How China Might Actually Handle a US Trade War

Joe Weisenthal (0:02)

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Tracy Alloway (0:18)

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

Joe Weisenthal (0:22)

And I'm Joe Weisenthal.

Tracy Alloway (0:24)

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, is it seems to be this economy that is always simultaneously a massive competitive threat, especially to the US. And then simultaneously, it always seems to be on the verge of some big disaster caused by too much debt or bad demographics 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.

Joe Weisenthal (0:57)

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 all this over capacity 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. There have been obvious hiccups.

Tracy Alloway (1:41)

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

Joe Weisenthal (2:31)

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.

Tracy Alloway (2:42)

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 Besson 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.

Joe Weisenthal (3:16)

For sure.

Tracy Alloway (3:16)

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 Gavkal Dragonomics. So Arthur, thank you so much for coming on Odd Lots.

Arthur Kroeber (3:31)

Hi there. It's great to be here.

Tracy Alloway (3:33)

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.?

Arthur Kroeber (3:47)

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 in the first 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, was they were really mad. This is very visible to me when I was in last 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, make it clear that they were interested in talking, 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 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 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. Then I think the other consideration was essentially political, which is that even if they hadn't re-attaliated, they were still facing tariffs of over 60 percent. 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 get people in China on board for what was going to be a tough time no matter what.