The Miracle Is Over: Inside China's Slow-Motion Economic Decay

Welcome to Geopolitics Decanted. I'm Dimitri Alperovitch, Chairman of Silverado Policy Accelerator, a geopolitics think tank in Washington, D.C. According to China's own economic data, which is chronically underreported, China peaked as a proportion of the global economy in 2021 at 18.5% of global GDP, and has declined ever since. The United States, by contrast, accounts for around 26% of global GDP, up from 24% since 2021. Not only is there virtually no chance of China overtaking the United States as the world's largest economy, but it is also likely that the U.S. advantage in economic strength will expand further in the next decade. That is the argument presented in the latest foreign affairs piece entitled China's Moment of Weakness, Economic Decay, an America's Strategic Opening by my guest, Logan Wright, who is a partner at Rhodium Group and leads its research on China's economy and financial markets. He's also the author of the book Broken China, How the Economic Miracle Shattered and What It Means for the World. Logan, welcome to the show. Thanks, Dimitri. Great to be here. Really appreciate it. Terrific. So what I found so interesting about this piece and your argument in it is that it actually dovetails into what I wrote in my book, World on the Brink, how America could beat China in the race for the 21st century, and that China is much weaker than we think they are. And we're actually a lot stronger than we often give ourselves credit for. But make the argument that you make in your piece about why it is that China's economic miracle is getting shattered, as your book is also titled. Sure. So it's pretty straightforward. I mean, I think that it's underappreciated that a lot of China's growth has depended upon an unprecedented expansion of credit. And the net result of the end of that credit expansion has been a slowdown in economic growth, particularly in investment. China has very weak operating cash flows in most of its local government and state-owned enterprises. So if you slow down credit, you typically slow down investment activity altogether. And so since the global financial crisis, China saw basically an expansion of around a third of global GDP in new credit in just eight years. And we've never seen anything like this. That started slowing down in 2018. And as credit was gradually cut in half, and now it's about a third of where it was at its peak, credit average growth averaged 18% from 2007 to 2016. And then it averaged only 9% starting in 2017. Right now it's just over 5%. So as you start to see credit growth slow, borrowers suddenly cannot refinance, investment activity has to slow. And because China's economy has not rebalanced toward domestic consumption and away from investment, that's had a huge impact on aggregate growth. And so officially China has reported that they've still grown even despite the collapse of the property bubble and despite the end of the impact of the zero COVID restrictions, they've officially reported, you know, 5.2% growth in 2023, 5% growth in 2024 and 2025. The reality is growth is much, much weaker, but the bottom line is... What do you think it is? Two, 3%? 1.5 to 2% on average over the last, basically since 2022. That's less than the U.S. growth. That's right. And so I make this argument in the foreign affairs piece. If you told anyone on average, you know, anyone in the Washington community and, you know, just any media literate person that the U.S. has outgrown China over the last five years, even on the official data, they probably wouldn't believe that. But it's undoubtedly true, even just in renminbi terms, it's definitely true in dollar terms. And so therefore you look forward and you say, is the U.S. likely to outgrow China over the next five years, given these headwinds? Like on balance, probably it has a reasonable chance of doing so. And the five years after that, it becomes a better bet given the demographic headwinds that China is facing overall, the notable decline in financial efficiency, the inability to continue to generate credit out of its current financial system and the inability to use fiscal resources to power growth. So one of the reasons I wrote this is precisely because this isn't in consensus at all. You know, in reality, we do not face a long-term strategic economic rivalry with China. We face a very different set of security challenges, which has to do with their concentrated controls over certain supply chain choke points and increasingly using the weakness of their domestic economy to continue to aggregate manufacturing capacity at lower and lower prices. And this is sort of the overcapacity argument that you're hearing around the world. So China shock. Yeah, I can get into this in much more detail, but that's basically the case. And so we should rethink the way we think about the challenge from China at this point. We should think about it as it's not only a short-term problem and it's not purely a short-term problem, but you do not have the risk that this is an economy that's going to generate more and more resources to be able to counter Western interests. You instead have problems that are likely deterrable, problems that are likely manageable, and a threat that is not inexorable. It requires a different strategy and response. That's the argument of the piece and much of the book in Broken China as well. The underappreciated aspect of all of this, and just for background of your listeners, so I lived in Beijing from 2001 to 2015 and Hong Kong from 2015 to 2022. My entire career has been following the financial system. And so no one who has looked at the financial system in great detail would ever assume that there has been a long-term plan in place for how China has managed its economy over time. So let me, yeah, there's very little evidence of this. I'm very sympathetic to this view, but let me play devil's advocate for a second. So one argument that a critic of your piece might use is to say, well, you're looking at nominal GDP, not purchase power parity, PPP metric of GDP by which China has already exceeded the United States. You're also not taking into account that the currency is vastly undervalued. And you could also say, is GDP even the right metric to look at the power of the economy? How do you answer these? Sure. There's a very legitimate debate about whether GDP is the right metric to look at economic power. This is a system that was designed in World War II era between the US and Britain about measuring wartime capacity. I mean, there's reasons to be skeptical about what you're measuring overall, but the PPP argument doesn't really make any sense. I mean, essentially you'd be rewarding China for creating deflation. If you were scoring this based on PPP, you'd be saying that the lower the domestic prices are, the more powerful the economy is when deflation is actually the problem that China is countering. You use purchasing power parity when you're comparing developing economies against developed economies. You don't use it when you're comparing the two largest economies in the world. It's also a very difficult calculation to sort of update over time. The moment that you engage in international transactions and a trading economy in general, PPP becomes just less relevant. So I don't think there's anyone who would seriously sort of take the PPP argument out there, even though it can be a talking point. The reason you use nominal growth and focus on the exchange rate is because, you know, basically debts are paid in nominal dollars, not real dollars and nominal renminbi, not real renminbi. So if you have a problem generating domestic inflation and you have a problem generating domestic nominal growth, it's going to impact the sustainability of your economy over time. So this is exactly why that's important. You ultimately need a base of comparison. And the interesting thing about the exchange rate is in China, it is indicative of China's policy capacity to influence the exchange rate. So in other words, China is, you know, constantly in this struggle between mounting capital outflows and encouraging inflows into its domestic, you know, bond and equity markets to balance that. Its inability to keep the exchange rate stable and therefore to see lower nominal GDP level would be indicative of policy failures and would be indicative of weakness in policy levers. What I mean in that outflows are inevitable is China has the largest single dollar money supply in the world at about $52 trillion at this point. Now, why is that? It's because credit growth has been so extensive. It's been overwhelmingly denominated in renminbi and there have been capital controls that have kept that renminbi inside of China. So the moment at which you relax those capital controls, you would likely trigger capital outflows that would weaken the currency. So in essence, I like to talk about this in financial terms. China's financial system is a bunch of assets without markets for them. And so when you reprice those assets, you can reprice them either by assessing credit risk that those assets might default. And that's been happening as the slowdown in credit has occurred, or you can reprice it in terms of currency risk that those assets aren't worth as much in global markets where China is valuing them domestically. And the exchange rate is the metric for that. So I don't view the exchange rate as exogenous. I view it as sort of endogenous to the attempt to maintain global influence for Beijing. And that's exactly why I think it's important to use a relevant comparison, which is sort of the dollar GDP levels. There's also this problem of just like, what do you use if you're not using nominal dollar GDP? You know, I've seen other assessments that look at, okay, if you take this in 2015, it doesn't look as severe a decline in terms of global GDP, but this is kind of nitpicking because in 2015, you had the peak of renminbi valuations as well. So is that the fair comparison? Probably not. And to be clear, you pick 2021 as a metric, the starting metric, because that's when the Chinese GDP peaked, right? That's when GDP peaked as a percentage of global GDP. So at 18.5 in dollar terms, and it has declined since then. So the official data would put it in the mid 16s right now. And I think on our adjustments, we're in the low 15s as a proportion of global GDP. Global GDP doesn't mean very much. It's just, we're talking about aggregate measures, but this speaks to a larger story, which is that China can only grow relative to the rest of the world if they are an investment-led economy. I mean, if you're a manufacturing economy that depends upon global demand, you can only grow as fast as your customers, which means you can't grow relative to the rest of the world. The only way you can grow relative to the rest of the world is by displacing your customers and therefore by gaining global export market share. So that's the debate we're having. How much of those gains in global export market share will continue? You know, how plausible is that? You run into several limits. You run into sectoral limits, just how many cars can the world buy at any given moment? You run into macroeconomic limits. How large can the Philippines trade deficit expand vis-a-vis China over time? How large can developing economy trade deficits expand? And then you run into political limits. How long will European publics put up with losses of manufacturing jobs to lower cost Chinese goods? And so those are some of the limits that I think are intrinsic within an investment-led growth model that continues to need to expand investment. And it's the collapse in domestic growth that has caused this dynamic. I think what's underappreciated is that none of this is externally caused. There's not a single foreign official who ever made China add a third of global GDP in new credit. There's not a single foreign official who led to the creation of a multi-trillion dollar shadow banking system inside of China. And it's been the bust of that shadow banking system and the associated fallout of the property market that has been responsible for the increasing competitiveness of Chinese goods abroad, precisely because domestic prices and domestic demand has been so anemic that it's created these deflationary pressures. So a couple more counterpoints in my attempt to be a devil's advocate here. I'm trying, please. So one is on the capital outflows issue. You're absolutely right. The capital controls are making it very, very difficult to get money out. Ironically, it's not just making it difficult for Chinese companies to get money out, but for Western companies that have bet all in on China, particularly Germans and others. And now they're generating profits in China that they can't get out. And as a result, they're reinvesting domestically. So you could argue that it's helpful, at least in the near term, because it's bringing in more investment from those profits that would otherwise leave the country that can now be reinvested domestically. Sure thing. The capital controls are difficult. In reality, capital controls are never going to be a panacea for a huge macroeconomic imbalance. There's the impossible trinity, the balance between control of cross-border capital flows, control of the exchange rate and control of domestic monetary policy. You can only have two out of three. China's long tried to control all three to some extent. And the whole point is that, you know, I don't think any of the Chinese regulators think that, well, we have capital controls, therefore we'll never have a problem with capital outflows. Capital does leave the country and virtually everyone can square their foreign exchange position given enough time and enough cost. What capital controls do is they buy time and they prevent a lot of the rapid cross-border movements that can lead to destabilizing moves in the exchange rate, such as what they saw in August, September 2015. So I think that's really where the focus is. It's not really on stopping the flow. It's on sort of regulating it to a certain extent and on channeling it to the extent possible through areas that are more visible to the Chinese state. Is that what's happening with Huawei and BYD? They're able to invest huge sums of money around the world to build data centers, to build manufacturing facilities. So obviously some capital is allowed to leave officially China, right? Yeah, exactly. Meanwhile, compare that to some of the acquisitive Chinese private firms like H&A Group and others that were facing these shutdowns of capital outflows and their outbound investments in 2016. So there's been a very different kind of dynamic there. But look, if China relaxed capital controls altogether, it would arguably be very bad for the world. You would have a really rapid depreciation of China's exchange rate that would exacerbate deflationary pressures in the rest of the world, especially in emerging economies as well. It would likely increase China's trade surplus further, but it would weaken China's overall influence in the rest of the world as well. So Beijing wouldn't be happy with this. This is just a part of the reality they've operated under. And the interesting thing is when they've had better opportunities to relax capital controls, like early 2021, late 2020, you had very few people traveling outside of China precisely because of COVID restrictions. You had steady inflows. If there was ever a time to float the exchange rate or relax capital controls to allow, you know, more of this offset to occur and therefore more market forces to have influence over the exchange rate, that was it. It would arguably have very minimal impact on cross-border flows at that point. And then you would have seen these relax, you know, going forward. But they didn't do that, which I think reflects this underlying fear that the outflows are inevitable, the inflows are not. And that's the problem they have. It also goes against Xi Jinping's desire to have full control over all aspects of the economy. Very possible. I think there's always this tendency of you can't control volatility everywhere. You try to control it in a few places and it shows up where you don't expect. So if you're trying to control all sorts of domestic pricing, you'll end up in, you know, distortions in pricing somewhere that you're not expecting. This is just the nature of, you know, the nature of attempted controls. And so in China, you always see this happen. Everything looks very stable until the government itself introduces changes in implied guarantees. The risk of a financial crisis in China is not some external shock. It's actually from reform. It's actually from when the government decides that, you know, these assets are no longer worth supporting. And then all of a sudden everyone is holding those assets, thought that they had what was guaranteed that Xi Jinping wanted to control. And all of a sudden, Xi Jinping doesn't want to control that. And so you have to price this, you know, very different risk. What about the argument that, you know, while you're absolutely right, that credit has decreased dramatically in China, that it has been in effect channeled into much more productive areas of the economy. So no longer do we see a massive property boom and zombie or ghost cities being built. Now you're focused on manufacturing of the latest and greatest technologies like EVs, like, you know, semiconductors, like AI technologies that they're now investing in, which present great potential for accelerating growth. How do you answer that? Well, the shortest answer is that the evidence indicates the exact opposite. That more and more credit is actually going to the least productive areas of the economy. And the ways in which we can track this are through the financial system. You know, the PPSC releases a data series on the proportion of loans extended at or below the loan prime rate. So the loan prime rate in China is right now 3%. It's fallen along with overall interest rates. So if lending was becoming more productive, and if lending was going toward private sector firms that were capable of generating higher nominal growth rates than We would expect that this proportion of loans extended at or below the loan prime rate would be falling. So in other words, we'd see fewer and fewer loans below the line. We'd see more profitable loans extended above the line. Instead, we see that proportion rising very, very sharply. So the proportion of loans extended at or below the loan prime rate right now is 59%. I mean, and that's up from the mid twenties, and it's risen virtually on a line. But that just means that they're subsidizing more and more. Doesn't mean that it's unproductive subsidization, right? Well, I mean, you might be saying the same thing there. If you need to subsidize something, how are you measuring the productivity of it in the absence of that subsidy becomes the question. And it's an open question about how much, you know, overall below market credit is definitely a form of subsidy that, you know, that needs to be taken into account. But if the goal is to dominate these sectors of global economy, and if you believe that these sectors are going to be incredibly economically lucrative down the line, particularly if you destroy all competition, then it might be worth subsidizing, right? Right. My broader point is that there is really no evidence that credit is being allocated toward more productive sectors. I mean, if you look at the actual state of the financial system, we can measure this in many different ways. So we monitor every single industrial land transaction in China. So if you saw a huge increase in investment by different sectors, you would probably see it in that data. Overall industrial land is still slowing and there is a marginal adjustment within individual sectors, but this is not an overall acceleration in manufacturing investment in more productive areas. So where is it going? So largely this is the decay of the system. So the other data source I was going to point to you is we track every special revenue bond in China. So every local government special revenue bond, the prospectuses demonstrate at the project level, like where things are going, so we can sort those by industry. So the increase in proportion of what we would call the new strategic industries from 2021 to 2025 is about from 2% to 6%. Meanwhile, the overwhelming proportion is still toward traditional industries. This is the decay of the system. They're throwing more good money after bad because it's becoming more and more expensive to maintain the debt burdens. And so when people make this argument, there's this very famous chart that shows like lending to real estate down this much, lending to manufacturing up this much. It's completely wrong. It's often cited as one of the most misapplied charts in Chinese economics. There are industrial policy applications in China that are channeling things toward these industries, but in aggregate, most of that increase in lending to new industries, and it uses a definition that they discarded back in 2010, is forbearance. It's forbearance of loans that was extended during, and it's refinancing of loans to government financing vehicles. So it's not really in new industrial lending overall. The other point is just that it is completely fair to say that China's putting a lot of resources, fiscal resources, government guidance funds into new industries, but in macro terms, these are very small. We've tried to add them all up, electric vehicles, lithium ion batteries, AI, advanced robotics, solar photovoltaics, and measure the decline of property and infrastructure investment relative to the acceleration in new strategic industries. So there was newly released 2023 input output tables that offer you the first visibility into some of the upstream and downstream implications of some of these new strategic industries that were released last November. Using those tables, and you have to extrapolate a bit because they don't include much on AI and robotics, you're talking about 6.3% of GDP collectively relative to the decline in property and infrastructure investment, which was roughly six times the acceleration in the new strategic industries from 2023 to 2025. Now we can be wrong about that exact number 6.3. We're not wrong by a factor of two, you know, we're not under counting six percentage points of GDP and new investment. But you know, that's almost scarier because if they're investing relatively little in those sectors and are already achieving dominance and batteries and solar and, you know, lots of these industries, EVs, imagine if that investment was larger. Well, I mean, this is China's the largest investor in the world and has been in a long time. China has 26, 27% of global investment. So yeah, and this financial system, even as it's slowing down and still generating four, four and a half trillion dollars in new credit every year. So, but the point is that I'm making is that from a macro perspective, I'm sure some of these will come out, but I haven't seen a single study and Yasheng Huang of MIT made this point recently as well. I haven't seen a single study that suggested that Chinese total factor productivity growth has improved at this point, like even despite all of these technological improvements. So even with automation taking hold in Chinese factories, you have not seen a product? Well, TFP is hard to measure, but the point is the past is strangling the future here. The past and the traditional industries, the problem is continuing to throw more and more good money after bad into the traditional industries, because you're so afraid that if you cut off those sectors and write down the capital stock, growth is going to collapse that much more and impact, you know, the overall momentum of the economy. It's a very legitimate concern. You know, how do you write down the capital stock? But, you know, the argument I make is just look, a lot of the gains externally in China's export markets have been because of prices and it's the weakness in domestic demand that have pointed to this rise in prices. So from a strategic industries perspective, I think it's best to understand these as national security related investments, not as an economic growth strategy. And therefore we should counter them and think about them as these are choke points that China is developing and this is how we will, you know, mitigate against the use of those using demand side metrics, which is what I argue for in the foreign affairs piece. My point is the campaign to say China is going to remain dominant in these sectors is partially an attempt to discourage investment in those sectors abroad. And so a lot of the tours that people go and say, I've seen the future and Chinese robotics is going to be this dominant. There's no chance that we'll ever catch up. I mean, that's the message they want. The message they want is that investment is not useful elsewhere. But the truth is that if other countries do invest and protect those industries, China still has to sell everything that they produce. The marginal demand for everything they produce is outside of China rather than inside of China. They have to remain overwhelmingly focused on keeping global export markets open. And if you do not care about ever developing an electric vehicle industry or an advanced robotics industry, you're happy to take the implied subsidize, you know, lower cost goods. If you do, and you're more concerned about the defense industrial base, and you're more concerned about China's industrialization and concentration of shares exceeding red lines of strategic resilience that are important in developed economies, then it's a call for redoubling investments in those sectors and protecting them precisely to counter this. And the pressure on China comes through deflation. This is the point that's often lost. It's not that you're going to see evidence of sudden bankruptcies or defaults. I mean, the state-owned enterprises can continue. This is why it's, I've described in the book, it's not crisis or collapse, it's decay that you're seeing in terms of this pressure. But with deflation, you cannot necessarily generate the same nominal growth. You cannot therefore repay debts as easily. It forces more difficult trade-offs and it impacts fiscal revenues at the same time, which impacts your capacity to continue funding new industrial policy objectives. China runs a fiscal deficit of around $2 trillion a year, just in deficit terms, like it's about 9.5% of GDP at present. This is still underappreciated, that it's not that you can't run those deficits, you can finance them internally, but you don't get the same bang for your buck ramping up. We would think about this economy entirely differently if it was growing at 6% to 7%, 5% to 7% real, 6% to 8% nominal in a very sustainable way, versus what it is growing at, which is roughly 0% to 1% right now in real terms, and arguably about the same in nominal terms. It's not that they don't have capacity to deploy fiscal resources, but they don't have the same as what they did in the past. So with the U.S. turning protectionist, and not just in recent couple years, but really the trend line has been going on since 2018 and only accelerated, now there's still lots of trans shipment going on and we have to deal with it, but they can't trans ship everything that they would sell to us normally. So clearly the U.S. market is getting harder and harder for them. So given that, is the answer about China's economic future all about Europe? What Europe is going to do? Because there's no other huge block that can take in all of this over capacity other than Europe, right? The developing world can't take it in and continue to finance even the moderate growth that they've had. So if Europe turns protectionist, are they really screwed? I think so, and I think there's more European leverage involved in this upcoming dispute that you're seeing with European Council debate in June, and some of the talks that are being set up that presumably are going to then catalyze additional discussions of safeguards later in the year. I think Beijing has been a bit complacent and thought that basically they can play European states off against each other, and there's real problems with European unity on this front, to be perfectly clear. But Europe does have a lot of leverage for exactly those reasons. It's hard to see what other markets are, but China's still exporting a lot to the U.S., just trans shipping goods also. I think there's far too much focus in the U.S. on bilateral deficits. The U.S. trade deficit is determined by the savings investment imbalance. Tariffs are really just reapportioning and trans shipment penalties, however you want to think about it, are just reshuffling that deficit between different countries. The question, I think, for from a security perspective is like, are we comfortable with trans shipment? Are we comfortable with overseas Chinese investment in Mexico, in Vietnam, and in other countries? Because there's a good argument that you should be precisely because there's more, you have more exercise over the underlying economic activity through influencing those governments rather than through influencing Beijing. There's also a good argument that you shouldn't be because you need to be developing alternative supply chains that are completely separate from China's influence, where they could still influence the intermediate goods they're in. But the problem is if you punish countries for trans shipments just by raising tariffs, you'll probably just get more trans shipment if you're just not addressing sort of the fundamental economic imbalances. So, you know, I think the administration is, it's still unclear exactly what the tariff system is designed to accomplish, whether that's restricting the trade deficit, in which case you need sort of more macroeconomic adjustments, creating alternative supply chains and reducing Chinese value added, which is, you know, a, I think a more appropriate goal, or just raising revenue, which is just... I think the administration would tell you all of the above. Yeah, but that doesn't make any sense because those are at odds with one another. I mean, if you're raising too much revenue, it means you're not redirecting any trade. So, you know, economics revealed preferences are powerful things. You can tell what you actually are intending to do based on, you know, how your policies are set. So, USTR has this difficult decision to make because they're beholden to the sort of diplomatic de facto detente that's been set in, the truce that's been set in place over Busan. They said they won't raise tariffs above the pre-Supreme Court levels after the Supreme Court invalidated the IEPA tariffs, which would mean that you basically have to announce the excess capacity investigation and then only raise tariffs by 7.5% in order to be within that. You will have sectoral tariffs, right? 301s, 232s that will go higher. Exactly. But look... You see my point. It's a difficult, it's a difficult dance. Yeah. Yeah. I think Busan truce is all about rare earths, right? And the fact that China played this card, we were completely unprepared for it and it hurt a lot, right? Our factories were days away from shutting down in Detroit and the defense sector was in a lot of pain. So that was, I think, a wake-up call for the administration that we can't push this too hard until we find other sources. And, you know, to their credit, they're diversifying rapidly, investing in new production, new refining, processing capacity, recycling, all of the above. But it's going to take time for that to work itself out. But coming back to the European question, I mean, if Europe actually moves on restricting Chinese imports, you know, will China face a depression? I would argue, look, I think there would be significant impacts on several industries, especially those industries where they are most competitive with German manufacturers in particular. If you started to face significant trade restrictions that are more structural in nature, you're going to see a lot of deflationary pressures within those industries. There's already a lot of employment pressure in China, precisely because capital, you know, the industries that they're favoring are capital intensive, not labor intensive. So they don't generate a lot of jobs anyway. I mean, one of the stories I tell people is that when I talk to reporters coming back from Beijing and Shanghai these days, they basically say, like, we want to write stories about jobs because that's what everybody's talking about. Our editors just want us to write stories about tech. And, you know, finally, you just had the FT publish a really extensive review of the difficulties in employment prospects. And this is structural because, you know, in the early 2000s, you had one, one and a half million college graduates a year, about 10% of the incoming labor force was college educated. Now you have 12 million every year, and it's closer to 60 to 70% of the incoming labor force is college educated, but the economy hasn't adjusted to it. So when you use words like depression, I mean, first growth has already collapsed. Like if I, if I, everyone wants to know the, what's the cathartic sort of, you know, financial crisis moment, the Lehman Brothers moment, the Northern Rock moment where you have depositors lining up, you know, outside the bank and you have a clear liquidity crisis. That's unlikely to happen, right? They have tools. It did happen in China, but it happened in property developers. It was, you know, this is who collapsed. So the book leads off with an anecdote of exactly one of these events in the headquarters of Evergrande. What was a de facto bank run on Evergrande, but Evergrande wasn't a bank, but it was operating like a bank. It had borrowed $310 billion in total debt. It had borrowed the GDP of Finland, you know, at that time it was that large and it couldn't meet its obligations. And so when the property developers started collapsing, you had a collapse in the most largest firms in China's most important industry. The obvious question is sort of what comes next. And if I told you that there was a financial crisis in date X, like what would you expect to see five years after date X? You would see exactly what you're seeing in China's economy today, which is deflation, low growth, weak fiscal resources, employment pressures, low consumer confidence, policy tools that are impaired, a reliance upon the export market. This is, you know, it doesn't have to be called a quote unquote financial crisis, but it has all the same consequences of a financial crisis. Domestic demand is weak or negative right now. So if China cannot grow via exports, there is effectively no driver of growth. Is there anything they can do to increase domestic demand? The argument of the book is, I mean, the answer is yes. And it involves very complicated political decisions that the Soviet Union struggled with in the late 1960s. There's remarkable work by Yakov Fagan called Building a Ruin. He's a historian and did this from the Soviet archives and chronicled the history of the Kasygin reforms, the 1960s, and how Brezhnev came to this point where he basically could have continued to push forward with reforms, but would have jeopardized sort of the ideological foundation of the Soviet state and instead turned to the scientific technical revolution and cybernetics as sort of this alternative, you know, that could have sort of bridged the gap. And, you know, Fagan is very good on this and recognizes the parallels to where China is right now. Can you imagine anyone in China stopping Xi Jinping from going on television tomorrow and saying, you know, comrades, the fiscal and financial system we've had has worked well for the last 10 to 15 years. It's not going to work well for the next 10 to 15 years. And so in order to improve all of our lives and, you know, make this more sustainable, we're going to cut down a lot of these risky investments. We're going to tax the wealthy. We're going to, you know, confiscate, you know, some of their ill-gotten gains and by a corruption. This sounds like the DSA platform. I mean, it's like, so, so, or, you know, think about, I'm just, and then we're going to basically create a, a consumer focused economy with subsidies for having children and restructure the tax system accordingly. And this involves slower growth in the meantime, but this is better for all of you, right? So the reason I say that is because like the savings pools in China that you can access are high net worth individuals, state-owned enterprises, and private firms that are basically cut off from the financial system. You can get at those, but it takes tax policy to do it. Like it's basically just a taxation decision on what to do. And so, you know, the net result is you have slower growth. Well, you have slower growth, but everyone's happier. You have higher standards of living. You have higher consumption. It's just not an economy that's competing with the United States, right? And so the obvious answer is that China can relax strategic competition and that sounds overwhelmingly simplistic, but it is, these decisions will probably come to the forefront precisely because it's not really possible for China to continue competing if they're using more and more sticks rather than carrots to do this. Now, why doesn't Xi Jinping go and make this speech? Well, A, he doesn't believe it and the Chinese leadership doesn't believe it. They probably don't believe they're in the kind of dire straits that I think they are. And so there's an analytical- I think they're actually very optimistic. They think we're in the decline, they're on the rise. It's inevitable, right? Well, that's the ideological component. So if you believed the opposite, do you think you could get that message to the Chinese leadership? I ask this of Chinese political scientists all the time. Like, if I'm right and time is not curing all wounds, time is the wound, how are you, you know, how do you tell Xi Jinping that if the East is rising and the West is declining? Do you think he ever gets that message? And how would we see that? I ask this question, like, honestly, because I don't think it's really possible. But the real reason they maintain this, I think, is strategic. I mean, I think the whole point is if this is your strategy, that means you're pushing back against de-risking and developing alternative supply chains. You want more and more choke points and you want to dominate some of these industries and continue to use this leverage. So you have a propaganda campaign that's designed to break down our export controls. And therefore you say, we are close. We are close to the frontier. We're getting close to the frontier. There's no point in restricting us. And second, there's no point in investing because we're this much more dominant than all of these sectors. So that's part of this. That's part of the deliberate messaging. Second, you want to break down export controls and sanctions. So you say, look, look, it's better to trade with us, even if the U.S. cuts us off, because our market is still worth arguing over. It's still worth fighting for. You know, we're still going to grow over time. And this is sort of exactly why you would maintain the idea that, oh, we're still growing at 5 percent, when it's very obvious that you're not. And I mean, I ask this question of anyone. Have we ever seen an economy that's grown at 5 percent in real terms over three years with three years of deflation, like especially investment led economy? I mean, I'd be interested. I don't think there is one. I certainly can't think of. There aren't that many episodes of sustained deflation. I mean, period. Yeah. Logan, you don't have a crystal ball. No one does. But if this trajectory continues, if there's no significant changes in policy and certainly I think the ones that you are proposing are very unlikely to even get to Xi Jinping, much less get accepted by him. What do you think the Chinese economy looks like 10 years from now, say 2035? Yeah. I mean, I think by 2035, you have run out of road, but the constraints are really external. So, I mean, I think that, like I said, there's limits to how much export led growth can be sustained because you eventually undermine the capacity of your own export markets to sustain these purchases. And in 2035, that's when the demographics really start kicking in. I mean, they're already declining, but that's when the migration from the rural areas to the cities no longer allows you to be as productive, right? I would argue that future is already now. And no one has looked at China's demographics in great detail, you know, becomes, you know, thinks that this is a next decade problem. So China had a, you know, life expectancy is 79, but that assumes you're born today. The average age at which people die is 73 in China. And so there was a baby boom basically right after the end of the civil war and the establishment of the People's Republic in 49. That is going to lead to a wave of deaths over the next decade, which means by our math, even if you assume that births stay steady at where they were last year, which was an astonishingly low 7.92 million births, you're looking at a loss So you're looking at a loss of about three to 4% of the populations. It's pretty shocking in terms of where the headwinds are. The broader answer to where it is, it looks kind of similar to Japan's adjustment. And, you know, there's going to be many caveats there in, but that's where Chinese economists are going to look at the future of the Chinese economy. They're talking to Japanese economists. And I spend a lot of time in Japan for exactly that reason, because that's where many of these conversations are. You're likely to see more persistent deflation. You're likely to see more persistent external surpluses. You're likely to see downward pressure, depreciation pressure on the currency rather than appreciation pressure on the currency from repatriating assets, I would argue. And you'll see lower interest rates. That's kind of where the economy will end up looking like. The more interesting thing is kind of what that means, you know, how the politics of this adjust. I think there is a moment at which China does sort of recapitulate and think about some of these objectives, these industrial policy-focused objectives. And I would argue that the sooner that the West can accelerate that process, probably the better off for global welfare in terms of driving that reconsideration. If you can reveal to the Chinese that the strategy isn't going to work, it's not going to generate growth, it's not even going to generate more choke points because we're going to develop alternative supplies for many key sectors. And rare earths are probably the best, you know, most valuable one they have. You want to keep China engaged in negotiating. Yeah, but rare earths is not a good one because it's relatively easy to process and refine rare earths, certainly relatively easy to mine them. This is not rocket science. This technology has been known for many, many decades, right? So it's just that we let them have this monopoly and capture the market through dumping and industrial policy. We're now reversing that, right? There's lots of investments going on, including the U.S. government taking equity positions in mining companies, refining companies, processing companies, recycling companies, and European Union is engaging there as well. So this is a near-term problem that's going to get solved. And, you know, it's going to be painful for the next few years, but it's not a forever problem. I agree. I think I have a very different focus on it, which is that it can be solved tomorrow with the right negotiation strategy. In other words, the structure of the global economy is such that the G7 runs a trade deficit. China commodity exporters run a trade surplus. In that world, China will always have choke points of industrial capacity that they can deploy. The question is how salient they are and whether there are substitutes and how much alternative capacity is elsewhere. But if you're concerned about them using it, the answer is to negotiate with them over the, and this is exactly why I call for, you know, retaliation using demand-side controls, because those become more salient over time, whereas supply-side controls become less salient over time. And so I would argue you could solve this, you know, much more easily, but the development of alternative supplies, as you suggest, is a very powerful signal in that negotiation and becomes more significant over time, the better. The problem, Logan, is that there's no evidence that Xi Jinping actually deeply cares about economics or understands economics and all evidence to the contrary that he actually prioritizes national security for the first time in decades, right, since Deng Xiaoping. I get that. And then the question becomes if the focus is to keep China's external environment relatively stable, continued economic escalation is not, you know, is not consistent with that. I don't think there's a world in which, you know, China's overwhelming focus has been stabilizing the relationship with the United States and stopping U.S. escalation of controls over China, you know, throughout this administration. And so if economic security is national security in their minds, this goes to the heart of that at the same time. But I totally agree. I don't think that Xi Jinping comes to a calculation that says, well, if growth is going to drop below X, then I'm going to have X amount of problems and therefore I have to, you know, cave on this issue. It's more that if the rest of the world is pushing back against everything that we're trying to export, why are we trying to do this? And is this, is any of this worth it? That is sort of, I think, the trade-off that will eventually come into focus. And the dilemma that Xi faces, the dilemma that China faces is if you win, you lose. Because let's say you do manage to continue to increase your export market share for two or three more years. I mean, do you think countries just give up and say like, okay, it's fine. I guess we won't have resilient supply chains. I guess we will leave our militaries capable to foreign influence. I guess, you know, we will just accept declining manufacturing jobs. I mean, some might, but more likely there will be different political alignments that will capitalize upon those and will, you know, throw up barriers to trade from both the left and the right. But his hope is that he gets to the point of so much influence over economies that we won't be able to say no. But we're arguably, I mean, this is the point. I mean, fast forward that into the future. What does that look like compared to today? This is something that they are already negotiating over. They have a powerful choke point in rare earths. They have several other choke points that they could use. They're probably, you know, they have pharmaceutical APIs, they have some semiconductors, obviously EVs and some form of green energy, but, you know, imagine that being a hundred different choke points. I would say it already is. My point is we're not imagining what the escalation ladder can look like on the other side. If you say like, hypothetically, you can do all these things. We're going to raise the cost of you doing it and your need to consider that cost before you consider doing it. And after that happens, like which set of tools becomes more powerful over time becomes the critical question. That's kind of what I wanted to raise in the foreign affairs piece, which is that if China cannot generate demand for what it's producing, the controls over demand are far more salient. There's good arguments, I think, that, that frankly, this isn't the job of democratic governments, like that democratic governments shouldn't be waging economic warfare with consumer goods, you know, in this way, or that you have to be more concerned about consumer welfare and that therefore there's just not, you know, the same sort of priority attached to this in Western democracies as there is in China. But I would argue that the moment this becomes a security issue, these supply chains are not efficient and the supply chains need to be reconsidered. And so it's also about jobs, right? And the number one political issue is jobs and preserving economic growth, even if that means rising prices for consumers in lots of areas, maybe not gas prices, that's a very sensitive one, but in others we're able to tolerate a lot more. Logan, this debate will continue. The good news is that we will know, according to you, in a relatively short period of time, which path China takes. So hope you come back and thanks so much for coming on. Thanks so much, Dimitri, really appreciate it. And appreciate if everyone takes a look at the book. I would argue it is less a prediction and more of a diagnosis or an explanation of what's happened. But it's exactly where, what I think is underappreciated at this point. Well, the book is Broken China, How the Economic Miracle Shattered and What It Means for the World. Logan Wright, thank you. Thanks, Dimitri.