The U.S.-China leverage game

Negotiations usually boil down to leverage — specifically, who has more of it. In the U.S.-China talks underway Monday in London, the question of who has the upper hand boils down to macro- versus micro-economics.The big picture: A slew of data out of China shows the massive cost that U.S. tariffs impose on the Chinese economy, reflecting both underlying economic weakness and what the nation stands to lose if no trade peace is reached.The U.S., meanwhile, has had a run of perfectly solid macroeconomic data, but has much to lose if China continues throttling supplies of rare earth minerals and other specific goods that U.S. industries desperately need.State of play: All is not well for the fundamentals of China's economy, and plunging trade with the U.S. exacerbated those problems.Chinese exports to the U.S. fell 34.5% in May from a year ago, according to Chinese National Bureau of Statistics data out Monday. Its imports from the U.S. also fell, by 18%.Consumer prices fell for the fourth consecutive month, the bureau said, while producer prices fell the most in nearly two years.The mix of moribund export activity and falling prices compounds the nation's challenges grappling with a property bust and debt overhang.Yes, but: That might make Chinese negotiators eager to make a deal. After all, the nation's leadership views maintaining stable economic conditions and good living standards as crucial for their own hold on power, and collapsing exports to the U.S. undermine that goal.But they have plenty of leverage of their own, tied to U.S. reliance on very specific Chinese exports.Reality check: China's power in this standoff is tied to its ability to restrict exports of rare earth minerals, certain electronics, and pharmaceuticals.By throttling a handful of export categories, China can potentially exact damage on the U.S. economy that's far larger than the dollar value of the lost trade flows.Adam Posen, president of the Peterson Institute for International Economics, argued in an influential essay this spring that this means China has "escalation dominance," the power to escalate or de-escalate according to its goals.What they're saying: "The United States gets vital goods from China that cannot be replaced any time soon or made at home at anything less than prohibitive cost," Posen wrote in Foreign Affairs.In the event of aggressive escalation, he wrote, the U.S. "will face shortages of critical inputs ranging from basic ingredients of most pharmaceuticals to inexpensive semiconductors used in cars and home appliances to critical minerals for industrial processes including weapons production."The intrigue: The Wall Street Journal reported Monday morning that President Trump has authorized his negotiating team to loosen export restrictions on jet engines and other products as part of the talks, citing people familiar.That's consistent with the decision to include Commerce Secretary Howard Lutnick on the U.S. team.It opens a potential new frontier for de-escalation across issues that are not normally part of trade talks.

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