Not much is certain these days, and the things we know with something approaching certainty are mostly bad.
For example, we know it is highly unlikely that China is going to live up to its commitments under the “phase one” trade pact.
Markets always doubted the deal for a laundry list of reasons, not least of which is that both parties to the agreement (China and Donald Trump) are notoriously unreliable and prone to negotiating in bad faith. Further, China can only be pushed so far before the need to preserve national pride overrides economic expediency, while Trump is so vain that he cannot suffer even minor slights without losing his temper.
The deal (if you can even call it that) was thus destined to fall through on any realistic assessment, although most observers (myself included) assumed both sides would attempt to preserve the optics even as it became apparent that the targets weren’t being hit.
COVID-19 changed the game entirely. Premier Li Keqiang emphasized China’s commitment to honoring the agreement while speaking at the NPC this week, but lip service is just that. And the fact that Li abandoned China’s 2020 growth target during the same speech speaks volumes about the extent to which the virus has changed the economic game.
The point is that even if tensions between the world’s two largest economies hadn’t escalated, it would be highly unlikely that China would be able to live up to the deal.
“It is becoming increasingly obvious that China will not come close to hitting the quotas in ‘phase one'”, BofA wrote, in a note out earlier this month, just prior to when some of the more inflammatory rhetoric started flying.
“To reach the targets laid out in the deal, China would need to nearly double its imports of manufacturing goods in 2Q-4Q on a YoY basis, and increase its imports of agricultural goods by around 150% YoY”, the bank went on to say.
That’s a pretty laughable gap to fill, especially in the midst of the worst global economic downturn in a century.
To be sure, this depends in part on domestic demand, so if China does manage to engineer anything that approximates a V-shaped recovery, I suppose it’s possible they can ramp up imports. But the latest read on PPI deflation suggested demand is subdued, although robust credit growth offers some hope.
For now, there are conflicting signals. Pork shipments to China surged early in 2020, for example, but that’s more out of necessity (pork prices have obviously spiraled out of control in China) than anything else.
It’s not clear how much US meat China will want in the months ahead considering how prevalent the virus is in American meatpacking plants. Last week, Li Qiang, chief analyst with Shanghai JC Intelligence, said China refrained from buying “millions of tons” of US corn due to souring relations.
Since BofA’s warning on May 8, the situation has deteriorated markedly. Here’s a quick recap (and it really is crucial to keep apprised of this):
- US lawmakers have pressed for sanctions against Chinese officials in connection with human rights abuses in Xinjiang, and the House intends to consider legislation on Wednesday
- A separate piece of legislation championed by Lindsey Graham calls for additional sanctions in the event Beijing doesn’t provide a satisfactory account of COVID-19’s origins
- The White House moved forward with the first capital restrictions aimed at choking off investment to Chinese equities
- Both the Senate and the House are angling to pass legislation that cracks down on Chinese listings on US exchanges.
- The Senate is pushing legislation to sanction China in connection with new national security laws Beijing plans to impose on Hong Kong
- The Commerce department put new rules in place designed to further strangle Huawei
- Commerce also blacklisted multiple Chinese entities in connection with national security and human rights abuses
All of that has played out over the past two weeks (give or take) and it speaks to the fact that “Cold War 2.0” is “still a thing”, as I put it earlier this month. In fact, Sino-US relations are easily the worst they’ve been under the Trump administration.
For BofA, relations between the world’s two largest economies aren’t likely to improve all that much regardless of who wins the election.
“The stakes keep getting higher”, the bank said, adding that “some movement towards decoupling seems inevitable once the election is over and once the economy is less fragile”.
Previously, BofA assumed tech would be the focal point of the decoupling. “The tech war gets to the heart of the superpower rivalry… as domination in tech is the key to both economic and military” prowess, the bank’s Aditya Bhave and Ethan Harris remarked.
Now, though, they’re concerned that medical supplies are at risk too, with a greater chance of “broad-based damage to supply chains”.
That would not be good news. I’ve long warned that severing supply chains cultivated over years of globalization poses a massive economic risk we cannot even begin to quantify. Bhave and Harris strike a cautious tone in that regard without resorting to hyperbole. “Optimists seem to view decoupling as a zero-sum game in which supply chains shift and growth goes on [but] we see a very big disruption if the movement in supply chains is forced”, they wrote.
And speaking of optimists and pessimists, here are the bank’s updated forecasts for the US economy (current as of Friday):
While lecturing political advisers in Beijing at the NPC sessions on Saturday, Xi said he won’t let China drift back to a total command economy. “We’ve come to the understanding that we should not ignore the blindness of the market, nor should we return to the old path of a planned economy”, he said.
While discussing development, he called the world “increasingly unstable and uncertain”.