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China's Fragile Economy Will Force Beijing To Deal With US, Economist Says

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China's Fragile Economy Will Force Beijing To Deal With US, Economist Says

China's deep-seated economic problems will motivate its government to make concessions in trade talks with the United States to avoid further tariffs from the Trump Administration, but Beijing will draw the line on any compromise it said would infringe on its sovereignty, a leading economist said today.

The outlook for the U.S. economy is directly correlated to the talks' outcome, said Donald Ratajczak, who runs the professor emeritus program at Georgia State University and who has spent decades as a global economist. The U.S. economy could fall into recession during the second half of 2020 as many of today's warning signs of slowing domestic activity become more prevalent, Ratajczak said. However, a substantive resolution to the U.S.-China trade dispute would be bullish for U.S. prospects and probably lead Ratajczak to shelve his recession call, he said at the SMC3 winter meeting in Atlanta.

U.S. and Chinese negotiators are racing a March 1 deadline to craft an agreement that, among other things, addresses Washington's concerns over the alleged theft of U.S. intellectual property by the Chinese. On December 1, President Trump delayed for 90 days a threatened January 1 increase in U.S. tariffs on $200 billion of Chinese imports to 25 percent from 10 percent. Trump has also warned that, should a deal not be reached, he could impose tariffs on $267 billion of additional Chinese imports currently exempt from the levy. Should he follow through on both threats, it would subject virtually all of China's imports to tariffs of some form. It would also ratchet up U.S. consumer prices, which Ratajczak said would effectively cancel out the benefits to consumers from the 2017 tax law that reduced individual tax rates.

At the same time, U.S. negotiators must be pragmatic over what they hope to achieve. For example, the Chinese will not agree to U.S. proposals resulting in foreign majority ownership of its companies, Ratajczak said. To Beijing, such a demand goes beyond economics and enters the realm of national sovereignty and identity, he added. Should the U.S. make that a deal-breaker provision, there will be no deal, he predicted.

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The Chinese economy has challenges that go beyond the tariff spat. Though the official government view is that China GDP grew by 6.4 percent in 2018, Ratajczak believes the actual number was in the 5 to 5.5 percent range. The price of copper has fallen by more than 20 percent from a year ago, which Ratajczak attributed to weakening demand from China, the world's largest consumer of the commodity.

Perhaps the biggest problem, Ratajczak said, is the Chinese government's continued support of so-called state-owned enterprises, inefficient and uncompetitive businesses reliant on government subsidies to keep the lights on and people employed in make-work jobs. Borrowing by state-owned enterprises accounts for 75 percent of new loan activity in China, according to Ratajczak. This is a potentially lethal one-two combo – it shows that China is having trouble keeping people employed, and it calls into serious question the quality of the government's loan portfolio, he said.

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Despite China's issues, the global economy performed well in 2018. Global GDP increased by 3.8 percent, which Ratajczak called a solid number. It was also the first time in four years that global trade grew faster than global output, he said. The International Monetary Fund is projecting 3.3 percent global growth in 2019.

The U.S. economy – the world's largest – will perform adequately this year, with strong corporate profits and a still-resilient consumer, said Ratajczak, who predicted 2.7 percent GDP growth in 2019. However, the U.S. economy is flashing numerous warning signs. The housing market, which leads general business conditions by six months or so, is struggling, with existing home sales stagnant despite the millennial generation now having the financial wherewithal to bid on homes. Once-buoyant auto sales have slowed, and are no longer "a force for growth," Ratajczak said. Consumer expectations, especially when compared to current conditions, fell dramatically in January. Wage growth will be adequate, and will remain in line with productivity growth, he predicted. However, corporate profits will become compressed should wages begin to accelerate faster than productivity, he said.

Industrial production, a crucial metric for less-than-truckload activity, will rise 3 percent in 2019 but tail off in the second half of the year. On monetary policy, Ratajczak noted that real interest levels are at zero, and that an argument could be made to hike them even more to discourage financial risk-taking that distort economic activity. However, he advised the Federal Reserve to hold off on further hikes until there is clarity on the U.S.-China trade front.

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