What Trump's China Visit Actually Achieved.

0:00So Donald Trump and Xi Jinping are meeting in Beijing this week. And if the footage is anything like prior summits, will be treated to two men in suits walking very slowly through a building, shaking hands at a slightly uncomfortable distance and staring at each other like two people who've been set up on a blind date by a mutual friend who has since left the country. Now to recap how we got here, because it has been quite a journey. Last year. Tariffs between the the United States and China hit levels that hadn't been seen since the 1930's. the US put tariffs of up to 145% on Chinese goods.

0:40China retaliated with tariffs of 125% on American goods. And then, just to keep things interesting, restricted exports of rarer minerals which are used in basically everything from vacuum cleaners to fighter jets, but mostly vacuum cleaners. This went on for a while, and then both sides appeared to quietly realize that they were running out of things to put tariffs on. So they agreed to a 90 day truce, which is the one currently in effect and which expires in November. Now, expectations for this summit are, to put it generously, modest.

1:19The press have taken to calling it the Beans and Bowing Summit, which tells you something about the level of ambition. Both leaders arrive at this summit under considerable domestic stress, but for very different reasons. China is dealing with a property sector that has been falling for years and shows no real signs of stopping, youth unemployment that the government briefly dealt with by not publishing the numbers anymore, and a demographic decline that no amount of government encouragement seems to be fixing. the US president is dealing with the inflationary consequences of his own policies, falling approval ratings, and a military situation in the Middle East that's not going particularly well.

2:04So this is the backdrop, 2 economies under strain, a temporary truce that expires in a few months, and the summit that will be mostly remembered for the photographs. But the thing that almost nobody on the news will explain, because it requires about 10 minutes of patience and some basic accounting, is that the problem these two leaders are trying to solve is not really a political problem at all. It's an accounting problem. And the reason it never gets fixed is not that politicians are unwilling to fix it, it's that most of them don't appear to understand what's actually causing it. And that's what this video is about. To understand the current trade dispute, we need to look at what trade is actually supposed to be. About 6 months ago, Robin Harding wrote a piece in the Financial Times about a trip he took to China where he posed the same question again and again to the economists, technologists and business leaders he met with. His question was simple.

3:04Trade is an exchange where you provide something of value to me and in return ioffer something of value to you. So what exactly does China want to buy from the rest of the world? A few of the economists he spoke to who had perhaps pondered the issue already jumped ahead to a different point altogether. Their answer to the question of what China would like to buy from the rest of the world was you should let Chinese companies set up factories in Europe.

3:33Which is not really an answer to the question, but it does tell you quite a lot about how they see the problem. Now, to a certain type of politician, this might sound like a triumph of national strategy, until you remember how trade actually works. The basic idea, going all the way back to David Ricardo, is that trade is supposed to be mutually beneficial. The entire purpose of selling your goods abroad is to acquire foreign currency so that you can buy the foreign goods that you need.

4:04If you accumulate foreign exchange that you never intend to spend, you're not running a brilliant economic strategy. You're just collecting pieces of paper. And if your goal is to systematically put the rest of the world's manufacturing out of business, you eventually run into a problem. Your customers won't have any money left to buy all of the goods that you're hoping to sell them. This makes no sense. It's the equivalent of the town's Baker aggressively pricing the butcher, the Brewer and the candle maker into bankruptcy, and then looking around a few years later wondering why nobody in town can afford bread.

4:42During the first China shock in the early 2000s, China's exports surged, but so did their imports. They were buying up the sophisticated equipment needed to build their factories. Today, as Samira Keynes pointed out in the FT, China's import volumes are comparatively anaemic. They are selling, but they're not buying, Which raises a fairly obvious question. If the strategy eventually makes everyone poorer, including yourself, would you do it? To understand why a country would do this, it helps to look at the work of Michael Pettis, a finance professor at Peking University and a senior fellow at the Carnegie Endowment. Pettis has been writing about this for years, and his core argument is the trade surpluses and deficits are not really caused by trade policy.

5:34They're the automatic consequence of domestic savings and investment decisions. Here's what he means by that. When a government suppresses household income through low interest rates on savings and undervalued currency, weak labor protections, and other policies that effectively transfer wealth from ordinary people to the state and to manufacturers, it forces up the National Savings rate. Households earn less than they produce, so they can't consume enough to absorb everything the economy makes.

6:07This is what economists call financial repression, and it's the mechanism by which countries like China and before Japan and Germany subsidized their industrial growth at the expense of their own consumers. Now all of that excess saving has to go somewhere. It goes into investment, and building infrastructure that you actually need does generate real economic growth. But once your investment exceeds your productive needs, once you build enough high speed rail and enough apartment blocks, continuing to invest doesn't create economic value, it destroys it.

6:46The money is spent. The GDP figures look impressive, but the underlying projects generate less value than they cost to build. The difference shows up as dead. President Xi has reportedly spent a good portion of his career studying Japan's last decades. Apparently, he found them inspiring. In the 1980s, Japan suppressed consumption to fund investment LED growth, built spectacular infrastructure, achieved extraordinary technological advances, and was widely expected to overtake the United States.

7:23Then the debt caught up with them, and they spent the next 30 years dealing with the consequences. Pettis argues that the only way out of this is to shift from investment LED growth to consumption LED growth. You have to stop subsidizing factories and start giving money to households so that your own citizens can actually afford to buy the things your economy produces. But politicians generally hate doing this, because shifting well to households means that the state has to give up control over where capital gets allocated.

7:58So rather than making that difficult choice, they keep subsidizing production. The domestic consumers can't absorb the output, and the excess has to go somewhere. It goes abroad as a trade surplus, not because anyone planned it that way, but because the accounting leaves no other option. So if China is producing vastly more than it can consume and doesn't want to buy anything from the rest of the world, who is absorbing all of this excess output? Well, let's look at who else is at the table. Europe is running a trade deficit with China of roughly €1 billion per day, which is a number that sounds made-up but isn't, and is driven by a massive imbalance in manufactured goods, particularly electric vehicles and electronics.

8:47The EU is simultaneously trying to deregulate it's own economy. A recent survey found that German firms alone had hired an additional 325,000 people over three years whose entire job was to take regulatory boxes. Europe is also preparing legislation that wood forest Chinese companies to hire European workers, buy European components, and transfer their technology as the price of market access. This is, of course, exactly what China did to Western multinationals a generation ago, and Chinese officials have apparently noticed the similarity.

9:27They're not finding the imitation flattering, but Europe is not absorbing all of this. Happily. The EU trade commissioners compared Europe dependency on Chinese minerals to its former reliance on Russian energy and has warned that without action, Europe risks losing whole sectors of industry within a couple of years. The IMF estimates that selling goods across EU borders costs firms the equivalent of a 44% tariff on goods and a 110% tariff on services. These are not tariffs imposed by a foreign adversary, these are tariffs the EU has imposed on itself through paperwork. The EU has essentially conducted a trade war against it's own economy and impressively appears to be winning. So Europe is already uncompetitive and it's now being flooded with cheap Chinese goods on top of that. This is not a combination that ends well for European manufacturing.

10:31That leaves the United States. the US has the deepest, most liquid, and historically best governed financial markets in the world. When surplus countries like China and Germany suppress domestic consumption and generate excess savings, those savings have to go somewhere. And roughly half of the world's excess savings end up in American financial markets, not because Americans invited them, but because there's nowhere else for that volume of capital to go. Now here's where the accounting gets important. When foreign capital flows into the United States, the US must, by definition, run a corresponding trade deficit. This is not a choice.

11:14It's a balance of payments identity. The foreign money is being used to buy bonds and financial assets, not goods. The US becomes the consumer of last resort for the global economy, not because it wants to, but because the accounting leaves no alternative. As Pettis puts it, the US doesn't fund its trade deficit. Surplus countries force it to run one. Now, you might think that all of this foreign capital pouring into America would be good for the economy, and that it would fund new factories and lower interest rates.

11:49And that might be true if American businesses were desperate for capital. But they're not. US corporations are sitting on trillions of dollars in cash. They don't lack access to funding. They lack customers who can afford to buy more of what they already produce. So the foreign capital doesn't flow into productive investment. Instead, the economy has to absorb it some other way. As Pettis points out, there are really only three options. The excess capital can push up unemployment as cheaper imports put American factories out of business. It can push up household debt as consumers borrow to maintain their spending.

12:29Or it can push up the fiscal debt deficit as the government borrows to keep the economy from contracting. Since no politician wants the first option, the US has historically chosen some combination of the 2nd and 3rd. And here's the part that almost nobody in Washington seems to understand. Running a massive fiscal deficit doesn't fix the problem. It feeds the monster. The bigger the deficit, the more Treasury bonds you issue. The more bonds that you issue, the more attractive your debt markets look to surplus countries with excess savings to park. The more capital flows in, the stronger the dollar gets, the less competitive American exports become, and the wider the trade deficit grows.

13:14And of course, all of that government spending is stimulative, which means it's inflationary, which pushes up interest rates, which makes the debt even more expensive to service, which requires yet more borrowing. It's a feedback loop, and it's one that no amount of summitry in Beijing is going to break. Now, being the consumer of last resort has not been entirely unpleasant. the US economy is remarkably productive. Labor productivity has been growing at about 2% a year over the last five years, the fastest rate in two decades. Cheap domestic energy means Americans pay about half what Europeans pay for electricity.

13:58The US economy is flexible, dynamic, and has been absorbing these imbalances for decades without anything obviously breaking. But the bill has been accumulating. A few days ago the FT reported that the US government sold 30 year debt at a 5% yield for the first time since 2007. Financing the growing national debt is getting meaningfully more expensive. In a video a couple of weeks ago on inflation, I discussed how the US Treasury under Scott Percent has been funding long term obligations with short term borrowing, a strategy that the economist Stephen Moran Annuriel Dubini described as activist Treasury issuance and compared to stealth quantitative easing.

14:47Besent, as it happens, criticized Janet Yellen for doing exactly the same thing before he took office and then adopted the strategy himself, which is the Treasury Secretary equivalent of mocking someone's cooking and quietly asking for the recipe. This is essentially a massive bet that long term interest rates are going to come down. Which seems like a rather aggressive gamble when you consider that the US government is simultaneously pursuing tariffs, running a massive fiscal deficit, reducing the labour supply through deportations, pressuring the Federal Reserve to cut rates, and fighting a war in the Middle East that has driven up the price of fuel and fertilizer.

15:31It's not entirely obvious why long term interest rates would fall while the government is actively engineering inflation. Betting that rates will come down while you borrow a trillion dollars a quarter to fund a trade war is a strategy that relies heavily on optimism. None of this is a new problem. As Martin Wolf pointed out in the FT this week, clashes over how to adjust these imbalances have reoccurred roughly every two decades. The 1920's, the 1960's, the 1980s, two, 1008 and now the 1920s version ended with a global depression and the World War.

16:10The 1980s version was resolved through the Plaza Accord, where the major economies agreed to coordinate their exchange rates. The 2008 version was resolved by, well, a global financial crisis. So the two available options appear to be international cooperation and economic catastrophe. And historically, we've tended to go with the second one. Economists have understood the structural problem since at least the 1940s. As Darren McFadden outlined in the FT last week, when the global financial architecture was being designed at Bretton Woods, Keynes proposed a system built around a neutral international currency that he called Bancorp.

16:56The key innovation was that it would penalize countries for running either persistent surpluses or persistent deficits, forcing both sides to achieve. Just as the economist Robert Triffin later pointed out, any country that supplies the world's reserve currency is essentially trapped. It must run persistent deficits to meet global demand for safe assets. Keynes saw this coming and designed a system to prevent it. the United States rejected that proposal at the time. the US was the world's largest creditor then and it's dominant manufacturer. It was basically the China of that era, and it had no interest in signing up to a system that would penalize it's surplus. In doing so, it consolidated the dollar as the anchor of the International Monetary system, which is the very thing that now forces it to run the deficits it's complaining about. So that worked out well.

17:58Wolf also makes a point that surplus countries tend to overlook. They are not in a strong a position as they think. Japan ran enormous surpluses in the 1980s, and the pressure to boost domestic demand led to a property bubble that, when it burst, produced 3 decades of stagnation. China ran huge surpluses after 2008, and the pressure to reinvest them domestically produced a property bubble. Germany ran persistent surpluses within the euro zone, and when the deficit countries hit crisis, Germany had to choose between financing them or watching the euro collapse. They chose to finance them, but they did want everyone to know that they were not happy about it. The pattern is fairly consistent. Surplus countries build their economies around selling to others, and when the music stops, they discovered that they needed those deficit countries more than they thought. So what happens when the global consumer of last resort, the United States, is running a 5% cost of capital and starts looking for ways to stop absorbing everyone else's excess production?

19:10Well, historically it ends in either one of two ways. Either the major economies sit down and negotiate a cohort coordinated adjustment, which requires a level of international cooperation that is, to put it politely, not obviously forthcoming at the moment, or the adjustment happens through crisis. If the US stops buying, American consumers will face higher prices and fewer cheap goods. That would be unpleasant but for the surplus economies, countries that have built their entire economic model on the assumption that foreigners will endlessly borrow money to buy what their factories produce. It will be significantly worse.

19:50A consumer can find a more expensive substitute or do it less. A factory with no customers has a much bigger problem. This brings us back to the handshakes in Beijing this week. Expectations for this summit are, to put it generously, modest. Both sides appear to be looking for just enough progress to justify the photographs. the US wants China to commit to buying those beans and bow wings. To oversee these purchases, the two sides are expected to announce a Board of Trade, a committee of senior officials from both countries, whose job will be to make sure the. With China actually follows through this time. This is necessary because China made similar purchase commitments in the phase one trade deal in 2020 and then didn't follow through.

20:41So the solution to China not honouring its commitments is a new committee to monitor whether China honours its commitments. I'm sure that this time it'll be different. Now the Board of Trade will sit alongside the already existing Board of Peace, which was established earlier this year to promote peace building, which Trump will chair for life. So we now have a Board of Peace and a Board of Trade, and all we really need next is a board of good intentions and we'll have the complete set. There's also the small matter that Trump arrives in Beijing having largely been disarmed by his own courts. In February, the Supreme Court struck down his IEPA tariffs, the ones he had been raising and lowering on a near daily basis last year.

21:28He immediately pivoted to a different legal authority, Section 122 of the Trade Act, which allows temporary tariffs to address balance of payments crises. Last week, a Federal Trade court ruled those ones illegal, too, on the grounds that the US is not actually experiencing the kind of balance of payments crisis the law was designed for. The administration is appealing, but the tariffs expire in July. Regardless, a third set of tariffs under Section three, O 1, is being prepared, but those investigations won't be complete until the summer. So the US president is sitting across from Xi Jinping at a in negotiating table, and his most prominent negotiating tool has been taken away from him by his own judiciary twice. His domestic position isn't helping either. Approvals ratings are at 34%, the lowest of his second term. And with midterm elections in November, Republican members of Congress are not exactly lining up to support inflationary trade policies in an election year.

22:37Several were reported to quietly celebrated when the Supreme Court struck down the tariffs. Xi Jinping will be aware of all of this. When you're negotiating counterparts own party is relieved that your signature policy has been overturned by the courts, it does somewhat reduce the credibility of the threat to bring it back. Both sides are really just trying to buy time. the US wants breathing room to build domestic rare earth processing capacity because China currently controls those supply chains and use them as devastating leverage during the tariff war.

23:14China wants time to develop it's semiconductor industry and reduce its dependence on western technology. And XI has his own grievances to raise too. China imports roughly 40% of its oil through the Strait of or move. So the American military situation in the Middle East is not just AUS political problem, it's costing China money and she will want to make sure Trump knows it. As Eli Ratner, who served as the US Assistant Secretary of Defense for Indo Pacific Affairs until last year, pointed out in the FT, the US has made this mistake before. The pattern is consistent.

23:56When Washington backs off, Beijing doesn't reciprocate it consolidate it's gains. When the Obama administration declined to challenge China's island building in the South China Sea, artificial reefs became military installations. When Trump paused tariffs in his first term in exchange for the phase one trade deal, China missed it's purchase commitments and the structural reforms were deferred to a phase two that never came. Ratner argues that the time being bought isn't being used to strengthen America its position, particularly given that the war in Iran has drained military readiness for any potential crisis in the Pacific.

24:38And all of this will happen while the much larger geopolitical issue, the future of Taiwan, hovers in the background. A senior Taiwanese official told Bloomberg last month that what they fear most is being put on the menu at a Trump XI summit. China would very much like rhetorical concessions on Taiwan in exchange for those beans and bowings. Whether they get them is another question. So the two leaders will shake hands, make announcements and fly home.

25:10The photographs will look very serious, but the underlying problem, the one we've spent this entire video explaining, will not have changed. Trade imbalances are not caused by lack of summits. They're caused by domestic policy choices that need either side appears willing to change. China will continue to suppress household consumption, the US will continue to absorb the resulting surplus, and the accounting will continue to do what accounting does, regardless of what anyone announces at a podium in Beijing.

25:44Thanks for tuning into this week's podcast. The podcast is entirely supported by viewers like you on Patreon. If you'd like to support it, you can sign up using the link in the show notes. Have a great week and talk to you again soon. Bye.