Why China had to negotiate with Trump

In a previous commentary on China, I started with the rather obvious point, often neglected, that China is run by the Communist Party of China. The way the Communist Party sees the world is in terms of historical progress outlined first in Marx and second in Lenin.

Right now, they see themselves living through the period described by Lenin in his "Imperialism: The Last Stage of Capitalism". In simple English, this means that they intend to rule the world and don't intend to be nice to anyone. Their bargaining position is that they will only make decisions regarding international negotiation not because they are attempting to establish trust or be generous to anybody but because they have to for structural reasons in their own economy.

The tentative agreement between China and Donald Trump emphasises that there are two short term structural problems within the Chinese economy which the Chinese leadership is attempting to address. One of those is in the food markets and the problem with food inflation, and the other is in the capital market; the increasing problem that China will have in financing its current account.

Food

I'll deal with food first because food is the most internally politically sensitive. Variation in food prices have historically had enormous impact on the political stability of China. Let's go back some decades to the events "that never happened" in Tiananmen Square in 1989. We find that those events were driven by a very rapid food price acceleration which in turn generated political instability. What we've got in China at the moment is the beginning of a possible circumstance like that forming from dramatic pork price rises.

The Chinese swine herd which is enormously large, many millions of animals, has been affected by African swine fever. This has meant that there has had to be an enormous amount of the Chinese swine herd destroyed. Thus, the domestic production of pork has fallen. This causes problems with prices and consumer price inflation.

Pork prices domestically in China are up by 75%. This has introduced an acceleration in food prices of 45%. The result of this acceleration is to bring overall inflation to 3%. This is towards the upper end of the inflation range this century. Moreover, core inflation is only 1.5%, which goes to show there's not an industrial problem.

Pork prices rocketing up 75% is a real problem with the potential to increase political instability. What the Chinese have to do is to launch a program to dramatically accelerate the repopulation of the swine herd. They need to find an awful lot of grain to do that. It just so happens that the number one grain exporter of soybeans and feed grains in the world is the US.

As a result, stage one of the potential agreement between China and Trump includes the importation of US$40-50 billion of agricultural products (mostly grains) to China. Historically the largest ever year of China buying American agricultural products was 2013 in which they bought US$29 billion. They are proposing to buy almost twice as much as the previous total record high. This move is absolutely necessary for China to rebuild their swine herd, to get pork prices down and not have that risk of political instability.

Importing Capital

The second thing that China has proposed to do, is to open up the capital market to US financial companies. The reason they're forced to do that can be seen in the outlook for both the Chinese budget balance and the Chinese current account balance within the IMF outlook database. What it shows is a change in the structure of Chinese growth.

I've said previously that China has moved from being a primarily industrial country to primarily a service economy. The problem with that is that as services rise and manufacturing falls as proportion of Chinese GDP, it is still manufacturing which generates most of the export income.