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US trade deal with Canada, Mexico on 'thin ice' as new round of talks begin

  • As a new round of trade talks are set to begin, analysts say it can't be ruled out that the U.S., Canada and Mexico will be unable to agree on a replacement for NAFTA.
  • The U.S. is expected to propose much stricter rules of origin that would require 85 percent of vehicle content to be made in NAFTA countries from 62.5 percent, and could possibly request that 50 percent of content would have to be made in the U.S. to be tariff-free.
  • Analysts say the odds have increased that the talks fall apart now that the stickier issues are up for discussion in a fourth round of talks.

With new trade talks set to begin, analysts say you can't rule out a failure by the U.S., Canada and Mexico to agree to terms on a replacement for the 23-year-old North American Free Trade Agreement.

Negotiators meet in Washington Wednesday to start a fourth round of talks aimed at revamping NAFTA. Canadian Prime Minister Justin Trudeau was also to be in Washington Wednesday, as the talks kick off, and he was expected to meet with members of the House Ways and Means committee before heading to the White House to meet with President Donald Trump.

Sources told CNBC that the U.S. is expected to come to the table with a new proposal on origination of content, which would require, for instance, an automobile made in Mexico and sold in the U.S. to have 85 percent NAFTA content in order to be tariff free. The current rule requires 62.5 percent of NAFTA content. The U.S. may also propose 50 percent of content be made in the U.S.

The "rules of origin" proposal is just one of the controversial demands the U.S. is planning to make this week that could alienate not just its trading partners — but also U.S. lawmakers and businesses. Others that are bound to draw ire: a "sunset provision" that would require any new agreement get unanimous buy-in every five years, otherwise it ends; and a proposal to settle disputes outside the World Trade Organization.

"We've reached a critical moment, and the chamber has had no choice but to ring the alarm bells," Tom Donohue, head of the U.S. Chamber of Commerce, said in a speech Tuesday that listed the items above as non-starters for U.S. business. "Let me be forceful and direct. There are several poison pill proposals still on the table that could doom the entire deal."

Such proposals are also met with disapproval by Mexico and Canada. A top economic advisor to the Mexican embassy, Karen Antebi, said in a speech at Georgetown Law Center last week that the Trump administration has "a vision of zero-sum trade."

"The risks of withdrawal are high, and we are preparing for that possibility," Antebi said.

Congressional aides have raised doubts about the viability of the White House's proposals on the Hill, where any new, finalized trade deal must be ratified. Lawmakers have found defending the merits of existing trade deals — and avoiding disruption of supply chains and import-export relationships — to be a source of rare bipartisan agreement.

"I definitely think there's a real chance this could fall apart," said Juan Carlos Hartasanchez, senior director at Albright Stonebridge. "There's been a lot of pressure in the last round of negotiations and going into this round, all governments are prepared to pull the plug if necessary. All the governments have a plan B. That plan being a non-NAFTA scenario."

There's a lot riding on a new NAFTA agreement for all three countries, and some trade disputes have broken out during the process. For instance, the U.S. has already put tariffs on Canadian soft lumber, and the Commerce Department proposed tariffs on jets made by Bombardier after Boeing complained Bombardier undercut Boeing's price with the help of government subsidies. U.S. dairy farmers are also angry about Canada's pricing structure, which they claim make U.S. milk products more expensive.

The renegotiation of the trade deal was prompted by the Trump administration, which has said the agreement was unfair to U.S. manufacturers and resulted in the loss of U.S. jobs. There have also been concerns that Mexico, a major exporter of auto parts, was being used as a back door into the U.S. by Chinese manufacturers.

Another sore point for the Trump administration is that the U.S. has a more than $60 billion trade deficit with Mexico, while there was a $12.5 billion trade surplus with Canada in 2016.

President Trump has threatened to pull the U.S. out of Nafta. This week, he was quoted by Forbes as saying he prefers bilateral deals and that NAFTA may have "to be terminated if we're going to make it good. Otherwise, I believe you can't negotiate a good deal."

"I think everyone knew that we were going to get to this point where the negotiations were going to get more difficult," said Dana Peterson, U.S. and Canada economist at Citigroup. Peterson said her base case is that a deal ultimately gets done but the negotiations are getting tougher. "This is so big . There are so many industries involved. There are three significant economies wrapped up in this and because we are getting into these more difficult areas, the rhetoric is going to ramp up."

Analysts said as the talks continue, the odds of failure are rising just because the issues are more contentious.

"I do think there's a chance the U.S. or Mexico could walk out. I don't rule that out at all. I think people would consider it a stunt and maybe we could resurrect the talks," said Greg Valliere, chief global strategist at Horizon Investment.

Hartasanchez said some U.S. demands are viewed as unreasonable, including one that would require Mexico to raise the minimum wage for its workers.

"There's definitely economic damage for all sides. A lot of jobs are on the line. A lot of regional competitiveness is on the line. I would argue the U.S. has the most to lose for a lot of reasons, particularly since it's the most developed economy," Hartasanchez said. He said under World Trade Organization guidelines for developing nations, the U.S. would be disadvantaged in a bilateral deal with Mexico. "It would have the most impact in terms of tariffs. Mexico would face lower tariffs to access the U.S. market than the U.S. would face to access the Mexican market."

Valliere described NAFTA as being on "very thin ice" and said if it looks like the talks are failing, the peso would drop. "I don't think it's a positive for the markets if they're thinking we could get into a serious trade dispute. The Canadians are sort of the adult in the room, but they could see some smack down here because Trump can't go after China, and Canada is a target for him."

Peterson said one of a number of issues for Canada is the fact the U.S. would like to drop an aspect of NAFTA under which the three partners could discuss any claims of trade abuses before taking action.

"The U.S. is asking for access to protected and supply managed industries. That includes the dairy industry, poultry and wine in particular for Canada," said Peterson.

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