Trump's Trade Policies, China, And The Midterms

Trump's crack trade negotiating team is headed to China this in an attempt to get China to address some of its trade practices and perhaps come to a negotiated agreement to stop a budding trade war between the two countries.

Because this is a Trump administration delegation, there is no real agreement among the members of the negotiating team about what strategy to take in confronting China. Hard liners like trade adviser Peter Navarro and trade representative Robert Lighthizer will be taking a very aggressive stance, demanding $100 billion reduction in China's trade surplus with the US as well as other concessions that would open up Chinese markets. On the more dovish side, (and I can't believe I'm writing that), will be Larry Kudlow who actually recognizes the downsides of a trade war for the US and will be looking to find a common ground with the Chinese that would also mollify the hard liners. Wilbur Ross will also be on the trip, making sure that his own interests as well as his corporate friends are represented in the demands to the Chinese. The final cabinet member on the trip will be Steve Mnuchin who will be representing whatever view that he thinks the President will actually line up with but nominally more moderate than Navarro and Lighthizer.

But the Chinese know that these discussions will be mostly for show and they have decided to take a hard line themselves. First of all, they know that none of the people they are negotiating with have any real credibility. Peter Navarro admitted as much when he said, "The discussions will take place in Beijing, the decisions will take place in Washington". Trump will ultimately make the final decision and that decision may, and probably will, have very little to do with what actually gets agreed to at these meetings. And the Chinese know that.

In addition, as usual, the Chinese are taking the long view. They believe they can outlast Trump in any trade war that might ensue. Xi has consolidated power while Trump becomes weaker by the day and may become powerless if Democrats regain control of Congress in the fall. And that's ignoring all the other scandals swirling around the President. Moreover, the Chinese populace has come to see Trump's rhetoric, trade policies, and, to a far lesser extent, immigration policies as specifically designed to punish China, further strengthening Xi's hand.

Any concessions that the Chinese seem willing to make are designed to potentially reduce the current trade surplus but only in ways that actually boost the Chinese economy. That includes the idea to increase imports from the US by purchasing more US high-tech goods. But that approach is seen by the US hard liners and others as just another ploy for the Chinese to more fully understand those technologies and then develop them domestically.

Xi not only believes his economy is strong enough to withstand Trump's trade war but that his people can endure whatever pain ensues from that war far, far longer then Trump and his base can. Xi has seen that when Trump's base gets nervous or disgruntled, Trump will automatically cave. And the Chinese have already started pressuring that base pretty dramatically before these negotiations even began. China has imposed its own tariffs on sorghum and has now apparently stopped buying US soybeans altogether. Those moves strike right at the heart of Trump country in Iowa, Pennsylvania, Ohio, Michigan, and Wisconsin. In addition, in retaliation for Trump's aluminum and steel tariffs, China had already imposed its own tariffs on US pork, again hitting states like Iowa and Arkansas. And, speaking of those steel and aluminum tariffs, they are already hurting certain US businesses.Considering all that, it's easy to see why the Chinese feel confident they have the upper hand in these negotiations.

Meanwhile, Trump's trade tactics are angering other large trading partners. At first glance, Trump's decision to delay the implementation of steel and aluminum tariffs on Canada, Mexico, and the EU for another 30 days may have seemed like a dose of rationality in order to continue negotiations with those partners. In fact, the EU was more angered than relieved by Trump's extension as they feel it merely prolongs the uncertainty for their supply chains and their finally growing economies.

At the same time of these extensions, the Trump administration also announced that it had reached agreements in principle on steel and aluminum imports with Argentina, Australia, and Brazil, with the details to be "finalized shortly".  That was news to Brazil who claims that the US negotiating team walked away from the table while offering Brazil an ultimatum to either accept the tariffs or implement voluntary quotas.

This is the current US negotiating stance on aluminum and steel imports from our trading partners - either accept tariffs or institute export quotas. As Paul Krugman notes, these tariffs will have far greater negative effects for the end users of aluminum and steel than positive wage and job growth among their producers. But having our trading partners institute voluntary quotas is arguably a worse policy option. The US will still suffer the negative effects of the tariffs but will not even receive the income from those tariffs.

Finally, because Donald Trump does not believe in staffing and runs the US government like his own small private business, Lighthizer's inclusion on this trip means that the NAFTA negotiations had to go on hiatus. The political deadline for NAFTA is fast approaching, driven by the Mexican elections on July 1. In those elections, the left wing candidate, Lopez Obrador, is ahead by nearly 20 points, largely driven by anti-Trump, anti-US sentiment. He has agreed to honor any NAFTA agreement made before his election on July 1 but is less precise on agreements made during the presidential transition period which ends on December 1st. But many believe that Lopez Obrador's position is merely posturing to protect his lead in the last days of the election, especially since he is committed to lessening Mexico's economic and energy dependence on the United States.

US GDP grew at 2.3% in the always disappointing first quarter of this year, a modest slowdown that was largely anticipated by the end of the quarter but significantly below the 3% estimates from early in the quarter. More significantly, despite the massive tax cuts, business investment fell and inventories rose. Inflation is also rising and has now reached the 2% target that the Fed has been predicting for much of the last eight years. The Fed expects inflation to continue to rise and is intent on hiking interest rates accordingly. In addition, gas prices are expected to reach their highest level in four years during the summer driving season, further fueling inflation fears.

This sets up a disturbing scenario where trade tariffs and quotas on important imported goods like steel and aluminum actually increase domestic prices and fuel inflation and, correspondingly, higher interest rates, while the export market for American goods, especially grains and livestock products, collapses. That combination could be quite negative for Trump's base where there are already significant concerns about his trade policies. And that could spell real trouble for Republicans and therefore Trump in the midterm elections.