1. Western commentators are once again connecting unnumbered Chinese dots to form the picture that they want to see.  The PBOC statement on Yuan flexibility says nothing about timing, direction –  or anything of substance having to do with the new RMB currency regime.  It may be the harbinger of a new Grand International Coalition, or it may be Orwellian doublespeak justifying anything Beijing wants to do.
2. The west is expected to take forex off the table forevermore in exchange for a vague non-promise of flexibility.  How does this change the situation on the ground?  Western financial leaders have once again been pressed into service against their own Main Streets.  If the rmb appreciates by less than 10% over the next year, Geithner & Co are going to look a lot like Jack trading the cow for magic beans.
3. The Chinese side is controlling not only the substance of the argument, but also the timing and the scope. This is classic Chinese negotiation tactics.

Still, the chundits (China pundits) and globalists are thanking Beijing and congratulating themselves for averting a crisis.  Well, it’s certainly nice to think so.  But as we prep for the Toronto G20, how does this announcement change the negotiating environment?

First, China gets to maintain the status quo until it sees fit to change.   Even more significantly, the global recovery debate has been shifted away from artificial exchange rates and structural trade imbalances to western debt levels (which are still very much on the G20 table).  China once again trades smoke and mirrors for concrete western concessions.

This time, however, Beijing may be outsmarting itself.  This is the second doublespeak manifesto to come out in 2 weeks – following close on the heels of the Internet White Paper  released on June 8.  Beijing is displaying a new tendency to spell out in black and white just how gray and subjective its standards are.  Chinese tacticians have always exalted ‘formlessness’ and misdirection, but after a while it becomes possible to benchmark deception.  A pattern is emerging – Beijing enacts a policy (the currency peg or the Great Firewall), calmly waits for international debate to die down, and then finally releases an official definition of terms.  These pronouncements are fait accompli that protect China’s complete range of motion – but are couched in legalistic terms that sound objective.

In the bad old days when capitalism was the enemy and secrecy the rule, China-watchers used to count  coal cars on trains heading into Beijing to gauge the level of economic activity.  With this new set of documents — the Internet Manifesto and the Yuan de-peg paper — we have a new metric by which we can understand Beijing’s true intent.  This time, however, we will be judging the hardness of the NO by the conviction with which we’re told MAYBE SOMEDAY.

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Old tensions were brushed under the rug
It’s been about 14 months since March 2009 when Wen Jiabao signaled the start of the ‘new relationship’ between China and the US by very publicly fretting about the future of the dollar and Treasuries.   The winter of 2010 saw relations between China and the West sink to their lowest level in decades.   During the few weeks between the Second China-US Strategic and Economic Dialogue (SED) and start of the Shanghai Expo there was a noticeable improvement in top-level relations.   Even the People’s Daily gushed that the world was amazed over sharp turnaround in China-U.S. relations:

The China-U.S. relations entered into a warm spring from a cold winter in less than a year, and previously, it also took almost the same amount of time to drive the ties from summer to winter.

New troubles on the way.
Ironically, it was China’s success at managing the last round of international tension that is feeding into a new, more serious round of conflict.  Leaders like Timothy Geithner who were so expertly ‘handled’ by the Chinese side in Round 1 are now looking like empty-handed suckers whose kowtowing to Beijing yielded nothing.  China’s argument that it could help the world most by keeping its own economy strong is wearing thin as the global economy sputters along while China overheats.  Globalists from Washington to Geneva have very little to show for their patience and diplomacy, and the international trade environment is becoming more hawkish than ever.

Old tensions are spawning new conflicts.  The WTO regulations that helped China pry open foreign markets are now being used by Europeans and Americans to press for increased access to Chinese consumers.  Labor unrest in the factories seems to be focused solely on overseas firms.  China’s whitepaper on the internet has  enshrined censorship and blockages as official policy. Domestic content rules and new trade restrictions are destroying hopes for a level playing field for domestic and international firms.

The economic recovery in the West is moving in fits and starts with persistent unemployment and uneven economic growth.  Main Streets in the US and Europe have grown tired of empty promises.   Chinese managers are facing troubles of their own, as inflation, labor strife and fear of bursting housing bubbles eat up what was left of their margins and threaten the only business models they know.  The Chinese operating environment is becoming expensive, less profitable and far less predictable than at any time in the last decade.   There are fears that a double-dip recession may strike in Europe, the US and China.

Why is this time different?
Where the pre-SED (crash – May 2010) round of tension was primarily a clash of world leaders over macro issues, the new troubles will be much more bottom-up.  If you were negotiating with a Chinese counter-party in the last year you may have noticed that the atmosphere was less cordial than in the times gone by, but your deal-points and goals probably weren’t affected.  Emerging tensions, however, will center on more bottom-line issues.   We all know that Chinese negotiators tend to put more emphasis on relationships.  During times of international harmony, this represents a significant but not necessarily unpleasant challenge for American negotiators. What about during times of rising tension?  How should Americans handle their relationship building?   In a word, ‘cautiously’.  Unlike the first round of trade conflict, this will not be a war of words between elites, but more of a bare-fisted brawl between street fighters.

The game is changing, and it’s up to you to decide whether or not the next phase will benefit you.

Next:  Best Practices for Bad Times.

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Two issues are undermining international cooperation. The first is that the US and China are at variance over the benefits of cooperation vs. competition. The second is that the two actors are working off a faulty stakeholder analysis – leading to misinterpretation of how the other side values the variables on the table.

Cooperation vs. Competition: An extended Prisoner’s Dilemma scenario:

Work I’ve done with US & Chinese negotiators in a prisoner’s dilemma-type scenario does not give cause for optimism. China-US negotiation is often characterized by relatively simple, naïve initial deal-making (usually based on incomplete or erroneous information) followed by increasingly uncooperative, competitive, often hostile disagreement.

Cooperation requires a ‘growing pie’ of benefits
For US & Chinese counter-parties to achieve stable cooperation in a Prisoners Dilemma type arrangement, 2 conditions must exist.

1. Both sides must believe that steady-state cooperation will enhance their long term benefit over multiple iterations compared with short-term competitive behavior.
2. The global payout must be rising over the course of the arrangement. In other words, for cooperation to be stable the ‘economic pie’ must be growing. Faced with a stable payout (a zero-sum game) the default behavior seems to be competition over cooperation.

Modern Chinese negotiators tend to believe that their BATNA (Best Alternative to No Agreement – otherwise known as ‘Bottom Line’) is enhanced by a constant stream of new counter-parties or options. American negotiators operating in mature economies tend to view stable-growth scenarios as sufficient to maintain cooperative negotiating relationships. Combined with lower penalties for breaking contracts in China than in the US, the result is that Chinese negotiators tend to be quicker to switch from cooperators to competitors than their American counterparts.

Stakeholder analysis & relative valuation of variables.
The second oar propelling us towards the whirlpool of acrimonious trade war is improper stakeholder analysis performed by both sides. Because US and Chinese actors seem to be working with a simplistic, incomplete view of their counterparty’s priorities and interests, each side made gross errors in estimating how the other side valued variables. In other words, US negotiators didn’t know what was important to Chinese counter-parties and Chinese negotiators didn’t know what was important to the US. This has driven China’s negotiation position to shift from relatively cooperative to extremely competitive over the last 2 years.

In many ways, our present problems started in 2008 when an uprising in Tibet turned violent. America and the West seemed not only sympathetic – but were perceived by China to be taking an active role in spreading false rumors and images about the cause and nature of the protests. A similar scenario played out in the summer of 2009 when violence broke out in Xinjiang – and anti-Beijing photos & clips (some of which were admittedly of a highly suspicious nature) started showing up on social media networks and YouTube.

These incidents were perceived as relatively minor or ‘business-as-usual’ in the West – especially since demonstrations and public criticism of US policy were commonplace in the waning days of the Bush administration. To Western negotiators, public reaction to mild street violence on the other side of the world simply wasn’t that big a deal. To Chinese decision-makers, however, these uprisings were considered to be major threats to their core values – the legitimacy of the CCP. In Beijing, US commentators and social networks siding with the protesters was likely perceived in much the same way that Washington policy makers would react to a string of Xinhua editorials cheering on Al Qaeda and the Taliban. It not only undermined trust and cooperation – but also empowered right-wing conservatives who felt that China had opened to far too fast.

The economic crisis in the West further undermined US-Chinese cooperation. In March 2009 Wen Jiabao sealed China’s competitive position in a speech at the CCP conference bluntly attacking the US currency and economic policy. This was an unusually unambiguous signal that China was taking a competitive tack in US-Sino relations.

This makes sense from China’s perspective – at least in the short term – since a crippled US economy meant that there was now a much smaller pie to divide. The system-wide payout was dropping just as China’s contribution to the global economy was rising in both relative and absolute terms. China simply had less to gain from cooperating with the West – and shifted to a competitive mode.

The Way Forward
Unfortunately, once a multiple-iteration negotiation (same 2 negotiators, many different negotiations over time) turns competitive it is very hard to break the cycle. Trade hawks on both sides are empowered and there seems to be little benefit for either Beijing or Washington to make the first move. If the US economy recovers or the Chinese economy stumbles, it will only reinforce the competitive mindset. Bluster about Iran sanctions or Taiwan arms sales might be just the beginning. Each new trade sanction or public dispute will reinforce the competitive environment and make it harder to break the cycle of conflict.

Next: The Whirlpool in your shop – how to negotiate under adverse US-China conditions.

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When it comes to China’s negotiating style, what’s new is what’s old. In many ways Chinese negotiating is shifting back to a more traditional style where the power of the state is paramount and the main job of rulers is to defend Chinese territory (be it physical, financial or symbolic) & keep the barbarians outside the gate. There is a new feeling in China – not isolated to Beijing – that the Deng Xiaoping’s grand experiment has accomplished its mission. International cooperation has served its purpose – now Beijing can get back to business as usual. Policymakers seem to believe that multinationals and local entrepreneurs were important steps in China’s development, but now they have outlived their usefulness. What’s good for the Party is good for China, and vice versa.

Look for 5 big trends to characterize Chinese negotiation in the coming decade. Most are already evident on the national stage, but dealmakers at every level will quickly find that Beijing sets the tone for the rest of the country.

1. China steps up to superpower status.
We’ve been tiptoeing around this for years, but Wen Jiabao’s Copenhagen gambit seems to confirm that Beijing is through playing coy about its status in the world. For years local Chinese would feign astonishment when asked if the PRC counted as a Super – hemming & hawing awkwardly before finally admitting to being “important economically – but certainly not a military or political force in the world”. But while an emergent 1960s USSR blustered and threatened, rising China will initially take a softer, more passive-aggressive approach. Khrushchev banged on a table with his shoe – Wen Jiabao convened a press conference to publicly worry about the integrity of US Treasury Bonds.

2. Head-to-head, zero-sum competition with the US
China’s default negotiation position is zero-sum game/ competitive – and there doesn’t seem to be a crisis big enough to get the US and China pulling in the same direction. In the last 2 years we’ve witnessed a financial crisis, a climate showdown, terrorist threats and the emergence of rogue nuclear states – and in each instance China and the US have been at odds with one another. If the two can’t agree on the scary but simple stuff (nuclear Iran, reduction of greenhouse gases, a functioning global banking system) then it seems unlikely that we’ll find a way to cooperate on more complex issues that don’t threaten the survival of humanity. China is reverting to the pre-Deng doctrine that what is bad for America is good for China – and vice versa. Look for China to continue to find opportunities in American & Western challenges.

3. State-control of all negotiation agendas
Not long ago, Western pundits were positing a China where entrepreneurs and an emerging middle class would exert greater influence on the CCP and bring about a kinder, gentler PRC. Well, just the opposite is occurring. The party has co-opted (or arrested) successful entrepreneurs and glamoured the urban middle class to the point where there is only one voice in China – the official one. Xinhua has done a phenomenal job of taking charge of the internet and the rest of the media, expertly using 21st Century technology to deliver an old Imperial message – that the fortunes of the Chinese people and the Chinese leadership are as one. In the last few years Beijing has learned that the party need not own the means of production to control them. State Owned Enterprises are a burden, but policy directed enterprises are the assets that keep on giving. Scratch a private Chinese business and you’ll find a policy-driven organ of the bureaucracy

4. RMB hegemony – from Harmony to Our Money
Beijing goes out of its way to promise that it will never resort to the sort of brutal hegemony practices by Western colonial powers – at every Chinese military parade and naval exercise. But it’s not the gunboats – or even the cyber-squads – that should raise alarms. The new projection of Chinese power will be infrastructure projects and commercial deals. China’s foreign policy is driven by a need for raw materials, and it isn’t squeamish about who it has to get in bed with to obtain them. Sudan, Iran, Sri Lanka, Afghanistan and Myanmar/Burma are just a few of China’s most favored nations, and for now Chinese policymakers don’t see a downside to enriching warlords, dictators and tyrants. China favors a dual purpose string-of-pearls approach that is already well developed – and expanding steadily.

5) Its not about the economy, stupid.
Non-economic considerations drive Chinese organizations, as long-term policy concerns ace short-term profit/loss decision. For years Western dealmakers were driven to distraction by Chinese counter-parties that seemed blind to their own self-interest. It’s not that the Chinese side was dim or daft – rather they were driven by non-economic factors like policy, bureaucracy, relationship, technology and access to intellectual property. For a while it seemed that all of those returning MBAs and MNC-trained local managers would influence Chinese negotiating practices and usher in a more ‘rational’ decision-making process. Beijing’s stimulus program, however, has once again made central policy the 600 pound panda in the room. This is why the rationalistic arguments about the RMB-USD exchange rate eventually conforming to market forces at best unrealistic – and at worst, completely irrelevant.

What does all of this mean to US negotiators in China? The bad news is that Beijing sets the tone – and in many cases the substance – for Chinese dealmakers all the way down the line. The good news is that now you know the bad news (as is often the case in China).

Next – Surviving the New China Negotiation

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There are three ways a sustained economy in the US could impact on the pan-Pacific meeting this month:

The Good:
A more engaged, confident, capable US will be less prone to hitting the trade-panic switch and a new sense of calm and mutual respect will characterize trade relations between the Pacific giants. A domestic recovery will keep the union bosses and congressional opportunists off Obama’s back – or at least give the President a little breathing room. The stronger economy will help shore up the flagging dollar – removing a thorn from the side of international trade relations in general, and big-lender China in particular. Peace will return to the valley and we will all find other things to worry about.

On the China side of the equation, a stronger US economy that is more capable of absorbing imports will be quite welcomed indeed. Nothing lubricates the gears of international relations like big slathers of consumption-driven spending. A US recovery in 409 or 1Q10 would be timed perfectly to help China wean its own consumption off of expensive Statist trickle-down stimulus spending.

A stronger US economy is Win-Win for everyone.

The Bad:
A recovering US economy will give US trade hawks and Buy-Americanistas the confidence and firepower to pursue their resentment. China has had it both ways – complaining about the weak dollar while still manipulating its own currency and thus preventing market mechanisms from doing their job. The recovery will be jobless at first, so the unions and the populists (i.e.: congressmen up for reelection) will be contending with uppity, unhappy constituencies that are sick and tired of being everyone’s whipping boy. First Washington, then Wall Street, and now China? Oh, No you don’t! A recovering US will be feisty and activist on trade.

A stronger US economy will also be met with mixed emotions in Beijing which has enjoyed the sustained glow of being the only stimulus hero on the block. China’s big swinging GDP has vindicated a lot of rhetoric – and burnished Beijing’s reputation as the policy-makers of the millennia. They were secretly hoping for pics of race riots and soup lines in to brighten up the People’s Daily homepage – a little payback for some unflattering Youtubery over the past couple of years. For China, this has been like Reagan and Gorbachev circa 1987 – with Wen Jiabao taking on the role of beneficent ascendant and Obama as the good-natured steward of a failed model. China has made great strides in international circles over the last 9 years – and the last thing the foreign policy people want to see is Obama’s charm backed up with muscular economic growth.

A stronger US economy is Win-Lose for China.

Most Likely –
Both sides will circle warily – with many photo ops and grand vagaries. The public sound bites will be about climate change – the back-room talk will be military cooperation. There may be an exchange or two about currency, but in the press each side will ‘endeavor to persevere” or something equally inconclusive. Cross-Pacific trade is, in actuality, one of the few global mechanisms that ain’t broke yet, and neither side is under much pressure to shake things up too much. In the grand scheme of things, US-China trade tensions don’t add up to a hill of cheap tires and chicken parts – yet.

A stronger US economy is not going to tilt the balance of power just yet.

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