How China Might Actually Handle a US Trade War

By now, everyone recognizes that the US and China are in the middle of a trade war, with the Trump administration having imposed tariffs of as much as 125% on Chinese goods. For an export-focused economy like China's, that's a big deal. At the same time, China is pretty much the only major country that's chosen to retaliate against the US with its own set of fresh trade restrictions. So why did it decide to reciprocate? And what's its negotiating position as the US and China head into initial talks? Can the Chinese economy -- and its policymakers -- withstand the pain of a trade war? We speak to Arthur Kroeber, head of research at Gavekal Dragonomics and a long-time China watcher, about how China might actually respond to the new tariff regime. Read more:Xi Fortifies China’s Economy Before First Talks on Trade With USWhat Years of Practice Tariffs Have Done Only http://Bloomberg.com subscribers can get the Odd Lots newsletter in their inbox each week, plus unlimited access to the site and app. Subscribe at bloomberg.com/subscriptions/oddlotsSee omnystudio.com/listener for privacy information.

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• 1:57Tracy Alloway?

  Hello and welcome to another episode of the Odd Lots Podcast. I'm Tracy Alloway.

• 2:02Joe Weisenthal?

  And I'm Joe Weisenthal.

• 2:03Tracy Alloway?

  So, Joe, one thing I find interesting about China, or maybe I should say, one thing I find interesting about how the world views China.

• 2:12Joe Weisenthal?

  Yeah.

• 2:13Tracy Alloway?

  Is it seems to be this economy that is always simultaneously a massive competitive threat, especially to the US.

• 2:20Joe Weisenthal?

  Sure.

• 2:21Tracy Alloway?

  And then simultaneously, it always seems to be on the verge of some big disaster caused by too much debt, or bad demographics.

• 2:28Joe Weisenthal?

  Yeah.

• 2:28Tracy Alloway?

  Or the collapse of the housing market, and so on. So, for as long as I can remember, China has been a bundle of contradictions.

• 2:37Joe Weisenthal?

  No, totally. And look, there are very good reporters on China, and there are very good analysts on China. But throughout my entire career, I completely agree with you, there has always been that narrative of the imminent disaster that is the Chinese economy, whether it's the housing bubble is going to collapse, which it kind of did, and maybe we'll talk about that. Or you mentioned demographics, or, you know, all this overcapacity that if there's a little bit of reduction in demand, they'll have mass unemployment, et cetera. And again, by and large, the Chinese economy, from my outside perspective, and I've never been there, continues to grow more robust. You know, there have been obvious hiccups.

• 3:20Tracy Alloway?

  Yes.

• 3:20Joe Weisenthal?

  To say the least.

• 3:21Tracy Alloway?

  Hiccups, for sure. Okay, so, speaking of hiccups, now that we have this new tariff regime from the Trump administration, I think we're getting even more contradictions, right? So, we hear that tariffs are going to be disastrous for the Chinese economy. Sometimes we hear that they could be a good thing if they encourage Chinese citizens to actually consume more than they save. So, maybe this is the impetus for actually finally restructuring the Chinese economy. We hear stuff like export controls are going to impede China's technological development. But then you also hear that the export controls are speeding it up because China now is forced to build domestic capacity. So, there are all these competing narratives. We should definitely talk about all of them. And I

• 4:06Tracy Alloway?

  realize, we haven't actually done a China-centric tariff episode anyway.

• 4:10Joe Weisenthal?

  No, that's right. We talk a lot about the US economy and... Potential of empty shelves and market reactions, but we have not talked about this story from the perspective of the Chinese economy right now.

• 4:22Tracy Alloway?

  Right, and obviously, this is important because we're talking about a potential trade war between the world's two biggest economies. But I think it's also important because China, so far, is the only big country that seems to really have retaliated against the US. And just to make things even more complicated, we've also seen Treasury Secretary Scott Besen basically offering reduced tariffs to countries that agree to implement tougher trade restrictions on China. So it seems to be a special case in the overall trade crackdown.

• 4:55Joe Weisenthal?

  For sure.

• 4:56Tracy Alloway?

  And we should talk about it. And I am very, very happy to say that we do, in fact, have the perfect guest. We're going to be speaking with Arthur Kroeber. He is the founding partner and head of research at Gavekal Dragonomics. So, Arthur, thank you so much for coming on All Thoughts.

• 5:10Speaker 05

  Hi there, it's great to be here.

• 5:12Tracy Alloway?

  So, I guess my first question is, if we assume that China does have a lot to lose in a trade war with America, which I think is a widely held assumption, why did it choose to retaliate against the US?

• 5:26Speaker 05

  Yeah, that's a great question, for a couple of reasons. First of all, you know, as you both know, China is a very heavily export-dependent economy. The pattern of exports has changed a little bit since the first trade war with Trump, but they still depend a lot on the US market directly and indirectly, so there's a clear direct cost there. And also, the government has been struggling for the last year and a half to revive growth that, by their standards, was very sluggish. So why would you take on an additional, not necessarily required, hit to the economy at this time when you're struggling? So it's a very good question. I think the basic answer is, number one, because of the first trade war and the first

• 6:10Speaker 05

  Trump administration, and the subsequent campaign of export controls and technology constraints by the Biden administration, they've been kind of girding themselves for a long time for more self-sufficiency, to insulate themselves against external shocks. So there's a kind of a baseline of confidence that they can take a lot of pounding and they'll still be okay. But then I think the specific reason why they alone, basically, of all countries in the world, chose to retaliate against the Liberation Day tariffs...

• 6:43Speaker 05

  Was they were really mad. This is very visible to me when I was in last in Beijing in late March. I got a lot of comments from people about basically how the Chinese had been trying since the beginning of the year before Trump was inaugurated to get messages to him to kind of lay out, you know, make it clear that they were interested in talking and suggest some things that could be on the agenda, et cetera, asking for who's the person that we should talk to. And they just hit a stone wall, basically. They were unable to establish contact with anyone in the Trump administration who would tell them anything. And instead, what they got was 20% tariffs, remember in February and January, on the

• 7:24Speaker 05

  grounds that they hadn't done enough to control fentanyl flows, which they were also mad about because they'd spent a lot of time in last year negotiating an agreement with the Biden administration, which they complied with, which made a real dent in the exports of fentanyl precursors out of China. It was not complete, but they had really made a serious effort. So from their standpoint, they'd been trying to open a conversation and the door had been shut in their face time and time again, and they'd just been whacked with stuff that they thought was completely unfair. So I think they were just kind of fed up. They had a baseline sense of security that if we hit back, we know it's going to be bad, but we'll be able to take it.

• 8:07Speaker 05

  Then I think the other consideration was essentially political, which is that, you know, even if they hadn't retaliated, they were still facing tariffs of over 60%. So no matter what they did, it was going to be bad. So they had to have a story to tell their people. What are we doing about this bad thing? And it's a lot easier to mobilize domestic support if you're standing tall and pushing back, which actually is, you know, it's like what Mark Carney did in Canada. That's how he won that election was by being the guy who pushed back against the so-called bully. So I think it was a combination of frustration, a sense of security that they could outlast the US in a war of economic attrition, and in a sense that this was the best way to

• 8:50Speaker 05

  get people in China on board for what was going to be a tough time, no matter what.

• 8:54Joe Weisenthal?

  Right. So even in a one-party state, there's politics and there's the requirement to maintain domestic credibility and so forth. You know, this actually gets to something I've wondered about for a long time. Rhetoric that you hear from Chinese officials will often talk about their very long history going back thousands of years. And then Americans will parrot that and sometimes say it's like, well, you know, they have history going back a long time and they suffered a century of humiliation, et cetera. How real is that? In the sense of like, it's a government that doesn't want to see unemployment go up in the short term, et cetera. I think many Americans have really internalized this idea of they think really long term. They think in centuries. They think in millennia. Maybe that's true.

• 9:39Joe Weisenthal?

  How should we think about some of this rhetoric?

• 9:41Speaker 05

  Yeah, it's sort of half true and half not true. So, you know, I've been looking at the Chinese economy for the last 35 years, basically. And I can tell you, there's plenty of short-termism and emergency thinking and ignoring problems until they catastrophically become too bad and then scrambling to come up with solutions. So underneath this veneer, there's plenty of chaos. But there are, I think, a few things that are true about that. So first of all, this century of humiliation idea, that is, number one, it's something that is played up by the Chinese educational system. This is drummed into people starting in elementary school. That's part of the nationalist narrative that the CCP has used for a long time. But I think it's important to recognize that this is not just a Communist

• 10:25Speaker 05

  Party thing. This is basically Chinese elites of whatever stripe, since the mid 19th century, have been really distressed at the loss of standing that China has achieved in the world. I mean, you know, up until the early 19th century, China was undisputedly this great empire. And people within China had this sense of being part of a great global power. And then that was all taken away. And they had a pretty catastrophic 100 years of civil war and famine and all kinds of stuff. So it has been a theme of Chinese elites since the 1840s, that they have to rebuild the nation, acquire the technological means to stand on the even footing with the West and so forth. And the current regime is just the

• 11:10Speaker 05

  one that has been most effective at sort of realizing that vision. But if you change the regime tomorrow... Whatever came in its place would have the same, I think, underlying ambitions. So that, I would say, is a common theme. I think the other thing that is, I don't, I'm not a real buyer in the, like, the super-long-term thinking thing, but, you know, if you look at Xi Jinping's utterances, he took over in 2012, and he started laying out some pretty long-term stuff right away. He had these various goals that stretched out to 2035 and 2049, which is the 100th anniversary of the Communist Party and so forth. And so there is an ability of the Chinese state, because they don't have to face elections,

• 11:54Speaker 05

  to organize kind of strategic plans that last a little bit longer than would typically be the case.

• 12:00Tracy Alloway?

  Longer than four years, certainly.

• 12:02Speaker 05

  Longer than four years. So a good example is Made in China 2025, which is their industrial policy idea, which was released in 2015. It builds on previous policies that they had. It was not some completely new thing. But they set out some 10-year goals for where we want to be, roughly, in a whole bunch of technologies. And the reality is, they did a pretty good job on a lot of them. So the planning is not, I think there's often a mystique about it, but they are able, sometimes, to sort of point the ship in a particular direction and then get a lot of people in society on board with steering that ship where they want to go.

• 12:41Tracy Alloway?

  So, speaking of long-term strategies, one thing that is different in this current bout of trade tension, we could probably call it a trade war at this point, I think that's fair.

• 12:51Speaker 05

  It's a complete embargo, except for, like, the few things that we've, you know, each side is exempted about 20, 25% of what they import, but otherwise, effectively, it's an embargo.

• 13:00Tracy Alloway?

  I definitely want to ask you about those exemptions, too. But one thing that's different about this trade war to the tensions that we saw in the first Trump administration is that China has basically had some practice with increased tariffs. And so what we saw in sort of 2016, 2018 was China just moved a bunch of production over the border to places like Vietnam, basically rerouted a bunch of things to get around the tariffs. Is that an option this time around, given that Trump seems to be cracking down on pretty much all of America's trading partners, all at the same time?

• 13:36Speaker 05

  Oh, it's totally an option, and I think it will definitely happen. So, a couple of things here. So, first of all, you can describe that as kind of a government strategy, but actually it was largely just companies on their own deciding. So, like, the first companies that did this were the solar panel makers, who got whacked by tariffs in the Obama administration, 2012.

• 13:56Tracy Alloway?

  Right.

• 13:56Speaker 05

  Very high ones. And so, they immediately moved a lot of their production to Southeast Asia. It wasn't the government saying, "Please do this." It was just, they said, "Well, we want to sell to the US. We can't do it from here. Where do we go? Oh, we can go across the border, and it'll be fine." And it was. And now, they've diversified. They used to be just in a couple of countries, now they're in a larger number of countries. If you try to go after this stuff, it's like playing a game of whack-a-mole, right? The other thing I would observe on that, just beyond the solar people, is China is now at a stage of development where they have very sophisticated companies that are very good at what they're doing, increasingly have markets in a wide range of places around the world.

• 14:37Speaker 05

  And what do companies do when they are in that situation, be they from China, or Japan, or the United States, or Germany? They invest abroad. They internationalize. And so, what we're in right now is kind of act one, I would say, of what is clearly going to be a very long process of Chinese companies turning themselves into multinationals, just like the companies of every other industrialized country have done. And so, they don't need the government to tell them, "Do this." They have their own reasons, not just tariff avoidance, but to be closer to different markets, et cetera. So, that process, I think, is just going to continue because it has many, many drivers, not just tariff avoidance.

• 15:19Joe Weisenthal?

  Right, and you know, we've certainly talked about BYD, setting up auto facilities all over the world. They're in Brazil, they're in Hungary, they're elsewhere. But it also, like, I mean, this is one of the things that, I guess, confuses me about the US administration policy. You know, all these other, it's like, oh, we're gonna like, split off Vietnam, or we're gonna make a deal. Like, it's hard for me to imagine that, given the amount of cross-border investment that we've seen over the last years and years.

• 15:46Speaker 05

  Right. Well, okay, yeah, basically, I would describe it, there's an economics term of art for that strategy. It's loony. So, but this gives me an opportunity, I guess, to make a little bit of a comment on what I see about what's coming out of the Trump administration.

• 16:01Joe Weisenthal?

  Okay.

• 16:02Speaker 05

  Which is basically chaos, right? There is not a clear strategy, there is not a clear policy. What you have, basically, is Trump's impulses, which are, number one, I want to sort of demonstrate dominance over everyone, and I want them to exhibit deference. And number two, I really like tariffs, for some strange reason that I don't think any of us understand, but he really likes them. But he also likes them specifically because they are a tool that, as the President of the United States, he has the legal authority to use without restraint. So if he wants to hurt people, he doesn't have to go to Congress, he doesn't have to ask anyone in Congress, he just does it. So it's very useful for him. And I've found a lot of the commentary over the last couple of months

• 16:43Speaker 05

  trying to explain the rational strategy behind this, to be completely off-target, because it isn't. And various people in the administration, like Scott Beson, would like there to be a strategy, and they are desperately trying to corral this stuff into the semblance of a strategy. But they have to improvise. So, that's sort of my general comment on it. And then, specifically, and the question is, does it work? No. The reality is, there are now, I believe, 140 countries in the world that trade more with China than with the United States.

• 17:19Joe Weisenthal?

  Hmm.

• 17:20Speaker 05

  China is now the number two source in the world, behind the United States, of direct investment. And it's growing. Its economic relationships with many countries, including in Latin America... Are much deeper than those in the United States, let alone Southeast Asia, where their economies are completely tied to China. So there is no way, no way that any sane leader of any of these countries would sign on to a deal where they would say, oh, we'll get our tariffs on the US lowered from 10% to 5% in exchange for which we have to sacrifice our principal economic relationship. It's not going to happen.

• 18:11Speaker 00

  What's next for virtual assets? I'm Jacob Grease, host of Economy Scale, a series exploring growth in key global sectors. And in this episode, we're diving into the digital forces shaping finance. Sean McHugh from Dubai-based Virtual Assets Regulatory Authority has this to say.

• 18:27Speaker 06

  We're seeing a lot of institutional players come in, digital asset dedicated hedge funds, high-frequency traders and that sort of thing, and folks who service institutional clients.

• 18:36Speaker 00

  As more capital enters the market, adaptive regulation is likely to become increasingly key. Reese Merrick of Ripple says.

• 18:43Speaker 07

  A lot of regulators globally would like to keep the industry at arm's length. That's the opposite here. I think also what you'll find is that regulation and frameworks can come out, but some of them are maybe a slight iteration on some 80-year-old policy and not actually in line with what the technology can do and offer. And again, that's very different in Dubai.

• 19:03Speaker 00

  Listen to the full episode wherever you get your podcasts. This series is brought to you by Bloomberg Media Studios and the Dubai Department of Economy and Tourism.

• 19:13Speaker 01

  This is the Bloomberg Tech Minute, brought to you by ChatGPT. I'm Carol Muster. Millions of Americans are taking peptides, short strings of amino acids that can act as biological signals for cells. Peptides like insulin can occur naturally in the body, or they can be synthetically introduced to induce a biological process, as happened with semaglutide, the active ingredient in Ozempic. Now Bloomberg's Anika Inampudi reports peptides may be exploring their next frontier, the brain. Taking peptides for mental clarity and cognitive benefits as alternatives to psychiatric medications and to gain a competitive edge or stave off the effects of aging. Both insulin and semaglutide are approved by the U.S. Food and Drug Administration.

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• 20:35Tracy Alloway?

  So you mentioned the exemptions earlier, and we've also seen some carve-outs for specific things like electronics imports. And at this point, I'm actually finding it kind of difficult to keep track of what's delayed and what's exempted, just because it changes so often. But my question is, how much signal should we take away from all those exemptions? Do they show that there's potentially a path forward to a U.S.-China deal? Or is it just Trump trying to retroactively protect some pretty important industries?

• 21:07Speaker 05

  Yeah, it's more of the latter, you know, and remember, there's exemptions on both sides. So Trump exempted cell phones and most consumer electronics, basically because he was told that you cannot allow the prices of iPhones to double. People will revolt, and he took that seriously. So that was clearly a political move just to alleviate the domestic political cost of this action, right? And similarly, if you look at what the Chinese did, they exempted a lot of imports like semiconductors and some key technology inputs despite all of their progress. They're still pretty dependent on global supply chains outside of China for a lot of stuff that goes into their tech ecosystem.

• 21:49Speaker 05

  And they could not afford to have this stuff cost a lot more. So I think in both cases, it's roughly 20% or a bit more that has been exempted. As you say, it's very hard to know exactly. When this is going into effect and blah, blah, blah. But both sides have sort of picked out the parts of their economies which are most vulnerable and said, okay, you don't have to take the pain. But it doesn't tell us anything about, it's not like both sides are signaling to each other, hey, if you lower your tariffs, I'll lower mine and then maybe we can get somewhere. They're just doing what they need to do to protect themselves.

• 22:25Joe Weisenthal?

  So Trump recently said that for gifts, that kids could maybe have two dolls instead of 30 dolls. And I completely agree. I spent this weekend taking out a bunch of random plastic garbage, broken toys, et cetera, for my children's room, five trash bags, and I've barely made a dent in what they have. So I'm completely in agreement on that point. All that being said, two questions about that. So let's say there's a major reduction in buying plastic stuff from China, low end stuff. A, are we already seeing real pain in China and parts of the economy from these tariffs that's visible from what you're looking at?

• 23:08Joe Weisenthal?

  And B, how much of that stuff is still in China as opposed to, that's the low margin stuff that you probably quickly have in some cheaper destination. How important is stuff, the cheap stuff, to China's economy these days?

• 23:23Speaker 05

  You know, it's somewhat important for employment purposes because a lot of that stuff is fairly labor intensive, those lower end exports. But it certainly is not very relevant from the standpoint of Xi Jinping's grand strategic vision as China is a technology superpower. So, and if you look in terms of like total value of what they export, the stuff that goes into Walmart is significant, but a shrinking portion of the total. They're moving up the value chain pretty fast. So you are starting to see some softness in the industrial and manufacturing indicators. I mean, you've had an employment, a pretty weak employment market. Since the end of COVID, basically, that they've been struggling to address. So this is going to have some impact.

• 24:05Speaker 05

  You know, the Chinese export numbers have still been quite strong. Most people think that's because there's been some front loading because people were anticipating tariffs and were expecting significant weakness, you know, in the coming months. I think that will happen. It will hurt, but I don't think any of that is going to hurt enough for China to feel like it has to make a move. They've clearly signaled Trump wants to have a deal. He has to make the first move. He has to initiate, show some good faith. They've laid out their position. They're waiting for him to pick up the phone and call, basically. So, yeah, this is going to cause some real difficulties. And I think they're going to have a real challenge meeting their growth target this year if this goes on for much longer. But I think they're willing to wait it out.

• 24:49Tracy Alloway?

  So, speaking of economic transformation, in addition to being a bundle of contradictions, the other thing that has existed for as long as I've been, I guess, covering China from an economic perspective is this idea that the economy needs to rebalance towards consumption. So Chinese people save too much and we really need to get them to spend on our own domestically manufactured goods. And that will help resolve some of the tensions in the economy. What's your sense of how much Chinese people might actually be able to boost their own consumption right now to offset the trade war?

• 25:28Speaker 05

  Oh, there's some, not a lot. So just to back up a little bit on that. So I think it's important to clarify that when people talk about this project of rebalancing the economy from investment to consumption, this has been a project of economists mostly outside China. It's never been a project of the Chinese government itself. They have never really forcefully and clearly stated that it is their objective to do that. They've put out various policies where they say, yeah, we want incomes to rise faster. We would like there to be. You know, stronger services consumption and so forth. But they have never said that we think we should fundamentally alter.

• 26:12Speaker 05

  Go out and shop. Well, they haven't said that, but the other thing is, I think it's really important to understand, these people are not, they're not Americans, they're Chinese. They have a different concept of how an economy grows. So we grew up in this sort of Keynesian world where we believe that demand drives everything. And the Chinese authorities don't believe that. They believe that investment drives everything, that progress, productivity, future income growth, it all comes from investing in the right things. So they have been very clear for as long as I've been studying it, including the last decade, on saying to secure the growth of the future that is stable, well-balanced, whatever, we need to invest in the right things.

• 26:53Speaker 05

  That is the principal job of government economic policy is to steer investment. So that's point one. They've never really had an agenda of substantially rebalancing. Second is, up until COVID, the fastest growing consumer economy in the world by an order of magnitude was China's for 20 years. There is no economy that comes even close to the rate of consumer spending growth that China enjoyed between 2000 and 2020. It was, I think, the total aggregate growth was more than triple what you saw in India, for example, and much faster than you saw in advanced economies that grow at slower rates.

• 27:34Speaker 05

  So they didn't really have, in my opinion, a consumer spending problem. And I think they look at that, you know, much the same way. They say, well, you know, we actually don't need to rebalance. Now, I think that's changed a little bit. I think they really, in the last few months, have started to say, oh, actually, we're going to be facing a lot of headwinds in the export economy, largely from the US, but not just the US. They're in a tariff battle with the European Union over electric vehicles. A lot of other countries are beginning to put up barriers. And I think they are beginning to realize that they need to, both for the short term You know, trade war issues, but also for just having a more comfortable place in the global economy that they have to do a little bit more to boost the consumer part

• 28:19Speaker 05

  of the economy, but they they're limited in their tools for being able to do that.

• 28:23Joe Weisenthal?

  When I think about consumer comfort, consumer wealth, et cetera, I'm on social media all day. And so I see all the videos of like these like amazing futuristic cities with these incredible plazas and lights and transportation that zips you from one place to another. And I imagine those things don't show up in consumption, you know, they're not retail consumption.

• 28:46Speaker 05

  Right.

• 28:47Joe Weisenthal?

  But it's a form of lifestyle consumption, whether your city just has greater amenities and comforts and cleanliness and so forth, et cetera. Are those all real? You know, because like, you know, you see like a 90 second video.

• 28:59Speaker 05

  Right.

• 28:59Joe Weisenthal?

  Like, you've been going to, you've been living and traveling to China for decades.

• 29:04Speaker 05

  Right.

• 29:05Joe Weisenthal?

  How different outside, you know, okay, I'm sure, you know, in multiple cities around the country.

• 29:10Speaker 05

  Right.

• 29:11Joe Weisenthal?

  Is the day to day experience of being a citizen or a consumer?

• 29:15Speaker 05

  Yeah, well, it's a large question. So if you had, if we had turned this around and you had said, well, you know, I look at these pictures of what life in Silicon Valley is like.

• 29:22Joe Weisenthal?

  Yeah.

• 29:23Speaker 05

  Is that really what it's like in America? You know, your responsibility, well, America's a big country. There's a lot of different things. And China is an even bigger country in terms of the number of people. So a huge variety. The stuff that you see there is real. You have a lot of first class urban infrastructure in places like Shanghai, Shenzhen, Beijing, and increasingly in a couple of interior cities like Chengdu and so forth. And things work quite well. And you have large swaths of the country where people are still living fairly, you know, modest lives, one generation removed from the family farm that their parents still live on and so forth. There's parts in the Northeast which are

• 30:04Speaker 05

  a, you know, a super rust belt of these old sort of 50s and 60s areas, industrial towns built around industries that really aren't that important anymore, or mining or whatever. So you have an enormous variety of things. But I would say it is fair, if you go around to sort of random Chinese cities in sort of Eastern and Central China, most people now have pretty comfortable lives. They're not as shiny as you might see in these social media videos. But things work, their needs are taken care of pretty well.

• 30:38Joe Weisenthal?

  Is that true for healthcare too?

• 30:39Speaker 05

  That is true, increasingly true of healthcare and pensions. They went through a period where they basically had abolished the old planned economy, social safety net, and there was nothing, and it was really bad. And it's still not terrific, but they have greatly increased the coverage of healthcare. There is universal, almost universal pensions, even for farmers in the countryside, they get something. People have access to facilities, the quality of care can vary quite a lot. I would say on average, the situation there is quite a bit better than it was 10 or 15 years ago, with a lot of room for improvement.

• 31:15Tracy Alloway?

  So you briefly mentioned the idea of tools that China can use to offset some of the impact from the trade war. Walk us through the levers that it has available, and then I guess how policymakers might actually balance the use of these levers.

• 31:31Speaker 05

  Right.

• 31:32Tracy Alloway?

  With the message that China is still a great place to do business and invest and so on. And I don't mean to single out China on this issue, because I think the US faces a very similar balancing act. But arguably, the US is much more developed in its capital markets and has certain advantages in global markets that China just doesn't.

• 31:51Speaker 05

  Sure. Yeah, well, so I think you could sort of divide it into two buckets, right? So there are things that China is doing to retaliate against the US, and that's where it really runs the risk of alienating the business community, because part of your retaliation has to be to make life difficult for US businesses, either in China or back in the US. But then there are also response mechanisms, which are basically things that they can do to make the economy stronger and able to weather the shock. So in retaliation, clearly, they have the countervailing tariffs, they have... Increasingly comprehensive export controls on rare earths and rare earth-based technologies, which are actually not just rare earths, but various sort of critical minerals,

• 32:36Speaker 05

  antimony being sort of the big example of the moment. I've never even heard of that. And those, that is, yeah, that's actually-

• 32:42Tracy Alloway?

  People don't talk about antimony enough.

• 32:44Speaker 05

  It's a, it's a mineral that is used, it has a lot of applications, many of them in the defense industry. There basically is no viable source of production in the United States and China has, I think, a 60 or 70% control of sort of global refined supplies and they have basically banned exports of it to the United States and this is starting to create real headaches in, you know, defense and other kinds of technology-related supply chains. So they have a few things that they can do like that. They've singled out a few US companies operating or selling into China for various kinds of investigations. Those are more kind of shots across the bow, they're kind of gestures, I don't think they're really that serious, they don't really want to make it harder for Nvidia to do business in China than it is already.

• 33:29Speaker 05

  But basically what they're doing is they're picking out companies that may sell a lot to China but don't have a lot of investment on the ground in China and saying, if you don't basically help us get this guy in the White House to see reason, we might make it a little difficult for you. And they'll only do that if they think there are reasonable domestic substitutes. So they're doing a little bit of that, but they're being very cautious because they are keenly aware that their economy still needs international businesses to participate in China at many different levels, they do not want to scare them away. So what they're mainly left with is response mechanisms, which is, you know, some of it is the usual stuff, they can lower interest rates and they'll probably do a bit more of that this year.

• 34:12Speaker 05

  They were already planning a big fiscal expansion this year, one of the biggest budget deficits in history, they're probably going to expand that more. To gin up consumption, they have this cash-for-clunkers kind of trade-in program-

• 34:25Tracy Alloway?

  Oh, yeah.

• 34:26Speaker 05

  -where you have an old appliance, you can trade it in, you can get a discount on the new one. That's for both households and for businesses, they can trade in old capital equipment and get new stuff at a, at a cheaper price. And then the other thing that they've been doing actually is to get more money into consumer pockets, they have started to expand pension payments, focusing on people lower in the income spectrum and just putting an extra five or 10 bucks into their accounts every month so that they have a little bit more cash to spend. And by focusing on the lower income people, those are people who basically spend most of what they have. So it has a big impact. But yeah, so they can do all of these things and they will all work to some degree. The cash for clunkers thing actually worked a lot better than I

• 35:11Speaker 05

  thought it was. I was very skeptical. But at the end of the day, consumer behavior is pretty sticky in any country. The job market is still not terrific. They're going to have a lot of difficulty really, really moving the needle on boosting domestic demand. They can get it up a little bit, but not a lot in the short term.

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• 37:10Tracy Alloway?

  Joe, I do find it really ironic slash remarkable that China has a cash for clunkers program, which we all recognize from, you know, the post 2008 era. And meanwhile, Trump is, you know, going on TV and telling everyone to stop buying this much. And you only need two Barbie dolls instead of 15.

• 37:31Joe Weisenthal?

  No, Trump, Trump has producerist impulses on some level.

• 37:36Speaker 05

  He sure does. Yeah.

• 37:37Joe Weisenthal?

  You know, actually, since we're talking about ideology, how much continuity in your view has there been in Chinese policy pre Xi Jinping to now? Because there's debates about this and the party itself always stresses continuity and nothing ever really changes. But you've seen the country for a long time. How much of a pivot happened in 2012 that continues to this day?

• 37:56Speaker 05

  Yeah, that's a really great question. And, you know, I hate to sound like, you know, Harry Truman's hated two handed economist, but there is both continuity and change here. There's no question, right? So the things I think that are largely unchanged is, I mean, I talked earlier about this kind of view of how economies work, that they are driven by the investment cycle and that the government has a important role to play in kind of identifying the key top areas for investment, not necessarily spending the money, but saying pointing and saying, go there. And then all the entrepreneurs in the country say, oh, we should go there. We'll go there.

• 38:41Speaker 05

  That has not really changed. That is a, and you can talk about people, you know, before Xi, who were more, quote unquote, reformist and so forth. But if you look closely at what they were doing, they had the same objective. They wanted to increase state capacity. They wanted to strengthen the technological foundations of the economy. The first long term science and technology plan actually came out in 2006, which was six years before Xi Jinping took over. It had nothing to do with him. And it was very much the product of everyone else in the government at that time. So that I think general orientation. Has not changed. What she has done is that he has made the coordination of that

• 39:22Speaker 05

  strategy much more effective. So he's increased the capacity of the central government to kind of mobilize and guide resources. He has reined in what he thought were big excesses, notably in the property market, but also in the internet sector, where he thought a lot of investment was going to stuff that was actually not advancing the ball technologically. And it was also creating significant social and political risks for the Communist Party, and it needed to be reined in. But, you know, a lot of the concerns that you see expressed about social media and the power of internet firms in China, totally indistinguishable from the discourse that we have here in the United States about the same problems. So part of what they were doing was try to say, let's have less resources to that

• 40:07Speaker 05

  kind of stuff and more to the kind of stuff that we think that will really generate long-term growth that is, will enhance productivity and social cohesion, right? So he hasn't changed the sort of the basic orientation, but he's made the execution of that generally much more effective. And then the other big thing that he did do that is a major change is that he overturned the foreign policy that Deng Xiaoping had laid down, which is, you know, the idea that you, you know, stay quiet and Stay behind. Stay quiet and sort of hide your capabilities or bide your time or whatever. And he pretty aggressively said, no, no, China's a great power now. We have to act internationally.

• 40:50Speaker 05

  And so we're going to take a much more aggressive view. And I think you could argue that that's a real shift. You could argue that he moved a little bit too quickly on that. And that has, you know, created some unnecessary costs for China. He would have been wiser to hide and bide for a few years longer. But anyway, he did it. And that is, that is material change, I would say.

• 41:12Tracy Alloway?

  So I think I just have one more question, and it's the big one, which is, do we have any idea or sense of what the off-ramp for all of this actually is? And do we have a good idea of what Trump actually wants from China? And do we have a good idea of what is palatable to China?

• 41:31Speaker 05

  Right. Okay, so what's the off-ramp? I think the off-ramp is basically that Trump and his people have to recognize that they've put themselves in an untenable position and they need to figure out a way to climb down from it as gracefully as they can. I think the Chinese have been very clear in their communications that they are happy to talk, and they keep saying, "We are happy to talk, but we're not going to make the first move, and if you want to prolong this trade war, we think that we can sit with our deflation longer than you, United States, can stick with your stagflation, given your political system."

• 42:15Speaker 05

  So I think the ball is really in Trump's court to do something, to figure out how to unstick this. And the difficulty is, I think, what does he want? My theory of the case is that Trump is not really driven by specific policy outcomes. He is a guy who has very authoritarian instincts, who wants to be recognized as the boss. It is basically all about power. And so everything that he does, and I think this applies to a lot of the domestic policy too, is to demonstrate that he has power and that other people have to show submission and deference, right? So if you really want to get on Trump's good side, that's what you do. And the Chinese will not play that game. They are too big, they are too strong, they have too much at stake domestically in terms

• 43:00Speaker 05

  of their own political credibility to play that. They will not do that. So that puts Trump in a bind, because what he really wants, they will not give him. So then people on Trump's team need to figure out, okay, what is an agenda that we can put together of actual policy aims that could form the basis of a negotiation? And then how do we communicate that to China and how do we get them to start talking to us? And that's not an easy problem to solve, right? So what it means is that people in the administration who have actual policy aims somehow need to seize control of that process. And they haven't done that yet. So a couple of other theories on how this could unwind.

• 43:41Speaker 05

  So one theory is that at the end of the day, nothing is going to happen until Trump and she get together face to face, because in both systems, no one really has the authority lower down to make a move. And so then you have to think about, well, how could that happen? It's unlikely that you're going to have a trip of one leader to the other countries. You have to start thinking about, is there some third country that could be?

• 44:08Tracy Alloway?

  Which country is exactly halfway between the US and China? We'll have to figure that out.

• 44:15Joe Weisenthal?

  What's your good? What's the third country?

• 44:16Speaker 05

  Well, somewhere in the Middle East. Yeah, I don't, I don't have a good theory on that. Erdogan and Turkey, they are kind of halfway between, and he sort of has these fantasies of being a broker. He tried to do that. I'm just making that up. I have no, you know, information that he actually has any interest in doing that. But so that's one theory is that you need somehow to get the two leaders together, and that will probably require a third party. So that's one way of thinking about it. Another way of thinking about it is just to say, well, Trump is driven by markets to some degree, not quite the same way that he was in his first term. But right now, you have this weird situation where basically, if you talk to people in the markets, they're convinced that a deal will happen. I keep telling them,

• 44:58Speaker 05

  on what basis do you hold this belief? I can see none. But they are convinced that essentially because it's impossible, or they think it's impossible to maintain these high tariffs for too long, therefore, something must happen.

• 45:09Joe Weisenthal?

  Yeah.

• 45:09Speaker 05

  So markets actually are doing okay right now, because they're essentially pricing in there will be a deal. And if you look at this from Trump's standpoint, it's like, oh, markets are happy. I have no incentive to deal. So the only way he can have more incentive to deal is if markets are convinced that there is no deal. And they tank, and then he says, oh, I really got to do something. So that's another theory. Full credit, that was suggested to me by my colleague Andrew Batson, who runs our China team very effectively. And I thought that was a very good way of thinking about it. So market pressure in the US could be a forcing mechanism. You could maybe have some kind of intermediary. But I think unless you have some kind of force acting like that,

• 45:53Speaker 05

  or some kind of revolution within the White House, where actual policymakers take over and seize command of things somehow, and start to work out, how do they get a communications channel open to the Chinese? Communicate some kind of mutual reduction of tariffs to a lower level as an opening thing, and then a negotiation. But I think we're some ways away from any of that happening.

• 46:20Joe Weisenthal?

  I just have one short comment. One is, I've talked to an investor who literally used that logic. They said, there is going to be a deal because there must be a deal.

• 46:30Speaker 05

  Right.

• 46:30Joe Weisenthal?

  And so therefore, there will be one.

• 46:32Speaker 05

  Right.

• 46:32Joe Weisenthal?

  One last question. Our colleague Anna Wong, US economist here at Bloomberg, she thought one possibility is, maybe there's a deal that still leaves the sort of like Vietnam transshipment open, that looks like something tough, and that there is some third-party country that could still be a route for flows.

• 46:51Speaker 05

  Right.

• 46:52Joe Weisenthal?

  Keep high nominal numbers up on China, et cetera. Could that be a path out where it looks like you've maintained a hard line, but you allow an escape valve of some sort?

• 47:01Speaker 05

  I think that's very plausible, because as I mentioned before, I don't think, it's just not realistic to think that you're going to be able to close off the transshipment channels. So, deal or no deal, a lot of those channels are going to remain open, one way or another. So you might as well take advantage of that and incorporate it into deal. One other comment on that, because you then get into this question of like, okay, suppose there is a deal.

• 47:22Joe Weisenthal?

  Yeah.

• 47:23Speaker 05

  What's in it? And my view on this is, most of the deal structures that seem plausible are not very meaningful, other than from the standpoint of calming markets down. So you have this situation where the US and China are very adversarial. Most people in Washington think we are already in another Cold War. And to me, a substantive deal would be one that makes a significant change in the quality of the relationship. And so if you have something that's like a phase one trade deal plus where China agrees to buy more stuff, and they make some gestures towards more domestic demand support, and we cut tariffs a little bit, okay, that's fine, markets will be okay with it, but it doesn't really change the underlying dynamic, which I think is really bad.

• 48:08Speaker 05

  And I think the thing to look for, which is what China really wants, one of the things that they really want that could be given to them, is the ability for their companies to invest a lot more in the United States. BYD, CATL, all of these Chinese ITech firms, they would love to be able to invest in the United States and tap into this market more directly. They would be very happy to accept, I think, a lot of different potential structures for that investment. But effectively, Chinese companies are shut out. And Trump, on the campaign trail, said that he was open to this. So the interesting thing there is that basically no one else in the administration seems very interested in this, but Trump might be. And if you're serious about re-industrializing the United States, you cannot do that without

• 48:53Speaker 05

  significant participation by China. I'm sorry, China accounts for a third of global manufacturing production now, going to 40. They are close to or at the leading edge of many of the technologies of the future. It is as absurd for us to think that we can ramp up our industrialization without China as it was 40 years ago would have been for China to think that they could ramp up their industrialization without bringing in the leaders then, the US, Japan, and Germany. So there is, in principle, it seems to me, there is a deal to be done there, where that's what you give to China, and then you might be able to get something for it.

• 49:30Speaker 05

  That could be quite transformational in terms of the basic relationship between these two big economies. Am I betting on that? No, I think the chances of that actually happening are quite low. But I think people who are serious about thinking that there should be a deal and that the deal is economically meaningful, not just like a sop to markets, they should be thinking about that.

• 49:53Tracy Alloway?

  Yep. Are we in a Cold War with China? Is that even useful framing?

• 49:57Speaker 05

  I think it's not. I disagree vigorously with the people who say that we are already there. I mean, we could get there. The reason that we're not is a couple of things. Just if you look at the substance of the economic relationship, China's trade with the US, direct trade with the United States several years ago before Trump's first term, was the same as our trade was with Japan in the mid 1980s. So it was about, I think, 17 or 18% of our total global trade. Our trade with the Soviet Union and all of its successor states after the Soviet Union collapsed never was more than about 1% or 2% of our trade. So we are linked. We have thousands of US companies that operate in China and generate somewhere between $5 and $700 billion a year of annual sales, which is triple or more the amount of exports

• 50:42Speaker 05

  that go from the United States to China. The global supply chains are linked. I could go on and on, but the economic linkages are not the linkages of countries at war. The reason you could call the Cold War a Cold War was because it wasn't direct fighting, but many of the other conditions, particularly economic, were very, very similar to wartime conditions. And this just is not. It is a completely different beast. And I could go on, but that's, I think, the principal thing. And the reason I think that it's really not only not useful framing, but I think toxic framing, is that we have this kind of view in the United States that essentially either if you're another country, you are our ally or we are at war with you.

• 51:27Speaker 05

  Those are the two possible states. And I think these are conditioned by the fact that we thought these... Multiple wars, hot and cold, in the 20th century. And our kind of national foreign policy ethos was defined by dividing the world into good guys and bad guys, beating the fascists, beating the communists. China is not a place that can be beat. It is a large country. It's not going away. It is very integrated, not just with the US, but with the entire global economy. They're heavily invested in the global order. So the only solution, it seems to me, is that you need to figure out what is a state of coexistence with China that you don't have to define in these martial terms.

• 52:11Speaker 05

  It's just like, and it doesn't have to be we're friends. And it can include, we have some very serious adversarial components to the relationship and really deep competition, not just in economics, but geopolitics, that can be there. But describing it as war, I think, is not only not useful, but I think is really dangerous.

• 52:28Tracy Alloway?

  For enemies, the US and China, maybe that, maybe we can describe it thus. Okay, Arthur Kropert, thank you so much for coming on All Thoughts. That was great.

• 52:37Speaker 05

  My pleasure. Thank you.

• 52:51Tracy Alloway?

  Joe, I thought that was a really great state of play conversation. And also, you know, sort of considering where things might be headed, I realized we forgot one very important thing, which is, we have to say the day that we're actually recording this, because you never know what's going to happen in between now and when we actually publish this episode. So it is May 6, 2:59 PM.

• 53:15Joe Weisenthal?

  I thought it was great. I kind of feel stupid for not having had Arthur on before, because I really thought he was excellent and very clear and clear-eyed about Chinese economy and our relation. You know, just, there's, there was a lot in there that was very good. That last point about, like, you know, if we were actually serious about, quote, "reindustrializing", unquote, that we would want to bring Chinese manufacturers, give them a stake in the US economy, both in terms of selling into the US economy, both in terms of owning assets, or maybe 49% of assets of various factories, like, that makes a lot of sense to me. It seems like that's distant politically, but it's certainly very intuitively logical to me.

• 53:59Tracy Alloway?

  Yeah, and I also thought the point about demand driving everything in the US and versus investment driving everything in China to be kind of interesting, although I would argue that those two things like they're starting to get mingled in both America and China. So you're seeing China kind of borrow a lot of policies or thoughts that would be very familiar to anyone who's lived in the US in recent decades. And meanwhile, you're starting to see the US take on some Chinese characteristics in various ways.

• 54:31Joe Weisenthal?

  Arthur raised a good point, and I think you've written about this as well. And I think others are confused on this is like, from Trump's perspective, what does a successful outcome look like? We know that he likes the forms of things. He likes handshakes. He likes the idea of

• 54:47Tracy Alloway?

  Wait, he hates handshakes, doesn't he?

• 54:49Joe Weisenthal?

  Oh.

• 54:49Tracy Alloway?

  He likes deals, but not handshakes.

• 54:51Joe Weisenthal?

  He likes tariffs, etc. But what does say the US economy look like in 10 years? Were we to take a correct policy line? Really hard to still totally understand. But again, like, yeah, maybe it's a lot more factories. And maybe we should invite one of the world's, you know, some of the world's most advanced companies to set them up.

• 55:10Tracy Alloway?

  Yeah. And I guess the question is, you know, he's on TV now saying that we don't need 15 Barbie dolls per child. But if we

• 55:18Joe Weisenthal?

  Which is true.

• 55:18Tracy Alloway?

  If we do build that Barbie factory in the US, then does that kind of consumerism become okay again?

• 55:26Joe Weisenthal?

  Well, you know, and this is just by the way, you know, it's like on this point. So I think a lot of people can make an intelligent rationale for more US manufacturing in certain areas. It's really unclear, you know, the White House, I think there was a tweet a few days ago talking about how much we import in terms of textiles, which is the vast majority of clothing, etc. We import. It's really unclear to me why it's important at all. To have significant domestic capacity in these low value, low margin, low strategic areas and what that benefits us. I get maybe there's an aesthetic appeal. Obviously, we

• 56:08Joe Weisenthal?

  want to have a lot of jobs, but this is a really difficult thing to wrap my head around, which is like, you have to make decisions, right? A worker on one line is a worker who's not on another line. And so why you want to have more clothes manufacturing or more doll manufacturing at a time when there is an impulse to sort of build up in these higher value areas is very unclear to me.

• 56:28Tracy Alloway?

  Yeah, there's definitely a tension there.

• 56:30Joe Weisenthal?

  Yeah.

• 56:30Tracy Alloway?

  All right. Shall we leave it there?

• 56:32Joe Weisenthal?

  Let's leave it there.

• 56:32Tracy Alloway?

  This has been another episode of the Odd Lots Podcast. I'm Tracy Alloway. You can follow me at Tracy Alloway.

• 56:38Joe Weisenthal?

  And I'm Joe Weisenthal. You can follow me at the Stalwart. Follow our guest, Arthur Krober. He's at A R Krober. Follow our producers, Carmen Rodriguez at Carmen Armin, Dashil Bennett at Dashbot, and Kale Brooks at Kale Brooks. For more Odd Lots content, go to Bloomberg.com/oddlots, where we have a daily newsletter and all of our episodes. And you can chat about these topics 24/7 in our Discord, discord.gg/oddlots.

• 57:02Tracy Alloway?

  And if you enjoy Odd Lots, if you like it when we check in on how China is dealing with the trade war, then please leave us a positive review on your favorite podcast platform. And remember, if you are a Bloomberg subscriber, you can listen to all of our episodes absolutely ad free. All you need to do is find the Bloomberg channel on Apple Podcasts and follow the instructions there. Thanks for listening.

• 57:56Speaker 08

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