Why China Is Gaining the Upper Hand in Trump’s Trade War with Arthur Kroeber | Trumponomics
Summary
Market Outlook: The podcast discusses the shifting balance of power in the US-China trade war, emphasizing that China is gaining leverage over the US due to its control over rare earth exports.
Trade Dynamics: Recent US export controls have prompted China to impose restrictions on rare earth exports, highlighting the strategic importance of these materials in global supply chains, particularly for high-tech and defense industries.
Economic Strategy: China is leveraging its position in rare earths to counter US trade measures, demonstrating its ability to withstand economic pressure and maintain export growth despite high tariffs.
Investment Implications: The ongoing trade tensions create increased compliance burdens and uncertainty for multinationals operating in both the US and China, affecting strategic planning and investment decisions.
Geopolitical Risks: The concept of "weaponized interdependence" is explored, where both the US and China have developed economic tools that can significantly impact each other's supply chains, akin to a balance of power during the Cold War.
Long-term Considerations: Despite efforts to reduce dependencies, both countries face challenges in decoupling their economies, with China particularly vulnerable to shifts in global demand due to its export-driven growth model.
Negotiation Dynamics: The podcast highlights the complexity of US-China trade negotiations, with China seeking reductions in US export controls and the US aiming for a deal that can be politically leveraged by the Trump administration.
Transcript
[Music] Bloomberg Audio Studios, podcasts, radio, news. >> I think we're going to be fine with China, but uh we have to have a fair deal. It's got to be fair. I'm Stephanie Flanders, head of government and economics at Bloomberg, and this is Trumpanomics, the podcast that looks at the economic world of Donald Trump, how he's already shaped the global economy, and what on earth is going to happen next. Our focus this week is the big lesson from the latest rounds of the US China trade wars. The long-term balance of power between the two economies is shifting and it's shifting in favor of China. Things had gone relatively quiet for a few months, but in the past couple of weeks, the US China trade war got noisy again with a tit for tatat over expanding US export controls and China's then imposition of more sweeping restrictions on its exports of rare earth magnets. There's been the usual talk of escalation and deescalation from President Trump. As I record this on Friday 17th of October, he's just threatened 100% tariffs on Chinese goods, but in the same breath admitted that would be unsustainable. Right now, the president is still set to meet with his opposite number, President Xi Jinping of China, at the Asia-Pacific Economic Cooperations Summit in South Korea later this month, APEC. I bet that meeting will be on and off again many more times before you hear this and certainly before they sit down. But whatever happens around that table, we may already have seen a permanent shift in the power dynamic between them due to the simple fact that the Chinese have shown not only that they have leverage in this trade fight with the US, but they're prepared to use it. That's why I very much wanted to talk to this week's guest, Arthur Crober. Arthur co-founded the China focused research service Dragonomics in Beijing in 2002. It's now called Gavacal Dragonomics and he's the research director. He's also the author of China's economy, what everyone needs to know. I describe him as the China expert other China experts go to for a deeper take. Arthur, thanks so much for taking the time for us. My pleasure. [Music] There's as ever the noise and the signal and one reason you are so widely read on China is you're you're very good at telling the difference between the two but maybe we should spend a little bit of time on the noise of the past few weeks for those who lost track who started it >> you could go back to the beginning of time in the you know who who went first kind of thing I don't think that's super fruitful but I think the sequence of events that we've seen recently is number one about a month ago negotiators met in Madrid. Uh they had what seemed to be a pretty productive meeting. They seemed to come up with a set of ideas for resolving the ownership of Tik Tok which is a big issue and the Chinese side seemed to indicate that there was kind of a wider set of discussions on you know investment flows more generally and we seem to be heading towards a meeting between Trump and she at the APEC summit at the end of this month where they would move the ball forward. Seemed to be good. Then what happened is at the end of September on the 29th the Bureau of Industry and Security at the US Commerce Department issued a set of rules expanding its so-called entity list which is a list of foreign companies that if you want to sell stuff to them, you have to get an export license. It's kind of a blacklist or a gray list or a dark list. And this did two things. One is it said any company that is at least 50% owned by a named company on the entity list is automatically deemed to be on that list. So it captures a whole bunch of subsidiaries that previously could kind of fly under the radar. And you can understand why they would want to close that loophole. That seems fairly fairly sensible. But as a practical matter with China, it expands the number of companies on the list perhaps by as many as 10,000 according to some estimates. It's a lot of companies, right? Second thing it did is it said if you're a US company, you want to sell to someone, you have to verify, you have to do your own due diligence to verify that they are not at least a 50% subsidiary of some Chinese company, which means if you think about it, that requires an awful lot of forensic due diligence on ownership, which might need to go through several layers of ownership to get to the truth. Huge, huge compliance burden on the on the company. So this was a very consequential move and it appears from some things that I've heard that this move which has been discussed for some time within the commerce department. The Chinese brought this up at the Madrid talks and said we hope you're not planning to do this right away cuz that would create a lot of problems for the trade talks and we would have to retaliate. So it happened and so the Chinese said, "Okay, we're going to have to retaliate." And then they came up with something that they also had on the shelf which was very detailed regulations on export controls for rare earths, rare earth permanent magnets and some things in the battery supply chain. And again, if you look at those rules and imagine that they were enforced fully, they could give China the ability to really substantially restrict the production of all kinds of products around the world that depend even on very small trace amounts of rarest sourced from China. So we had these two different things. And so basically what has now happened is that I think both sides have recognized that they kind of went too far in their efforts to gain leverage over the other person and now they have to dial it back. And it it seems like the signaling that we're now getting from both sides is that they kind of want to somehow resolve this issue and tea up a meeting between she and Trump at the end of the month in in Korea that can allow for the trade talks to continue. So there was a lot of noise but and the signal in it is that both sides have pretty powerful tools that they can use against each other and what's new is that generally this has been oneway street the US has a lot of tools it counterparties don't have any China has a really powerful tool that can cause the US a lot of problems >> and I think that's one of the things certainly from talking to colleagues in China you don't get to see she maybe necessarily enough to uh talk about a spring in his step but there is definitely this sort of feeling of strength and confidence that's come because a lot of countries have effectively given in to Donald Trump's tariff demands and just decided it was easier to go along with a certain level of tariff and not necessarily tried to impose their own in in response. But China has shown that it can go toe-to-toe with the US and the US has effectively had to back down. So in a note that you put out you said in the past few weeks that had shown us that US and China had now weaponized their interdependence. So just talk us through what what that means. >> Yeah. Well, that's not a phrase that I concocted. That is a phrase that was coined by uh two very astute political scientists, Henry Farrell and Abe Newman, who wrote a book about this about five or six years ago, in which they were mainly talking about what the US was doing in its sanctions regime through financial sanctions and controls on technology to take advantage of the fact that other countries relied heavily on on certain kinds of inputs and networks controlled by the United States. the United States was weaponizing these in order to achieve certain political goals, right? Sanctions on Iran, we've seen sanctions on Russia, the, you know, the trade war and the technology restrictions against China, etc., etc. And yeah, I think this is a very important and valid concept and a good description of the way that the world has evolved over the last couple of decades. But what's now new and I think has really been reinforced step by step this year is that China is also able to play the weaponized interdependence game because they have this uh massive choke hold on the whole rare earth complex and these elements are very important for a whole bunch of high-tech industries for defense products notably and they also have significant controls within the battery uh supply chain. So, China is able is in principle able to make use of this to put pressure on people that it has political problems with. And we've seen this, you know, from time to time, but now it's very visible in terms of its relationship with the United States. And I think it's very powerful and this is something that people don't really talk about that much. There are a lot of commercial applications for rare earths. They're quite important, but the defense supply chain depends upon them quite a lot. And I think what is underneath the US sort of concern on this is that their defense production supply chain actually is quite vulnerable to restrictions on these elements by China. So they have to step pretty carefully. >> And we should say actually because you've reminded me I mean that that book Underground Empire we've actually talked about it in the past. I think it's was a really excellent guide. It has stood the test of time in terms of thinking about the economic dynamics of this time. I recommend it to people. But people do often say, "What's the big deal about rare earths or rare earth magnets?" You know, the value of the imports that to the US and other countries is very small. But as you're pulling out, I mean, it's this it's like it's the weakest link in some of these very important global supply chains, defense, consumer electronics, cars. >> Yeah, I think this is worth exploring because there are a couple things that people say. One is, you know, the values are very small. all these are very small proportional inputs into various things which is true and the other thing they say is you know famously rarers are not rare you can dig them up you know in lots of places around the world so what's the big deal and I've had people who spent a fair amount of time working on export controls as recently as a year ago who said oh well you know trying to export controls rarest is dumb because it's just a commodity and then all you do is you create incentives for mining and both of these arguments are flawed so the first one is flawed because as you say it's not that these are a huge part of the value of the finished product. It is that they are things that you need and if you don't have them you cannot make the rest of the product. So it might only be 1% or half or percent of the bill with materials but it's the one or half percent without which you can't make use of the other 99%. >> It's a bit like looking at the utilities value share of GDP but if you don't have electricity you can't do very much else. >> Exactly. Exactly. except maybe even more so than that. And then on the second point, the issue is that it's not the raw ores that are an issue here. It is the refined ores and products, notably permanent magnets that are made from them. And these both the refining and the products require pretty sophisticated technology processes which now basically only exist in China. The technologies for refining are in fact also export controlled by China. So if you set up a a mine elsewhere and you want to refine them, you have two choices. One is you can send the ores to China to get refined, which is a lot of what happens. Or you can try and get the Chinese to issue a license for the technology or you can try and you know recreate the technology on your own. It's non-trivial. And then when you look at the magnets that has an additional manufacturing process on top of that which is distinct from rare earth refining specifically also pretty technical also something where the Chinese have a huge cost advantage and so there are many layers here which means that it is these are things that are quite important they are quite important not only defense industries but to a lot of new green technologies that people want to develop and it is very there's a big technology component so the export controls have real bite And there's no quick way to extricate yourself from that vulnerability. >> The more we talk about this, it sounds like those debates one would have or the sort of theories of nuclear deterrence from the cold war days. It's very flawed the comparison between the cold war and the situation of US and China. But this does feel a bit like the sort of mutually assured destruction that people used to talk about in that time. Both sides have built up things that could blow up the other count's supply chains in one way or another or at least make things extremely difficult for them and their companies. It's obviously somewhat extreme example, but it is that sort of a sensible way of thinking about it. >> Yeah, I I think that's kind of the the flavor of it. I I wouldn't want to push it too far. I mean, the metaphor that I've used is I just borrowed a a phrase from Scott Bessant, who rather notoriously said in a speech a year ago talking about Trump's then prospective tariff strategy that, as you recall, the idea was to escalate to deescalate. And his phrase was the tariff gun will always be on the table cocked and loaded, but it will be rarely fired. And now there are two guns on the table, right? There's the US tariff and export control gun pointed at China and there's the China rare earth control gun that's pointed at the US. They're both on the table. They are both loaded. They could be used. But in fact, I think the Chinese point on this, and I actually take them seriously on this in their public statements, they say, "Yeah, we could do this, but not only is it not in your interest, it's not in our interest to do this because we're a globally integrated economy. We depend on being able to trade freely. We want to be able to sell this stuff to people who are going to use it for non-defense purposes. That is actually good for us, too. So, we don't really want to use this weapon, but we have to pull it out because this is the only way to prevent you from using this other weapon which is going to be really bad for us. And I think that should be taken very seriously. But it sounds like what economists might think of as a stable equilibrium, right? I mean that is supposed to be that was even what the mutually is destruction. We was you were sold it as a stable equilibrium because both sides were assured of yeah real harm if anything happened. >> Well, yeah. So economists call it stable equilibrium because they're economists and other people call it a balance of terror, right? Which is >> okay. But it's a balance. Sounds better than imbalance, >> right? No, no, no, no. It is a balance. And I think this is why the USChina trade negotiations have gone on for so long is the Chinese are very clear that they want to get something out of these negotiations. It's not going to be just a capitulation and they have the tools to force the US to stay at the table and do something that they might want. So I think if you look at this from a a broader standpoint, I think the net effect of this for now is probably beneficial because it is useful for the world to have some constraints on the ability of the US unilaterally just to impose whatever conditions it wants on everybody. You know, just as it's useful to have those constraints on China, they've done plenty of economic bullying of their own over the years when they can get away with it. So having some kind of of balance there I think is potentially helpful. The problem is we also have some fairly volatile leadership particularly on the US side and so you can imagine things going wrong and that was always the worry with the uh uh MAD during the cold war is yeah it was great but we were one step away from be really bad. [Music] going back a little bit to the sort of real world implications of the network of different export controls and potential guns that could be used at various times. I know you talked to a lot of multinationals and businesses active in China but also operating around the world. What's the implications for a multinational that's actually still got very much caught up in the US and China both as a market and as a manufacturing base? It seems like it may be useful to have a balance of terror, but in the meantime there's a hell of a lot of paperwork, right? >> I think the short answer is that at a minimum your compliance burden goes way up, right? Because you now have to satisfy regulators in the US, you have to satisfy regulators in China and various things. just the friction and the transaction costs of doing things a lot of crossber activities have gone up quite a lot. So that's your kind of most benign baseline scenario is that has occurred. And you know I think the other thing that people talk about a lot very hard to quantify is the uncertainty premium goes up. You're constantly kept guessing you know will these things be imposed? If so when? If so will I be you know victimized or are there ways to work around it? So that requires there's sort of an additional cost in terms of uh strategy planning, hedging planning for how you do this. I think at the moment that's where we are and frankly both Trump and she at the leadership level have in fact made it pretty clear repeatedly over the course of the last year that they want an agreement. They want a deal. They want to set up some kind of regime under which people can trade and invest. And the Chinese I think fortunately in this case have the leverage to make sure that deal is somewhat real rather than just a fake deal. So if we get there that will be I think somewhat helpful. But even if we do get a deal the reality is that the US and China really have this extremely adversarial relationship. You can create a deal that sort of creates a day taunt if you will to use another cold war metaphor. But if you're thinking about the long run 5 10 15 year timeline investments, you have to do a lot of hedging and you have to figure out ways that you can forstall or live through situations where there might be a huge escalation in the tensions between the US and China and many more decoupled. It makes the strategic planning process a lot more difficult more costly. But if you think of the goals that the government, the Chinese authorities are pursuing in many ways they are trying just as as they try and advertise and strengthen US dependence on certain things from China. China is obviously actively trying to reduce the degree of dependence it has on the US and that that seems to be going pretty well. I mean that's not we're not it's not far off. >> Yeah, it is. And so if you look at there's a bunch of work that you can do um looking at sort of the OECD databases on trade and value added that shows if you if you just break down US supply chain supply chains for physical goods within the US they are about two to three times more reliant on inputs from China as the other way around. And this is, you know, partly the result of differential industrial development, but partly the result of deliberate Chinese efforts to deamericanize specifically their supply chains. And they have made good progress there. Now, some areas it's really tough. So the semiconductor industry, good luck trying to deamemericanize because the US position on on at various nodes in that is extremely extremely strong and despite huge investments, Chinese have made, you know, some progress there, but not a ton, frankly. So again, it's very difficult to build an alternative rare earth supply chain, probably even more difficult to build a fully autonomous semiconductor supply chain. these interdependencies, both countries would like there to be less of them, but in fact, it is very difficult to untangle them, which is why I've always been skeptical of sort of like the easy decoupling story that, oh, the China and the US are decoupling. It's like yeah you can try and in individual sectors you can get reasonably far but on a macro basis untangling the interconnections that have been built up in the global economy over the last 45 years is extremely difficult and the other thing I would say is that as China has tried to decrease its dependency on the rest of the world from a supply side it has increased its dependency in the rest of the world on the demand side because it's now basically an export-driven of an economy. They depend very heavily on markets being open to them. And this dependency has increased substantially over the last 5 years is not decreased. And their own sort of supply side obsession at home creates a deflationary weak consumption environment which just intensifies this dependency on international markets. And I think this is something that's not sufficiently appreciated in the world is that yeah on a producer basis China is kind of self-sufficient but they have really exposed themselves to a lot of potential economic downside if export markets close up or if just there's a global recession and people can't buy as much and that is a real problem for them to which they have no very clear solution. >> I was going to ask you about that. I mean we have in fact we've calculated that our economists that China's manufactured goods trade surplus is the largest now relative to global GDP of any country since the US after World War II. And we've also shown how the amount of sort of trade diversion that's happened, just the sort of wave of exports going across Asian economies and to some extent to Europe that might otherwise have gone to the US due to these tariffs. And as you said, you know, that itself produces a vulnerability because we see countries potentially reacting to that wave of of imports. And you know, it's funny because it's kind of the weakness on the other side of the strength, right? You know, we we tend to say China politically has an ability to withstand pain that the US doesn't have, and that means it can sort of hold its ground against Donald Trump. But to your point, ignoring quite a lot of domestic economic pain. I mean, do you see I know you're not one of those people who is continually kind of announcing there's going to be a crisis or, you know, an end of China's growth story, but do you think they are underestimating the costs of this strategy? Yeah, that's a good question. It seems to me that the government over the last several years, they've adopted a very very sort of a techno fetishist supply side growth model. And basically they've said all of our problems, productivity, income growth, whatever, they will be solved by just investing massively in the technologies of the future which will create this productivity miracle which will then drive future incomes and growth. It's a little bit like the people who are now going around saying AI is going to solve all known economic problems because of these productivity magic. The Chinese view is that this is a the result of sort of physical technologies at least as much if not more so than AI but it's similar kind of thinking. >> They haven't been doing too badly on these technologies. >> Oh no, you know and but >> we've got we've think they've global leadership position in five of the 13 key technologies and they're catching up in all the others. >> No, for sure. So they've done very well on the production side and meanwhile nominal growth in China is less than half of what it was 5 years ago. Right? So they used to very reliably be able to count on nominal growth of 8 n%. Very consistently it's now down to four. And these things are linked because they basically say the supply side will solve all problems. We don't need to have a demand side strategy. We don't need to support consumers if they're hammered by a pandemic. We can impose a gigantic compression of their balance sheets by crushing the properties five years in a row and that's fine because capital will move to the correct places and that's a very very one-sided and incomplete view of the economy. So they are paying a price for this that is material and I guess the question is are they unaware of that price? Are they do they say, "Well, we know that's the price, but it's fine." Or do they think, "Actually, you, Mr. Krober, you're wrong about the price. Actually, this is a short-term thing." That's a harder thing to read, and I think you can make multiple different interpretations. But what I would say is they don't look like they are changing their minds anytime soon. They may be right, they may be wrong, but they're staying the course. >> And everything we've said, I'm pretty sure, is going to stand the test of time because we're talking fairly long term. But obviously it is dangerous these days to have a conversation which you then don't publish for a few days. They're talking about trying trade issues and as I've said at the start it's likely that the meeting with she is going to be on and off and on and off several times before before we get there. But I guess one way of thinking about this or that people could have in the back of their minds when if and when that meeting happens and then they assess the results of that meeting which may be Donald Trump announcing some great deal or maybe not. Is it at the heart of what you were just saying? You know, short term it actually does matter. Even though they're pretending it doesn't matter and they can put up with the pain, China's facing a pretty high tariff, sort of 40%ish, it does actually matter to them that they bring this down. And it seems to matter to them a bit more than it matters to Donald Trump. Well, this is an interesting question. So if I look at the Chinese side on this, yeah, I think they would like lower tariffs, but actually I don't think that is the top of their list, frankly, because the reality is they are enduring very high tariffs right now relative to the past and relative to anyone else in the world and their exports are doing fine, right? And some of that is frontloading, but I think most of it is not. Some of it is trans shipment. They're routing things through third countries that wind up in the US. But most of it seems to be that they've actually been very successful at developing other export markets. Southeast Asia, Europe, Latin America, you name it. And yeah, there's some protectionist concerns there. But in most cases, in most product lines, there really aren't great alternatives at a comparable cost to what you're buying from China. And most countries don't have the same kind of security concerns that the US has. So they're doing fine. So I think they've concluded, yeah, we would like lower tariffs, but if we have to live with the current tariff level, we've shown that we can, which also means that they can walk away. If they think if all we're getting is a few points off tariffs, that's not enough. We need more in a deal. And if that's all you're going to give us, sorry, then there's no no deal. We'll just do our thing and we'll see how you like it because we think that we can bear more pain. So I think what they really want is they would really like to see some scaling back of the US export controls uh on technology. That is a number one on their list. And I think that will be very interesting to see whether they can dislodge the US on that point because historically the US position has been export controls are sacrianked. Once we put them on they are tablets from Sinai. They are the word of God. They cannot be altered in any way. So that's you know that's a that's a big ask. My view would be I think the US has overdone it on export controls and it would be very possible to go through and do some culling and say here are things that are important that we really need and here's some stuff actually that was overreach and we could pull back but there's a people don't want to go there because of the principle. I think the other thing that Chinese would like is as we saw with the Tik Tok deal some kind of a pathway that would make it easier for Chinese tech companies to invest in the United States because they see this is coming. They see it's important for their companies to internationalize. As you grow, you can't do everything through exports. You have to get closer to your customers, build up distribution networks, build up branding, etc. Every country in the world once it gets to a certain point, it's companies start to multinationalize. China is the same. The US is the world's biggest single market. They like to see a pathway there. And I think they also think that this would be a stabilizer in the relationship. But obviously there are a lot of political problems with that. On the US side, people are very nervous about that. So I think those are the asks. On the US side, I find it very hard to understand what it is that the US is negotiating for. I'm perplexed. It is very clear that Trump wants something that he can call a deal. Okay. And because he wants a deal and the Chinese feel that they can walk away if they don't get a satisfactory deal, that gives them a slight edge in negotiations. And it'll be interesting to see if we get something out of this, what the US obtains other than additional agricultural purchases, a restart of Boeing sales, etc. Is the US after any kind of bigger game here? It's not at all clear that they are. Uh, and it's it's quite hard to understand what the purpose of the negotiations is. The purpose of the other US trade negotiations was basically to demonstrate to other countries how powerful the US is and how we can like push you around. That that was essentially the purpose of the negotiations. >> China has said we're strong enough to not play that game. So >> that ship has sailed. >> What what's your plan B? And it's maybe some things are being talked about there that we don't know about, but it's it's a little obscure. you've reminded me I mean of course there's the grand story of why things are happening and then often with this administration especially there's the sort of slightly lower story and you talked about the export controls being a really kind of thorny aspect of this that's causing quite a lot of problems. The commerce secretary is obviously the one it's his office the commerce department that's responsible for the export controls and it's obviously the treasury secretary that's been in leading a lot of these negotiations on the core trade issues. There is a theory that just says that Howard L I think wants to make things as hard as possible for Scott Besson. >> I've heard that theory, you know, all of these stories are slightly unverifiable. What I think you can say with high confidence is that the Bureau of Industry and Security within commerce which supervises the export controls has pretty hawkish leadership and they basically feel that it is the right thing for the US to tighten the screws on export controls. And I think they have a reasonable point in the sense that if you have an export control regime and you think it is valuable, you don't want it on the table. >> Yeah. You should not have a lot of loopholes that undermine what you're trying to do. And that, you know, I think that was clearly their view on these latest regulations. But >> for them to issue these regulations essentially goes against the policy that Trump had laid down as as early as May, saying, "Okay, let's not have any more export controls until our trade negotiations are through." So they violated what everyone understood to be the president's wishes there. And I guess what you could say is that Lutnik, given his well advertised problems with Bessant, he didn't really have much of an incentive to stop them from going rogue if that's what they chose to do. I think that's we can say that. >> Arthur Craver, thank you so much for doing this. >> My pleasure. >> Thanks for listening to Trumpomics from Bloomberg. was hosted by me, Stephanie Flanders, and I was joined by the founder and director of research at Gaval Dragonomics, Arthur Crob. Trumponomics was produced by Summer Sadi and Moses Andam, with help from Amy Keane. And special thanks this week to Rachel Lewis Kriski. Sound design is by Blake Maples and Kelly Garry, and Sage Bowman is Bloomberg's head of podcasts. And please to help others find us, rate and review it highly wherever you listen to podcasts. [Music]
Why China Is Gaining the Upper Hand in Trump’s Trade War with Arthur Kroeber | Trumponomics
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[Music] Bloomberg Audio Studios, podcasts, radio, news. >> I think we're going to be fine with China, but uh we have to have a fair deal. It's got to be fair. I'm Stephanie Flanders, head of government and economics at Bloomberg, and this is Trumpanomics, the podcast that looks at the economic world of Donald Trump, how he's already shaped the global economy, and what on earth is going to happen next. Our focus this week is the big lesson from the latest rounds of the US China trade wars. The long-term balance of power between the two economies is shifting and it's shifting in favor of China. Things had gone relatively quiet for a few months, but in the past couple of weeks, the US China trade war got noisy again with a tit for tatat over expanding US export controls and China's then imposition of more sweeping restrictions on its exports of rare earth magnets. There's been the usual talk of escalation and deescalation from President Trump. As I record this on Friday 17th of October, he's just threatened 100% tariffs on Chinese goods, but in the same breath admitted that would be unsustainable. Right now, the president is still set to meet with his opposite number, President Xi Jinping of China, at the Asia-Pacific Economic Cooperations Summit in South Korea later this month, APEC. I bet that meeting will be on and off again many more times before you hear this and certainly before they sit down. But whatever happens around that table, we may already have seen a permanent shift in the power dynamic between them due to the simple fact that the Chinese have shown not only that they have leverage in this trade fight with the US, but they're prepared to use it. That's why I very much wanted to talk to this week's guest, Arthur Crober. Arthur co-founded the China focused research service Dragonomics in Beijing in 2002. It's now called Gavacal Dragonomics and he's the research director. He's also the author of China's economy, what everyone needs to know. I describe him as the China expert other China experts go to for a deeper take. Arthur, thanks so much for taking the time for us. My pleasure. [Music] There's as ever the noise and the signal and one reason you are so widely read on China is you're you're very good at telling the difference between the two but maybe we should spend a little bit of time on the noise of the past few weeks for those who lost track who started it >> you could go back to the beginning of time in the you know who who went first kind of thing I don't think that's super fruitful but I think the sequence of events that we've seen recently is number one about a month ago negotiators met in Madrid. Uh they had what seemed to be a pretty productive meeting. They seemed to come up with a set of ideas for resolving the ownership of Tik Tok which is a big issue and the Chinese side seemed to indicate that there was kind of a wider set of discussions on you know investment flows more generally and we seem to be heading towards a meeting between Trump and she at the APEC summit at the end of this month where they would move the ball forward. Seemed to be good. Then what happened is at the end of September on the 29th the Bureau of Industry and Security at the US Commerce Department issued a set of rules expanding its so-called entity list which is a list of foreign companies that if you want to sell stuff to them, you have to get an export license. It's kind of a blacklist or a gray list or a dark list. And this did two things. One is it said any company that is at least 50% owned by a named company on the entity list is automatically deemed to be on that list. So it captures a whole bunch of subsidiaries that previously could kind of fly under the radar. And you can understand why they would want to close that loophole. That seems fairly fairly sensible. But as a practical matter with China, it expands the number of companies on the list perhaps by as many as 10,000 according to some estimates. It's a lot of companies, right? Second thing it did is it said if you're a US company, you want to sell to someone, you have to verify, you have to do your own due diligence to verify that they are not at least a 50% subsidiary of some Chinese company, which means if you think about it, that requires an awful lot of forensic due diligence on ownership, which might need to go through several layers of ownership to get to the truth. Huge, huge compliance burden on the on the company. So this was a very consequential move and it appears from some things that I've heard that this move which has been discussed for some time within the commerce department. The Chinese brought this up at the Madrid talks and said we hope you're not planning to do this right away cuz that would create a lot of problems for the trade talks and we would have to retaliate. So it happened and so the Chinese said, "Okay, we're going to have to retaliate." And then they came up with something that they also had on the shelf which was very detailed regulations on export controls for rare earths, rare earth permanent magnets and some things in the battery supply chain. And again, if you look at those rules and imagine that they were enforced fully, they could give China the ability to really substantially restrict the production of all kinds of products around the world that depend even on very small trace amounts of rarest sourced from China. So we had these two different things. And so basically what has now happened is that I think both sides have recognized that they kind of went too far in their efforts to gain leverage over the other person and now they have to dial it back. And it it seems like the signaling that we're now getting from both sides is that they kind of want to somehow resolve this issue and tea up a meeting between she and Trump at the end of the month in in Korea that can allow for the trade talks to continue. So there was a lot of noise but and the signal in it is that both sides have pretty powerful tools that they can use against each other and what's new is that generally this has been oneway street the US has a lot of tools it counterparties don't have any China has a really powerful tool that can cause the US a lot of problems >> and I think that's one of the things certainly from talking to colleagues in China you don't get to see she maybe necessarily enough to uh talk about a spring in his step but there is definitely this sort of feeling of strength and confidence that's come because a lot of countries have effectively given in to Donald Trump's tariff demands and just decided it was easier to go along with a certain level of tariff and not necessarily tried to impose their own in in response. But China has shown that it can go toe-to-toe with the US and the US has effectively had to back down. So in a note that you put out you said in the past few weeks that had shown us that US and China had now weaponized their interdependence. So just talk us through what what that means. >> Yeah. Well, that's not a phrase that I concocted. That is a phrase that was coined by uh two very astute political scientists, Henry Farrell and Abe Newman, who wrote a book about this about five or six years ago, in which they were mainly talking about what the US was doing in its sanctions regime through financial sanctions and controls on technology to take advantage of the fact that other countries relied heavily on on certain kinds of inputs and networks controlled by the United States. the United States was weaponizing these in order to achieve certain political goals, right? Sanctions on Iran, we've seen sanctions on Russia, the, you know, the trade war and the technology restrictions against China, etc., etc. And yeah, I think this is a very important and valid concept and a good description of the way that the world has evolved over the last couple of decades. But what's now new and I think has really been reinforced step by step this year is that China is also able to play the weaponized interdependence game because they have this uh massive choke hold on the whole rare earth complex and these elements are very important for a whole bunch of high-tech industries for defense products notably and they also have significant controls within the battery uh supply chain. So, China is able is in principle able to make use of this to put pressure on people that it has political problems with. And we've seen this, you know, from time to time, but now it's very visible in terms of its relationship with the United States. And I think it's very powerful and this is something that people don't really talk about that much. There are a lot of commercial applications for rare earths. They're quite important, but the defense supply chain depends upon them quite a lot. And I think what is underneath the US sort of concern on this is that their defense production supply chain actually is quite vulnerable to restrictions on these elements by China. So they have to step pretty carefully. >> And we should say actually because you've reminded me I mean that that book Underground Empire we've actually talked about it in the past. I think it's was a really excellent guide. It has stood the test of time in terms of thinking about the economic dynamics of this time. I recommend it to people. But people do often say, "What's the big deal about rare earths or rare earth magnets?" You know, the value of the imports that to the US and other countries is very small. But as you're pulling out, I mean, it's this it's like it's the weakest link in some of these very important global supply chains, defense, consumer electronics, cars. >> Yeah, I think this is worth exploring because there are a couple things that people say. One is, you know, the values are very small. all these are very small proportional inputs into various things which is true and the other thing they say is you know famously rarers are not rare you can dig them up you know in lots of places around the world so what's the big deal and I've had people who spent a fair amount of time working on export controls as recently as a year ago who said oh well you know trying to export controls rarest is dumb because it's just a commodity and then all you do is you create incentives for mining and both of these arguments are flawed so the first one is flawed because as you say it's not that these are a huge part of the value of the finished product. It is that they are things that you need and if you don't have them you cannot make the rest of the product. So it might only be 1% or half or percent of the bill with materials but it's the one or half percent without which you can't make use of the other 99%. >> It's a bit like looking at the utilities value share of GDP but if you don't have electricity you can't do very much else. >> Exactly. Exactly. except maybe even more so than that. And then on the second point, the issue is that it's not the raw ores that are an issue here. It is the refined ores and products, notably permanent magnets that are made from them. And these both the refining and the products require pretty sophisticated technology processes which now basically only exist in China. The technologies for refining are in fact also export controlled by China. So if you set up a a mine elsewhere and you want to refine them, you have two choices. One is you can send the ores to China to get refined, which is a lot of what happens. Or you can try and get the Chinese to issue a license for the technology or you can try and you know recreate the technology on your own. It's non-trivial. And then when you look at the magnets that has an additional manufacturing process on top of that which is distinct from rare earth refining specifically also pretty technical also something where the Chinese have a huge cost advantage and so there are many layers here which means that it is these are things that are quite important they are quite important not only defense industries but to a lot of new green technologies that people want to develop and it is very there's a big technology component so the export controls have real bite And there's no quick way to extricate yourself from that vulnerability. >> The more we talk about this, it sounds like those debates one would have or the sort of theories of nuclear deterrence from the cold war days. It's very flawed the comparison between the cold war and the situation of US and China. But this does feel a bit like the sort of mutually assured destruction that people used to talk about in that time. Both sides have built up things that could blow up the other count's supply chains in one way or another or at least make things extremely difficult for them and their companies. It's obviously somewhat extreme example, but it is that sort of a sensible way of thinking about it. >> Yeah, I I think that's kind of the the flavor of it. I I wouldn't want to push it too far. I mean, the metaphor that I've used is I just borrowed a a phrase from Scott Bessant, who rather notoriously said in a speech a year ago talking about Trump's then prospective tariff strategy that, as you recall, the idea was to escalate to deescalate. And his phrase was the tariff gun will always be on the table cocked and loaded, but it will be rarely fired. And now there are two guns on the table, right? There's the US tariff and export control gun pointed at China and there's the China rare earth control gun that's pointed at the US. They're both on the table. They are both loaded. They could be used. But in fact, I think the Chinese point on this, and I actually take them seriously on this in their public statements, they say, "Yeah, we could do this, but not only is it not in your interest, it's not in our interest to do this because we're a globally integrated economy. We depend on being able to trade freely. We want to be able to sell this stuff to people who are going to use it for non-defense purposes. That is actually good for us, too. So, we don't really want to use this weapon, but we have to pull it out because this is the only way to prevent you from using this other weapon which is going to be really bad for us. And I think that should be taken very seriously. But it sounds like what economists might think of as a stable equilibrium, right? I mean that is supposed to be that was even what the mutually is destruction. We was you were sold it as a stable equilibrium because both sides were assured of yeah real harm if anything happened. >> Well, yeah. So economists call it stable equilibrium because they're economists and other people call it a balance of terror, right? Which is >> okay. But it's a balance. Sounds better than imbalance, >> right? No, no, no, no. It is a balance. And I think this is why the USChina trade negotiations have gone on for so long is the Chinese are very clear that they want to get something out of these negotiations. It's not going to be just a capitulation and they have the tools to force the US to stay at the table and do something that they might want. So I think if you look at this from a a broader standpoint, I think the net effect of this for now is probably beneficial because it is useful for the world to have some constraints on the ability of the US unilaterally just to impose whatever conditions it wants on everybody. You know, just as it's useful to have those constraints on China, they've done plenty of economic bullying of their own over the years when they can get away with it. So having some kind of of balance there I think is potentially helpful. The problem is we also have some fairly volatile leadership particularly on the US side and so you can imagine things going wrong and that was always the worry with the uh uh MAD during the cold war is yeah it was great but we were one step away from be really bad. [Music] going back a little bit to the sort of real world implications of the network of different export controls and potential guns that could be used at various times. I know you talked to a lot of multinationals and businesses active in China but also operating around the world. What's the implications for a multinational that's actually still got very much caught up in the US and China both as a market and as a manufacturing base? It seems like it may be useful to have a balance of terror, but in the meantime there's a hell of a lot of paperwork, right? >> I think the short answer is that at a minimum your compliance burden goes way up, right? Because you now have to satisfy regulators in the US, you have to satisfy regulators in China and various things. just the friction and the transaction costs of doing things a lot of crossber activities have gone up quite a lot. So that's your kind of most benign baseline scenario is that has occurred. And you know I think the other thing that people talk about a lot very hard to quantify is the uncertainty premium goes up. You're constantly kept guessing you know will these things be imposed? If so when? If so will I be you know victimized or are there ways to work around it? So that requires there's sort of an additional cost in terms of uh strategy planning, hedging planning for how you do this. I think at the moment that's where we are and frankly both Trump and she at the leadership level have in fact made it pretty clear repeatedly over the course of the last year that they want an agreement. They want a deal. They want to set up some kind of regime under which people can trade and invest. And the Chinese I think fortunately in this case have the leverage to make sure that deal is somewhat real rather than just a fake deal. So if we get there that will be I think somewhat helpful. But even if we do get a deal the reality is that the US and China really have this extremely adversarial relationship. You can create a deal that sort of creates a day taunt if you will to use another cold war metaphor. But if you're thinking about the long run 5 10 15 year timeline investments, you have to do a lot of hedging and you have to figure out ways that you can forstall or live through situations where there might be a huge escalation in the tensions between the US and China and many more decoupled. It makes the strategic planning process a lot more difficult more costly. But if you think of the goals that the government, the Chinese authorities are pursuing in many ways they are trying just as as they try and advertise and strengthen US dependence on certain things from China. China is obviously actively trying to reduce the degree of dependence it has on the US and that that seems to be going pretty well. I mean that's not we're not it's not far off. >> Yeah, it is. And so if you look at there's a bunch of work that you can do um looking at sort of the OECD databases on trade and value added that shows if you if you just break down US supply chain supply chains for physical goods within the US they are about two to three times more reliant on inputs from China as the other way around. And this is, you know, partly the result of differential industrial development, but partly the result of deliberate Chinese efforts to deamericanize specifically their supply chains. And they have made good progress there. Now, some areas it's really tough. So the semiconductor industry, good luck trying to deamemericanize because the US position on on at various nodes in that is extremely extremely strong and despite huge investments, Chinese have made, you know, some progress there, but not a ton, frankly. So again, it's very difficult to build an alternative rare earth supply chain, probably even more difficult to build a fully autonomous semiconductor supply chain. these interdependencies, both countries would like there to be less of them, but in fact, it is very difficult to untangle them, which is why I've always been skeptical of sort of like the easy decoupling story that, oh, the China and the US are decoupling. It's like yeah you can try and in individual sectors you can get reasonably far but on a macro basis untangling the interconnections that have been built up in the global economy over the last 45 years is extremely difficult and the other thing I would say is that as China has tried to decrease its dependency on the rest of the world from a supply side it has increased its dependency in the rest of the world on the demand side because it's now basically an export-driven of an economy. They depend very heavily on markets being open to them. And this dependency has increased substantially over the last 5 years is not decreased. And their own sort of supply side obsession at home creates a deflationary weak consumption environment which just intensifies this dependency on international markets. And I think this is something that's not sufficiently appreciated in the world is that yeah on a producer basis China is kind of self-sufficient but they have really exposed themselves to a lot of potential economic downside if export markets close up or if just there's a global recession and people can't buy as much and that is a real problem for them to which they have no very clear solution. >> I was going to ask you about that. I mean we have in fact we've calculated that our economists that China's manufactured goods trade surplus is the largest now relative to global GDP of any country since the US after World War II. And we've also shown how the amount of sort of trade diversion that's happened, just the sort of wave of exports going across Asian economies and to some extent to Europe that might otherwise have gone to the US due to these tariffs. And as you said, you know, that itself produces a vulnerability because we see countries potentially reacting to that wave of of imports. And you know, it's funny because it's kind of the weakness on the other side of the strength, right? You know, we we tend to say China politically has an ability to withstand pain that the US doesn't have, and that means it can sort of hold its ground against Donald Trump. But to your point, ignoring quite a lot of domestic economic pain. I mean, do you see I know you're not one of those people who is continually kind of announcing there's going to be a crisis or, you know, an end of China's growth story, but do you think they are underestimating the costs of this strategy? Yeah, that's a good question. It seems to me that the government over the last several years, they've adopted a very very sort of a techno fetishist supply side growth model. And basically they've said all of our problems, productivity, income growth, whatever, they will be solved by just investing massively in the technologies of the future which will create this productivity miracle which will then drive future incomes and growth. It's a little bit like the people who are now going around saying AI is going to solve all known economic problems because of these productivity magic. The Chinese view is that this is a the result of sort of physical technologies at least as much if not more so than AI but it's similar kind of thinking. >> They haven't been doing too badly on these technologies. >> Oh no, you know and but >> we've got we've think they've global leadership position in five of the 13 key technologies and they're catching up in all the others. >> No, for sure. So they've done very well on the production side and meanwhile nominal growth in China is less than half of what it was 5 years ago. Right? So they used to very reliably be able to count on nominal growth of 8 n%. Very consistently it's now down to four. And these things are linked because they basically say the supply side will solve all problems. We don't need to have a demand side strategy. We don't need to support consumers if they're hammered by a pandemic. We can impose a gigantic compression of their balance sheets by crushing the properties five years in a row and that's fine because capital will move to the correct places and that's a very very one-sided and incomplete view of the economy. So they are paying a price for this that is material and I guess the question is are they unaware of that price? Are they do they say, "Well, we know that's the price, but it's fine." Or do they think, "Actually, you, Mr. Krober, you're wrong about the price. Actually, this is a short-term thing." That's a harder thing to read, and I think you can make multiple different interpretations. But what I would say is they don't look like they are changing their minds anytime soon. They may be right, they may be wrong, but they're staying the course. >> And everything we've said, I'm pretty sure, is going to stand the test of time because we're talking fairly long term. But obviously it is dangerous these days to have a conversation which you then don't publish for a few days. They're talking about trying trade issues and as I've said at the start it's likely that the meeting with she is going to be on and off and on and off several times before before we get there. But I guess one way of thinking about this or that people could have in the back of their minds when if and when that meeting happens and then they assess the results of that meeting which may be Donald Trump announcing some great deal or maybe not. Is it at the heart of what you were just saying? You know, short term it actually does matter. Even though they're pretending it doesn't matter and they can put up with the pain, China's facing a pretty high tariff, sort of 40%ish, it does actually matter to them that they bring this down. And it seems to matter to them a bit more than it matters to Donald Trump. Well, this is an interesting question. So if I look at the Chinese side on this, yeah, I think they would like lower tariffs, but actually I don't think that is the top of their list, frankly, because the reality is they are enduring very high tariffs right now relative to the past and relative to anyone else in the world and their exports are doing fine, right? And some of that is frontloading, but I think most of it is not. Some of it is trans shipment. They're routing things through third countries that wind up in the US. But most of it seems to be that they've actually been very successful at developing other export markets. Southeast Asia, Europe, Latin America, you name it. And yeah, there's some protectionist concerns there. But in most cases, in most product lines, there really aren't great alternatives at a comparable cost to what you're buying from China. And most countries don't have the same kind of security concerns that the US has. So they're doing fine. So I think they've concluded, yeah, we would like lower tariffs, but if we have to live with the current tariff level, we've shown that we can, which also means that they can walk away. If they think if all we're getting is a few points off tariffs, that's not enough. We need more in a deal. And if that's all you're going to give us, sorry, then there's no no deal. We'll just do our thing and we'll see how you like it because we think that we can bear more pain. So I think what they really want is they would really like to see some scaling back of the US export controls uh on technology. That is a number one on their list. And I think that will be very interesting to see whether they can dislodge the US on that point because historically the US position has been export controls are sacrianked. Once we put them on they are tablets from Sinai. They are the word of God. They cannot be altered in any way. So that's you know that's a that's a big ask. My view would be I think the US has overdone it on export controls and it would be very possible to go through and do some culling and say here are things that are important that we really need and here's some stuff actually that was overreach and we could pull back but there's a people don't want to go there because of the principle. I think the other thing that Chinese would like is as we saw with the Tik Tok deal some kind of a pathway that would make it easier for Chinese tech companies to invest in the United States because they see this is coming. They see it's important for their companies to internationalize. As you grow, you can't do everything through exports. You have to get closer to your customers, build up distribution networks, build up branding, etc. Every country in the world once it gets to a certain point, it's companies start to multinationalize. China is the same. The US is the world's biggest single market. They like to see a pathway there. And I think they also think that this would be a stabilizer in the relationship. But obviously there are a lot of political problems with that. On the US side, people are very nervous about that. So I think those are the asks. On the US side, I find it very hard to understand what it is that the US is negotiating for. I'm perplexed. It is very clear that Trump wants something that he can call a deal. Okay. And because he wants a deal and the Chinese feel that they can walk away if they don't get a satisfactory deal, that gives them a slight edge in negotiations. And it'll be interesting to see if we get something out of this, what the US obtains other than additional agricultural purchases, a restart of Boeing sales, etc. Is the US after any kind of bigger game here? It's not at all clear that they are. Uh, and it's it's quite hard to understand what the purpose of the negotiations is. The purpose of the other US trade negotiations was basically to demonstrate to other countries how powerful the US is and how we can like push you around. That that was essentially the purpose of the negotiations. >> China has said we're strong enough to not play that game. So >> that ship has sailed. >> What what's your plan B? And it's maybe some things are being talked about there that we don't know about, but it's it's a little obscure. you've reminded me I mean of course there's the grand story of why things are happening and then often with this administration especially there's the sort of slightly lower story and you talked about the export controls being a really kind of thorny aspect of this that's causing quite a lot of problems. The commerce secretary is obviously the one it's his office the commerce department that's responsible for the export controls and it's obviously the treasury secretary that's been in leading a lot of these negotiations on the core trade issues. There is a theory that just says that Howard L I think wants to make things as hard as possible for Scott Besson. >> I've heard that theory, you know, all of these stories are slightly unverifiable. What I think you can say with high confidence is that the Bureau of Industry and Security within commerce which supervises the export controls has pretty hawkish leadership and they basically feel that it is the right thing for the US to tighten the screws on export controls. And I think they have a reasonable point in the sense that if you have an export control regime and you think it is valuable, you don't want it on the table. >> Yeah. You should not have a lot of loopholes that undermine what you're trying to do. And that, you know, I think that was clearly their view on these latest regulations. But >> for them to issue these regulations essentially goes against the policy that Trump had laid down as as early as May, saying, "Okay, let's not have any more export controls until our trade negotiations are through." So they violated what everyone understood to be the president's wishes there. And I guess what you could say is that Lutnik, given his well advertised problems with Bessant, he didn't really have much of an incentive to stop them from going rogue if that's what they chose to do. I think that's we can say that. >> Arthur Craver, thank you so much for doing this. >> My pleasure. >> Thanks for listening to Trumpomics from Bloomberg. was hosted by me, Stephanie Flanders, and I was joined by the founder and director of research at Gaval Dragonomics, Arthur Crob. Trumponomics was produced by Summer Sadi and Moses Andam, with help from Amy Keane. And special thanks this week to Rachel Lewis Kriski. Sound design is by Blake Maples and Kelly Garry, and Sage Bowman is Bloomberg's head of podcasts. And please to help others find us, rate and review it highly wherever you listen to podcasts. [Music]