The benefit of the doubt is still given to the continuation of the risk on trade that commenced on Boxing Day, with the S&P500 and the MSCI AC World Index up 15.3% and 12.7% respectively since then (see following chart). One reason for this remains the continuing base case here, namely that a US-China trade deal will be agreed within the 90-day deadline, which means by March 1. The view here remains firmly that both Donald Trump and Xi Jinping want such a deal.

S&P500 and MSCI AC World Index Performance Since the Beginning of 2018

Source: Datastream

Support for this view came with a recent Wall Street Journal report that U.S. Treasury Secretary Steven Mnuchin favours removing the existing tariffs introduced last year in order to put pressure on China to make concessions in areas such as intellectual property and market access (see The Wall Street Journal article: “Officials Debate Cutting Tariffs”, Jan. 18, 2019). It makes sense to assume that the existing tariffs will be removed, as well as the threatened tariffs not implemented, if a deal is done. This is important because most investors have been assuming that the existing tariffs are staying whatever the outcome of the current negotiations. This is why, if they are removed, it raises the potential for investors to hope that globalization may not be ending after all.

 

The Threat of Chinese Telecom Companies to U.S. National Security

If this is the positive, it is a negative that someone has leaked this to the Journal since the purpose of the leak was probably to try to disrupt the continuing negotiations. In this respect, it has become very clear that Beijing is correct to try and do a deal with Trump now since other future American presidents might prove much less friendly to Beijing amid growing evidence of anti-Beijing sentiment on both sides of the political aisle in Washington.

Democratic Congressmen have already begun to declare in public that Trump should not make too many concessions to China. While on Jan. 13 a bipartisan group of Republican and Democratic lawmakers introduced bills that would ban the sale of U.S. chips or other components to Huawei, ZTE or other Chinese telecom companies that “are in violation of the export control or sanctions laws of the United States”.

This is a reminder that national security issues remain hard to resolve, which is also why it is the base case here that they will be kept outside the current trade talks precisely because the Donald wants to “make a deal”. That means the current export controls will remain. Remember that the U.S. Department of Commerce added 44 Chinese entities to its export control list in August for posing a “significant risk” to U.S. national security or foreign policy interests. The export controls restrict companies’ access to products that America deems could have dual military or civilian use.

Meanwhile, after a lull in newsflow on the issue, there has also been renewed noise level on the Huawei extradition case. The U.S. Department of Justice announced on Jan. 28 that grand juries in Seattle and New York have issued indictments on 23 criminal charges against Huawei, its CFO Meng Wanzhou and some of its affiliates. In particular, Huawei and Meng are charged with conspiring to violate U.S. sanctions against Iran by doing business with Tehran through a hidden subsidiary. Canada’s Justice Department has also reportedly confirmed that officials have received a formal request for Meng’s extradition to the U.S.

China has offered to increase imports from America by a combined value of more than US$1 trillion over the next six years, seeking to reduce its trade surplus with the U.S. to zero by 2024.

The view here remains firmly of the view that Trump did not know about the arrest of Meng, the daughter of Huawei founder Ren Zhengfei, on Dec. 1. I also remain firmly of the view that the correction of the U.S. stock market when that news broke on Dec. 5 will have been a powerful signal to Trump of the economic risks that could result in implementation of the threatened hike in tariffs.

Meanwhile, one focus of the current trade negotiations is likely to be on China agreeing to buy American goods by a fixed amount to reduce the bilateral trade deficit with the U.S., as also leaked recently (see Bloomberg article: “China offers a path to eliminate US trade imbalance, sources say”, Jan. 18, 2019), as well as a general commitment by Beijing going forward not to offer market access as a quid pro quo for access to intellectual property. Bloomberg reported that China has offered to increase imports from America by a combined value of more than US$1 trillion over the next six years, seeking to reduce its trade surplus with the U.S. to zero by 2024. The offer implies increasing the annual imports from America from US$155 billion in 2018 to around US$200 billion in 2019 and about US$600 billion by 2024.

This is the kind of ‘win’ the Donald can sell to his supporters. Any kind of formal U.S. monitoring of Chinese compliance with the deal, as has also been rumoured, could prove a deal breaker with Beijing for cultural reasons.

China Trade of Goods with the U.S

Source: China General Administration of Customs, CEIC Data

Will the Donald Score a Second Win in North Korea?

One reason Trump is focused on North Korea is because he wants to register a ‘win’ in an area of policy where all of his predecessors have failed, and he may be trying to win the Nobel Peace Prize!

Moving on from the continuing Sino-U.S. discussions on trade, with Chinese Vice Premier Liu He having visited Washington on Jan. 30-31, there has also been further evidence that the Donald still wants to do a deal on North Korea. This was the announcement on Jan. 18 that a second summit between Trump and North Korean leader Kim Jong-un will be held in late February, most likely in Hanoi. This development followed a 90-minute meeting in the White House between Trump and North Korean lead negotiator Kim Yong-chol, a former intelligence chief of that country. It also follows Kim Jong-un’s four-day visit to Beijing last month.

One reason Trump is focused on North Korea is because he wants to register a ‘win’ in an area of policy where all of his predecessors have failed, and he may be trying to win the Nobel Peace Prize! Another reason is because he has seemingly taken the view, after meeting Kim personally at the Singapore summit last June, that the North Korean leader is serious about seeking to modernize his economy.

If this is the case, the street smart Trump will also understand that Kim is not going to agree to a deal based on the demands set by Washington’s national security hawks, such as national security adviser John Bolton. This is that America will not sign any peace treaty with Pyongyang ending the Korean War unless North Korea owns up to and shuts down all its existing nuclear facilities. This is why Trump needs the support of Xi to try to come up with some formula that bridges the current impasse. After all, China has long wanted Pyongyang to modernize its economy while Trump is not pushing a Korean reunification agenda.

It was interesting to read an article in Hong Kong’s South China Morning Post recently (“Nigerian mission ‘offers model to disarm N Korea’”, Jan. 20, 2019). It reported that nuclear experts from America and China had cooperated last year to remove highly enriched uranium from a reactor in Nigeria to prevent the material falling into the hands of “terrorists”. In this case the material was reportedly moved to China. The article speculated that a similar process could take place as regards the Korean issue in the sense that North Korean nuclear weapons or material could be moved to China. Clearly, however, such an approach would run contrary to Pyongyang’s core ideology of Juche which can be broadly translated as self-reliance. The question is what pressure Beijing can exert on Pyongyang. On this point, Kim has now visited China four times in the past ten months.