Summary:
US-China negotiations in London concluded on Tuesday evening with a notional “framework” agreement for restoring the trade truce agreed in Geneva on May 12. The framework now goes to President Trump and President Xi for approval, which seems likely.
In line with our expectations, London marks a de-escalation in recent non-tariff tensions that have erupted since Geneva, rather than a breakthrough or substantial progress towards a broader trade deal:
- It will restart China’s rare earth exports, avoiding disruption to major US supply chains, particularly autos.
- It will preserve the tariff truce struck on Geneva on May 12, allowing the two sides to continue discussions towards an extension of that agreement. However, we see limited room for substantial tariff reduction this year.
The London meetings, along with the Trump-Xi phone call last week, reduce the risks of serious US-China escalation for the next several months and probably through the end of the year. Beyond then the outlook is much more uncertain.
RARE EARTHS AND EXPORT CONTROLS
While the details have not been released, the London meetings involve a quid pro quo: China will restart exports of rare earths to US firms, while the US will unwind or loosen recently imposed export controls targeting Chinese companies.
While we expect rare earth exports to restart, China’s rare earth export control regime is here to stay and is the new uncomfortable reality for global industry. Beijing will continue leverage China’s dominance in the production of rare earths to: (1) act as a deterrent and form of economic coercion against the US and other countries; (2) incent certain industries reliant on rare earths to keep production within China; and (3) limit the supply of some materials to the US military. A key question is how short of a leash Beijing intends to provide for the US (and other countries) moving forward).
The durability of US commitments on export controls is also uncertain, given intense US-China tech competition. We are awaiting details on which export measures the US has agreed to loosen:
- (Likely) Recently imposed controls the export of semiconductor EDA (electronic design automation) tools to Chinese tech companies that are not otherwise subject to US export controls.
- (Likely) Restrictions on the export of aircraft parts to Chinese aerospace giant COMAC. The US had imposed these in retaliation for China’s refusal to export rare earths.
- We will be surprised if the US loosens its effective ban on Nvidia H20 chips to China but may signal openness to Nvidia’s plans to design new modified chips to China.
- The US may tweak language warning companies not to use Huawei Ascend chips, a fledgling rival to Nvidia’s GPUs, but we do not expect a significant loosening in the overall stance towards Huawei.
A critical question is how Beijing will respond to future U.S. export control and tariff actions:
- It is very unusual for the US to negotiate on export controls with China, and the London talks demonstrate the powerful deterrent effect of China’s rare earth restrictions. However, there is intense pressure on the Commerce Department from Congress and the national security establishment not to significantly loosen export controls on advanced semiconductor and AI technology to China. Indeed, media reports suggest that Commerce has been considering a range of further restrictions on Chinese chipmakers, cloud providers, and AI firms. It is not clear whether the Trump administration made forward-looking commitments to China on export controls, and also not clear what Beijing has demanded.
- The Trump administration also has pending decisions on sectoral tariffs on semiconductors, which take aim at China in particular. If the courts deprive the Trump administration of tariff authority under IEEPA, the administration is likely to announce new tariffs on China (such as under Section 301).
- These dynamics point to ways the London framework could come under pressure in the future, with China against tightening rare earth exports in response to future US actions. More details on the framework will be important for assessing these risks.
Stepping back, it is possible that after two rounds of measures that threatened global supply chains (first with tariffs, then with export controls) the US and China will settle into a new equilibrium of more carefully managed strategic competition. But given a backdrop of intense competition and distrust, and a Trump administration inclined to exploit every source of US coercive power, we are skeptical that a stable new equilibrium has arrived. If US-China tensions spike – whether on trade or geopolitical issues such as Taiwan – the two sides will look to exploit new chokepoints and existing ones.
NEXT STEPS ON TRADE AND TARIFFS
London meetings and other developments point to a likelihood that the two sides will maintain their tariff truce beyond the August 12 deadline:
- De-escalation of non-tariff tensions above now put the Geneva tariff truce back on track.
- President Trump’s interest in meeting with Xi, potentially in China, is another source of near-term stability in the relationship. Aside from a potential Trump visit to China, the two leaders will have the opportunity to meet this fall on the sidelines of the APEC meeting in South Korea (Oct. 31-Nov. 1) or the G-20 Summit in South Africa (Nov. 22-23). While that window is too early for the two sides to announce a broad trade agreement, though could announce an interim agreement. At the very least it should keep an agreement alive.
- The hurdles that Trump faces in passing the fiscal bill is also a source of near-term restraint on trade escalation with Beijing.
The next watchpoint in negotiations is whether the two sides can make progress on fentanyl cooperation and lowering related tariffs. Progress on fentanyl will probably be a necessary but not sufficient condition for Trump to grant tariff relief. And some tariff relief may be necessary to start Chinese purchases of US agriculture and energy, given that China’s retaliatory tariffs currently make such purchases uneconomical.
The two sides have yet to make progress on the core economic issues at the heart of the relationship, which will make a broad trade deal difficult to reach. Geneva and now London were both about the two sides stepping back from the brink, not bridging the gap between them. Moreover, President Trump retains a strong affinity for keeping high tariffs in imports from China, as demonstrated in his post on Wednesday morning touting a “55% tariff” rate on Chinese imports.
Watchpoints:
- Trump/Xi approval of the “framework” and its details
- Pending US decisions on sectoral tariffs, especially semiconductors
- Status of US-China negotiations on fentanyl
- Signs of planning for a Trump-Xi meeting/visit this year
