Phase One China Trade Deal Faces Moment of Truth

  • The US and China are expected to sign the phase of the US-China trade deal next week. The two sides agreed to the agreement in December and eased some of the tariffs as part of the deal.
  • Uncertainty over US-China trade relations has rattled global markets over the last two years. However, optimism over phase one of the trade deal helped lift sentiments in Q4 2019. Both the Dow Jones Index (NYSEARCA: DIA) and the S&P 500 (NYSEARCA: SPY) hit record highs in December. But then, phase one faces a moment of truth this week. As they say, the devil is in the details!

Phase one of the US-China trade deal

Chinese Vice Premier Liu He is expected to travel to the US next week to sign phase one of the US-China trade deal. Both the US and China agreed to the trade deal in December. While both the countries eased some tariffs, there were few details on what all would be covered under phase one trade deal.

As the two countries get to the signing table, we might finally get more information on the trade deal. Phase one of the US-China trade deal faces a moment of truth this week. Let’s discuss this in perspective.

China to buy $50 billion of US farm goods?

President Trump said that China will buy $50 billion of US farm goods as part of phase one of the US-China trade deal. Notably, Trump has frequently talked about a hard number on China’s proposed purchase of US agricultural goods. However, China hasn’t committed to any number yet. According to a CNBC report, China imported only $8.6 billion of agricultural products in 2018. So, buying $50 billion of US farm products a year looks like an uphill task.

Furthermore, there are three ways in which China can increase its purchase of US farm goods. First, it can substitute some of its domestic production with US farm goods. Second, it can replace imports from other trading partners. Third, it can change some policies that would enable the country to increase imports of US farm goods.

How realistic is the $50 billion target?

Replacing domestic production with US imports would impact Chinese farmers. However, being a planned economy, China can shift some workers engaged in the agricultural sector to other industries. It did something similar when it curtailed some of the steel and other polluting industrial units.

However, a slowing Chinese economy does not give its leadership the privilege to absorb farmers to other industries. Despite phase one of the US-China trade deal, China’s economic growth in 2020 is expected to be slightly lower than in 2019.

Now, if China replaces imports from other trading partners with US imports, it wouldn’t sit well with other countries. After all, China runs a trade surplus with other countries as well. So, it could face the ire of other nations if it lowers farm goods purchase from them.

Incidentally, China contracted huge volumes of soybean from Brazil, according to a Reuters report. So, despite the trade deal, China is not cutting back on farm good purchases from other countries.

Phase one US-China trade deal faces a moment of truth

Also, the report cited an unnamed source that said, “Beijing has suspended its plan to implement a nationwide gasoline blend containing 10% ethanol this year. The plan had spurred hopes of a jump in U.S. exports of the biofuel to China, as well as shipments of U.S. corn to produce it domestically.”

In a nutshell, it looks highly unlikely that China would be able to buy $50 billion of US farm goods immediately as part of phase one of the US-China trade deal. At best, China can incrementally increase its purchases of US farm goods. But here again, when the figure reaches $50 billion is anybody’s guess.

China’s commitment to buy US farm goods as part of the phase of the trade deal is not the only thing that markets are watching for in the draft. President Trump made several demands from China apart from bridging the trade deficit. Read Analyzing Trump’s Seven-Point Wish List for Xi Jinping for a detailed analysis of what Trump wants from China.

For now, some of the contentious issues might be rolled under the carpet to make way for phase one of the US-China trade deal. The two countries intend to discuss these issues as part of the deal.

Structural issues

That said, if none of the structural issues form part of phase one of the US-China trade deal, it could come out as a disappointment to Trump’s supporters. Mere vague promises to address the structural issues won’t justify the pain that the trade war inflicted.

Not to mention, Democrats may seek even more from China. Incidentally, Democrats played hardball on the USMCA as well. The deal had to signed for a second time in December to incorporate their suggestions.

Unlike USMCA, phase one of the US-China trade deal would not require the support of Democrats for ratification. All said, they would criticize Trump if phase one trade deal does not bring tangible and substantial benefits. Read China Trade Deal to be Signed: Sell the News? for more analysis.