China Trade Talks Outcome Uncertain–But Market Reaction Even More Difficult To Read

Today, a day when the U.S. financial markets seem to be in a mood to worry about China, is a good time to look at the likeliest outcomes of the U.S.-China trade talks and the likely market reaction to those outcomes.

The clock is ticking on the Trump administration’s deadline of March 1 for settling the U.S. trade dispute with China.

After President Trump declared this week that there would be no deal until he met with Chinese President Xi Jinping and that he would not meet with the Chinese leader until after the March 1 deadline, global financial markets developed a mild case of the worries.

The most likely outcome, the market consensus holds, remains an extension of the deadline and then a face-saving deal that has Chinese promising to buy enough U.S. goods to eliminate the U.S. trade deficit with China over some period of time. The Chinese have already put this framework on the table and if U.S negotiators could get the Chinese to tweak that proposal enough to eliminate the trade deficit earlier, add some means of verification, and maybe even up the total purchases, then I think that’s a deal that the Trump administration could accept.

“Could.” If U.S. China trade hawks such as Peter Navarro convince President Trump that China has to agree to restructure its economy and give up on its plans to dominate 10 global growth industries via subsidies and technology transfer agreements, then the talks are dead, the penalty 25% tariffs get imposed, and the global economy heads off into chaos. In my opinion there’s just about zero chance that President Xi will agree to the level of restructuring of the Chinese economy that the U.S. has proposed. It would be seen as caving into U.S. power and an abdication of Chinese sovereignty by a Chinese leader who has bet his reputation on restoring China to its “rightful” place in the world political and economic order.

At the moment, the market is focused up the question of “will they/won’t they” negotiate a deal. Understandably so since a failure in these talks would open the global economy to the possibility of a major collapse in growth.

But beyond the issue of how the talks will be resolved, there’s an equally important issue of what happens to the Chinese and global economies after a successful conclusion to the talks.

The consensus opinion in the markets is that the successful conclusion to these negotiations would lead to a strong rally in U.S. and Chinese stocks and in global financial assets in general. That makes sense since a successful end to these talks would removed a huge uncertainty that is now hanging over asset prices.

And please note that I’m intentionally not defining what “success” means here. In the period immediately after the successful conclusion of these talk, success is whatever the participants in the talks and the financial markets say it is.

But what if the successful conclusion to these talks doesn’t result in a significant uptick in economic growth in China and the United States in particular and the global economy in general.

China’s economy has problems that aren’t addressed in any way by trade talks with the United States. The banking and corporate sectors are dragging around a mountain of bad debt. Chronic structural inequalities in the system–the migrant worker system that excludes hundreds of millions of Chinese from education, healthcare, and retirement benefits; and depresses wages to such an extent that it slows economic growth for the country as a whole. The infrastructure engine that the Beijing government has been able to fire up whenever it needs to juice economic growth is increasingly inefficient when it comes to turning yuan in new spending into points of GDP growth.

The world’s developed economies all are forecasting a slowdown in growth that seems unlikely to be fixed by any China deal. An end to the possibility of a global trade war will certainly help export economies such as Germany and U.S. exporting companies such as Boeing and Caterpillar, but the global demand slowdown isn’t simply a result of the Trump administration’s tariff policies. The world’s central banks, which have by and large cut their projections for economic growth and moved to provide additional monetary stimulus for their home economies, recognize by those actions that any U.S.-China trade deal won’t fix the demand side problem. (And then, of course, there’s the possibility that these stimulus plans will make the looming global credit crisis worse. But that’s a problem for another day.)

In other words, there’s a very good possibility that a successful conclusion to the U.S.-China trade talks won’t fix the global growth problem.

Which argues that any rally after the announcement of a successful end to the talks would be an occasion to sell before disappointment on the continuation of lagging global growth has a chance to set in.

I don’t think we’re yet at the point of selling the news of a successful conclusion to the talks, but that is an alternative that Wall Street is starting to consider.

Buying China now is a bet that the talks will be successful–by no means certain.

Buying China after the successful conclusion of these talks is a bet that growth in the global economy will pick up with an end to these trade tensions. I don’t think that’s an inevitable outcome.

No one should think that this market is easy.