It’s good for taxes to be progressive. But it’s more important that they can’t be avoided.

There’s been a lot of talk recently (particularly out of the US) about increasing taxes on the wealthy – Elizabeth Warren has proposed a wealth tax of 2 per cent for assets over $50 million and 3 per cent for assets over $1 billion. Alexandria Ocasio Cortez (AOC) has proposed a top marginal income tax rate of 70 per cent for incomes over $10 million. Bernie Sanders wants to lower the threshold for the estate tax and make it more progressive.

On the face of it, there is a good argument for countries like the US collecting and redistributing more tax than they currently do. I've written before that there is a good inverse relationship between tax collection and inequality. Countries in the OECD with the highest tax revenue as a percentage of GDP (e.g. Norway, Denmark) tend to be the best at keeping inequality low while still maintaining some of the strongest free market economies. On the other hand, countries like the US with one of the lowest levels of tax revenue as a percentage of GDP and also one of the strongest free market economies have among the highest levels of inequality.

What is the best way to raise tax revenue though? Income taxes? Wealth taxes? Corporate taxes? Consumption taxes?

Warren, AOC and Sanders seem to think the first two. I think they're also considering a reversal of Trump’s corporate tax cuts. And it makes sense. Income and wealth taxes can be progressive, with the richest people paying higher rates. Consumption taxes disproportionately affect the poor who spend a higher proportion of their income on goods and services than the wealthy. The same applies to flat corporate tax rates and small vs. large businesses.

So I can understand why Warren, AOC and Sanders picked these taxes.

Unfortunately, income, wealth and corporate taxes are rife with avoidance. Wealthy individuals and companies have the means to use every form of accounting trickery to avoid actually paying these taxes. Shifting profits overseas to avoid corporate taxes. Minimising your official income with every imaginable deduction to avoid income taxes. Even wealth and property taxes can disproportionately affect the middle class because the wealthy tend to hold most of their wealth in shares rather than houses and therefore, avoid such taxes. It’s not easy to enforce these taxes.

This is why, according to a recent article by Bloomberg, the OECD countries that are able to raise the most tax revenue as a percentage of GDP are the ones with the *least* progressive tax systems – economies that rely proportionately more on consumption taxes (e.g. Denmark, Finland). The US on the other hand, has very little reliance on consumption taxes.

As mentioned above, consumption taxes disproportionately affect the poor, but are much harder for the rich to avoid. They also have the added advantage of not discouraging work (like income taxes can) or investment (like corporate taxes can).

Consequently, these countries are able to raise much more tax revenue, and then undertake much more income redistribution to offset the disproportionate impact on the poor – social welfare, infrastructure, education, health care, paid vacations, paid parental leave, child care, all provided by the State to greater extents than in the US.

This redistribution can also include much more targeted exemptions for specific items or activities society wants to encourage above others. This can include fruit and vegetables, health care and, in Australia, possibly new home building. Given the barriers that existed to new home building for much of the 21st century, the affordability crisis that developed, the sudden influx of supply (especially apartments) and the subsequent risk (though not expectation) of a deep and protracted correction, this is not something of which we’d like a repeat episode. Even if such sudden new taxes don’t discourage investment, extra incentives for new home building are still a good idea given our history.

The IMF too, in their latest assessment of the Australian economy, recommended a shift away from less efficient taxes like stamp duties to more efficient ones like consumption taxes (our GST) and land taxes.

This does not mean all taxes need to be consumption taxes but a greater reliance on them seems wise. If high tax collections are the best way to minimise inequality – thereby helping people into the Australian dream of home ownership – while retaining a strong free market, then the taxes that are most difficult to avoid are surely the preferred option over more progressive, but easier-to-avoid, taxes – even if it involves the extra step of greater redistribution.

Redistribution is not a dirty word after all – it’s literally the one and only job of government.

Interest rate speculation pushed into overdrive.

Australia’s economic fundamentals are still strong.
But the local housing downturn, the global trade war, increasing international borrowing costs, a slowing EU, structural issues in China, and general instability all threaten to derail both global and local economic momentum.
The risks are asymmetric to the downside – the RBA should pre-empt them by dropping interest rates this year. The costs of not doing so are potentially much larger.

 

Death, taxes and cash rate speculation – these are universal constants. But in recent months, speculation about the direction of the Reserve Bank of Australia’s (RBA) cash rate have pushed this speculation into overdrive (at least amongst us economists).

The RBA – for many months now – has very clearly been signaling that its next cash rate move will likely be upwards. Many players in the industry agree, speculating some time in 2020 for the next rise.

There are good reasons for this upwards cash rate broadcasting.

Australia is continuing its approach towards 30 years of uninterrupted economic growth. Growth recently returned to trend following the mining and resources fallout, supported by strong home building activity and public infrastructure spending. The labour force continues to strengthen too, with unemployment back down to 5.0 per cent.

We are also being supported by a buoyant global economy. The US is experiencing one of its longest economic recoveries on record. China continues to generate economic growth rates beyond the dreams of any developed country. And advanced economies have driven strong global economic growth in recent years.

It is in spite of – or perhaps *because* of – this strong performance that there is increasing nervousness about the future. A number of prominent pundits have broken from the herd and begun canvassing the idea that the next move could actually be a cut. These concerns mainly surround two perceived risks – a global shock and a major local housing correction.

The IMF has just revised down its forecasts for global growth in the next couple of years; the trade war between the US and China (and perhaps the EU too) threatens to derail global momentum; recent negative economic data out of both the EU and China have raised concerns; and ongoing insular, nationalistic and anti-globalisation sentiments surrounding not just Trump’s America, but also Brexit, the Italian budget situation, recent French riots, and many other regions, threaten in the short term to shock the economic outlook, and over the longer term unwind decades of wealth generation, poverty reduction and international cooperation and stability.

Closer to home, Australia has its own ‘Moloch and Mammon’ on the horizon. Since their respective 2017 peaks, dwelling prices in Sydney have declined by 11.1 per cent to December 2018, and by 7.2 per cent in Melbourne. Nationally, prices are down by 5.2 per cent. The November housing finance figures showed that the number of loans by banks for the construction of a new home fell by 2 per cent in the month of November to be 9 per cent lower than the previous year. The change in the housing cycle had a direct impact on the flow of new residential building work entering the pipeline and creates a risk that the change in housing wealth may cause households to reduce consumption expenditure.

The continuing housing market downturn has thus far not resulted in a significant wealth effect on household consumption. The largest price declines have been at the top end of the price spectrum – households that are less sensitive to changes in wealth and therefore, less likely to significantly cut back on consumption. But this is not a forgone conclusion and while we have long been anticipating a housing downturn (five years of housing construction completed in just four years couldn’t be sustained indefinitely), and ongoing population growth will continue to absorb housing supply, there is still ongoing uncertainty about the downturn’s true length and depth.

Record household debt levels have not yet caused households to tighten their belts and there are few concerns from the RBA about debt serviceability with mortgage arrears remaining low. But wage growth has only just begun to tick upwards from is recent sluggishness and is definitely not guaranteed to continue that way. Combined with structural issues like ageing populations and low productivity growth, wage growth could continue to struggle, putting pressure of heavily-indebted household budgets and increasing their vulnerability to increasing borrowing costs.

Slower global growth will slow the pace of interest rate normalisation around the world but the combination of APRA’s tighter lending standards for investors and interest-only lending and the Royal Commission into the financial industry have acted to tighten local finance conditions not just for investors, but also owner-occupiers (even though APRA’s caps have since been removed). The time it takes to gain approval for a loan has blown out from around two weeks to over two months. And we saw just last week that NAB increased interest rates independently of the RBA and other commercial banks, citing these increasing costs of finance. When the impact of the findings from the Royal Commission become apparent, plus Labor’s proposed changes to negative gearing and capital gains tax, it could be the trigger to a steeper property market decline and the thus far-absent wealth effect on the broader economy.

Perhaps most important to Australia – as has been the case for the last 20 years – is the fate of China’s economy, our single greatest export market. There too, significant amounts of debt have been accumulating. China’s massive ‘pump-priming’ following the GFC averted a significant downturn. But it unfortunately also shifted huge amounts of resources away from potentially productive and innovative private sector uses back into government infrastructure and programs, unfortunately derailing their transition from an investment-led to a more sustainable consumption-led economy.

Recent slower economic growth and other worrying data out of our behemoth neighbor to the north poses the question – do they still have the will and the means to carry themselves through the next downturn? To be fair, people have been talking about Chinese imbalances and slowdowns for a couple of decades now, and China has continued to defy expectations. Even the GFC couldn’t knock them over. Policy makers and regulators have also been attempting to address some of these imbalances for a while now. But these predictions only need to be right once. And doesn’t the fact that these imbalances haven’t disappeared (and have actually got worse) add *more* weight to the argument for every year China keeps kicking the can down the road, not less?

Furthermore, the international trade war – even though escalation is still forecast to cost the global economy only in the low single digit percentages of GDP – could represent the trigger for some of China’s more significant imbalances to reveal themselves.

 

These are a lot of national and international factors that could turn against Australia in the near future. Hence the recent boom in RBA cash rate speculation.

Monetary policy is supposed to be proactive, not reactive. The US provides a good case study of this during the GFC. It was real-time feedback from financial institutions around the country rather than deterioration in official statistics that revealed the sudden liquidity emergency being faced and triggered the unprecedented response from Ben Bernanke and the Federal Reserve.

In Europe on the other hand, they did wait for longer and actually initially increased interest rates because they were more concerned about inflationary pressures than the financial crisis that had already begun. Consequently, the pain that followed was much greater than in the US.

Our own RBA Governor Philip Lowe – generally seen in the industry as a rather conservative figure – would arguably need a significant new development to occur to consider not just delaying any future increases, but actually dropping the cash rate from its current record low 1.5 per cent.

What then would need to happen for the RBA to reverse its long-broadcasted position that the next cash rate move will be upwards? A sudden deterioration in official economic indicators? Unemployment to jump up over 6 per cent? Inflation to fall below 1.5 per cent? Economic growth to turn negative? An influx of panic from their business liaison program?

There is a lot that could go wrong in the near future for Australia and the world.

Notwithstanding one (or more) of the above potential global shocks, I am only predicting a manageable slowdown in the Australian economy, rather than a drastic correction or recession. But I do think this will be a valid justification for the RBA to drop interest rates this year. They no longer have to concern themselves with overheating the property market. In fact, the combination of tighter credit conditions, the imminent impact of the Royal Commission’s findings and increasing global borrowing costs means it may be very irresponsible not to drop interest rates further. The risks are asymmetric – much larger to the downside than the upside. Why not drop rates?

The RBA may suffer a bit of embarrassment if they suddenly change their position. But policy makers need to be willing to consider rapid reversals of position if the worst should happen. By the time it shows up in the official data, it could be too late.

Modern Monetary Theory

MMT reinforces some valuable lessons, including that fears over government debt and deficits are often overblown – especially during major economic downturns.
But there are problems with this approach in terms of trusting government to not stoke inflation or crowd out the private sector in the face of the temptations of ever-expanding government.
These are big asks.

I can’t believe it, but Twitter actually taught me something new. It’s not just about fighting with strangers.

Recently I came across a ‘new’ idea in economics called ‘Modern Monetary Theory’ or MMT. As it turns out, it’s actually not particularly new. But it does offer some useful insights into the relationship between government debt, inflation and taxes.

Granted, I only really encountered the idea recently, so I’m sure I’ll be missing or overlooking certain aspects of it. But here is my understanding.

I suppose the main conclusion of MMT is that concerns about government debt and deficits are overblown. MMT asserts that for a country that has its own currency (e.g. Australia, US, UK, etc, but not countries like Greece), there is technically no limit to the amount of money a government can spend. Even if the rest of the world no longer wants to lend money to that government (or for some reason, they start charging a much higher interest rate on that country’s debt), the central bank can hold all the government’s debt – it’s their money, they create it, they can create and spend as much as they want.

Not only does this mean a government can always ensure their economy runs at full employment. Technically, it also means a government that has its own currency can never go broke.

I know, I know, I had the same reaction – “hang on, a government can’t just print whatever money it wants, it’ll spark inflation!”

Correct. That’s why MMT advocates taxes – not as a means for the government to *afford* what it spends, but as a way of shrinking the private sector enough to *accommodate* that government expenditure without sparking inflation[1].

And this reveals what I think is the critical insight of MMT – a government’s budget is not limited to how much it *taxes*. It is limited to how much the economy can *handle*. This still means tax revenue and government spending will approximately coincide. Generally, every dollar the government spends, it has to tax from the private sector so as to not spark inflation. But not always precisely equal.

During a recession for example, the private sector has already retreated. Government spending will not crowd out the private sector – in fact, by supporting economic activity and private sector confidence, government spending in this case will actually crowd *in* the private sector.

And it can do this simply by borrowing money (either from people, businesses, other countries or just their own central bank printing press) – no additional taxes needed to be raised in the short term.

Now, once the economy is back on a solid footing, this extra money in the system can cause problems. Once the private sector recovers, that extra money may be too much for the economy to handle. So … the government has to gradually withdraw it from the system in taxes to keep inflation down.

So there will be a long run close correlation between government spending and taxes – but it doesn’t have to be exact. Which means any debt that happens to be accumulated during this process is, by definition, not a problem. If it doesn’t spark inflation, and it doesn’t crowd out the private sector, it is perfectly acceptable.

So essentially, MMT advocates allowing governments to print whatever money they want/need to finance their expenditures, as long as they correspondingly shrink the private sector with taxes in order to manage inflation. And any money they happen to borrow in order to achieve this – especially if it’s from their own central bank – is irrelevant. It’s their money.

There are useful insights here. First, it destroys the analogy of the government budget being like a household budget – that governments need to ‘live within their means’ like any household. Households are currency-users, not currency-creators, so for that reason alone, it’s not a valid analogy. A government ‘living within its means’ relates not to how much money it ‘earns’ in taxes, but how much the economy can handle (even though the two roughly coincide).

Second, it reinforces the traditional Keynesian idea of government stimulus during an economic downturn. Not only does this kind of stimulus help prevent the kind of human costs and hardships we saw during recent European austerity, and back in the Great Depression. It also gets the economy back on a solid footing sooner, allowing government tax revenues to recover sooner, thereby managing government debt levels sooner. So even if your only concern is debt, stimulus, not austerity, during a downturn is the way to go.

And MMT adds another piece to this argument – the government won’t go broke if it has its own currency. Again, this doesn’t apply to countries like Greece, but it does to countries like the US, who also got caught up in ill-advised austerity following the GFC. Even ignoring MMT, government debt is always manageable if the interest rate on that debt is lower than the country’s economic growth rate – which has almost consistently been the case for the US, especially over the longer term.

There’s also almost no concern of inflation during a major downturn – so the government can just print and spend for much longer than usual without sparking inflation because the private sector has already retreated. No additional taxes required (at least in the short term).

Now for my concerns …

In the end, MMT is advocating for giving government, rather than an independent central bank, greater control over the printing press.

And it’s not as though we haven’t seen what happens when we’ve done this in the past. Governments always have an incentive to print and spend more. And they’ve often not correspondingly increased taxes sufficiently to avoid massive inflation.

Trusting a government to frequently review tax policy – and change it – in response to inflationary fears, is a much bigger ask than for a central bank. Not just because of their incentives to drop taxes and increase spending, but because the administrative logistics of changing taxes are far more onerous than changing interest rates.

But even if we assume a government can adjust taxes effectively enough in response to their own spending and consequent inflationary pressures, there is still the problem of a continually-expanding government.

If a government always has the incentive to spend more, and manages to tax more to keep inflation down, this means the private sector has to keep getting smaller and smaller to accommodate a larger and larger government.

This raises at least a couple of concerns.

One, government is generally less efficient than the private sector. So a government that crowds out private activity will make the economy as a whole less innovative, less productive/efficient and more prone to crises.

Second, there is simply the matter of personal liberty – the right for an individual to choose how to best spend their own money for their own personal benefit, rather than trusting a government to know what is best *for* them and spend accordingly. This doesn’t override the entire need for government, but it does put a limit on how much we should expect or allow governments to do. Personal liberty should not be *entirely* sacrificed under the guise of the greater good.

So can MMT inform current policy in a way that avoids the above concerns?

In short, don’t give additional power to the government. An independent central bank-type entity should still be in charge of managing the economy, and enforcing at least some fiscal prudence on the government.

I’ve written before about the potential value of an independent fiscal body that picks the best infrastructure projects to undertake, and decides when to undertake them. This way, politicians don’t end up picking politically-convenient projects with limited economic value. And their construction is timed consistent with the business cycle.

And the central bank should remain in charge of interest rate policy and (if not some other independent body like Australia’s APRA) financial system stability.

This way, during a boom, the central bank can cool the economy with higher interest rates and the independent fiscal body can slow down the infrastructure activity.

And during a downturn, if the central bank’s interest rate policy can’t provide enough stimulus (i.e. interest rates are at zero and the economy is still sluggish, as was the case in the US and EU following the GFC), then the independent fiscal body can borrow up big (either from their own people and businesses, the rest of the world, or just from their own central bank) and speed up their infrastructure investment activity.

Any debt that is accrued should not be a concern, as long as it doesn’t over-stoke inflation and crowd out the private sector (which are virtually non-issues during a major downturn). Even if your only concern is debt (which as we’ve discussed for a country with its own currency, it shouldn’t be), stimulus during a downturn is better than austerity.

This action of using fiscal policy to complement monetary policy (rather than replace it, as MMT seems to advocate) can help manage economic downturns with far greater effect, without risking the long-term problems of an ever-expanding government.

It also doesn’t risk a central bank’s credibility being undermined by the threat of political incentives – which can make their job much harder to undertake.

So MMT does seem to have something to offer. But we mustn’t forget the lessons of history. Political incentives are not always consistent with economic realities.

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[1] There are other mechanisms, such as interest rates, credit rationing, etc. that could shrink the private sector instead of (or in conjunction with) taxes. But for now, we’ll just focus on taxes doing the job, which is what many MMTers recommend.

It's time for an intervention.

State governments are addicted to stamp duty.

Here's a link to a brief I helped write for the Housing Industry Association.

US Hawks vs NZ Doves.

Here is a link to a brief that I wrote for the Housing Industry Association. Below is an extended version.

New Zealand’s apparent willingness to accept higher inflation than the US could come in handy in the next downturn.

Terminology time! An inflation ‘hawk’ is a person who is more worried about inflation getting too high. An inflation ‘dove’ is someone more worried about inflation getting too low.

The US and New Zealand demonstrate both these positions quite well.

The US is increasing interest rates while inflation barely touches their target of 2%. Understandable – they slashed interest rates so dramatically in the GFC and have remained so low for so long that they’re no doubt eager to bring them back up, lest they spur some unintended imbalances, like an over-inflated stock market or housing bubble. Still though, hawkish.

In NZ however, recent economic data is pointing to strength – stronger economic growth, decade-low unemployment now at just 3.9%, and employment and inflation expected to overshoot their targets on a sustained basis. Inflation is still currently in the middle of their 1-3% target, but given this strong data, you’d think they’d upgrade their intentions for future interest rates rises. On the contrary, they’re being quite dovish about it. They’re intent on keeping interest rates where they are until mid-2020 (the same intention they had before this new stronger data came out).

As Westpac’s Dominick Stephens said:

“RBNZ recognises that inflation pressures have built. The inflation forecast was lifted, upside risks to inflation were emphasised more heavily, and rising inflation was discussed up front in the document. Intriguingly, the forecast was for inflation to rise above [their target] 2% in the medium term. [But] RBNZ has declined to alter its [cash rate] forecast … They’re choosing higher inflation rather than a higher [cash rate]”.

There has been commentary for several years, including from Nobel Prize-winning economist Paul Krugman, that advanced economy central banks may have set their inflation targets too low – the US and UK at 2%, the EU under 2%, Australia 2-3%, NZ 1-3%. Again, understandable. They were set in the 1990s, with the high inflation of the 1970s and 80s still fresh in policymakers’ minds. So they were extra keen to keep inflation under control, and believed a 1-3% buffer above zero would be enough to prevent self-fulfilling deflation during any downturn (which can actually be just as bad and just as hard to fix as high inflation – if not more so).

The GFC however, demonstrated that inflation can indeed, still get too close to zero – and lower. Current inflation buffers have not negated the dreaded ‘liquidity trap’, where central banks have already dropped interest rates to zero but, because of inadequate inflation, real interest rates (the gap between interest rates and inflation) are still not low enough, making monetary policy impotent to help recover the economy. Consequently, many advanced economies undershot their inflation targets for most of the last decade. It turns out, even getting close to deflation – let alone actually achieving it – can be hard to reverse.

If however, inflation targets were increased to, say, 3-5%, that would provide a bigger buffer, without inflation getting out of control. Another way to look at it is that the risks of central bank policy are asymmetric: the costs of allowing inflation to venture a little too high right now are far smaller than the risks of increasing interest rates too fast and driving the economy back into a liquidity trap or worse, a deflationary spiral.

Perhaps this is what NZ’s central bank is thinking – an upwards reset of their 1-3% target so they have more inflationary ammunition in the next downturn.

Take the following hypothetical example of what NZ and the US could be facing soon.

 

The US is raising interest rates rapidly to keep their inflation rate no higher than 2%. NZ however, is raising their interest rates more slowly, willing to accept higher inflation of, say, 4%. This means that the real interest rate remains much lower in NZ, actually below zero and declining for most of this period – much more stimulatory for the economy. Therefore, in almost two years, inflation is much higher in NZ and interest rates much lower; and in the US, inflation is much lower and interest rates much higher.

Then in two years, where I have assumed a significant global downturn, both the US and NZ drop their interest rates back down to zero. It would appear the US is in a better position – they were able to drop rates a full 5%, NZ only 2.25%. NZ however, had a much higher inflation rate beforehand that only falls to 2%, whereas the US’s 2% inflation rate falls back to 0%. Which means upon the downturn, NZ’s real interest rate becomes -2% and the US’s just 0%.

This would leave the US dealing with a ‘liquidity trap’ situation. Whereas in NZ, investment would still be preferable to holding cash, so ongoing investment in NZ would act to stabilise the economy during the downturn. In the US, the prospect of deflation would create a disincentive to invest[1] and the lack of investment would be an additional headwind exacerbating the downturn.

So even though the US can drop interest rates more dramatically upon the downturn, NZ is able to achieve a lower real interest rate (even though it barely decreased in the last month) and therefore, undertake stronger stimulus – because they allowed their inflation rate to rise further beforehand, rather than rushing to increase interest rates.

While these numbers are somewhat arbitrary, it does illustrate that it’s not the size of the interest rate cut you have up your sleeve. It’s the stimulatory effect of your interest rate position after the cut has been made – the real interest rate. 0% interest rates with 2% inflation is more stimulatory than 0% interest rates with 0% inflation. Furthermore, in the former case of 2% inflation, people are also less worried about self-fulfilling deflation[2].

The implications if Australia’s Reserve Bank similarly chose to run the economy hotter for longer are clear for the housing industry. Lower interest rates for longer will support mortgage holders and investors alike, thereby supporting one of Australia’s most significant industries, even in the face of the current housing downturn.

I know all of this sounds like a bit hypothetical and abstract. But remember, psychology is very important in economics. The perception of being too close to deflationary territory can, all by itself, cause an economy to fall into deflationary territory. And the housing industry, through the mortgage market, can be the hardest hit in such an event. That’s why an arbitrary buffer sufficiently above 0% inflation is so important. Because perception very much becomes reality.

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[1] Not just business investment in things like property, buildings, equipment, machinery and staff, but also household investment in property, appliances, furniture, vehicles, etc. Even government, upon the deflationary expectation that things will be cheaper (or at least not much more expensive) in the future, may be tempted to put off major infrastructure investments.

[2] And as for the unintended consequences of prolonged low interest rates, like financial instability – interest rates are not a good tool for reigning in asset markets, especially if they are running in the opposite direction to the real economy (as was the case in Australia until recently with booming housing markets). This is more a job of macro-prudential regulation and oversight, by the central bank and/or other regulators (like APRA and ASIC in Australia). Interest rates should be the tool used to manage the real – not financial – economy.

The hangover.

As predicted, US soybean exports surged last quarter in an effort to beat Chinese retaliation to Trump’s trade war (artificially inflating economic growth figures), and have now plummeted 97% as a result.

China is weaning themselves off US soybeans, consistent with the broader global trend away from the US.

Combined with the ongoing drag of Trump’s trade war and the inevitable weakening of the impact of Trump’s spending spree, the US’s current binge can’t go on much longer. The hangover is coming.

Sayonara, America!

Just as predicted, while Trump continues his trade war, the rest of the world continues to move on without him.

This time … fierce rivals China and Japan.

China, Japan Vow to Cooperate as Trump Hits Both on Trade
By Isabel Reynolds and Emi Nobuhiro
‎26‎ ‎October‎ ‎2018‎ ‎12‎:‎50‎ ‎PM‎ ‎AEDT Updated on ‎26‎ ‎October‎ ‎2018‎ ‎11‎:‎07‎ ‎PM‎ ‎AEDT

China and Japan capped a restoration of ties with agreements on everything from currency swaps to ocean rescue Friday, a thaw that comes as President Donald Trump seeks better trade terms with both nations.

Shinzo Abe became the first Japanese prime minister to pay an official visit to China in seven years, as Asia’s two largest economies sought to play down disagreements that have hindered relations for decades. They both reiterated support for free trade and called for the early conclusion of a regional trade pact with 16 Asia-Pacific nations that doesn’t include the U.S.

After Abe and Chinese Premier Li Keqiang commemorated the 40th anniversary of a peace and friendship treaty on Thursday, the two held formal talks on Friday and oversaw the signing of cooperation agreements between the two governments. Abe then met and dined with President Xi Jinping, marking a new high point for a relationship he has long sought to mend.

At that meeting, Xi said the two countries are becoming increasingly interdependent and that they should be partners rather than threats to each other, according to a Japanese official. He also said China’s Belt and Road initiative provides a platform for cooperation and that the nations will adhere to free trade and face global challenges together.

Abe was accompanied to China by foreign and trade ministers and a 500-strong business delegation. The two sides signed 50 cooperation agreements, including reviving a 200 billion yuan ($29 billion) currency-swap deal. The neighbors also agreed to discuss establishing a clearing bank for offshore yuan and cooperation between Japan’s Financial Services Agency and the China Securities

“China is willing to work together with Japan to take Sino-Japanese relations back to a normal track, maintaining stable, sustainable and healthy development and making new progress,” Li said during an appearance with Abe on Friday. Both sides believed that stable relations were important and that they should take “concrete measures” to become cooperative partners, he said.

Japan’s relations with its biggest trading partner turned hostile in 2012, when it nationalized part of a disputed East China Sea island chain, sparking sometimes violent protests and damaging business ties. Since taking office at the end of that year, Abe has consistently sought meetings with Chinese leaders, even as anger simmered over the territorial and other disputes.

Abe said he sought frank talks with Xi and Li covering North Korea and trade issues. The two sides also agreed to cooperate on search-and-rescue operations at sea, and assist each other in developing health care and elderly care services.

In a speech to a business forum on Friday, Abe harked back to Japan’s role in providing aid and private sector investment from the 1980s that helped turn China into an economic powerhouse.

“The Japanese government and companies invested and worked with the Chinese people toward modernization,” he said. “Seeing how China has developed is a source of pride for Japan as well.”

The thorniest issues between the two sides had so far received little mention. There were no immediate agreements on how to handle the territorial dispute, or the issue of gas resources around the disputed sea border between their exclusive economic zones.

“The difficult issues are going to stay,” said Akio Takahara, a professor at the University of Tokyo, adding that he expected relations to remain cordial at least until Xi visits Japan, which he is expected to do for the Group of 20 summit in Osaka next year.

“The Chinese Communist Party always has this history card against Japan in their pocket,” Takahara said. “Whenever they feel the need to take it out, I’m sure they will do that.”