◎ Beijing’s response to the trade war is shaped by the complexities of the CCP factional struggle.
On May 10, the United States raised tariffs rates on $200 billion worth of Chinese goods from 10 percent to 25 percent. On the same day, the Chinese trade delegation led by vice premier Liu He left Washington without reaching a trade agreement.
On May 13, China announced that it would increase tariffs on $60 billion of U.S. goods from 5 to 10 percent up to 10 to 25 percent. The rate increase would take effect on June 1. On the same day, the United States Trade Representative Office started the formal process of imposing tariffs on another $300 billion of Chinese products. A public hearing is set for June 17 and a public comment period will end on June 24.
We believe that the escalation in the Sino-U.S. trade war will heighten political contradictions in the Chinese regime.
The backdrop:
Both America and the Chinese regime appear to have hardened their stance on compromising to reach a trade deal after U.S. tariffs were raised on May 10:
United States
Between May 10 to May 13, U.S. President Donald Trump posted a series of tweets where he laid out America’s advantages and China’s disadvantages in a trade war.
For instance, Trump tweeted on May 12: “We are right where we want to be with China. Remember, they broke the deal with us & tried to renegotiate. We will be taking in Tens of Billions of Dollars in Tariffs from China.”
Trump also called out the Chinese Communist Party’s strategy of dragging out trade negotiations in the hopes that he will not win reelection in 2020. “I think that China felt they were being beaten so badly in the recent negotiation that they may as well wait around for the next election, 2020, to see if they could get lucky & have a Democrat win – in which case they would continue to rip-off the USA for $500 Billion a year,” he wrote. “The only problem is that they know I am going to win (best economy & employment numbers in U.S. history, & much more), and the deal will become far worse for them if it has to be negotiated in my second term.”
China
On May 13, Xi Jinping chaired a Politburo meeting where it was decided that an education campaign on the theme of “not forgetting the original aspiration and staying true to the Party’s founding mission” would commence in June. The Politburo also reviewed a plan for integrated regional development of the Yangtze River Delta.
On the same day, the state-run China Media Group issued a commentary on the trade war titled, “China is Prepared for a Comprehensive Response.” Xinhua and other state media carried the commentary on their websites.
Also on May 13, China’s foreign ministry spokesperson Geng Shuang said that “countries should champion the principles of equality, mutual learning, dialogue and inclusiveness between civilizations and reject the misguided and wrong belief of “clash of civilizations” or the superiority of one civilization over others.” Geng also promoted the Chinese regime’s upcoming Conference on Dialogue of Asian Civilizations.
In reviewing CCP propaganda on the trade war since Trump announced plans to impose tariffs on May 5, we have identified several key narratives:
- America and China should meet “halfway” and seek a “win-win and mutually beneficial agreement on the basis of mutual respect”;
- China opposes the U.S. tariffs;
- There are no winners in a trade war;
- America does not stand to benefit from a trade war with China;
- America is dealing in “unilateralism” while China is for “multilateralism”;
- China has done its utmost to accommodate America’s asks, but America is asking too much from China;
- China will not compromise on principle, but is still willing to negotiate with America;
- China will not back down on three core issues: America must remove all tariffs; trade purchase data cannot be changed at will; and the trade agreement text “must be fair” and cannot allow China to lose face;
- China’s “bottom line principle” cannot be given up, and the trade war and trade talks must go on simultaneously;
- The CCP is not compromising in trade talks “for the benefit of the people.”
In other words, the latest CCP propaganda on the trade war has “reverted” to the passive-aggressive stance during the period before Xi Jinping and Donald Trump agreed to a trade truce in China last December.
Our take:
1. We believe that both Party and factional struggle factors are swaying the Chinese regime’s current stance on the trade war.
2. The CCP prioritizes regime survival above all. Thus, the Party may believe that getting “hardline” with America is the most logical option at this time.
First, the Party is highly resistant to making reforms that would undermine its rule over the Chinese regime. Signing a transparent trade agreement with the U.S. that would commit the CCP to make genuine structural reforms or risk punishment is intolerable to the Party for face-saving and existential reasons.
Second, the CCP may believe that the regime is now in a better position to get confrontational with America as compared to five months ago. The trade truce on Dec. 1, 2018 has allowed the Chinese regime to catch a breather and recover economically. Also, the regime found some success in courting Europe, promoting the Belt and Road project, and finding alternative markets to export its 5G in the first quarter of the year.
Finally, the CCP may still be pinning its hopes on “weathering” out President Trump’s first term. On the one hand, the Party might actually believe that the “rebounding” Chinese economy and weakness in the American economy (the Party has interpreted Trump’s repeated calls on the U.S. Federal Reserve to cut rates as a sign of a troubled U.S. economy) would allow the regime to withstand a full-blown trade war (i.e. tariffs on all Chinese goods) until 2020. On the other hand, the CCP might be gambling that Trump would end up in a disadvantageous position going into the U.S. presidential election; in fact, the Party would likely step up influence and interference campaigns, as well as continue with delaying tactics, to put Trump at a disadvantage.
3. Beijing’s response to the trade war is also shaped by the complexities of the CCP factional struggle.
We previously explained that Xi Jinping needs to pursue reform to eliminate factional opposition to his rule and push through his own policies. Naturally, Xi’s rivals (the Jiang faction and other interest groups) are opposed to reform because successful reform would mean their demise. Such is the “you die, I live” nature of the CCP factional struggle.
In considering the above factional struggle dynamic, it is in the Xi leadership’s interest to reach a trade deal with America. First, U.S. pressure would likely drop off for a period, which would allow Xi Jinping time and energy to focus on resolving domestic problems, including the factional struggle. Second, Xi can use the excuse of implementing structural reforms to remove the remaining factional resistance to his rule. Thus, the Xi leadership has been paving the way to sign a trade deal with America since January 2019 (see here and here). To counter attacks from political rivals, the Xi leadership has also been “signaling a left-turn to go right” in state propaganda.
At this juncture, it should be noted that there is no contradiction between Xi’s reform intent, the trade deal, and CCP priorities. While Xi likely sees the trade deal as his best option to buy time for personal survival, he would likely also resort to delaying tactics during the trade negotiations to buy time to adjust China’s economic policies and expansion strategies. Further, Xi will likely try to avoid making concessions that would result in criticism from political rivals while “using” U.S. pressure to push through structural reforms that are beneficial to his political survival. Put another way, the trade deal is almost certainly a means to an end (economic rescue and personal survival) for Xi.
Trump’s tariff escalation, however, appears to have scuppered whatever plans Xi might have had. Xi’s political rivals very likely latched upon Trump’s tariff move and the CCP’s anti-reform priorities to pressure the Xi leadership into not “caving” to the United States by signing a trade deal. The fact that Liu He came back empty-handed from Washington after the latest round of trade talks suggest that Xi was unable to suppress rival voices in the Party (Liu, however, at least managed to persuade the U.S. to leave open the possibility of finishing the trade talks instead of shutting the door completely on future negotiations).
Contrary to popular believe, Xi Jinping is not all-powerful despite having consolidated power to a high degree. Xi is still at risk of a “soft coup” if his factional rivals are able to make a solid case that Xi is acting against the Party’s interests in dealing with America. While Xi now faces considerable political risks, we do not believe that he is in danger of being fully disposed of by factional rivals due to his control over the military; Xi’s military reforms have at least disrupted old power networks and makes it much harder for factional elements in the military to coordinate a takedown.
4. Ultimately, the U.S. tariffs have heightened political dilemmas in China.
Xi Jinping may want a trade deal to ensure his political survival while his rivals and “hardliners” do not want a trade deal to preserve their own survival.
Regardless, time is on neither side given the vast economic problems facing the Chinese regime. Both sides are under pressure and time constraints to get their way quickly.
Looking ahead, Xi appears to have the shorter end of the stick. The Trump administration would likely want more concessions and guarantees from the Xi leadership given the recent breakdown in talks to avoid further delays. And the Xi leadership will find it even harder to “sell” a tougher trade deal to the Party without being criticized by political rivals and “hardliners.”
In dealing with the Trump administration, the CCP cannot both save face and ensure its survival. Going forward, both Xi and the Party will likely look to take a gamble on America’s economic problems and the outcome of the 2020 U.S. presidential election.
What’s next:
1. The CCP factions may reach a compromise to cope with the current trade crisis facing the regime. Any compromise, however, will be short-lived, if history is a guide. We believe that the CCP factional fighting would against intensify with the release of poor second quarter economic results.
2. The CCP will step up propaganda and indoctrination work to control officials and the society at large. For instance, the propaganda apparatus could sell the narrative that the regime is clashing with the U.S. “in the people’s interests” and that the people should “share hard times” together with the Party.
3. The CCP could allow the renminbi to depreciate to preserve property and asset prices while offsetting the impact of a portion of the U.S. tariffs. The RMB exchange rate could fluctuate between the 7 to 7.5 mark. However, the CCP would likely not seek to overly devalue the yuan to avoid being called out as a currency manipulator by the U.S. and face even higher tariff rates (up to 45 percent), as well as avoid incurring increased foreign debt repayment costs.
4. RMB depreciation will accelerate capital outflows. Also, low-priced Chinese goods could shock non-U.S. markets such as those in the EU. To prevent a balance of payments deficit, the EU could also raise tariffs on Chinese goods.
5. Food prices in China could rise with RMB depreciation, the spread of swine flu and pest infestation, as well as poor grain harvest.
6. More and more foreign companies could shift manufacturing out of the mainland and to neighboring Asian countries. Unemployment and societal problems could rise sharply in China.
7. The CCP could step up influence and interference campaigns against the U.S. to fragment society and sway the outcome of the 2020 presidential election. U.S. allies could also be targeted with increased influence campaigns.
8. The CCP could play up the “clash of civilizations” issue and accuse the Trump administration of being “racist.”
9. Both the Chinese regime and America could step up influence efforts in Taiwan. Military activity from both sides could also ramp up in and around Taiwan.
10. Political risk will escalate in China, and there is a high probability of Black Swan events occurring on the mainland.
