March 14, 2019
Scott Miller: I'm Scott ...
Bill Reinsch: I'm Bill ...
Scott Miller: ... and we're The Trade Guys.
Bill Reinsch: ... and we're The Trade Guys.
Andrew Schwartz: You're listening to The Trade Guys, a podcast produced by CSIS, where we talk about trade in terms that everyone can understand. I'm H. Andrew Schwartz, and I'm here with Scott Miller and Bill Reinsch, the CSIS Trade Guys.
Andrew Schwartz: In this episode, it looks like the US and China are finally closing in on a trade deal.
[Bob Lighthizer via news clip]: What we want is fair trade that requires structural change, and it has to be enforceable.
Andrew Schwartz: So is it a good deal? Was it a win for the US, and what does this mean? Also, this is the one-year anniversary of the steel and aluminum tariffs.
[Donald Trump via news clip]: When they raised their tariff from 10% to 25% and then to 40%, we should have been doing the same thing to them.
Andrew Schwartz: We'll discuss all that and more on this episode of The Trade Guys.
Andrew Schwartz: Gentlemen, China and the United States are in the final stages of completing a trade deal it's been reported, with Beijing, and China's offered to lower tariffs and other restrictions on American farm, chemical, auto and other products while Washington is considering removing most if not all of the sanctions levied against Chinese products since last year. What do you think? Is this the real deal? Is it really happening?
Scott Miller: Doesn't look to me like anybody's blinked at this point.
Andrew Schwartz: Okay.
Scott Miller: We always thought there were going to be at least three components to this program that would get agreed. The first was a market access component. The second is an improvement in the structural conditions of commerce in China for American firms, specifically contestability of markets and intellectual property protection, and third, some set of measurements, some set of monitoring and enforcement actions if the Chinese did not live up to their bargain.
Scott Miller: So what we have in the news today is pretty much basket one. We have some news about market access, so there's some commitments to purchase US products at a higher level, there is a commitment first to ethanol, then to natural gas, although that will take a while to build the export terminal, and so that's probably up to 2023 export. But still, the commitment is pretty important.
Andrew Schwartz: But that's a ... The gas deal's a big deal. We're talking about $18 billion?
Scott Miller: Well yes, over time, it'll add up, and we happen to have a lot of it, and China has needs. So that's all good, and farm products are part of this, whether it's ethanol or soybeans. And so the market access part is coming into some degree of resolution, which has always been the easiest part. What we don't know much about yet are the structural changes, and so presumably the group is working on it. There's a lot of documentation behind this, and I imagine there's a lot of work yet to be done.
Andrew Schwartz: But there are skeptics about this, right Bill?
Bill Reinsch: Yes. Scott's talked about what's in it. What's missing seems to be anything on reining in state-owned enterprises, which has been an American ask, doing anything about subsidies, which has been another big American ask.
Andrew Schwartz: Right.
Bill Reinsch: Even ... I don't see forced technology transfer being mentioned in the most recent articles.
Scott Miller: The one thing that was there was apparently allowing higher shares of foreign ownership in the auto sector, which would at least take people off your board in China who might be interested in technology transfer.
Bill Reinsch: Yes, a small step.
Scott Miller: Small step in only one sector.
Bill Reinsch: Yes, only in that sector. The other place where they seem to be clearly not yet in agreement is the enforcement part of the package, the third part of the package, where Ambassador Lighthizer has been deeply skeptical that the Chinese will keep their word whatever it is they commit to, and wants to build in basically procedures that will allow the United States to unilaterally determine Chinese compliance, and then unilaterally take steps to retaliate if we determine that they have not complied. With the Chinese not being able to counter-retaliate.
Bill Reinsch: China as you might expect is not happy about that. We'll see how that turns out, but that's a pretty significant step. I think what it leads to for ... I think Lighthizer's doing it because he wants to be in kind of a failsafe position if the agreement ends up being weaker than he would like, which is the way it's going right now.
Bill Reinsch: I think he at a minimum wants to be able to prove that they haven't complied if that's the way it turns out and set up a situation where the United States will be able to act in the future. That poses some significant political risk for the President, I think. He may want to reach agreement this month, and if he does, market bump. End of trade war, the businesses will say. People will-
Scott Miller: Victory will be declared.
Bill Reinsch: Victory will be declared. It will also be the greatest agreement in history. We've already decided that.
Andrew Schwartz: But hold on. The president's former brain, Steve Bannon, says that for him to get the structural reforms that he really needs, it's going to take all of 2019 to negotiate it.
Bill Reinsch: Well, Bannon has a good point, but the danger is, and we've said this before, is that the President will undercut his own people by agreeing to something less than that sooner than that, and-
Andrew Schwartz: For the immediate bump.
Bill Reinsch: For the immediate bump, and then the question will be, "Where are we a year from now?" The only path I think to political success for the President is if it's A, a strong agreement, and B, the Chinese honor it. Those are both heroic assumptions. I think it's increasingly likely that where we end up a year from now is the agreement turns out to be not as great as he said it was, and B, the Chinese aren't implementing it anyway, which puts him back in the position of business saying, "What happened?" Nothing.
Andrew Schwartz: So not the most beautiful agreement in the history of the world.
Bill Reinsch: Not the most beautiful agreement. And the President then starts talking about more tariffs to retaliate, because Lighthizer has set up a structure in which we can do that if they haven't complied, and so we're really back where we're started from, but it's a year closer to the election.
Andrew Schwartz: Yeah, hot mess going up in flames right on the eve of a political brawl.
Scott Miller: Total return to square one, and it will look like a big waste of time.
Andrew Schwartz: Yeah. Let me ask you guys this: doesn't the President need a big win coming off the Vietnam summit?
Bill Reinsch: Well, yes. There's a very interesting debate about that, and it seems to be sort of half and half. Half the people say, "What happened in Hanoi is he proved he could walk away."
Andrew Schwartz: Right, sometimes you gotta walk.
Bill Reinsch: Sometimes you have to ... It's like The Gambler: you know, gotta know when to hold 'em and know when to fold 'em, and know when to walk away and know when to run.
Andrew Schwartz: Yeah, the great Kenny Rogers.
Bill Reinsch: Never count your money while you're sitting at the table.
Andrew Schwartz: Ah, that is words to live by.
Bill Reinsch: It's every day. Anyway, that he demonstrated that he was willing to do that, and that therefore, says one theory, the message to Beijing is he might do it again and you better shape up and offer more.
Bill Reinsch: The other side argues, "No, no, no, no, no. That's wrong. That having done that with Korea, he now has to have an agreement with China, because otherwise it looks like he can't negotiate anything, and he needs a victory. And so the message to China is he'll take anything; hold firm."
Andrew Schwartz: 'Cause the Great Deal Maker can't make a deal.
Bill Reinsch: Yes. And I don't know which is true.
Andrew Schwartz: Scott, what do you think?
Scott Miller: Well look, I think those are the two scenarios. I think we'll find out, based on the next couple, three weeks, whether there is an alternative offer from North Korea or a proposal for yet another meeting. That may be the best way to get any understanding of what the North Koreans took away from this. If there's progress toward another summit, which national security advisor Bolton mentioned could well happen, then all of a sudden, walking away looks like the right thing to do.
Bill Reinsch: Hard to see that in the short term.
Andrew Schwartz: All right, but you guys brought up something interesting, and I want to ask you this: can we actually trust the Chinese to keep their word?
Bill Reinsch: Lighthizer thinks not. There are some good reasons to think not. My experience with them has been that if you can get them to make a specific, identifiable quantitative commitment, for example, you know, "We will reduce this tariff to zero in 90 days," if you can get them to commit to that, their record of compliance is pretty good. And it's pretty good because it's measurable; you know, if they don't do by the date they said they would do it, it's obvious. So they're good at honoring the letter of their commitments.
Bill Reinsch: They're not very good at honoring the spirit of the commitment. And if you negotiate an agreement that says, "We'll treat foreigners fairly," or "We won't do ..." A classic is, you know, "We won't do forced technology transfers." If you look at their WTO accession agreement, that's what they said. The government won't force technology transfers. And they don't, but what happens is the government says, "You have to have a joint venture partner." And then when you start negotiating with your potential joint venture partner, who's Chinese, that partner says, "Well, we have to have technology transfer as a condition of entering into the partnership." The government says, "We have clean hands. This is a negotiation-
Scott Miller: Private transaction.
Bill Reinsch: ... between two ... a transaction between two companies. We're not forcing it." But the result, and of course the Chinese company is doing what the government's telling them to do, but on the surface, this is just a private transaction. So when you don't negotiate things like that, that's what you get.
Scott Miller: Over the long run, so since WTO accession for China, so that's what now, 18 years? I think it's fair to say when China sees it in their interest to engage in reform, they're actually pretty good at delivering it. And in the early days of their accession to the WTO, there were dramatic changes in transparency, dramatic changes in sort of both rule-making and implementation of rules. The business environment got a lot better very quickly, and clearly that was part of their economic strategy at the time. So I think whether or not they can be trusted now, depends in large measure whether they're convinced that the steps that we are insisting that they take are in their interests or not.
Bill Reinsch: The WTO-
Scott Miller: Right.
Bill Reinsch: When they lost a tax case on the VAT, they complied and got rid of the offending measure. When they lost a case about movies, they cut a deal. And you can argue about whether or not it's a good deal. I mean, they and the Americans cut a deal. You can argue about whether it's a good deal or not-
Scott Miller: But they settled the case.
Bill Reinsch: They settled the case, and they've complied with the settlement. When they lost a case involving Visa and MasterCard, they haven't complied, and they've strung that along for now what, five years?
Scott Miller: Five years. Something like that.
Bill Reinsch: So it's a mixed bag. When they lose a case that really matters to them, they're not always there, you know.
Andrew Schwartz: So what's their incentive to change? What's their incentive to have a deal with us if they can just continue to, you know, cheat the deal, ignore the deal, put a good face on the deal?
Scott Miller: Well, Bill's talked about this a couple of times. Look, they have two goals. One is economic growth, and the second is social order. And sometimes those-
Bill Reinsch: Which means party control.
Scott Miller: Party control, okay.
Andrew Schwartz: Can't they just enforce the control and clamp down, and can't they kind of make up the growth within a certain-
Scott Miller: There are limits.
Andrew Schwartz: ... [inaudible 00:11:25] growth?
Scott Miller: And a bad economy makes it more difficult.
Bill Reinsch: This is a country that acknowledges publicly between 100,000 and 200,000 demonstrations a year.
Scott Miller: Right.
Bill Reinsch: Most of them are not against the national government. Most of them are against basically some local party official who confiscated land from 12 peasant farmers so that his nephew could build a shopping center, and the national government has been adept at pushing that down and directing the irritation at lower levels, and then occasionally coming in and saving the situation. But they're nervous, and if you look at the history of China, small things become big things very quickly.
Bill Reinsch: This is a government that understands deep in its heart that it doesn't have any inherent legitimacy. It is tolerated by the public because it's produced an astonishing record of economic growth. That's a record of economic growth that is beginning to decline. We think it's beginning to decline because Xi Jinping has chosen to emphasize control over growth, channeling more money to state-owned enterprises, more control over the economy, starving private companies of credit. He's doing exactly the wrong thing for growth because he thinks that it provides more control.
Bill Reinsch: Probably in the long run, it's going to lead to less control, because it's going to produce more grumpy people. But that's the dilemma that he's had.
Andrew Schwartz: Haves and have nots.
Bill Reinsch: Yes.
Scott Miller: And very few haves.
Andrew Schwartz: Very few haves, and then you're also going to have people ... How long can they maintain the iron fist? When is the next generation that doesn't remember Tiananmen Square going to pop up and say, "Hey, we can do this."?
Bill Reinsch: It's becoming a less equal society. One of Deng Xiaoping's famous quotes when he changed their economic policy in 1978 was to say essentially, "Look I can distribute poverty or I can distribute wealth." And everybody in China was equal in 1978-
Scott Miller: Equally poor.
Bill Reinsch: And they were all poor. And Deng said it would be better to distribute wealth. The consequence of doing that, which was moving to a market economy, is you have to tolerate a level of inequality, and that's what's happened in China. That does make some people unhappy.
Andrew Schwartz: China has an awful lot of billionaires now.
Bill Reinsch: More than we do.
Andrew Schwartz: There are neighborhoods.
Bill Reinsch: Maybe because they have more people than we do.
Scott Miller: There are neighborhoods in Shanghai which are wealthier than the Upper East Side of New York City. There are also people living in the Bronze Age out in the country, with a one acre plot of land.
Bill Reinsch: No electricity and no running water.
Scott Miller: Everything in between.
Andrew Schwartz: So where does this leave Ambassador Lighthizer as he tries to negotiate these rough waters?
Scott Miller: Well look, he's going to try to document this. It's his pattern and his discipline to get everything as nailed down as possible, to have snap-back provisions which we've talked about, where if the Chinese don't comply in the mind of the US officials, that we can implement negative actions that they can't retaliate against. But I also think he probably worries as Bill has mentioned in the past, that he'll be undercut in the final deal, so he's probably trying to ensure that doesn't happen.
Bill Reinsch: This is his insurance for when Trump s-
Andrew Schwartz: Undercut by the President. Yeah.
Bill Reinsch: This is his insurance for when Trump sells him out. You know, he's going to create a-
Andrew Schwartz: And you're convinced Trump's going to sell him out?
Bill Reinsch: It's going that way right now, judging from all the tweets. It looks like the President wants to make a deal, and based on the newspaper reports of the weekend of early March, it's heading in a direction of not addressing the significant structural issues that Lighthizer and Navarro have demanded, but addressing a lot of other stuff that would be good. This is not a bad agreement, but it won't be everything that Lighthizer wants. And I think he's trying to build in enforcement provision, so a year from now, they can come back and try for a second bite of the apple, basically.
Andrew Schwartz: Alright so do you guys think that this is something that's going to be an actual achievement, something that is better than what we had before? Something that America and the President can point to as a success?
Bill Reinsch: Well, he'll say it is.
Andrew Schwartz: Well, but will it be?
Scott Miller: Well look, here's the thing. First, I think the odds of a failure at the end here a very low because look, the meeting between President Trump and President Xi is going to take place in the United States. You don't have a meeting on your home court and let it go bad, so I just think the probability is for success. But also, I think the President can use even a minor success, even on just a market access win, to bolster his support among the American people for continuing pressure on China. Look, for all the irritants of the President's trade policy, the one area where he has clear-cut public support, and largely support from the Congress, is on dealing with China, so I think he takes this as a down payment. At worst, he takes the market access as a down payment, says, "We've still got some things to work on but thanks for coming. Here is my hearty handshake, and let's have dinner."
Andrew Schwartz: Yeah, he thinks this is a winning issue for him either way.
Bill Reinsch: That works if the Chinese acknowledge that there's going to be a second bite.
Scott Miller: There is more work to do.
Bill Reinsch: I mean, if I were the Chinese, I would say, "This is it. This is it for the next five years, the next 10 years. We made all these commitments and you're not getting anything else. Don't come back."
Scott Miller: "We're done."
Bill Reinsch: "We're done." Now, that doesn't mean that that's what they'll say, but you'll see it in what happens with the tariffs, because what the Chinese are saying is as a condition for whatever we agree to, all these tariffs need to go away. And what I think the US administration is saying, is, "Not right away. Let's see if you comply, and let's wait. We won't add them, we won't raise them-"
Andrew Schwartz: "And if you cheat, we're going to snap back."
Bill Reinsch: Well, they'll say that, but they can always say that. The question is, what happens in the short run. The Chinese are going to say, "Get rid of at least the $200 billion that you added on," and I think Trump's going to say, "No, we're going to keep them for a while to see if you guys comply, and you're going to see an agreement with lots of checkpoints, benchmarks." I mean, Lighthizer alluded to this last Wednesday when he testified before the Ways and Means Committee, where he talked about basically a three-level process of director level, vice minister level, minister level, to address inadequacies, conflicts, things that are not happening. The important statement he made was at the end, he wants the United States to be able to do what it wants. But there's going to be this process along the way.
Bill Reinsch: We had a very interesting conversation last Wednesday at CSIS when we had a trade event on affirming America's leadership and we had some breakout sessions. Scott was in one of the other ones, but there was a breakout session on China, where the debate was do we engage or do we disengage? And the proponent of disengaging was the former Mexican ambassador to China, Jorge Guajardo, who made a very interesting comment, in which he says, you know, "With the Chinese, when you start talking about process, that means they're winning."
Scott Miller: Why is that?
Bill Reinsch: Because they are masters of dragging out the process.
Scott Miller: They love process.
Bill Reinsch: They love process, and they can make a process that is endless. So if you get sucked into process, that means they win. Lighthizer knows that, which is why every time he talks about process, he says, "Well, you can have a process, but at the end of the process, I get to do what I want." And that of course is what the Chinese want to stop.
Andrew Schwartz: Okay. So we're going to have to wait and see, like always with this, but are we-
Bill Reinsch: I suspect we'll be talking about it again.
Andrew Schwartz: Yeah. So we're cautiously optimistic here, I guess?
Bill Reinsch: I don't know what that means.
Andrew Schwartz: I don't know.
Bill Reinsch: I think he'll make an agreement.
Andrew Schwartz: Right.
Bill Reinsch: Whether it's a good agreement ... It won't be a good agreement in the sense that it solves all the problems that they've said are very important to solve.
Andrew Schwartz: But we'll have some kind of an agreement.
Bill Reinsch: Yes, and let's not underestimate the advantage. The people who are going to sell all that gas, and all those soybeans, are going to be happy.
Andrew Schwartz: Yeah, sure.
Bill Reinsch: And in the process, it will solve a bunch of outstanding issues. I think they'll address the MasterCard/Visa licenses, probably too late, but, you know, they'll do it. They'll do something on beef. The Chinese will get us to do something on chickens, because there is going to be an element of [crosstalk 00:19:22].
Andrew Schwartz: Soybeans are going to be okay for us.
Bill Reinsch: Soybean people will be happy. A lot of cats and dogs will get taken care of.
Scott Miller: But those boxes usually get folded into a big deal, and they're important to the constituencies who put them on the list in the first place, so that's good.
Andrew Schwartz: This is complex stuff, no doubt. Let's switch gears a bit. We're on the anniversary, the one year anniversary, of steel tariffs, right?
Scott Miller: Correct. March 1st with the implementation.
Andrew Schwartz: Okay. So did the predictions come true? What effect have they had? And has the economy ... How's the economy fared?
Scott Miller: Look, I think the economy's holding up just fine. One of the hardest things to find in American economic output, in the reports that are issued by various government entities ... The hardest thing to find is where the higher prices of steel actually went, because consumer pricing has been very steady. The consumer price index is well under control, even when adjusting for the big declines in energy prices. So the CPI hasn't been bothered; US economic growth seems robust. The steel-producing industry itself which this measure was by and large targeted to support, has achieved the targeted capacity level that the original proposal was intended for them to achieve, which is to be operating at 80% capacity. Now, prices are higher both at for US products and for imported alternatives. Imported products are higher prices because of the tariffs themselves, and the steel industry priced up to meet that for their own internal profitability needs.
Scott Miller: For me, one of the outliers is what investors think of the US steel industry, because the year before the steel tariffs, American steel producing companies as a whole kind of tracked the major market averages. Since the tariffs, steel industry has declined about 22% in market capitalization and stock value, while the total market has been about flat. And so this is a mystery to me, why investors are deciding the steel industry is less worth investing in than it was a year ago. I wouldn't have expected that, but likely the steel industry has had as much harm as help from the tariffs, because they have inputs.
Bill Reinsch: We have not changed ... I don't think we've changed the long-term fundamentals. I used to do steel when I was on the Hill, ran the Senate steel caucus for I think 17 years. And one of the things-
Andrew Schwartz: Bill Reinsch: The Man of Steel.
Bill Reinsch: Well, not any more. But a long time ago.
Scott Miller: It's turned to rust.
Bill Reinsch: Well, yeah I have. [inaudible 00:21:53].
Andrew Schwartz: As Neil Young said, "Rust never sleeps."
Bill Reinsch: Right. It's frustrating because basically, there are market fundamentals here that are more determinative. The United States, since the 70s, has taken a series of actions to help insulate the steel industry from what have been very clearly unfair trade practices by other people. I mean, they're up against subsidies, they're up against dumping, they're up against national policies to create national champions in the steel sector. They've had generations of unfair treatment.
Bill Reinsch: There's one of those in place right now, what we're talking about, the tariffs. Despite all of that, what's happened to our industry is that they're making about as much steel as they ever made with about one fourth of the workers. And what you've seen is productivity improvements largely driven by technology improvements, have not saved the workers.
Scott Miller: And won't, quite frankly.
Bill Reinsch: And won't. There are larger macro issues at stake here, sadly, and I think if you're an investor, you've got to look at this industry and say, "At some point, these tariffs are going to go away," probably sooner rather than later on Canada and Mexico, and if I'm going to invest, first of all a steel plant is not a short-term investment. You're investing for a generation, and you've got to look at that with some jaundice, I think.
Scott Miller: And of course, within the industry there's a range. For the last decade or so, AK Steel has been a relatively poor performer. Nucor Steel has been a relatively good performer within the industry, because of their different approaches to the business and different strategy and different cost structure. But overall, you're right; the fundamentals of steel production in the United States are unchanged, and that may be the bottom line on investor skepticism.
Bill Reinsch: Well, plus people are waiting. I mean, Scott has said famously several times here that it's very hard to measure things that don't happen. You know, if people don't invest in something, you don't know that they haven't done that necessarily, and if they have ... And you don't know why. And it could be simply that people are uncertain about the future of these things, and they're waiting to see.
Andrew Schwartz: The tariffs were meant to help US businesses, right?
Scott Miller: US steel-producing businesses, yes.
Andrew Schwartz: But who have they helped? So they've helped who? And who have they hurt?
Bill Reinsch: They've helped steel companies.
Scott Miller: I think the President would claim that they would help steel companies and steel workers. Okay, then new plants that reopened. Both steel and aluminum businesses. So he would point to specific results like that. But the fact is, these overall dynamics are very hard to change.
Bill Reinsch: They've hurt the people that are downstream.
Scott Miller: Yes.
Bill Reinsch: The people that-
Scott Miller: Purchase steel.
Bill Reinsch: That buy steel to make it into something else. And they've kind of taken a double hit, because their input has become more expensive if they import, and thanks to the retaliatory tariffs from others, their end product has become more expensive when they try to export it.
Andrew Schwartz: So is this going to be a stumbling block to the ratification of the USMCA?
Bill Reinsch: Seems like it.
Scott Miller: Well look, I think that many members of Congress are making the removal of Section 232 tariffs on steel and aluminum for Mexico and Canada a threshold issue in the consideration of USMCA. They've given the administration a pretty clear message: lift the tariffs, and if we're like Mexico and Canada, we'll lift the retaliation before we can even talk about the USMCA. So that part of it ... But keep in mind, these are global tariffs, and there's still a number of major importers where we've not come to any agreement.
Bill Reinsch: And there are members of Congress who like the tariffs, because they represent steel districts and I think they have yet to weigh in on this. It'll be an interesting debate. It won't be unanimous.
Andrew Schwartz: To our listeners: if you have a question for the Trade Guys, write us at firstname.lastname@example.org. That's email@example.com. We'll read some of your emails, and have the Trade Guys react to it. We're also now on Spotify, so you can find us there when you're listening to the Rolling Stones or you're listening to Tom Petty or whatever you're listening to. Thank you, Trade Guys.
Bill Reinsch: Thanks, Andrew.
Scott Miller: Thank you.
Andrew Schwartz: You've been listening to The Trade Guys, a CSIS podcast.