Are the Trade Clouds Finally Lifting?

• The announced trade deal between the U.S. and China lessens the risk of a further slowdown in world trade: The U.S. will forgo duties slated for December and lower those in September in exchange for China’s commitment to boost imports from the U.S. over the next two years.
• The agreement should help shield U.S. consumers from the trade dispute; however businesses seek greater clarity on future rounds before increasing capital outlays. According to U.S. Trade Representative Robert Lighthizer, whether the agreement works will be determined by who’s making decisions in China – hardliners or reformers.  
• Meanwhile, the U.S.-Mexico-Canada Agreement (USMCA) is headed for congressional approval. Amid all the uproar over NAFTA, the outcome is an updated version of it, which is the best that can be hoped for in contentious times.

Global Risks Have Lessened… 

For the past 18 months the greatest risk to the global economy and markets has been the ongoing escalation in the trade conflict between the U.S. and China. Since it was launched in the spring of 2018, global growth has decelerated close to a post-crisis low of 3% in the third quarter of 2019 from a peak of 4% in the first quarter of 2018. The principal reason is the costs and uncertainty associated with tariffs have stalled business investment globally and disrupted supply chains. Looking ahead, the IMF estimates that by 2020 trade tensions between the U.S. and China will have reduced global growth by 0.8%, or about $700 billion.¹  

Over the last 18 months, the U.S. economy has also slowed by a full percentage point to 2% recently from a peak of 3%. Some of this slowdown reflects the waning influence of the round of tax cuts that were enacted at the end of 2017, as well as tightening by the Federal Reserve during 2018. Thus far, the impact of tariff hikes has mainly been felt by U.S. manufacturers, farmers, and businesses that have borne the brunt of the tariff hikes.

Prior to the phase one agreement, there was concern American households could feel more of the impact in the coming year. The reason: The tariffs implemented in September and those scheduled for December mainly apply to consumer goods. With the Trump administration willing to forgo the December round of hikes and to scale back tariffs implemented in September, the risk of consumer confidence being impacted has likely diminished. 

…But Trade Uncertainty Persists

The phase one agreement, however, does not mean the trade dispute is over. One issue that requires clarification is whether China is committed to purchase $40-$50 billion of agricultural goods that President Trump is seeking. The Chinese authorities previously maintained the targeted amount exceeds China’s needs considerably, and that such a requirement is not compatible with WTO rules. It is unclear whether their stance has changed.

In a television interview on Sunday, Robert Lighthizer said the phase one  deal is “totally done” and will be signed in January.²  He also claimed China has agreed to double its imports from the U.S. over the next two years, which would boost them by a minimum of $200 billion.³  At the same time, Lighthizer acknowledged that “whether this whole agreement works is going to be determined by who’s making decisions in China, not in the United States.” He indicated that the U.S. is hoping reformers rather than hard-liners will call the shots.

In either case, negotiations over intellectual property and technology issues and China’s subsidization of companies will be difficult to resolve. Indeed, the easiest part of the trade dispute was over Chinese purchases of agricultural goods, and this took just shy of two years to achieve. Changing China’s stance on technology and its practice of subsidizing businesses is a difficult proposition, because it is an integral part of China’s economic model. There is a possibility, therefore, that phase one may be the only agreement that is implemented. 

Forthcoming USMCA Trade Deal

Another trade development this past week was the agreement reached between the White House and House Democrats to approve USMCA. It will replace the North America Free Trade Agreement (NAFTA), which President Trump had ridiculed as “the worst trade deal ever” when he ran for office and threatened to tear it up.  However, the new deal has been dubbed “NAFTA Lite” because it mostly patches and updates the original deal.⁴  

The key component of the proposal the White House drafted last year related to auto production in Mexico. It would raise the U.S.-content of cars manufactured in Mexico from 62.5 percent to 75 percent for automakers to avoid tariffs on their cars. Also, 30 percent of vehicle production would have to be done by workers earning at least $16 per hour, which is roughly double what Mexican auto workers have been making.

House Democrats had held up passage of the proposal, because labor groups and other critics complained the provisions did not did not include sufficient enforcement mechanisms. Last week, while the impeachment proceedings were going on, the House Democrats said a series of revisions they negotiated with the Trump administration would provide for adequate monitoring, accountability, and enforcement. While Democrats hailed the changes as a victory for American workers, some trade experts believe these provisions could make it easier for special interests to halt trade by simply accusing Mexican factories of violating labor and environment provisions.

The good news is that a highly contentious issue that could have disrupted trade in North America – the world’s largest trading bloc – has been put to rest. The criticisms of NAFTA, which date back to Ross Perot’s presidential run in 1992 and which resurfaced during the elections in 2008 and 2016, asserted that it resulted in significant losses of manufacturing jobs in the U.S. However, the facts do not support these assertions. As shown in Figure 1 the vast majority of job losses occurred following China’s entry into the World Trade Organization in December 2001. During the 1990s when NAFTA was enacted there was little net change in manufacturing jobs.⁵  
 
In sum, what transpired last week on U.S.-China trade and NAFTA lessen the risk of a further disruption of trade. The key difference is that whereas the controversy over NAFTA is now resolved, the dispute between the U.S. and China is about to enter a more difficult phase of negotiations.

¹ IMF World Economic Outlook, October 2019.
² CBS “Face the Nation,” Sunday, December 15, 2019
³ Ibid.
⁴ See Michael Collins’ article in USA Today, December 11, 2019.
⁵ For further discussion of this issue, see Chapter 8 of my book Investing in the Trump Era.