Trump, China, and the Art of Easy Promises

Chinese officials can afford to make assurances about reducing the trade surplus—as long as things are going well back home

By Nathaniel Taplin

Donald Trump’s summit with Chinese President Xi Jinping this weekend may have passed calmly, but one comment should make investors sit up: Chinese officials expressed an interest in reducing the country’s trade surplus.

Given how hard the U.S. has been pressing on this subject—arguing that the gap is the product of unfair trade practices—this looks like great news for investors hoping the two sides can head off a trade war.

China has good reasons to want a narrower surplus. When its exporters sell their dollar earnings for yuan, the increase in the domestic money can stoke inflation—a headache the central bank had to deal with for much of the 2000s. Domestic inflation is already on the rise, thanks to massive credit-fueled stimulus in 2015 and 2016 and tighter capital controls that keep more money in the country. Lower export earnings might help subdue inflationary pressures.

The problem is that higher inflation may not last. When Chinese prices stop rising so quickly—and tighter credit starts pressuring heavily indebted corporations—assurances given on trade now will be harder to keep.

As recently as the third quarter of 2016, Chinese exports were contracting rapidly—down 7% from a year earlier—and capital was streaming out of the country. Factory-gate inflation was persistently negative, in part because the central bank’s efforts to support the currency by selling dollars and buying yuan were pressuring domestic money supply.

Those conditions could return easily. The main domestic drivers of inflation—easy money and real estate—are already showing signs of reversing. Commodity prices are losing momentum, and industrial overcapacity remains severe, making a sustained pickup in domestic inflation unlikely.

When, as seems likely, prices at home lose momentum, Chinese policy makers may welcome the money-supply boost that healthy export earnings provide. That is when investors will see whether this weekend’s cordiality has truly changed Chinese trade policy in a meaningful way.

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