to purposely depreciate the yuan, agreements on technology transfers in joint venture deals, stronger intellectual property protections on patents, and promises to import billions of dollars worth of commodities and U.S. manufactured goods.

Phase One Trade Deal Seems Totally Dependent On China

A farmer holds soybean from the 2018 harvest, a harvest China largely abandoned in favor of Brazil. … [+] Now they are promising to return to the market. But Washington wants them to buy even more. How can they do this without angering other trade partners? (Photo by Johannes EISELE / AFP)

AFP/Getty Images

Agribusiness companies that are members of the U.S. China Business Council like the idea, but they too are not sure how China nearly doubles imports of commodities, let alone agricultural commodities.

“Maybe if this includes energy exports,” says Craig Allen, the Council’s president, thinking out loud.

President Trump has said China agreed to import roughly $50 billion worth of agricultural commodities, something Lighthizer said China would do in interviews over the weekend.

Industry experts are skeptical.

China mostly imports soybeans from the U.S., but to increase its dollar value of imports Chinese firms would either have to nearly double U.S. soy purchases instead of from its other biggest market, Brazil, and increase imports of things like chicken.

“I think both sides want to get this right this time, but we are all waiting for details,” says Allen, adding that China cannot agree to import more of a commodity from one country only as this could open up a case against it in the World Trade Organization by commodity exporters like Brazil.

Markets are semi-euphoric about no December tariffs and a rollback of some existing tariffs 30 days after the deal gets signed next month, but risks remain. The phase one trade deal is a razor’s edge.

The agreed upon text is still going through translation. Then China’s legal team is going to look at this. In other words, the mortgage is not signed yet on this McMansion.

Bank of America chief China economist Helen Qiao said in a note to clients to expect “a noisy ceasefire” with room for disappointment. “We acknowledge the risk that this ceasefire period does not remain eventless in the run-up to the U.S. presidential election,” she wrote.

Some of that risk includes being more beholden to China. If losing some $17 billion in agricultural exports to China due to the trade war was tough for farmers, imagine a much larger market, with China taking some $50 billion away from American agribusiness in the future.

There is also the risk that the phase two talks, which Trump said would begin the moment phase one is signed, could come with the stipulation that phase two happens only if tariffs are completely rolled back.

A full reversal of tariffs is still on Beijing’s mind.

Phase One Trade Deal Seems Totally Dependent On China

Chinese President Xi Jinping: is he really the ultimate decider on trade? Or can hardliners in the … [+] CCP convince him that promising to buy more from the U.S. is akin to capitulation. (Photo by Noel Celis – Pool/Getty Images)

At a press conference in Beijing on Monday, spokesman for the National Bureau of Statistics, Fu Linghui (Fooling You!? If this was the China Trade War movie, this would be the name of your villain), said that “we hope the two sides can continue step-by-step negotiations to gradually roll back or even fully roll back…tariffs”.

There is a simple economic rationale for reassessment the economic relationship with China. In a world where the No. 1 and No. 2 economies have enormously different political and economic systems, something’s got to give. This is not France versus Germany. This is a capitalist democracy versus a Frankenstein economy that’s one-part capitalist, one part state controlled, and run by a single party long considered the enemy of Western democracies.

“Allowing a centrally-planned economy a dominant position in global trade and finance will inevitably infect the rest of the world with the inefficiencies inherent in central planning,” says Brian McCarthy, chief strategist for Macrolens, an independent investment research firm and a close China watcher. “If China refuses to further marketize – a process which may have hit the limits of compatibility with authoritarian Communism – then two choices remain: invite the infection of capital allocation inefficiency that comes with integration, or rid it from the system by decoupling,” he says.

It’s a position some China hardliners maintain, too. If Washington wants us to change our ways and become more like them, then they too can go pound sand.

Everyone knows that if the phase one deal fails, all of the leveraged risked investments will dump equities. Longer term investors are trying to remain calm.

“If they get rolled back, to be frank, it’s not going to effect the way we are investing,” says Gerardo Zamorano, a fund manager for Brandes Investment Partners. “How many times now have we heard about a deal now? Yes, both sides don’t want negative headlines right now. The closer we get to the elections, China will probably roll the dice and see who wins. Neither side wants to be seen as capitulating,” Zamorano says, a consensus view in the market.

“We have historically been underweight China anyway,” he says. “We still are.”

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