US-China tariff cuts a ‘giant surprise’, says economist

Key Concepts:

• Tariff rollback (US-China trade)
• Economic pain (China): job market deterioration, deflation
• US consumer market impact (empty shelves)
• Financial market impact (stock market, bond market)
• Negotiation preconditions and political capital
• State-led model vs. re-industrialization
• High-tech sector competition
• Fentanyl tariffs
• Phase One deal (energy, agricultural products)
• Export controls (semiconductors)
• Non-tariff barriers
• Currency revaluation (RMB)
• Trade balance/deficit
• Plaza Accord (1985)
• Basket of currencies

1. Initial Impact of Tariff Rollback

• The fact that talks occurred and a rollback to 10% reciprocal tariffs was unexpected.
• For China, the primary concern is economic pain. If tariffs remained at 25%, the job market would continue to deteriorate, and deflation would become a permanent issue, deterring long-term investment.
• For the US, the calculation is focused on the domestic consumer market (avoiding empty shelves) and the financial market (stock market and bond market stability).
• President Trump seems to be sensitive to the bond market and potential consumer goods shortages.

2. Economic and Political Drivers for Negotiation

• Both sides have sufficient economic pain to reconsider their positions.
• China had preconditions for talks (US tariff rollback, avoiding appearing weak), which leaders seem to have maintained.
• Trump has spent significant political capital on tariffs and needs substantial improvement before the next midterm election.
• China cannot sustain prolonged deflation and economic slowdown.

3. Fundamental Differences and Long-Term Goals

• The fundamental differences between China and the US remain unchanged.
• China's state-led model and industrial policy are key points of divergence.
• China aims to produce more and capture a higher market share in global manufacturing, particularly in the high-tech sector.
• The US wants to re-industrialize its economy, which clashes with China's ambitions.
• China seeks a stronger global voice, which the US perceives as a threat.

4. Risks to the Truce and Potential Areas of Negotiation

• The focus of negotiation may shift to fentanyl, as the 25% fentanyl tariff would be the highest.
• Chinese export industry may perform well in the next 90 days, boosting confidence for further negotiations.
• China might commit to a larger purchase agreement (similar to the Phase One deal) involving energy and agricultural products.
• The US might loosen export controls on high-tech products, especially semiconductors (e.g., Nvidia).

5. Broadening the US-China Agenda

• The agenda could broaden beyond trade to include public health (fentanyl) and technology.
• A comprehensive deal would be necessary due to the deep integration of US-China trade.
• The US is a consumer, and China is a producer, making decoupling difficult.
• Trump's goal to reduce or eliminate the trade deficit is technically challenging.

6. Currency Revaluation as a Potential Solution

• China could partially address the trade deficit by revaluating its currency (RMB).
• A 15% revaluation could immediately reduce the US trade deficit by 15%.
• Easing financial restrictions on Chinese companies listing in the US could be a win for China.

7. High-Tech Competition and Long-Term Commitment

• Movement on high-tech issues is unlikely due to the bundling of economic and national security concerns.
• Neither side is expected to budge on high-tech export controls.
• The US-China relationship rests on long-term competition, especially in high-tech.
• China is heavily invested in and committed to artificial intelligence, automation, and smart manufacturing.
• The US has a comparative advantage in some cutting-edge technologies, but China's government commitment is stronger.
• US decisions are often affected by election cycles, giving China a potential upper hand.

8. The Plaza Accord Analogy

• The 1985 Plaza Accord involved the US agreeing with other countries to depreciate their currencies to reduce the US trade deficit.
• A similar agreement for China is possible but unlikely in the short term.
• China may prefer to keep its currency stable for now.
• In the long term, China might re-anchor its currency to a basket of currencies, with the US dollar as only a fraction.

9. Balanced Trade and Investment

• A common notion of balanced trade is difficult to achieve.
• A broader definition of balanced trade could include investment flows.
• Increased Chinese investment in US manufacturing could help shrink the trade balance.
• US dependence on China for final goods and industrial inputs will continue in the short term.
• Chinese companies need security regarding their long-term investment, financial investment, and branding in the US.

10. Conclusion

The US-China trade situation is complex, driven by both economic necessities and long-term strategic competition. While the tariff rollback and renewed negotiations are a positive start, fundamental differences in economic models and technological ambitions remain. Potential solutions involve currency revaluation, increased investment flows, and a broader definition of balanced trade. The high-tech sector remains a key point of contention, with both sides committed to long-term dominance.