News in Charts: Phase one or Phase none?

Ever since President Nixon normalised relations with China in 1972 after years of diplomatic isolation, the relationship between China and the US has been strained. Competing ideologies and the battle to be the dominant global player has caused tensions over the years. These tensions have heightened during the current US administration, as President Trump’s America First policy has taken aim at China. Central to this is the famous ‘trade war’ between China and the US, in which President Trump slapped tariffs on Chinese goods in order to try and correct the ballooning trade deficit between the pair.

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In order to scale back trade tensions, in January 2020 a Phase one trade agreement was signed. This deal stipulated that the US would cut tariffs in exchange for the centrepiece of the deal — that over the following two years China would purchase $200bn more of US goods than it did in 2017. $32 billion of these extra imports were to come from additional farm product purchases. At the time the deal was signed, we commented that to scale up imports of that magnitude was unrealistic in a short period of time. Couple that with a global pandemic and, as the chart below shows, China is further away from reaching the Phase one commitment than it was when the deal was signed. Despite these shortcomings, following a discussion between the two global powers at the end of last month, the Office of the United States Trade Representative claimed in a statement that “both sides see progress and are committed to taking the steps necessary to ensure the success of the agreement.”

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Although the Phase one progress talks seemed mistakenly optimistic, this is not representative of current Sino-US relations. Since the start of the year, already fraught relations have taken a turn for the worse. Disagreements over the origins of the virus, human rights abuses, the Hong Kong security law, the South China sea and Huawei to name a few have dampened relations between the pair. This has led to the expulsion of journalists and closing of consulates. The spread of COVID-19 has made matters worse, with the US disproportionately worse affected than China.

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It is not just the numbers that is a cause of concern for Sino-US relations, it is also China’s recovery plan. We have been telling our clients that China’s strategy to navigate out of the COVID-19 induced economic crisis is to double down on old drivers of growth, such as investment. With a consumer environment struggling to bounce back, this strategy is causing a disparity between the consumer economy and the stimulus-powered producer economy.

Chinese retail sales, which give us an indication of the strength of the consumer economy, have only just reached positive growth territory, up 0.5% in the twelve months to August. This is in stark contrast to measures of the producer economy, which have been in positive growth territory for many months. With goods being manufactured and domestic demand in the doldrums, this excess capacity may well be sold to international markets, and perhaps at a discount, just as China has done in the past. Raw monthly data from China are already suggesting that this is translating into an increase in China’s trade surplus with the US, which would be a significant blow to President Trump.

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Months of heightened tensions culminated in President Trump suggesting that the US and China should decouple. Although unlikely, this threat is not to be taken lightly — a full termination of economic relations with China would cause a lot of pain and disruption on both sides of the world. Looking ahead, it is likely that tensions will increase in the run-up to the US election. In terms of the Phase one deal, there are many signs that suggest this will soon be a Phase none deal.