Brinkmanship has been one of the defining characteristics of the Trump administration, as the White House ramps up the pressure to create a sense of crisis and force negotiating partners to make concessions. The administration has employed the same tactics in trade negotiations with Canada, Mexico, South Korea and the European Union, as well as with the U.S. Congress for border security funding, with varied results.
In China's case, however, the administration may have missed its moment of maximum leverage back in September-October 2018, and as a result, may have to settle for a less ambitious deal. Leverage is always relative and at the end of the third quarter, China's economy was showing signs of strain while the U.S. economy and markets were at the top of a growth cycle.
Since then, China's economy has remained under pressure, but the U.S. economy and financial markets have also started to show signs of slackening momentum. Global trade flows and manufacturing activity have shown even clearer indications that the rate of growth decelerated in the fourth quarter and early 2019.
Back in September-October, the administration could have risked imposing punitive tariffs on China and hoped to weather the economic fallout while waiting for China to capitulate. But the economic and financial market situation is now much more fragile and punitive tariffs would threaten to tip the domestic and international economies into a recession.
Concern about the consequences of failing to reach a deal by the deadline of March 1 set by the U.S. president appears to be making both sides more eager for some form of the accord, even if it is an incomplete or interim one.
News reports based on leaks from inside the talks process suggest the two sides have been inching towards an interim understanding, despite remaining far apart on some of the most contentious issues. The talks may have to settle for a partial agreement, in which the two sides reached agreements on farm and energy trade, goods and services, but leave tougher issues on the intellectual property, technology transfers, subsidies and state-owned enterprises to be settled later.
Hardliners in the United States have been upping the pressure on the administration not to settle for anything less than a comprehensive deal that transforms China's economy and ensures fair trade. For maximalists, the risk of short-term cyclical damage in the form of a recession is worth taking to ensure longer-term structural gains and entrench U.S. technology and economic leadership.
For the White House, however, structural objectives must be balanced against recession risk and an inexorable political cycle that has presidential and congressional elections less than 21 months away (and primaries less than 12 months away). The administration is likely to put the economy at the centre of its re-election campaign in 2020 and a cyclical downturn would complicate that narrative.
A broad range of U.S. economic and financial indicators show the rate of expansion peaking at the end of the third quarter or early in the fourth, before slowing significantly:
* The U.S. S&P 500 equity index hit a cyclical high in late September and slid 20 per cent by late December, before recovering partially to be around 5 per cent down (mostly on hopes tariffs will be avoided).
* Benchmark yields on 10-year U.S. Treasury notes hit a cyclical high between late September and early November, before slumping amid concerns about a deteriorating economic outlook.
* Business surveys show U.S. manufacturing activity growing rapidly through October-November, decelerating in December and January, according to the Institute for Supply Management.
* First-time claims for unemployment insurance reached a cycle low in September and have since trended gently higher, according to the U.S. Department of Labor's Employment and Training Administration.
* Consumer sentiment hit a cyclical high in September-November before softening through the end of the year and into 2019, according to the University of Michigan's Survey Research Center. The slowdown has been even more marked outside the United States, with global manufacturers reporting export orders falling since September, and the decline is accelerating.
Air freight through Hong Kong is falling at the fastest rate for seven years, according to data from the Special Administrative Region's Civil Aviation Department. Container trade volumes through major cargo hubs including Singapore, Los Angeles and Long Beach all show a sharp slowdown in the second half of 2018 and into 2019.
The rebound in U.S. equity markets and steadying of consumer and business sentiment over the last month have been largely attributed to hopes that the trade negotiators will reach a deal or at least postpone tariff increases.
Top policymakers, including the U.S. president, have fuelled financial market optimism by describing positive progress made in the talks, and the hopeful sentiment has spilt over into commodities such as oil. Markets are banking on a deal (even a limited, incomplete one, or a talks extension) to keep the U.S. and global economies growing and avoid a slide into recession.
As a result, the economic outlook has become deeply entwined with the fate of the trade negotiations, which has reduced the leverage of U.S. negotiators. China would undoubtedly take a severe economic hit if the talks fail and punitive tariffs go into effect, but the United States might be hit even harder in relative if not absolute terms.
China's currency hit a low against the U.S. dollar at the end of October and has since appreciated significantly, in a measure of shifting relative economic performance. The administration cannot be sure tariffs would not push the economy into a recession for which it would likely be blamed, which makes brinkmanship very risky.
The administration has a mixed track record on brinkmanship, securing some gains, but also miscalculating the determination and resilience of its opponents in some cases. No one can be certain that the White House will not choose to risk a recession by refusing anything less than an ambitious deal. Uncertainty is the essence of brinkmanship.
But both the United States and China, and specifically their top leaders, have a lot to lose if the talks fail, which is the main reason they are likely to succeed, even if the price is deferring some of the harder issues until later.
(With inputs from agencies.)