July 2, 2019
Scott Miller: I'm Scott.
Bill Reinsch: I'm Bill. 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.
Jack Caporal: I'm Jack Caporal, in for Andrew Schwartz. In this episode, Scott and Bill talk about the U.S.-China ceasefire and all the other trade developments that came out of last week's G20 meetings. Donald Trump and Xi Jinping hit the reset button on trade talks, but is it a true truce? And-
Andrew Ross Sorkin: Chinese tech giant Huawei becoming the proverbial chess piece in this tense trade situation between Washington and Beijing.
Jack Caporal: The administration is lifting the U.S. ban on selling equipment to Huawei. What's that all about? Plus, the European Union signed a huge trade deal with Mercosur, a group of countries in South America.
Cecilia Malmstrom: The agreement reached today will create a free trade area covering 760 million peoples.
Jack Caporal: We'll discuss all that and more on this episode of The Trade Guys.
Jack Caporal: So, there's a lot to unpack from the outcome of the G20 last week in Osaka, Japan, and particularly the meeting between Trump and Xi. I kind of want to say that we've been here before. They agreed to a ceasefire or trade truce. The president opted not to impose tariffs essentially on the rest of imports from China that would have amounted to about 300 billion worth of imports. The Chinese apparently made some commitments to purchase more agricultural goods and apparently President Trump also committed to loosen restrictions on Huawei, but it's not entirely clear what specifically happened in the meeting and what specifically the two leaders agreed to. So-
Scott Miller: Let me be the first to compliment Bill on his almost eerie prediction of events on last week's podcast that basically all proceeded as you had foreseen.
Bill Reinsch: This saves me from taking credit. Thank you.
Scott Miller: But most of us expected as this meeting was in its formative stages that one of the things that was a pretty sure outcome would be no tariffs on List 4. In other words, no escalation. And well, it looks like it's not terrible news in my view. Look, we're back to negotiating, which is I think an improvement versus the prior condition. I don't know how long this will go, but Trump appears to be patient. The president has said on a number of occasions that he's not in a hurry to reporters after the fact so that's probably okay. I think what we have ... Well, we had a brief bit of euphoria from markets yesterday morning when the U.S. markets opened. I think what you're really seeing is we've reached an equilibrium on U.S.-China trade tensions that there'll be continued uncertainty, but they're at the moment not being escalated. Whether there's any possible resolution that gets into what we're asking for and what China's willing to do, which as we've noted a number of times is a mess. Overall, I think we're at a sort of a steady state with regard to it in terms of its effect on the economy.
Bill Reinsch: I think it's not a stable equilibrium. First I have to say, this is for people that are in the prognostication business, this was really a good weekend because everybody predicted what happened and it upped our percentage so we all look better for the weekend because it was so obvious how it was going to turn out. The one thing that surprised me is that Trump did not have a new deadline. And I expected three months, six months, something to where he would again threaten to fire all guns, and he didn't do that. And I'm still thinking about what that means. For the rest of it, I mean this is sort of like the AMC channel. We've just seen this before and we're going to see it again. It's going to be a replay of December through April all over again. And Scott's right. Short term happy news, no tariffs-
Scott Miller: Right.
Bill Reinsch: … market bump, disaster averted. But it continues to be kind of an untenable long-term situation. The truths, if you will, solve nothing. The disagreements that led to the collapse in the end of April are still there. There's no sign that they discussed any of them in detail-
Scott Miller: And we're still demanding things from China that China is unwilling to provide under almost any circumstance.
Bill Reinsch: Exactly. Exactly, so I continue to say that he is inevitably going to face either making a weak deal or escalating, and then we will have more tariffs with a more significant impact because they've avoided the big consumer impact so far by avoiding tariffs on consumer items, which means that that's all that's left so if you go to Tranche 4, you're picking up, like we discussed with … when Steve Lamar was here, you're picking up apparel, you're picking up footwear, you're picking up toys, you're picking up iPhones, laptops and other consumer electronics. And this will all be back on the screen. Three months, six months, whatever.
Scott Miller: And if there is a calculation here, it may be that the U.S. economy is better positioned for uncertainty in the trade front than the Chinese economy is. In other words, there may be a way to keep the pot on simmer that does create some movement or creates more pressure there than here. I don't know if anybody's actually said that. It's not a totally crazy conclusion to reach.
Bill Reinsch: I'm beginning to think that that's what's going to happen for a political reason and not an economic reason. If you think about it politically, if Trump's choice is a weak agreement or escalate the trade war, I think what he will choose is the weak agreement and then sell it as a great agreement.
Scott Miller: Sure.
Bill Reinsch: And then the question is timing because in the first instance, market bump, everybody's happy, crisis is averted for the third time, at least for a while. But then you have to think about what happens a year later. And in a year, the weaknesses of the agreement are exposed, Chinese noncompliance is exposed, we're back where we started from and Trump is talking about tariffs again. If he's smart politically, he makes this agreement which he will sell as the greatest thing ever a year from now because a year from now there won't be enough time to discover what's wrong with it before the election.
Scott Miller: Sure, you want the report card to come in sometime after the 2020 elections.
Bill Reinsch: Exactly. Exactly. He cuts the deal in … this fall, people have got plenty of time to see what's wrong with it, so it's in his interest to wait as long as he can. It's in China's interest to wait. It's always been in their interest to wait. They'll drag this thing on for 10 years.
Scott Miller: And who knows? They may get a better counterparty after the election.
Bill Reinsch: Yes. I mean he may go leave the scene in a year and a half or not. But they would talk for five and a half if they could. That's been their strategy from the beginning. It may well be that this ends up sort of bumping along or simmering as you put it. The problem with that is at some point it doesn't pass the laugh test anymore because you can only tweet so many times how serious it is and how unfairly China is treating us and how big the deficit is and how I'm going to fix all this. And if we go through essentially, 3.8 years of not fixing it, people are going to start asking questions.
Scott Miller: It becomes a problem.
Bill Reinsch: Why is this, the greatest deal maker in the world, not able to make a deal? And the farmers who I think are beginning to say, “I'm with him, I understand the short-term pain, long-term gain thing, but can't we get to the gain part because I'm hurting.”
Scott Miller: Well, I understand there was a modest purchase of soybeans in advance of the meeting-
Bill Reinsch: 500,000 tons.
Scott Miller: Yeah, something like that, which is not nothing and maybe at least a helpful sign. But on the other hand, the president was criticized back in Washington by some of his political allies about what arrangements we’re making with Huawei and the conflation of national security and economic policy. So what's the deal?
Bill Reinsch: Well, yeah, he got it from both sides on Huawei, and he kind of deserves it because he's made Huawei a security issue.
Scott Miller: Right. And that's the Commerce Department's statement in May that led to basically where all transactions had to be licensed if I read it right.
Bill Reinsch: That's exactly right. They were put on something called the Entities List, which has a sophisticated description. Basically it's a list of bad guys and what it means is that … bad guys from a security perspective … and what it means is if you want to ship them anything, even this coffee mug, you need a license. Now, Commerce simultaneously took some of the sting out of that by saying, “We will create a temporary general license,” which means you don't need specific permission for these items. And then they listed them. And those items were largely non-5G items that had to do with allowing people that already had Huawei equipment to continue to service and maintain in some cases upgrade it.
Scott Miller: And this was pre-G20, right? This was the ruling or the action by Commerce back in May.
Bill Reinsch: Yes. When they put them on the list at the same time, they developed this temporary general license for 90 days, which I think would be August 19th is when it would expire.
Jack Caporal: And you were talking about U.S. exports to China to Huawei, which was totally separate from the U.S. ban on Huawei 5G in the U.S.
Bill Reinsch: Yes. That's separate. That's a question of an executive order that will come out in October in all probability. This is just about exports.
Scott Miller: And exports of U.S. components.
Bill Reinsch: Yes. Or technology.
Scott Miller: Or technology. Okay.
Bill Reinsch: And it appears that Trump basically said we're going to give them a break. He didn't say what that meant. I think this week they're deciding what that means, and I don't think it's clear yet what it means. At the most, it means they could take Huawei off the end of these lists and restore the status quo ante. I think that's very unlikely because that would sort of say ... That's a big, "Never mind."
Scott Miller: But you can give them a bigger general license or different general license.
Bill Reinsch: I think that's the most likely outcome. That they will first of all extend the general license beyond August 19th, and that's kind of an implicit deadline. So even if you didn't name one, they'll make it through the end of the year or something like that. And they'll probably expand it to cover more stuff. But again, I think it will be non-5G stuff. It will be stuff that will be at a lower level than that. So that will ease some of the concerns of the private sector … the semiconductor industry for whom Huawei is a big customer.
Scott Miller: And yeah, I think that's an important point for our listeners, is that while Huawei is the top level company there, it's their brand name on the devices, a lot of the internal components, particularly the most sophisticated internal components, are U.S. items. They're U.S. manufactured items that are ... So our high tech companies are essentially part of Huawei's supply chain.
Bill Reinsch: Yes. And what the company's pointed out is the aftermath of a debate that we actually began when I was at Commerce and which we have had ongoing on and off ever since. And it began with the Defense Department. Really thanks to Bill Perry, who was the undersecretary and then later the secretary, realizing that in the modern economy, particularly in the information communications technology sector, which is increasingly defense-critical, think smart bombs and all the other things that even we used in the Iraq war, I once had a Pentagon official tell me seriously that the problem they were having was their procurement cycle took longer than the lifecycle of the stuff they were buying.
Scott Miller: Yes.
Bill Reinsch: So they were always buying stuff that was not state of the art. And Perry attempted to grapple with this to figure out, "Well, what do we need to do?" And that produced a sequence of logic, which is still being born out today with Huawei, which was we need to go away from specially designed for military use and instead look at commercial off the shelf. That way we get the latest best stuff that HP, Qualcomm, IBM, Cisco, whatever, whoever is producing. So, if you think about that, then you realize all of a sudden we, the military, are becoming a customer of this very large important commercial sector. But we are not going to be a very big customer. Everything we buy for military use is going to be probably 1% of their total, less than 1% of their total revenue.
Scott Miller: And what you have is you had a defense procurement system that was really built around acquiring unique articles.
Bill Reinsch: Yes. Which ends up being very slow.
Scott Miller: Right. It's not so much of a problem if it is slow.
Bill Reinsch: Then. But in this sector, particularly software and technology, slowness is fatal. So once Perry realized, all right, we are not their best customer, we're a customer. What do we really want from them? And the answer is we want them to be healthy and profitable because if they're healthy and profitable, then two things are going happen. They're going to make next generation products that we can take advantage of. They'll be competitive, they'll be strong, and because they're profitable, they can do classified work for us over on the side that they otherwise wouldn't be able to do. So then the next thought that Perry had was, "So okay, how do we make sure that they are happy, healthy, and profitable?" And the answer is once you realize that more than 50% of their revenue comes from exports, the answer is you have to let them export.
Scott Miller: Right.
Bill Reinsch: Not necessarily everything.
Scott Miller: And to everyone.
Bill Reinsch: And to everyone. But this was transformative in Pentagon thinking in the 90s and it is still right there today because what the companies said about Huawei is, "Look, it's not only the fact that selling them all this stuff allows us to make a lot of money. It's what keeps us competitive. It's what makes us able to develop the next generation of products. It's what will enable us to be competitive on 5G products. And if you take this away from us, you're not just compromising current revenue. You're compromising future competitiveness.”
Scott Miller: Including competitiveness in the defense space.
Bill Reinsch: Yes, exactly.
Jack Caporal: So now the Commerce Department has to determine what can these companies export, what can these U.S. companies export to Huawei in order to maintain their profitability, their viability, their long-term growth? But you know, what can they not export that would pose a risk to national security? Right?
Bill Reinsch: Yes, exactly. And there'll be a skirmish about that, because reasonable people won't agree.
Jack Caporal: And so if this is a national security issue, why is it on the negotiating table when it comes to a trade dispute with China?
Bill Reinsch: Well. That's why the president I think is being criticized, particularly from the right.
Jack Caporal: Yes, yes. We have Marco Rubio saying that if the administration reverses sanctions against Huawei it would be quote, "A catastrophic mistake.” It would quote “destroy the credibility of his administration.” There would be veto proof legislation to reimpose the penalties. And then from the left, of course, he's been criticized by Chuck Schumer who said that the move would undercut our ability to change China's unfair trade practices.
Bill Reinsch: It's nice to see the two of them agreeing on something, although you'll notice in what they said, they're agreeing for different reasons.
Scott Miller: Yes.
Bill Reinsch: But Rubio's point is well taken. What Rubio is saying is you shouldn't make national security a trade bargaining chip.
Jack Caporal: Right.
Bill Reinsch: If there's a national security problem, you should make a decision that's based on preserving our security and you don't trade it away for 3 million bags of soybeans. Schumer's saying a little bit different, but he ends up in the same place.
Scott Miller: Right. And now I'm just hazarding a guess here, but my guess is the specifics of what was going to be licensed and not was not worked out by President Trump and President Xi while they were having the conversation.
Bill Reinsch: That's a safe assumption.
Scott Miller: So there's some space here to actually figure out what is going to be done. And as we've talked before, the professionals in the security side of the Commerce Department are people who at least I personally trust to do the right thing for U.S. national security interests. And so, do you think we'll wind up at a place that Senator Rubio will not be as concerned by the time we get done or?
Bill Reinsch: Well, maybe. I think there's growing concern in the business community that, in some respects, the process is as you described it, but it may be hijacked by political people.
Scott Miller: Got It.
Bill Reinsch: And that will probably make Rubio happy because that will produce more controls.
Scott Miller: Yes.
Bill Reinsch: And stricter controls.
Scott Miller: Even if it disappoints President Xi.
Bill Reinsch: Yes. And it will also disappoint our industry.
Scott Miller: Right.
Bill Reinsch: That remains to be seen. And it's not clear. I think what I've discovered over the years, when you get military people coming in and explaining what is really good for them, our military people, not the PLA. When you've got American military people coming in and explaining what works for them and what helps them, the people on the right pay attention and Republicans pay attention. So that conversation needs to take place. I don't think it has yet.
Scott Miller: So we haven't seen the end of the politics that come out of the G20 yet.
Bill Reinsch: Oh no.
Jack Caporal: And there was a larger G20 meeting last weekend. It wasn't just the Trump and Xi show.
Bill Reinsch: Really?
Jack Caporal: Yeah. Yup. Indeed.
Bill Reinsch: Tail wagging the dog, if you ask me. But go ahead.
Jack Caporal: They did issue a statement or communiqué that included a bit on trade. Not a lot of language about … you know, in terms of urgency-
Scott Miller: Did they reaffirm motherhood as well in this?
Jack Caporal: Well, they reaffirmed the need to realize free, fair, and nondiscriminatory, transparent, predictable, and stable trade.
Scott Miller: And we're intensifying our support for motherhood.
Bill Reinsch: Motherhood was not mentioned. Apple pie was not mentioned. Chevrolet was not in the house.
Scott Miller: How sad.
Jack Caporal: They did reaffirm the support for the necessary reform of the WTO and the lead up to the next ministerial conference in summer next year.
Bill Reinsch: Apparently a notch down from an earlier draft is what I ...
Jack Caporal: Yes. So apparently they stripped out all language related to urgency. The urgency of the matter. And part of the reason why there is this urgency is there's a deadline to fill vacancies in essentially the highest court of the WTO by December. And so, I mean, are you surprised? Are you disappointed by the final language in the communiqué or is it par for the course?
Scott Miller: Well look, it's the G20, but one of the G20 is the United States. And when it's come to drafting these communiqués, the Trump administration has been very clear on their direction and they've been pretty consistent about not infringing on their own agenda in international meetings. So this sounds like about what to expect. As a result, nobody paid any attention to the communiqué. So that's one of the problems with both the meetings and the U.S. stance.
Bill Reinsch: Yeah, there's inside baseball here if you look … if you compare to a leaked earlier draft and the final product, you can say, well it changed in some ways that indicate some U.S. influence. On the other hand, you know, if you just look at the words, they flagged WTO reform and I think that matters and if you’ve got the 20 saying we need to reform, I think that's an important step forward. I don't know that by itself it's going to advance the ball very much, but it certainly is better than-
Scott Miller: And they haven't specified what reform precisely would be the solution.
Bill Reinsch: No, but the good news is other countries are coming forward with proposals on that. So you don't just have the usual suspects, the EU, Canada, and Australia and the Nordics who are always coming forward with constructive proposals. But Honduras has made a proposal. Taiwan made a proposal. Brazil made a proposal. The Brazilian proposal’s probably closest to the American position. These are all proposals that I think would be a basis for negotiation if the U.S. wants to do it.
Scott Miller: Sure. If somebody can get to yes for an answer.
Jack Caporal: Sure. Actions speak louder than words, but the words do matter. The other news from the weekend was the EU continues it's winning streak when it comes to concluding trade agreements. So they concluded a 20 year negotiation with the Mercosur countries, which include Paraguay, Uruguay, Brazil, and Argentina. That's on the heels of them concluding an agreement with Japan and Canada. You know, what's behind the EU strategy there? Just some numbers really quick. You know the population covered in the EU-Mercosur deal, 773 million people. That's a pretty big market. EU-Japan, 639 million people, over half a million when it comes to Canada. Those countries are doing a combined trade in goods, all together of roughly $300 billion, massive amounts of tariff savings for U.S. companies and the joint GDP of Canada, Japan, Mercosur, and EU, around 40, 50 trillion euros. So, compare that with the U.S. strategy. The EU is kind of going around picking off countries, negotiating deals.
Scott Miller: Well, we're creating the opportunity for them. I mean look, there is a consequence of the America First sort of tougher trade policy and less focus on market opening, less focus on liberalization in general and preferential agreements in particular. And the … is that there is still a demand for this. Increasing trade improves people's lives. Okay, so there's still a market for agreements that broaden the access and reduce trade barriers. So that market exists. The United States is not competing in that segment right at the moment. And Europe is. Now, this is not new. First, the backdrop I would point out is that Europe runs a large current account surplus with the world. Not worried about, I'll never talk about bilaterals because bilateral trade deficits don't matter. But if you're running a current account or trade surplus with the world, what it means among other things is your growth would be slower if it weren't for the exports. Exports are boosting your growth. And that's true of Europe today. So Europe has incentives to continue to boost exports. It's easier for Europe to boost exports when one of their major point to point competitors across a wide range of industrial economy sectors is absent from the initiative at this point. Now 10 years ago, my complaint was the United States is so slow that what we do is we announce we're going to negotiate a free trade agreement with someone and then we take seven or eight years to conclude it, and while we're talking or not talking, Europe proceeds to negotiate similar or better terms but implement it quickly. This happened with South Korea as an example, where we started a U.S.-South Korea chorus for negotiations. Europe came in six months later but concluded five years earlier. And so basically all the industrial goods where the United States and Europe are essentially comparable in their price and quality and export attractiveness, European companies or European firms got all the business.
Jack Caporal: Sure.
Scott Miller: And so it's just happening for different reasons now. It's happening because we're choosing not to do it, but Europe has been savvy at essentially helping their economy by boosting their export-led industries and taking advantage of what we're not doing.
Jack Caporal: And these deals aren't just about tariffs and goods, you know, in terms of generating market share. So you know, for example, the U.S. doesn't have a trade agreement with Mercosur and in the EU agreement with Mercosur, they've gotten approval to use EU food safety regulations, EU vehicle safety standards, geographic indications, which can limit how food items are labeled essentially. And it's not just the fact that, you know, 90% of tariffs between Mercosur and EU goods are going to be eliminated. It's also the fact that those countries are now accepting EU regulations and haven't even had the conversation, or at least an in-depth conversation with the U.S. about U.S. regulations, right? And those are in the areas where the administration really wants to win out, to beat competitors like the EU, right? Cars and food.
Bill Reinsch: Exactly. First a footnote, Jack mentioned Mercosur took them 20 years, so they're not always the most efficient.
Scott Miller: Well, yes and I would contend that Mercosur doesn't have an agreement with Mercosur. I mean this is something that was allegedly a free trade agreement and ask anybody trying to import something from Venezuela to Brazil, whether there was free trade, and you'll find out, not so much.
Bill Reinsch: You’ll notice Venezuela's miraculously disappeared from Mercosur.
Scott Miller: It has. From Mercosur.
Jack Caporal: They’ve been suspended.
Scott Miller: That's right.
Jack Caporal: Technically, yeah.
Bill Reinsch: The other thing is that the European process has gotten slower because of the Parliament.
Scott Miller: Yes.
Bill Reinsch: And you've got to get approval not only by the parliament, by the member states. You saw what happened with CETA the Canada-EU agreement. Sometimes the endgame takes up a long time.
Scott Miller: Yes. In fact, I think Europe is approaching the point that the United States faced in the '70s that led to-
Bill Reinsch: They’re beginning to look like us.
Scott Miller: It led to the creation of Fast Track because we really couldn't tolerate the breakdown and that was our solution. I think they'll need one as well.
Jack Caporal: Right.
Scott Miller: That's another subject.
Jack Caporal: So the Canadian agreement, the EU-Canada agreement, was held up for something like a year because one parliament and one province of Belgium didn't like one specific agreement.
Scott Miller: And it's still not fully implemented.
Jack Caporal: Yeah.
Bill Reinsch: Getting back to … The central point, is the one that you guys were just talking about, which is we're not involved in these agreements, which says something about our absenting ourselves from the process, but they have an impact on us.
Scott Miller: Yes.
Bill Reinsch: In some cases, like Brazilian beef, they're going to take up market share that we could otherwise have gotten. This is exactly what happened with the Japan-EU agreement.
Scott Miller: Correct.
Bill Reinsch: Basically, they're getting a market share that would have gone to our agriculture community.
Jack Caporal: And CPTPP, the Australians and Japan-
Bill Reinsch: Yeah, exactly. Exactly. And they are setting up a ... Increasingly the whole thing is rules anyway, rules and standards, and the Europeans have been adept over many years at trying to promulgate their standards globally and on issues like geographical indications, which is you know, feta cheese and parmesan and all that stuff and genetically modified organisms, they have an agenda that is very different from ours and to the extent they're getting the rest of the world to agree with their agenda, we are being isolated and that means our farmers are going to end up being isolated.
Scott Miller: Yes, and when it comes to standards, there's always been a close relationship between particularly Brazil but also the whole of Mercosur and Europe. When you travel to any of those countries, you'll probably need an adapter because they have European-style electrical systems and the outlets, you won't find a 110 volt, 60 cycle plug like we have all around the U.S. Well that's an old set of choices that were made and there have been long periods of time in our history where Europe was more interested in South America than the United States was commercially. And so that's continuing on perhaps for different reasons now, but it will have consequences for our producers.
Jack Caporal: And the standards issue is important because let's say you're an American car producer, Ford, shipping an F-150 to a Mercosur country or to the EU. You essentially need to build almost a different vehicle or at least use different components. The vehicle needs to be structured with certain parts in certain ways, et cetera, for that vehicle to be approved. When it comes to food, you have to label your cheese parmesan-like instead of Parmigiano Reggiano, because that cheese can only come from that part of Italy. Right? And that makes it more costly to export. The other thing-
Bill Reinsch: Which really doesn't help Wisconsin.
Scott Miller: Right.
Jack Caporal: Right. And the other thing I would draw attention to is, the Europeans are going around and racking up these deals using a strategy much different than the United States is, or at least the Trump administration is, right? They're not going and threatening countries with tariffs, et cetera. They're not going and essentially bullying countries or badmouthing allies, but they're still getting it done.
Scott Miller: Come on in. Come on it. The water's fine. Yeah.
Jack Caporal: Exactly.
Bill Reinsch: I would not accuse them of altruism, however, they're doing what's good for them.
Scott Miller: This is in their interest and as I mentioned, you look at the overall economy in the European Union, they need growth, right? At the moment, they're benefiting from their export position. Enhancing that export position is a smart move on their part and so they'll continue.
Bill Reinsch: But it's a reminder, it should be a reminder to our president that successful trade negotiations are win-win and our president seems caught in a cycle of he's not winning unless somebody else is losing, and that is not the way to get to the end successfully.
Jack Caporal: So we'll have some catch up to play.
Andrew Schwartz: To our listeners, if you have a question for the Trade Guys, write us at email@example.com. That's firstname.lastname@example.org. 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.
Scott Miller: Thanks Andrew.
Bill Reinsch: Thank you!
Andrew Schwartz: You've been listening to The Trade Guys, a CSIS podcast.