China sees EU investment deal as diplomatic coup after US battles

Pact signed in waning days of Trump presidency and despite warnings from Biden team

Tom Mitchell in Singapore and Katrina Manson in Washington

Xi Jinping, China’s president, has signed the EU deal weeks after agreeing a pan-Asian trade deal despite US warnings to Europe about its relationship with Beijing © AP

When EU and Chinese negotiators began discussions on an investment agreement seven years ago, Beijing hoped it would help counter the Trans-Pacific Partnership trade pact championed by Barack Obama, the former US president.

The TPP was a far more ambitious project than the China-EU Comprehensive Agreement on Investment and a potential geopolitical coup for Washington, as it excluded Beijing. But Donald Trump, Mr Obama’s successor, abandoned the TPP on his first full working day in office.

In the end, it was China’s president Xi Jinping who would steal a march on his US rival by signing both the CAI and the Regional Comprehensive Economic Partnership, a separate regional deal with many of America’s closest Asia-Pacific allies, in the waning days of Mr Trump’s administration.

Mr Xi and Ursula von der Leyen, European Commission president, signed off on the CAI on Wednesday, although it will take at least another year to formally conclude. Valdis Dombrovskis, EU trade commissioner, hailed the pact as “the most ambitious [trade deal] that China has ever agreed with a third country”.

Beijing views the agreement as a strategic breakthrough, especially after Joe Biden’s incoming administration registered concern over the pact in recent weeks.

Jake Sullivan, Mr Biden’s incoming national security adviser, wrote on Twitter last week that the new administration would “welcome early consultations with our European partners on our common concerns about China’s economic practices”. The language was diplomatic but a former Obama official said the message to the EU was to “slow things down”.

Matt Pottinger, Mr Trump’s outgoing deputy national security adviser, also weighed in after the CAI was concluded. “Leaders in both US political parties and across the US government are perplexed and stunned that the EU is moving towards a new investment treaty right on the eve of a new US administration,” he told the Inter-Parliamentary Alliance on China, an international grouping of parliamentarians that seeks a tougher approach to Beijing.

A Biden transition official said after the agreement was signed: “The Biden-Harris administration looks forward to consulting with the EU on a co-ordinated approach to China’s unfair economic practices and other important challenges.”

“What the US wants is not necessarily in the EU’s interests,” said Cui Hongjian, a European specialist at the China Institute of International Studies, a state-affiliated think-tank in Beijing. “The EU should have learned that over the past four years,” he added, referring to Brussels’ many trade disputes with the Trump administration.

The EU argues that the CAI “will not affect our commitment to transatlantic co-operation, which will be essential for addressing a number of the challenges created by China”. In private, however, EU officials have expressed frustration with the Biden team’s last-minute sniping at the CAI, especially after German chancellor Angela Merkel last year publicly committed to concluding it by the end of 2020.

“It was as if no one paid attention to the German chancellor saying it must get done this year — it was communicated very clearly,” said one person close to the talks. “For the US side it’s a really bad start.

“They believe they can tell their allies what to do instead of being a little bit humble and trying to solve bilateral [US-EU] problems first.”

The EU also argues that the CAI represents a “major breakthrough” in long-frustrated efforts by western countries to get Beijing to sign up to International Labour Organization conventions banning the use of forced labour and the protection of workers’ rights of association.

The former emerged as a critical area of divergence in the final weeks of negotiation, largely because of the controversy over the Chinese government’s incarceration of millions of Uighurs in the northwestern region of Xinjiang.

Franck Riester, France’s junior trade minister, said last week that Paris would block the deal if the CAI did not force Beijing to abolish forced labour. However, the Chinese government merely agreed to make “continued and sustained efforts” to ratify the relevant ILO conventions.

“On labour it’s impossible for China to agree,” said Shi Yinhong, an international relations professor at Renmin University in Beijing and an adviser to the State Council, China’s cabinet. “Can you imagine China with independent labour unions? Forced labour also relates to Xinjiang, so that’s another ‘no’ for China.”

Mr Pottinger condemned what he called the EU’s “haste to partner with Beijing despite its grotesque human rights abuses”.

“There is nowhere for bureaucrats in Brussels or Europe to hide,” he added. “We can no longer kid ourselves that Beijing is on the verge of honouring labour rights while it continues to build millions of square feet of factories for forced labour in Xinjiang.”

EU companies have invested more than €140bn in the world’s second-biggest economy. Most large European multinationals support the agreement, which they feel will help them catch up with “market access” concessions Mr Trump secured for US companies in the January “phase 1” trade deal with China.

But one senior European executive complains that the CAI, like Mr Trump’s agreement, does little to address “structural issues” in the Chinese economy that create informal barriers for foreign investment.

“We need mechanisms for enforcement,” the executive said. “If my Chinese competitors are receiving central or local government subsidies, who exactly do I talk to and what do I do? On the other hand, in Europe, Chinese companies can freely litigate against us.”

Additional reporting by Xinning Liu in Beijing

The Pandemic’s Long Economic Shadow

While mass vaccination points to an end to the COVID-19 pandemic in the next year or so, it does not provide immunity against longer-term economic damage. And research on the aftermath of previous pandemics suggests that the impact on supply and demand is likely to be far-reaching and profound.

Stephen S. Roach  

NEW HAVEN – The outlook for economic and financial markets hinges on the interplay between two cycles – the COVID-19 cycle and the business cycle. 

Notwithstanding the true miracles of modern science that we are now witnessing, the post-pandemic economy is in need of more than just a vaccine. 

Extraordinary damage was done by last spring’s lockdown. Now, a second and more horrific wave of the coronavirus is at hand – not dissimilar to the course of the 1918-20 influenza outbreak.

The world received the blessings of cutting-edge science this holiday season with the record-fast development of effective COVID-19 vaccines that promise to end a pandemic that has so far killed more than 1.7 million people and caused the worst economic crisis in generations. 

But the rush by rich-country governments to secure enough doses for their own citizens threatens to prolong the agony for the developing world.

In the United States, the adverse economic repercussions are evident in mounting jobless claims in early December and a sharp decline in retail sales in November. With partial lockdowns now in place in about three-quarters of US states, a decline in economic activity in early 2021 seems likely.

The history of the US business cycle warned us of the possibility of a double dip. Eight of the last 11 recessions featured just such a pattern. Yet financial markets still made a big bet on a V-shaped recovery. 

Investors were lulled into a false sense of complacency by reading too much into the dead-count bounce of a 33% annualized surge in real GDP in the third quarter, as initial lockdowns were lifted. 

But reopening after a sudden stop hardly qualifies as a self-sustaining economic recovery. It is more like a fatigued swimmer gasping for air after a deep dive.

The source of the coming economic relapse hardly comes as a surprise. It is the echo effect of the first wave of COVID-19. 

Despite extraordinary breakthroughs in vaccines, therapeutics, and treatment protocols, the second wave is far worse than the first in terms of infection, hospitalization, and death rates. 

While the new restrictions on economic activity are not as tight as those last April, they are already having an adverse impact on aggregate economic activity. 

The double dip of early 2021 will be a painful reminder of the lingering vulnerability of the US business cycle in the aftermath of a major recessionary shock.

The longer-term consequences of the COVID-19 cycle are likely to be more severe. 

While mass vaccination points to an end to the pandemic itself (one hopes by late 2021), it does not provide immunity against lasting economic damage. 

Recent research on the impact of 19 major pandemics dating back to the fourteenth century – each with death counts in excess of 100,000 – highlights the long shadow of the economic carnage. 

Real rates of return on “safe” European assets – a measure of the interplay between aggregate supply and demand – were found to be depressed for several decades following these earlier horrific outbreaks.

The long shadow of the COVID-19 cycle looms as well. Lost in the celebration of an imminent V-shaped economic recovery have been many hints of lasting damage. 

In the US, employment is still 9.8 million jobs below its pre-pandemic peak, and consumer expenditures on services – restrained by persistent and understandable fears of face-to-face interaction – have recouped only 66% of the plunge that occurred during the March-April lockdown.

Moreover, a second wave of partial lockdowns will only reinforce dislocations that are now painfully evident in most major US cities, including excess office and public-transit capacity, along with the devastation of hospitality, entertainment, and retail businesses. 

The permanent destruction to aggregate supply and demand, in conjunction with fundamental shifts in behavioral norms, aligns the long-shadow contour of the COVID-19 cycle with comparable patterns in the aftermath of earlier major pandemics.

The interplay between the short-term dynamics of the US business cycle and the longer-term pattern of the COVID-19 cycle bears critically on the current policy debate. Yet hope is widespread that this time is different – that creative new policy strategies can offer new solutions to old economic problems.

That is certainly true of so-called Modern Monetary Theory, which supposedly gives fiscal authorities open-ended license to binge on debt. But MMT is neither modern nor a theory. 

What is new is something far more basic: the supposed death of inflation. As long as inflation remains subdued, goes the argument, then both monetary and fiscal authorities can ignore the risks of higher borrowing costs and work in tandem in providing relief for a pandemic-stricken real economy.

But nothing in economics is forever – not even the death of inflation. Here is where it gets especially tricky. 

US inflation is hardly immune to further dollar depreciation, which seems increasingly likely, given a sharp deterioration in the US current-account deficit, the strengthening of the euro, and the weak-dollar bias of a Federal Reserve that remains wedded to zero-interest rates. 

Supply-chain disruptions – reversing the powerful disinflationary forces of globalization – should also boost underlying inflation. 

And, of course, there are painful memories of policy mistakes made in the late 1960s and early 1970s, when overly accommodative monetary policy set the stage for a wrenching and lasting acceleration of inflation. 

How different is today’s seemingly enlightened penchant for open-ended quantitative easing?

The confluence of the pandemic cycle and the business cycle – the second wave of COVID-19 and a double-dip in the US economy – has left US policymakers with little choice but to approve another relief package, this time for $900 billion. 

Never mind, argues MMT, if that puts US federal debt on the cusp of exceeding the previous record of 108% of GDP, reached in 1946, in the immediate aftermath of World War II.

Yet back then, the mounting debt overhang was finessed by a reflationary surge in GDP, which caused the debt-to-GDP ratio to plummet to 47% by 1957. 

“All” it took was a 6.4% average consumer inflation rate from 1946 to 1951. 

Maybe that is all it will take this time as well. But what might that spell for interest rates, debt service, and incredibly frothy financial markets? 

Don’t look to MMT for an easy answer.

Stephen S. Roach, a faculty member at Yale University and former chairman of Morgan Stanley Asia, is the author of Unbalanced: The Codependency of America and China.

King Dollar Is Abdicating and That’s OK

The Fed’s stance means the greenback’s weakness is likely to continue, but that isn’t a disaster for investors who position themselves correctly

By Aaron Back

The premium of U.S. interest rates to those in Europe and Japan has largely disappeared as Jerome Powell’s Federal Reserve cut short-term rates to near zero. / PHOTO: POOL/REUTERS

There are many reasons to expect a weaker U.S. dollar next year and perhaps for longer, but none more important than the new policy stance of the Federal Reserve.

The U.S. dollar briefly rallied in March due to its haven role in investment portfolios. Since then, it has dropped around 12% against a trade-weighted basket of currencies as the U.S. turned out to be even harder hit by the coronavirus pandemic than most major economies.

As vaccines are rolled out and the global economy snaps back, this trade won’t necessarily run in reverse. Rather, currencies of countries that export commodities and manufactured goods are likely to keep strengthening against the dollar, as would be seen in a typical global recovery. Some Asian exporters already are quietly intervening to limit their currencies’ rise.

But this time, reasons to expect a weaker dollar run even deeper. For several years before the pandemic, U.S. interest rates on both the long and short ends of the yield curve were substantially higher than in Europe and Japan—a major source of strength for the U.S. currency. That premium has largely disappeared, though, as the Fed lowered short-term rates to near zero and launched a new round of asset purchases. The yield on 10-year U.S. Treasury notes has fallen from almost 2% at the start of the year to around 0.93% now.

Granted, that is still well higher than the 0.02% and minus-0.58% yields on 10-year Japanese and German government bonds, respectively. But real yields in the U.S. are in fact lower on an inflation-adjusted basis, points out markets economist Simona Gambarini of Capital Economics. In the U.S., the core consumer-price index was 1.6% higher than a year earlier in November. That compares with slight deflation in Japan and the eurozone.

This gap in real rates is unlikely to narrow soon. 

After all, the Fed pledged in August to let inflation run above its 2% target for an extended period and not to respond to falling unemployment with pre-emptive rate increases. 

Meanwhile, peer central banks around the world continue to target inflation rates of around 2% while falling well short of that.

If markets take the Fed at its word, they won’t bid up the dollar as they normally might in response to robust inflation or growth data out of the U.S. 

This is why TS Lombard economist Steven Blitz calls the new framework an effective end to the traditional “strong dollar” policy of the U.S. government.

Consider, for instance, the likely market reaction to a large stimulus package early in the Biden administration. 

Big doses of deficit spending are typically seen as dollar-negative because they mean the U.S. will have to import more foreign savings. 

But stimulus could be seen as dollar-positive if it successfully boosts U.S. growth. 

This time, however, the Fed has essentially pledged not to lift rates pre-emptively in response to positive economic news, so a big stimulus package is likely to be unambiguously negative for the dollar.

None of this needs to be bad news for investors. 

As most assets are priced in dollars, a weaker dollar often means higher asset prices on everything from stocks to commodities to emerging-market bonds. 

Investors whose net worth is concentrated in dollars should make sure they are diversified, for example by not hedging the currency exposure on their foreign equity holdings, says Brian Rose, Senior Economist, Americas at UBS Wealth Management.

The perennially strong dollar may be a thing of the past. 

Investors are unlikely to miss it.

Food price rally sparks warnings of pressure on developing countries

Large rise in agricultural commodities creates ‘recipe for unrest’ within fragile economies

Emiko Terazono

China has been a particularly big buyer of corn, the price of which has hit a six-year high © Bloomberg

A sharp rebound in food prices is stirring concerns over inflation and potential unrest in some developing countries.

Stockpiling, logistical bottlenecks and dry weather have pushed wheat, soyabeans, rice, and corn markets higher. 

The Bloomberg Agricultural sub-index has jumped more than a third since its low point in June to a two-and-a-half-year high, while the UN Food and Agriculture Organization’s food price index hit a six-year high in November. 

Soyabeans, a key ingredient for livestock feed and an important source of vegetable oil, are trading at just under $13 a bushel, with traders anticipating “beans in the teens” for the first time in six years.

In 2007-08, severe droughts drove up prices, triggering food riots in some African countries. 

A wheat export ban by Russia in 2010 also led to a surge in food prices in the Middle East, contributing to the Arab uprising. 

Some are now concerned about a “Covid shock” hitting some of the more vulnerable countries.

“The real impact is the access to food. People have lost their income. 

There are a lot of unhappy people and this is a recipe for social unrest,” said Abdolreza Abbassian, senior economist at the FAO.

The issue is not a food shortage at this point — grains and oilseeds have had bumper crops over the past few years, leading to higher inventories. 

But analysts worry that higher prices at a time of economic stress bodes badly, especially for poorer countries, particularly while an economic rebound in Asia is bumping up demand for grains and soyabeans. 

“Food inflation is the last thing governments need right now,” said Carlos Mera, analyst at Rabobank.

Fitch Solutions expects higher agricultural commodities as travel and spending “edge closer to normal, as the hospitality and restaurant sector reopens and consumer confidence rises”. 

Various governments shoring up their food reserves have also pushed markets higher.

China has been a particularly big buyer of everything from corn to rice. 

The country’s authorities used their reserves to damp down price increases during the pandemic and are replenishing their strategic stockpiles. 

A recovery in the hog herd after the devastation caused by African swine fever has also meant a rebound in grains used for livestock feed.

In the corn market, for example, the US Department of Agriculture’s Beijing bureau recently more than tripled estimates for China’s imports in the 2020-21 crop year from 7m tonnes to 22m. 

Due to the low level of state reserves, “substantial corn imports will be necessary to meet demand while also controlling further price increases and maintain stocks throughout 2021”, it said.

Wheat purchases by North African countries have kept pace, and food companies are also making sure they do not end up with shortages. 

Wheat itself was plentiful, but inventories were piling up in importing countries, said Mr Mera. 

“It’s a transition from ‘just in time’ to ‘just in case’,” he added.

Supply worries are also fuelling the grain bulls. 

Dry weather has affected crops around the world, especially in South America, where the La Niña weather pattern is causing hot and dry conditions in southern Brazil and Argentina. 

Farmers there are struggling with the lack of rain, with many having to dig up fields of shrivelled-up crops. 

Corn has rushed to a six-year high, and although wheat is off this year’s peak, it is still trading at more than $6 a bushel, levels last seen in 2014, due to dryness in Russia, the world’s leading exporter of wheat, and worries about grains export restrictions by Moscow. 

Rice prices, which jumped after south-east Asian producers threatened to limit overseas sales at the start of the pandemic, have remained elevated over logistics bottlenecks and buying by China. 

Port congestion and a lack of containers had caused shipping durations to double in some cases, leading to jitters in the market, said Frank Gouverne, chief operating officer at Rice Exchange, a digital platform for rice trading. 

“Freight prices have doubled. 

People are also waiting three to four months for their orders, adding further pressure on the market,” he said.

Hedge funds and other speculators have also bought food commodities in the second half of 2020, further adding to the rally. 

At the end of October, speculators held record net “long” positions in agricultural commodity futures and options after an unprecedented 22 consecutive weeks. 

While some have taken profits, bullish positions remain at multiyear highs.

Although prices on the international markets are lower than levels seen in 2009 and 2010-12, food is expected to remain a pressure point, especially for less developed countries.

“If [people] will realise the vaccine won’t solve the problems in the near term and they don’t have food, then things could get out of control,” warned the FAO’s Mr Abbassian, adding: “Although I still doubt we will hit those [previous] peaks, we will see volatility in the coming year.”