China Decode: How China Is Breaking the World of Trade

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1:21Download today. China's trade surplus is bigger than the trade surpluses of the next eight countries combined. So that just gives a sense of how enormous this is. I was also going back and looking into history to see if this is the biggest trade surplus we've ever seen by any country in history. And this is certainly by far the largest trade surplus that we've seen in peacetime.

1:55Welcome to China Decode. I'm Alice Han. And I'm James King. Well, in today's episode of China Decode, we're discussing China's push for near total self-sufficiency in technology and industrial goods and how that rewires global trade. A tense week in Asia where the US, China, Japan and Taiwan are navigating trade security warnings and a massive new Taiwanese defense buildup. And Beijing's newest experiment to spark consumer spending using school holidays to jumpstart travel and revive a slowing services economy. That's all coming up, but first, let's do a quick check-in with how the Chinese markets are starting off the week.

2:33On Monday, both their Shanghai A-share index and Hang Seng's H-share index rose 0.7%, boosted by a tech rebound and growing confidence that the U.S. will choose to cut rates later this month. Internet giants such as Alibaba, Tencent, and Trip.com all closed higher, benefiting from the tech rally. And PopMut International, creator of the famous Libubu, closed down over 4 % due to growing fears from investors that the Libubu craze may be fading. A lot to discuss, James. We're almost at the end of the year, but I think there's still a lot coming out of China in the news cycle on multiple fronts. Well, I mean, we did an episode on the Libubu craze at the very start of this podcast.

3:15It's interesting that that appears to be fading already. Yeah, but let's get straight into it. China's shifting toward a model where it barely imports anything strategic. James, we've talked about this on many episodes in the past. And that trade surplus is blowing up the old logic of global trade. Beijing still wants to sell to the world, but beyond raw materials, commodities, and a few consumer goods, it doesn't want to buy much. That imbalance is already reshaping growth. China's economy no longer lifts other countries, as it once did. It increasingly replaces them. And you can see this transition in the latest data.

3:51Factory activity coming out of China is still in contraction mode for an eighth consecutive month. Services are softening as holiday spending fades. And global multinationals now say China isn't a cash cow anymore. It's hyper-competitive test lab where foreign brands must slash prices and redesign products just to survive. All of this points to the same reality. China is doubling down on self-reliance while squeezing already limited space for foreign companies and high-value imports. James, there's so much to talk about on this subject alone. By the end of the year, we could see China's trade surplus reach a record level, surpassing$1 trillion for sure, maybe even$1.2 trillion.

4:33We're already close to$600 billion in trade surplus in the first half of the year. Certainly what has been interesting in the news cycle that I've seen is the fact that more and more European countries have voiced consternation and concern. I'm thinking especially about Germany in this case, that China is eating its lunch and increasingly replacing it in key supply chain areas from chemicals to cars. I think that this is going to be an ongoing story for sure. But what is interesting, and hopefully we can dwell on this in this segment, is how other countries in East Asia and Europe are going to deal with China increasingly replacing them as they go up higher on the supply chain.

5:14So James, having spent a lot of time in Europe and in the UK, how are people in those countries reacting to this increasing China threat? Absolutely, Alice. I mean, you know, the thing that really sparked my interest was an article last week by a former colleague of mine, Robin Harding at the Financial Times. And the article was entitled very starkly, quote, China is making trade impossible. And that really made me think. He basically was traveling around China asking normal people what they thought China might want to buy from the rest of the world. And a few people said, you know, we would buy soya beans or we would buy iron ore or a few more would say maybe Louis Vuitton handbags.

5:59And some said higher education. But in general, the response was really desultory, uninspired. And Robin Harding's conclusion was, and this is a quote again, there is nothing that China wants to import, nothing that it does not believe it can make better and cheaper, nothing for which it wants to rely on foreigners a single day longer than it has to. And this has caused a lot of readers' comments. It's been a very widely read article. And of course, it's not meant literally. I mean, we need to say at the top that China last year imported 2.6 trillion US dollars of goods. So obviously, China is importing.

6:46But I think that nevertheless, this article really does capture a mood. And that is the fact that China wants to institute import substitution pretty much wherever it can. Everybody is already familiar, I think, with the so-called Made in China 2025 plan, which started 10 years ago and identified 10 areas in which China wanted to boost self-sufficiency, things like electric vehicles, robotics, biotech, etc. And in all of those 10 areas, China's been spectacularly successful. So it really does raise the question of how big is China's trade surplus going to get? You've just mentioned that this year, it'll be well over a trillion US dollars in trade surplus.

7:35It could be as much as 1.2 trillion. And I just did some calculations before, and I calculated that China's trade surplus is bigger than the trade surpluses of the next eight countries combined. So that just gives a sense of how enormous this is. I was also going back and looking into history to see if this is the biggest trade surplus we've ever seen by any country in history. And there seems to be a little bit of a question as to whether or not the US, straight after the Second World War, had trade surpluses that were larger as a percentage of global GDP. But that was wartime. I mean, that was the aftermath of a war in which many economies in the world were shattered.

8:23This is certainly by far the largest trade surplus that we've seen in peacetime. So I think it raises a couple of really basic questions. The first is, can the world absorb these surpluses? Or are we going to face a big backlash? Is there going to be a big backlash from Europe or there has already been from the US or even countries in Asia? And the next question is, you know, is there going to be some empathy from China as to what other countries are going through as their industrial base is progressively hollowed out? I don't know whether you're picking up any signals on that or what aspect of this issue you're finding interesting, Alice.

9:10Well, James, I'm glad that you led with the micro story, the anecdotal story, and then ended with the macro outlook because it's all signs point to the fact that China is using its economies of scale to effectively outcompete the traditional trade surplus manufacturing giant countries like Japan. I was reading an article that I highly recommend by Brad Setzer, who I think is preeminent in the realm of looking at balance of payments, trade balances as well across countries. And he looked specifically at the IMF data of manufacturing surplus. So he looked at the manufacturing goods across countries, calculated them, and found that China's manufacturing surplus as a share of GDP is now exceeding 2%.

9:52It is definitely higher now than Japan's and Germany's were at their historic peaks. And his point in that piece, again, published in the CFR Council of Foreign Relations that I highly recommend, his point is that China's manufacturing surplus growth is faster than Japan's and Germany's ever were, and its scale has now outpaced both countries. So we're seeing a country that, to your point, James, is using import substitution and autarky and basically out-competing a lot of these countries. Now, a traditional macroeconomist would say this is bad for China. It creates inefficient investment. It leads to higher prices.

10:30It leads to overcapacity and lack of innovation. Now, that I don't think is universally true in China. I think the opposite is true in a way where we've seen hyper-competition driving down prices. Certainly, we do have the overcapacity element. But I think what makes China so generous or unique is just the scale of the country. If you think about the federated system of many competing local governments, a huge labor force, a flexible labor force, I think that makes China slightly different when you look at it from a macroeconomic theory lens. But certainly, I don't think that the Europeans are listening to Draghi's report about how to revive industry in Europe.

11:08And similarly, and we'll get to this in the next segment, Japan and Korea, although they're still, I would say, competitive in certain areas, especially when it pertains to chips, semiconductor equipment, some software. You know, increasingly, you're seeing China outcompete them as well in electronics and cars. I find the autos example particularly interesting. So Germany and Japan export the majority of their cars. I think somewhere like 80 to 90 percent of the cars they make, they export. China, it's the flip side is true. They actually domestically consume most of the cars they make. But this is, again, we're starting to see a change here where it's projected that China's exports of cars has surged to well over 6 million cars.

11:49That's a tenth of the global auto market outside of China. And by 2026, there's a projection that this could be 8 million car exports. Given what we're seeing in the economy, the overcapacity, the need to move out, it's inevitable that this number increases. And again, first-hand evidence looking at these cars, they're pretty competitive and user-friendly. So, you know, watch this space for sure. I think autos is going to be a huge political issue and is in general, historically, a major political issue because of labor unions, because of the outside's influence on the economies of different countries.

12:22This is going to get political very quickly, I think, in other countries. Yeah, absolutely. I mean, it's very interesting that you chose autos. I also have a car example, not because it's special, but because it's really representative. I mean, the number of different components that go into making a car, I think the car basically represents a country's manufacturing prowess. The example I have is really scary for Europe. And that is that Volkswagen, obviously one of Germany's biggest car makers, has just said that it can make an electric vehicle entirely in China for half the cost of doing it elsewhere.

13:02You've got to consider that Volkswagen employs hundreds of thousands of people back in Germany. And now it's saying it can make a car, an electric vehicle, at half the cost of making it back in Germany. And this is the first time that it's developing cars outside Germany. And it's also announced that it's going to release about 30 electric vehicle models in China over the next five years as it bets on localized research and development. So this is the kind of innovate in China for China and for the outside world model. It basically means that all of the smart stuff that Volkswagen used to do back in Germany, it is now going to be doing in China.

13:47And as I said, I chose this example because I think it's representative, not because I think it's an outlier, of what different companies, very well-known companies in Europe in all kinds of different sectors are going to be doing. So it basically means that we're hollowing ourselves out with our biggest companies moving all of their smart stuff to China or moving a lot of their smart stuff to China. I must say, I think this is quite different from any period in history that I can think of since the Second World War, we're facing really big headwinds. And I just sort of return to Robin Harding's question, you know, is this simply going to break the world of trade?

14:32I don't think there's an answer to the question yet, but I do think the question is justified, and that's a big statement in itself. Yeah. And now we're hearing China building more plants in Europe. I think that is going to be the modality moving forward. Whereas in the 90s, 2000s, a lot of plants, Volkswagen, BMW were doing tech transfers, quote unquote, in China or setting up JVs. Now we're seeing the flip side, which is CATL, the Chinese battery giant, setting up lots of plants in Spain. So we're seeing a bit of a mirror image in this relationship between Europe and China moving forward. One data point that I want to end on, which I found very startling, but really sums up the enormity of this China problem, is the IMF global goods trade volume data.

15:18Chinese exports cumulatively are up 40 % since end of 2019 in volume terms. Their imports are only up 1%, so basically flat. And again, the flip side of this trade export machine is that China is just not buying from the rest of the world. Okay, we'll be back with more after a quick break, so stay with us.

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18:07to cool its rhetoric. And Taiwan, caught in the middle, unveiled a massive new$40 billion defense package to harden itself against a potential Chinese attack. Meanwhile, Hong Kong is reeling from a devastating apartment complex fire that's killed at least 151 people. The tragedy has triggered anger over safety failures, but Beijing immediately moved to stifle criticism, warning residents not to protest, and arresting people who called for an independent inquiry. And all of this is happening as China expands its use of AI-driven censorship and surveillance, deploying new tools across its justice system and outsourcing enforcement to private tech companies.

18:47It's another reminder that the region's security tensions aren't just about armies and alliances. They're increasingly about information control and political stability at home. James, I had a lot of questions from my clients about this phone call. There was one side from Ling Ling Wei, the Wall Street Journal, saying that Xi Jinping initiated it. Besson and Co said that Trump and the U.S. team initiated it. I had heard from somebody close to the Trump team that it was actually Trump himself that had initiated it. A lot of the discussion was about Taiwan from the Chinese side, but Trump wanted to make it clear that he was worried about Ukraine and wanted Chinese collaboration.

19:25So we're getting two sides of the same phone call. What did you hear about it yourself, James? I think that really the most important aspect of this phone call from our perspective is that Xi Jinping clearly decided to focus on Taiwan. We all know what a big issue Taiwan is in China. It is China's geostrategic priority. And what I'm talking about, of course, is at some point in the future, regaining control or recovering control over Taiwan. And of course, on the other side, the US has the Taiwan Relations Act, which doesn't explicitly pledge direct US military support for Taiwan or intervention in the event of an attack on Taiwan, but it does commit the US to maintaining the capacity for Taiwan to resist force that would jeopardize Taiwan's security.

20:21So Taiwan is obviously one of the biggest issues, if not the biggest geostrategic issue between the US and China. And so I think it was interesting that Xi Jinping chose to highlight this in a way that was quite interesting to me. He said that it would be an integral part of the post-war international order that the US and China would together fight fascism and militarism. And then he said, and this is a quote, given what is going on, it's even more important for us to jointly safeguard the victory of the Second World War. And I think what he was referring to when he said, given what is going on, he was referring to comments recently by the Japanese Prime Minister Sanai Takeuchi, who said that a Chinese attack on Taiwan could trigger a military response from Tokyo.

21:19And to me, that sounds like the impetus behind Xi Jinping either agreeing to this call or asking Trump to talk about this topic, because this statement by Takeichi, the Japanese prime minister, has plunged relations between Japan and China into their worst crisis in a decade. And it's clear that it's had big blowback in Beijing. And I think if I was to summarize what Xi Jinping is trying to do, he's trying to get reassurance from Trump that together, the US and China will not drift further apart on Taiwan, that Taiwan will not kind of get up a steam of impetus behind it to go for independence or anything like that that could trigger some kind of military response from China.

22:07That's my reading of it. But overall, Alice, I mean, I think everything that you've just mentioned, including that tragic fire in Hong Kong, I mean, my heart goes out to those people. That apartment complex was very close to where I used to live in Hong Kong. But all of the geopolitical issues that you've mentioned show to me just how fractious and tense and complicated the big power relations in Asia really are. For sure. And it shows that it's a multiplayer game. It's not just about the China and US conflict. I think with a more hawkish administration in Tokyo, led by Takeichi, it's clear that the Chinese are worried about the Taiwan question again.

22:50And like you, James, I believe that Xi Jinping was motivated to take that call that Trump initiated because he ultimately wanted American pressure on the Japanese prime minister to lower the heat. Because as you mentioned, James, Xi had made statements alluding to the fact that if Chinese troops were surrounding Taiwan, it would be a survival-threatening outcome. And that in itself was read by Chinese elements on the mainland as a provocative statement. And even although they've since the Japanese officials have tried to, I think, improve relations, right now it doesn't look like Beijing is interested in seriously lowering the heat.

23:28In fact, they probably want to send a message. This is happening at the time in which Taiwan is nominally showing that it is willing to increase its military readiness and defense spending. It planned recently to increase its defense spending to 3.3 % of GDP by next year and is committed to 5 % of GDP by 2030. But as we know, James, money isn't everything. And China has an overwhelming defense superiority. If we just take America out of the equation, China has four times more personnel than Taiwan has. It has roughly 200 more tanks. It has more than double the artillery capacity. And as we saw in Ukraine, that's actually quite important.

24:08It has 10x the submarines and double the military aircraft. Now, Taiwan can, I think, rely somewhat on some of these regional players like Japan, South Korea, and obviously the US. But to my mind, the Taiwanese increased support in the military is a little too little too late. I remember reading several years ago when Russia, Ukraine broke out as a conflict, a study that was looking at polling in Ukraine and Taiwan. And what was clear was the Taiwanese public, especially the young generation, were far less willing to go to war or use war as a means to solve any tensions with China, unlike the Ukrainians, where I think there was a lot more civilian and military battle readiness and appetite for conflict.

24:51It seems in the Taiwanese case that that is less true. That remains to be seen, obviously. But certainly I worry when I look at Taiwan's general net capabilities vis-a-vis China. And then I worry also about the Trump administration. How credible is it for us to really believe that Trump would come out on the side of the Taiwanese if China were to go for a quarantine or blockade, let alone an amphibious assault. I think that that is not clear in this administration, especially at a time where the impetus in the call at the next six, 12 months is to try to reduce trade tensions, try to get talks back on track.

25:29So I think if I were in Taiwan and Japan, I would be slightly worried about what's happening along the Taiwan straight. Yes. I mean, I actually have the same feeling as you. I think that in some way behind the scenes, the U.S. implicit support for Taiwan is taking a couple of steps back. I don't want to be too definitive about this. I don't want to call this. But I think that this is the reason why we see China getting really quite confrontational towards Japan and also pushing Trump as well. I mean, these statements that Xi Jinping has come out with are rather cryptic, but the way I read them is he's putting pressure on Trump not to get too emboldened about Taiwan.

26:14So I would say, without being definitive, that the U.S. pledge of support for Taiwan is ebbing just a little. I'm not going to say one way or another whether the U.S. would come in on the side of Taiwan if some kind of a conflagration blew up. But I do think that at the moment, it sounds as if U.S. support is ebbing just a little. And you quoted Xi Jinping when he spoke to Trump about this friendship, especially during World War II, where you had Japanese aggression. Parts of China were occupied, in fact, by the Japanese military. And it reminded me, as you were reading that, of the Rana Mida book about China's experience of World War II and Japan's invasion.