Stephen Roach Warns of Disaster From Our 'Sinophobic' China Policy

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1:23Hello and welcome to another episode of the Odd Lots podcast. I'm Joe Weisenthal. And I'm Tracy Alloway. Tracy, you know, when it comes to U.S. trade tensions with China, obviously there are a number of people, they sort of reach back for the fear and the anxiety of trade with Japan in the 80s. But I have to say, like, I don't actually know much about that. I wasn't paying that much attention to trade policy when I was seven years old or nine years old and stuff. That's very disappointing. Even though I'm aware, I know, even though I'm aware that that was a thing and probably some of the concerns, particularly about automobiles specifically and the threat to Detroit and all that was popular the way it is popular now.

2:03Like, I actually know very little of that story. Don't you watch movies from the 1980s? There are quite a few villains from 1980s cult classic movies that end up being Japanese businessmen. And I do remember some pop culture zeitgeisty moments from the big fear that Japan Inc. was going to eat the U.S. economy. For instance, there was that famous photo of, I think it was a bunch of congressmen smashing like a radio or a TV or something in Washington in the late 1980s. Do you remember seeing that? Which you can imagine, like, so the idea was the U.S. feels threatened by Japan's dominance in certain, primarily consumer electronic goods back then, but also increasingly in computers.

2:54And so a bunch of politicians went out and started smashing those publicly to make a statement. That hasn't happened with China just yet, but you could imagine something like that being done today. But it would be with Chinese solar panels or something like that. Oh, I'm looking at the photo. They smashed a boombox right in front of the Capitol. You can't get much more in 1980s than smashing a Japanese boombox. This photo goes, it goes hard, as the kids say. It's quite a photo. But you're right. And I do remember the pop culture elements and, you know, movies like Falling Down or the villain in Back to the Future 2, I think it was, or maybe whatever.

3:31So I remember it, but I certainly don't remember how it resolved or why it faded or why, you know, I know a little bit, but not really like what the ultimate was there, how similar it actually was. Because, yeah, sure, you know, it's one thing with boom boxes and cars, but obviously there seems to be, at least in U.S. policy circles, this big national security element that dovetails with some of the concerns about cars and solar and stuff like that. And of course, when speaking of analogies, you know, we've also talked about the history with the real estate bubble and bust. We've talked with Richard Koo about the similarities of the real estate boom that Japan had and the bust that subsequently followed.

4:13And there may be parallels there. But I definitely feel like I need to wrap my head around even further about how useful or not some of these historical patterns are. Absolutely. The other thing I would say is it is remarkable in some respect that the commonality between Biden and Trump is being tough on China trade. Right. That is a common thread. And so no matter what happens in November, it seems reasonable to expect that these trade tensions are going to continue in one way or another. So I definitely think it's worth talking about. Yeah, totally. This is really an important element. And I'm glad you brought it up, which is the complete Washington consensus.

4:53It would seem at this point where there doesn't seem to be any disagreement about the basic notion that we have to do something on trade, that we have to amp up the national security anxiety, whatever it is, with respect to China has become completely conventional wisdom of both parties. And, you know, when something is conventional wisdom like that, it's probably good to question some things. Absolutely. Let's do it. All right. I'm excited. We really do have the perfect guest today, someone I don't believe we've ever had on the podcast before, but someone whose work and writing I've admired and read for a really long time.

5:27Really excited to be chatting with Stephen Roach. He's a senior fellow at Yale Law School, former chairman of Morgan Stanley Asia, and has been talking a lot about this topic for years and years and has been warning about what he sees as the errors of our current approach to China. So, Stephen, thank you so much for coming on Odd Lots. Well, great to be with you, Joe and Tracy. I'm astonished at how young the two of you are. Thank you. You don't have any firsthand knowledge of what it was like to live in an era where Japan was our main economic enemy. Well, I was in Japan in the 1980s, so maybe I missed out on it because I was on the other side.

6:09Japan in the 1980s was great, I got to say. Just one background note. I mean, I taught a seminar at Yale for 12 years called The Lessons of Japan. And in that seminar, I went through in great detail what happened to what at the time was Asia's first major growth engine, the rise in the fall, and how that came into the crosshairs of American economic and political. policy. And that was just the first half of the course. The second half of the course was to look at those lessons to see how they applied to other economies around the world. And, you know, in keeping with your pithy introduction, you know, the main candidate was China.

6:58So how much of the China story has an antecedent in our experience with Japan is a very, very important question that I'm delighted to talk to you about. Fantastic. You know, one thing I remember at the time, and I guess by this point, I was 11 years old. I remember George H.W. Bush vomiting onto the lap of the former prime minister while on some, you know, visit. But what happened? I mean, the story is so big, as you mentioned, it was a whole lecture series that you did over years at Yale. But like, how did that end? Because I remember like some of the anxiety about cars from when I was 10 or nine or whatever, and they're eating our lunch and stuff like that.

7:39But and then, you know, by the mid 90s, it did not seem to be a thing that people were talking about as much. How did I guess in the minds of America or in the literal economics, did that end? What happened? How did that fade? You alluded to the auto area. That was a major issue of contention. We've negotiated some voluntary export restraints on Japan. And then in Japan, who we had a very close security relationship with, which is, of course, very different than our current situation with China. Japan was eager to shift some of its domestic auto production into the United States through building and investing in American-made facilities using American workers.

8:30And so we all ended up buying Japanese cars, but they were produced in the United States. But I think the endgame was quite tough for Japan. Japan went from a growth miracle to a growth bust, went through arguably three lost decades of near economic stagnation, a considerable amount of which was an outgrowth of the currency policy that we and other developed nations imposed on Japan. They voluntarily agreed to it. But that triggered a series of policy blunders that led to asset bubbles. And you said you spoke with Richard Kuh, the balance sheet recession that he's written so eloquently about that really left Japan flat on its back for, as I said, nearly three lost decades.

9:30So Japan didn't end around in moving production to the U.S. and then was effectively neutered as an economic power by these lost decades. And so it didn't end all that well for Japan. Maybe we could step back for a second, because the thing that I'm unclear on with the Japan-U.S. business rivalry of the 1980s is, and you touched on this, Stephen, already, but there was, there is a security alliance in place between the U.S. and Japan. I mean, the U.S. has lots of military bases in Japan. I grew up on one of those. So how was it that Japan's industry and technology was viewed as such an enormous threat for the U.S., even if they were military and strategic allies?

10:22That's the one thing I don't get. Well, it's a fair point. The main issue in the United States at that point was, I think, a total misunderstanding of international economics. We had a large trade deficit as a nation, and we came out of a horrible recession in the early 80s that continued, even in the face of economic recovery, to leave our manufacturing sector under pressure. The manufacturing recession continued well into the mid-1980s, even though the overall economic recovery was progressing nicely. Our politicians figured out that the main culprit in the manufacturing recession was this thing that they didn't understand, but it was a trade deficit.

11:21And the biggest piece of the trade deficit was with Japan. They were highly critical of Japan. The politicians were for unfair trading practices, for running an undervalued currency, the yen in their case, and for basically eating our lunch in terms of putting pressure on our companies and our workers and our communities. You noted in your intro that, you know, there was a boom box that was destroyed. There were a number of other highly public episodes of destroying Japanese cars. There was even an unfortunate instance in the late 1980s where two displaced, laid-off auto workers assaulted and ultimately murdered a Chinese-American in the late 80s, not being able to mistake the difference between the two nationalities.

12:29So it wasn't a particularly pretty period, but it unmasked a really critical misunderstanding of the role that trade plays in an economy that was evident in Japan that is even more evident than today in China. And that is the U.S. has trade deficits with many countries, and it's wrong to single out one country in an effort to eliminate the trade deficit. You can't do it because our multilateral trade deficit, a trade deficit with many countries, is an outgrowth of our shortfall of domestic savings. When nations don't save and they want to grow, they import surplus savings from abroad, and they run what's called a balance of payments deficit that gives rise to a multilateral trade deficit with many, many nations.

13:30So fast forward to today, in 2023, we ran trade deficits with 106 countries. China was the largest, although it has come down as a share of our overall trade deficit because of the tariffs that were imposed and sustained from Trump to Biden. But if you take China out of the equation, it still leaves you with 105 other countries that we ran deficits with last year. So we tried the Japan recipe on China. We put huge tariffs on China. The Chinese piece of the overall merchandise trade deficit, which peaked out a little below 50 % in 2015, has since come down to a little below 30%. So you say, wow, that's a great strategy.

14:33And Trump would say, see, my policy worked. but we didn't boost our domestic savings because we run these massive budget deficits. So all that happened was the Chinese piece went somewhere else. And that somewhere else were countries like Mexico, Vietnam, Canada, Korea, Taiwan, India, Ireland, and even Germany. In large part, These countries are higher cost producers. So the trade shifted from a low cost producer like China to higher cost producers, which ends up taxing American workers. So the policy reflects a total misunderstanding of the way that international economics works in the context of our saving short U.S.

15:23economy.

15:28Thank you.

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17:14Crypto trading provided by ZeroHash. Complete disclosures available at public.com slash disclosures. So I want to obviously get into more soon about the current conditions and the mistakes that you believe we're making with respect to China. But, you know, going back to the parallels between China and Japan, and there's something we talked with Richard Koo about, is like they had this real estate bubble. And for Japan, the aftermath is really bad, multiple lost decades. And, you know, obviously there are a lot of academics and policy makers in China today looking at that experience and hoping to avoid similar lost decades after as they try to control their own real estate bubble, which is something they've done.

17:55I mean, when you tell the story of what happened with U.S. and Japan, I listen to that and say, actually, it seems like it turned out fairly well from the U.S. perspective, but that it turned out very badly from the Japanese perspective. Had they not acquiesced in the same way to our desire for export restrictions or building some of their vehicles in the U.S., would that have allowed the country to move from manufacturing to a robust industrial power in a more stable manner that didn't result in so many lost years? It's a fair point. Japan had an economic model that it developed in the aftermath of the total destruction of its economy during World War II that was very focused on boosting economic growth through exports largely supported by a cheap or undervalued currency.

18:51We called them on that. There was a currency agreement in the mid-'80s, the so-called Plaza Accord, that forced the Japanese to revalue their currency. They panicked over this threat to their economic model. And the Ministry of Finance, which controlled the central bank as well as the foreign exchange policy, basically ordered the Bank of Japan to slash domestic interest rates. And that's what boosted asset bubbles in equities and property. And when they burst, as all bubbles do, the rest is history, one lost decade followed by another. So this policy that was imposed from the outside on Japan was not without consequences for other policy choices they made.

19:52by no means was that the sole source of the lost decade. As I teach it in my seminar, there are many, many sources, but that was clearly an important part of their story. Talk to us about the Chinese economy now, and in particular, how you would characterize trade relations between the US and China. What are you seeing? Well, the Chinese economy is in difficult shape right now. It's facing, a number of short-term headwinds brought about by the property crisis, which is very Japanese-like, and also financial problems amongst many of their local governments. And that combination of issues has certainly led to a significant slowing of the Chinese economy relative to this historic 30 plus years of 10 % growth.

20:54And yet, that is only part of the problem. China is afflicted by a number of structural problems, not the least of which is declining population, especially the working age piece of the population, and weak productivity. What we learned from Japan, and this is very relevant for China, is when the demography works against you, as it certainly did and continues to do so in Japan, you've got to have strong productivity to offset that. You've got to get more out of the surviving workforce. Otherwise, your growth will weaken. And it has done that in Japan now for three decades plus. China's got a similar problem.

21:42Its population is now declining. We knew this was coming because of their unsustainable one-child family planning policy, but it's come sooner than we thought. And their productivity problems are actually worse right now than they were in the 90s in Japan. So, you know, China's got some structural issues on top of the cyclical problems. U.S.-China trade relations, your second question, you know, the relationship is in the worst shape it's been in since the U.S. championed China's membership in joining the WTO in late 2001. We've had tariffs initiated by Trump and sustained under Biden, who has tightened the news further through sanctions and through making every conceivable effort to contain Chinese technology under the guise of national security risks, which, as you pointed out earlier, were not a serious consideration with Japan in the 1980s.

22:57So that is obviously does seem like a pretty big difference. And when I think about the tensions between the U.S. and China, there seems to be the national security concerns, the concerns that Chinese exporters are going to undermine American industrial powerhouses, whether we're talking chips, planes, cars, solar powers, whatever. And then the synthesis of the two, which is, well, if we continue to let our industrial companies weaken, then that also has security concerns directly due to our ability to manufacture things like weaponry or whatever else from a national security standpoint. So maybe the way I'd ask you is, setting aside trade, do you consider the national security concerns real, or is this something that has been more ginned up in the head of policymakers in D.C.?

23:47Should it inform how we trade with China? I think that there has been a lot of exaggeration of the so-called security threat from China. Certainly, they are moving ahead aggressively in the area of technological change and innovation, and they're applying these breakthroughs to their military capabilities, as you would expect any leading power to do. But I think, personally, I've looked at a lot of this very carefully, wrote about it in my last book called Accidental Conflict, where I lay out the thesis that a lot of the national security concerns that have been expressed by politicians and by executive branch officials, either in the Trump or the Biden administration, are false narratives based on the presumption of intent on the part of China.

24:51They cannot really be validated. I mean, just take electric vehicles. I mean, we had the spectacle of a commerce secretary, Gina Raimondo, warning that if China was for some motive that she was unable to articulate, felt like it, they could transform transform Chinese-made EVs, presuming that they were allowed to be sold in the U.S., into vehicular weapons of mass destruction. And there's just absolutely no credible evidence of that. And you could argue the same thing with respect to, and I have, Huawei on 5G, telecommunications, Even TikTok in terms of the allegations that TikTok has corrupted the minds of innocent young teenagers.

25:48We've got concerns that have been raised over dock loading cranes that are made in China that with the flick of a switch that the Chinese could disable all of our dock loading infrastructure. You have an FBI director, Christopher Wray, who's been negative on China as long as I can remember, who's absolutely convinced that China has a stranglehold on America's utility infrastructure. And again, with just a flip of a switch from Beijing, our entire public utility system will come to a halt. Our politicians are eager and aggressive to warn of consequences based on the presumption of intent that they have not been able and are unwilling to validate.

26:41And I know that's an unpopular view to hold in this bipartisan era of what I've called Sinophobia. But I've never seen in my adult lifetime an adversary that's been so vilified as we are now vilifying the Chinese. So I find it very worrisome. My sense of some of the concerns is that they have more to do with the strategic importance of certain industries and the idea that, well, if something were to happen with China, you know, for instance, if it were to invade Taiwan, the assumption would be that the U.S. is cut off from Chinese exports, or at least they would be disrupted in some way. And so it might be desirable from the U.S.'s economic and national security perspective to build out your own strategically important industries.

27:40So things like batteries, semiconductors, maybe even solar panels. So I guess I always thought they were coming at it from more of an autarky point of view rather than a vehicular weapons of mass destruction point of view. There's some of that, Tracy. I will. Every nation wants to be able to stand on its own and not be strategically reliant on others, especially on a nation who has a different ideology, who you feel has been engaging in activities, whether it's with respect to Taiwan, the South China Sea, the partnership with Russia, who happens to be prosecuting a criminal war in Ukraine. I mean, so, yeah, that's certainly a part of the political equation.

28:37You know, the idea of being strategically reliant on production at home is good, but this just gets back to my economic lesson that I tried to teach you guys earlier on. If we want to be strategically reliant on our own production, then we have to be able to save more at home and reduce our tendency to run these trade deficits, which create this linkage with overseas production. I gave you some of the numbers. I mean, you know, we've cut our trade deficit with China. So you could arguably say that, you know, we have made some progress in at least weaning ourselves from the Chinese. But, you know, we've shifted our reliance to other countries.

29:33Our overall trade deficit is bigger today, a lot bigger today than it was when the Trump tariffs were imposed on China in 2018. So, you know, you've got a good point, but it just the numbers just don't add up. And the point you're making on strategy and its role in shaping national defense, how do you stretch that to the outright ban of TikTok? I mean, I have a hard time with it. What happens if we go down this route? Because, like Tracy said, it's consensus. It's probably the case that if we get another Trump presidency, we will see policy tighten or harden even further against China. What worries you about this trajectory?

30:22How does it go bad? Well, again, I'm not trying to sell my book because, you know, it's been out for a while. But I did write a book called Accidental Conflict. And that doesn't sound good. That's just the title. But what I argue in the book, Joe, is look, both nations are prone to politically expedient false narratives that they framed about the other. And that has really poisoned the relationship. We don't trust the Chinese for a second, and they don't trust us either. They are convinced that we want to bring them down. There's certainly a lot of evidence that supports their view as well. And so when you have this relationship that's gone from initially back in the 90s and early 2000s, from a relationship built on mutual trust to now a relationship that's built on mutual distrust, it doesn't take much of a spark to trigger a very worrisome escalation that could lead to outright war.

31:29That's why I wrote this book. And I subscribe to the notion that was articulated by the late Henry Kissinger a number of years ago, actually at a Bloomberg conference, where he said, I think it was back in 2019, that the U.S. and China were in the early stages of a new Cold War. He described them as being in the foothills of a new Cold War. And, you know, before he died, he said, you know, they're at a higher elevation now. It's a very worrisome development. And Cold Wars, when you've got two nations acting in an adversarial position, both focused on national security and building up their defense capabilities, you know, you can come very close and possibly even get into the realm of a kinetic outright war.