Showdown in Osaka and the Fate of the World

Osaka will be a showdown less between Trump and Xi than between the forces of globalization … rising nationalism that may steer us toward a sharper confrontation.

With last week’s Central bank decisions behind us, all eyes are on the face-to-face meeting between Donald Trump and Xi Jinping that will determine the fate of the world. That may sound a little breathless, but it feels like we are approaching one of those moments that will linger in future history books when things either got a little better or turned much worse.

Much of the week ahead is entirely predictable: markets will bounce nervously as both sides try to set expectations with strategic press leaks. After they talk, the two leaders will emerge to shake hands for the cameras, issue a statement and likely designate teams to continue the process.

What remains far more crucial about this meeting is whether it helps steer the increasingly complex relationship back on a familiar course or whether it stirs winds and currents that sweep us further off into uncharted waters. Osaka will be billed as a showdown between Trump and Xi, but the real confrontation that looms is between the forces of globalization that have shaped the world economy for three decades and the rising nationalism steering us toward a potentially sharper confrontation.

Most of the recent analysis has centered on the tariffs that each side has placed on the other and their impact on American farmers and Chinese manufacturers. But the actual tariffs are just not that important in and of themselves and will hardly knock either country’s economic path off course.

China’s exports to the United States are about 4% of its GDP and actually much less if you strip out components imported from elsewhere. Tariffs on U.S. exports to China are significant to anyone who makes planes or grows soybeans or slaughters cows, but altogether they represent less than 1% of the American economy.  

If talks fail to strike a temporary truce, fresh tariffs on Chinese toys and clothing and consumer goods will hurt U.S. retailers. But they’ll barely dent public optimism. If anything, they might offer a small boost to counteract the recent price weakness that has the Fed worried.  

Xi’s team has not only drawn up a careful retaliatory list of U.S. targets to minimize damage to the Chinese economy, but they have actually lowered tariffs on similar imports from other countries to soften the blow. It’s a boon for Canada’s lobster industry over Maine’s (unless you’re the lobster). 

This means that Osaka is much less about any tariffs than the direction of the entire U.S.-China relationship. This has taken a much more complicated turn in the last six weeks.

Chess masters urge young players to see the whole board, rather than focusing solely on a few pieces in play. Instead of futilely wrangling over a single issue, diplomats have long resorted to expanding the conversation and bringing leverage from other areas. Henry Kissinger, for example, famously tried to link Soviet restraint in the Third World to concessions in nuclear and economic negotiations. Those results were mixed, but we appear to be entering a period of similarly complex linkages between Beijing and Washington.  

Trump finds the intricacies of these connections appealing, as Mexico learned this month when immigration issues were tied directly to tariffs. Xi seems willing to broaden the discussions, too.  

Through most of the last year, tariff discussions have been proceeding remarkably isolated with so many other issues on the table. Recall that China essentially ignored the arrest of a Huawei executive in Canada following the G-20 Summit in Argentina last December.

When trade negotiations collapsed in early May, however, Trump blacklisted Huawei itself. National security concerns have been simmering for years, but the timing to increase pressure on Beijing over tariffs was unmistakable.

Just as interesting was Xi’s unexpected scheduling of a visit to North Korea last week, which may represent his attempt to supplant Trump’s unraveling effort or advance an issue where they are largely aligned. In any case, it allows them both to frame the trade standoff amid a broader range of issues.

Trump has so far restrained from any escalatory language regarding recent protests in Hong Kong, but he will be mindful that those events have put Xi on the defensive. Other issues like the South China Seas, human rights and Taiwanese politics have yet to take center stage in their talks, but the spotlight is widening quickly.  The escalating tensions between the U.S. and Iran will be high on everyone’s mind, too. 

So as the leaders emerge from their meeting, there will likely be clear signals about how they intend to manage the relationship across this broadening set of dimensions. Will they manage to link a U.S. compromise on trade to a Chinese breakthrough in Korea? Will recent Chinese signals that it will resist currency devaluation lead to a softer tone from Vice President Mike Pence whenever he delivers his long postponed speech on China policy?  Or has the souring mood in both countries made it impossible to patch up an interim truce? 

For investors, any more cooperative signals will indicate that both sides still want to protect important economic benefits of their relationship even if the trade static persists. An impasse, however, will open an era of significant political and diplomatic uncertainty that will make all the worries over tariffs seem like a quaint annoyance.

Watch closely.