I'm joined today by Barry Nton,

professor and so Kuwan Lock, chair of

Chinese International Affairs, School of

Global Policy and Strategy at UC San

Diego. Professor, welcome to Monetary

Matters.

>> Thank you. It's great to be here. How

are you currently assessing the Chinese

economy? You've been observing it very

poignantly for for many years. As we

begin the new year, what are your

thoughts? I think the Chinese economy

today is grappling some with some of the

most difficult and most entrenched

problems of really any period in which

I've been observing it. You know, we see

this tremendous contrast where on the

one hand because China has put so much

in terms of resources and human skills

into technology and industrial

upgrading, we see some very very

impressive achievements. that I think

that I'm sure we'll talk about on on

this show, but I think most people are

already aware of them. But behind that,

because of the attention that policy

makers have been putting on

technological rivalry and artificial

intelligence and moving to the frontier

in a whole series of areas, they've

really neglected other fundamental areas

of the economy. And so you've had a

longunning housing bust that has not

been resolved. You've got a fiscal

crisis. You've got a debt crisis. And

there are really reasons to worry about

the long run impact of these negative

factors.

>> So the positives are the technological

breakthroughs. The negatives is the

housing bust. Any other potential

negatives you're focusing on?

>> I think the biggest negative is it's a

little bit abstract. It's not something

we can quantify, but it's the retreat

from robust market mechanism and the

lack of political will to tackle some of

the economic problems that are building

up. Now, that doesn't mean I'm

predicting some kind of, you know,

imminent meltdown or collapse or

anything like that, but I think we're

starting to see a China where problems

are incrementally building up that will

drag on growth and drag on productive

economic interchange with the rest of

the world. Even when China looks strong,

some of these weaknesses are building

up. So the lack of market mechanisms is

very abstract.

What are the pitfalls of that? Where are

you seeing that?

>> I think there's two sides of it that

that we really need to emphasize. One is

that increased government intervention

in industry and technology policy which

has some some benefits for sure but also

is increasingly distorting the market

environment in which Chinese companies

and entrepreneurs are operating.

The second is the implications

of the high levels of debt that the

Chinese economy has. that now this debt

is something people have been worrying

about Chinese debt for certainly more

than a decade right and so in a way it

feels oh it's yesterday's news didn't we

hear about that you know many times in

the past and that's true we have been

talking about China's debt for a long

time but in the process of that

discussion the Chinese have first of all

demonstrated that they can contain any

incipient financial crisis at least so

far. And they've also carried out a

couple of rounds of deleveraging, right,

of lowering debt. But in spite of those

issu those efforts, the aggregate debt

level has continued to increase. And in

some ways, it's become

a more difficult problem to tackle with

because it's now intertwined with these

two other issues. One is the housing bus

and the other is technology policy, the

urge to compete with the United States.

to put a little bit of an edge on it. I

guess I would say some of the situations

that China is facing today,

approach the conditions of what we used

to call Japanization,

the development of the Japanese economy

during the '9s

when all of a sudden it dealt with very

heavy debt loads and much slower growth.

Now the Japanese economy avoided

financial crisis, right? They avoided

financial crisis by essentially

incrementally resolving

financial distress, slowly reorganizing

banks and other financial crimes and

then only after about a decade adopting

quantitative easing and bringing the

economy back to growth. Now, China has a

lot of differences with Japan, but in

many ways, it's starting to replicate

some of the mistakes that Japan made.

And so, I think we're going to see that

weighing on Chinese growth,

not the same, but in a way that's sort

of parallel to and similar to what

happened in Japan in the 1990s.

>> And professor, talking about the decline

in real estate prices. So, you make the

comparison to Japan. In Japan during the

1980s, debt levels increased, but

property prices increased so much more

that on paper, equity, it looked very

good for growth as well. And then

suddenly when real estate prices stopped

going up and they went going down, you

had this huge bust.

In terms of the Chinese real estate bust

that has been going on for what, three

or four years, I think property prices

are down 20 to 25%. That is pretty close

to where the the levels of decline that

we saw in the US market during the

subprime mortgage crisis probably from

like 2006 to 2009 I might guess. So, is

it a credit? Is China going through a

level of real estate correction that

rivals the great financial crisis in the

United States? And might there some be

something positive to say? Is it a

credit to some measure of the Chinese

economy that they are not having a giant

recession like we did 15 or 20 years

ago?

>> Yes, there's definitely some truth to

what you just said. But before we would

say that we're in complete harmony here,

we'd have to say first, I think the

decline in Chinese real estate prices is

certainly more than 25 30%. Um,

it is true. You're absolutely right.

That's what the official figures say,

but I've never met anybody in China who

felt that was an accurate description of

their particular market. And more

generally, housing prices in in Beijing

and Shanghai and Shenzhen, they're down,

but they're down in that range, 15 to

20%. The big problem is in the 50 or 60

other second tier, third tier cities.

They're still big cities where the

overwhelming majority of the real estate

is. And there we're talking about 40% or

more decline. So it's a big impact on

people's aggregate household saving

because remember as I'm sure but just to

remind our listeners for Chinese

households real estate has been a much

more important asset in their

portfolios. They hold fewer stocks

almost no bonds.

What's more important is bank deposits

and real estate. And so that you know

that if we call it a 30 35% overall

decline in the value of your by far

biggest asset that's a pretty

substantial hit.

>> If the hit you know might be even bigger

than the on paper hit in China and

rivals that of the great financial

crisis in the US. Why is GDP you know 5%

and you know not a negative number like

it was for the US? Is it because they're

exporting so much? The approximate

answer is that as real estate investment

declined, China ramped up its investment

in high-tech manufacturing.

It's almost a dollar fordoll shift when

you look at the credit balances in

particular. Less for housing, more for

industry.

So in the short term that did exactly as

you predicted. It present prevented the

GDP growth from falling below

approximately 5% per year. But imagine

the flip side of that. All of that

investment going to industry in a way

that wasn't driven by market forces but

rather driven by government policy

mandates means that industrial capacity

has increased very rapidly. So that

virtually every sector has over

capacity, has intense competition

and falling prices. Consumer prices are

essentially flat but very slight

deflationary, but industrial prices have

been in out andout deflation for three

years now. So prices are falling, profit

margins are falling. There's a lot of

distress in the system and the Chinese

call it involution, right? And the

Chinese government launched a campaign

middle of last year against involution.

Nobody really thinks it it's fundamental

enough to reverse these different these

different forces. So in other words, the

shift to industrial policy

kept GDP growing but entrenched the

macroeconomic problems even more

severely.

>> In economics, mainstream economics hold

that deflation is generally a bad thing.

Te tell us why that is the case and does

the head of China Xiinping does he agree

with mainstream western economics that

deflation is generally bad?

>> Let's start with the f the second part

because that's easy to answer. No.

Xinping famously does not agree with

western economists that deflation is a

bad thing. In fact, he's very famously

quoted as having said in a meeting with

his adviserss, he said, "Wait, if prices

are low, isn't that a good thing?" And

of course, many people feel the same

way. China is inexpensive, especially at

today's exchange rate. You go to China,

you will feel, wow, things are really

inexpensive. not just, you know,

manufactured goods, but everything. You

can get a good meal in Beijing for a

fraction of what it costs in San Diego,

for example. So, not everybody agrees,

but I think we can adopt the economic

standpoint and say it is a bad thing.

It's a bad thing for a whole number of

reasons. Let me just take two. One is

this tremendous market pressure

is driving this enormous

trade surplus that China is developing.

As I'm sure your listeners will have

heard, by November, China had a trillion

dollar trade surplus. That's enormous.

And of course, one of the peculiar

things is this trade the trade surplus

with the United States is not

increasing. it's decreasing. So, China's

surplus with everybody else in the world

is just massive.

And that's creating that's a huge

obstacle to world economic growth. And

it's of course for China strategically

it creates problems. They want to say,

"Oh, we're a brick country. We're allied

with Brazil." But Brazil is saying, "Oh,

thank you. You know, we're also we're we

have a kind of populist left-wing

government. We want to be friendly with

China, but we also have our own industry

to to worry about and we're being

deindustrialized because of the impact

of these Chinese exports. So, so that's

that's certainly one set of problem. The

other set of problems is that interest

rates have to come down. Nominal

interest rates have to come down in

order to try and stimulate

growth. Right? if we're in this

deflationary environment. And so China

is in a very low interest rate

environment, which means the banking

system isn't able to make very much

money from the interest rate margin

between its loans and its deposits.

So the profitability of the banks has

gone down, which means the ability of

the banks to clear up bad debt on their

own has decreased. So the the stress in

the financial system tending to

japanization that I talked about earlier

is in part the result of this

deflationary environment that makes it

harder to clean up bad balance sheets.

>> So the cause of the cause of the

deflation a near-term I guess maybe

cyclical force is the negative wealth

effect of real estate prices going down

so much. So consumers their on paper net

worth has gone down.

What might the other forces be of

Chinese deflation and do you see an end

in sight? So the other forces would be

the the sort of very important but

relatively longer term structural

forces. China of course was a growth

superstar for 35 years, right? And after

about 2010, the growth rates started to

come down significantly for reasons that

were inevitable. I mean, the the

essentially the countryside emptied out

of undermployed workers, especially

undermployed younger workers. So the

flood of young men and women into

coastal factories to make garments and

toys finally came to an end after 30

years. So that was going to happen

anyway. It so happens that this then

went along with demographic changes

where the size of families dropped even

more than people expected. Labor force

started declining in size by 2021. and

it's dropped every year since that time.

That's already happening, but it's going

to accelerate from now on. So, there are

these very powerful long run structural

forces that are also at play. And

therefore, as a result, when you look at

Chinese household psychology,

there's been a tremendous shift. This is

one of the most striking things when

people including myself returned to

China after co

there was this remarkable

shift in how ordinary people were

talking about the economy. They would

start to say things like we're not

taking a vacation on this three, you

know, this long weekend because of the

economy.

in the same way that that we started in

the US to say that in the 80s and 90s.

And this was such a reversal because for

so many years because China had been

growing so fast, people even when they

were poor were always optimistic about

the future, right? You had this builtin

stabilizer which was the willingness of

households to believe that things were

going to get better anytime there was a

shock and all of a sudden that

disappeared. So I would say you you've

got these sort of three things long run

structural change

housing bust and then reinforced by this

change in household psychology that

makes it a very different kind of

overall macro environment. Now I'm not

saying these things couldn't be changed.

They could be affected by a very astute,

targeted, intelligent policymaking.

But we're not getting that because

policy makers led by Xiinping are

obsessed

with this technological competition with

the United States. If Beijing wanted to

end deflation and improve the consumer

domestic economy in China and they were

listening to economic advisers such as

yourself or or other uh uh folks, what

might you advise them to do? Question

one. Question two, I think you hinted at

the answer is no. Does Beijing want to

do that?

>> Yeah. So the question two is easy. They

don't. So they're not ready to listen to

people like me. And there are plenty of

excellent economists in China who are

saying similar things. I'm not saying

everybody thinks the same thing, but

there are many very good economists who

have advice. And I think the thing to

start with is it's not going to be easy,

right? Housing downturns are really

debilitating. They really take a lot of

a lot of time and effort to overcome.

But we can easily imagine a kind of

three or four component set of policies

that would have a beneficial effect.

First, you almost certainly have to set

up some kind of new housing bank or

bailout fund or a wellfunded

resolution institution. We did it in

this country in the 80s, right? After

the local savings and loans had so many

difficulty, we set up the resolution

trust, right? China needs something like

that. It needs So that would be number

one. Number two would be some kind of

aggressive visible effort to resolve

the real estate firms that are

technically bankrupt. You have this has

been going on now for more than five

years. Actually, if you go back to

Everrand in 19 in uh 2020,

um firms break down. They're not

recapitalized. They get cannibalized.

The system drips funding into it to keep

things going, but nothing ever gets

clearly resolved. and therefore people's

expectations can't find a ground and

they can't turn around. I think there's

a lot of tension between the Chinese

government and different company private

companies in China today because the

because of the very high priority that

the government gives to technological

competition but also to ideological

orthodoxy.

private firms feel as if the Chinese

government is not their ally in the way

that it was 20 years ago. And a simple a

few simple political demonstrative acts

that say no, we actually really value

these private firms which after all are

still the most technologically

innovative dynamic firms. That could

make a huge difference. And then I think

the fourth thing would be to tackle

local government finances because local

governments used to depend on real

estate transactions for a lot of their

revenue. Now that's evaporated and yet

they're still under all this pressure to

spend for all these different things

including high-tech industrial parks and

various deont demonstration projects of

different times. So if the government

demonstrated some will to help local

governments resolve their finances on a

fundamental level that would also make a

huge difference. So none of these things

are easy, right? They all require

political commitment and a certain

willingness to bear some risks. But I

think absolutely if you started to do

things on a on a multiple

dimension frame, then people would

pretty quickly

realize that the economic conditions

have changed and that there's going to

be more opportunity again in the future.

So first and third recommendation that

the first was fix the bad debts in the

system particularly with real estate and

housing. The third was with local

government's finances which is someway

related to the first one. I'm sorry I

didn't write it down. What was the

second one?

>> So the second one was resolving the

corporate finance of the of these real

estate companies which have

unsustainable balance sheets. So really

the first one was a setting up a new

government institution

>> that is going to inject money into the

system. On the one hand, it would be a

confidencebuilding

exercise and targeted toward the real

estate sector, but on another level, it

would simply be a Keynesian stimulus,

right? You just pump money into the

system in order to prop up aggregate

demand, but in particular, the aggregate

demand is coming from the consumption

side. That's what we really want to see

and that we haven't seen in the past

several years. Would you also include

consumer stimulus in that to increase

consumption?

>> So I mean consumer stimulus is what we

need. I'm a firm believer in in the view

and I think you had Michael Pettis on

this program not too long ago and I'm

very much in in his camp that the

Chinese economy needs a restructuring in

which aggregate demand shifts

significantly towards households and

towards consumption demand. So I think

that's the underlying thing that that we

need.

The Chinese government thinks that too.

And in fact, in the most recent

five-year plan, of course, five-year

plans are still very important in China,

they actually for the first time ever

put a phrase in there that says the

share of consumption in GDP should

increase.

Now,

if they meant it, that would be a

dramatic breakthrough, right? Because if

the share of consumption is going to

increase then something else has to

decrease right the share of investment

has to decrease the share of the trade

surplus has to decrease or so some

combination of those two because those

are the only three elements there are in

GDP demand side right so that would be

very dramatic

but the amazing thing is that in the

final document

this commitment is put in a subordinate

clause of one long sentence that

includes improving the efficiency of

investment and doing that. Oh, and by

the way, raising the share of

consumption and GDP. So it's the

credibility of it as a policy objective

is really undermined because it's clear

with then when you read the whole thing

it's clear what the number one priority.

The number one priority stated in many

different terms is build the high-tech

manufacturing future and beat the United

States at artificial intelligence and

other types of future industries. So

that that might be the right thing to do

on some philosophical plane depending

upon what benefits AI does bring us, but

at least in terms of the shortrun

economy, it's definitely not the right

balance.

>> You you referenced the five-year plan

that was just out. Can you talk about

the intentions and publicly announced

goals of Beijing and when they're

announced? So I know there's the

National People's Congress in March and

then in October there or September

October there's also something

important. There was a lecture that you

gave in India a year or a year and a

half ago and you showed you had this

great little table showing how in 2023

the number one priority was expanding

domestic demand. But then in 2024 that

got downgraded from number one priority

to number three priority. And you just

said that in the 5-year plan it appears

optically like it has a high importance

but it's subordinate to all these

various things. Just how seriously are

you taking this announced Chinese goal

of supporting and expanding domestic

demand specifically not just in absolute

terms but as a share of GDP and then

these publicly announced goals on the

spectrum of this is actually what the

government wants versus this is PR where

are these kind of goals aligned? I think

the government policy makers led by

Xiinping

honestly want to improve consumption

standards for Chinese people. I think

it's part of the China dream and they

can also see that GDP growth which

constantly threatens to be below their

target and possibly is below their

target depending upon exactly what

numbers you believe. They understand

that more robust consumption demand is a

crucial part of that. So I think they're

genuinely

in favor of this idea. The problem is

that they're not willing to make the

sacrifices in other areas that would

really be needed in order to make this

happen, which might include lowering

investment

first, which of course would immediately

mean your GDP growth would stall out,

right? You might have a year of zero

growth, but that might be what's

necessary to establish a credible

policy orientation that signals to

households and especially to private

business that this is a new reality and

they have new opportunities. Instead,

every time they reach one of these

crunch points, they end up doubling down

on their technology and industry policy.

So for instance in November so just two

months ago not even two months ago the

state council issued a big document on

application scenarios

which means and they have a whole list

of them sectors I think which means

areas where government actors and

stateowned enterprises

should create final use cases for new

technologies like AI for instance in

other words it's not enough that we just

subsidize the production of these

things. We should also be creating

structured demand situations

so that we can bring begin to bring you

know certain new technologies and new

manufactured products into new markets

that we're essentially making

essentially creating for them.

Now that's not necessarily a bad idea,

right? That's it. It makes sense and in

some ways it's more consistent with our

own much narrower

idea about how industrial policy should

function, right? For government to

create a market and then let private

businesses respond. It's not a bad idea

and and it may be good, but at the same

time it it also shows where their

attention is. Are they going? You could

imagine

Chinese policy makers looking at 2025

and saying, "Huh,

was a good year for us. The Americans

challenged us and we stood firm and we

didn't make concessions and we hit back

with our control of supply chains which

we'd built up over the years and we

forced President Trump to back down and

now we're in a kind of day." Now, you

could follow that and say, "Therefore,

maybe we can ease off a little bit on

these very intensive mobilization of

resources. Maybe we could ease off a

little bit and really release resources

to the Chinese people, but they haven't

done it." Quite the opposite. What

they've done is to say, "Aha, you see,

this shows we were right all along and

we should do more of it." And so this

sort of new application scenarios and

who knows if it ends up really being

important or not but what it shows is

this intention

to add another layer to industry and

technology policy. They're already

working hard on the research part on the

engineering on the commercialization.

This is another slice that says in order

to make commercialization of new top new

technologies successful, the

government's got to step in and

structure these scenarios they call

them. It's a funny word because in

English scenario means something that

you know hasn't happened, right? But

this is indeed it hasn't happened yet.

But the idea is to make it something

very concrete, real and practical that

will take this step toward

commercialization, make it more

feasible. a former chief economist for

the IMF, Ken Rogoff, he in an interview

told me that in the year 2000 or 2001,

he sat down with the then Chinese leader

and told him that ch the Chinese economy

was incredibly imbalanced and that there

was a lack of demand, internal demand,

and that it was exporting the difference

and that this is a big problem and the

the Chinese leader appeared to to

understand and agree. Is China ever

going to do something about this or is

there lot you know in China you know

allegedly um you know claims to think in

very long-term things in60 or 2080 what

does China have their consumption as a

share of GDP or are they still going to

be having 2% 3% or extremely high

current account surpluses as far as the

I can see

>> bringing up the leadership is exactly

right and I'm sure Ken Rogoff spoke to

the leader in 20201 Those leaders are

very different from the current leader.

They have different priorities and

different ways of viewing the world. So

I think it's very hard to predict. Right

now

the current leadership

as I said they can claim

victory in 2025, right? At least in

terms of a economic contest with the

United States. at least they have a

plausible story for their people, right?

That says, "Hey, there was conflict. We

were prepared and we stood them down."

So, I think that short run probably

contributes to his popularity and the

stability of his government.

On the other hand, there are a lot of

people who are saying

this, that's nice, but what about me?

What about my family? What about my

children's future? And they would say,

of course, quietly and privately, I

don't feel that the future outlook for

my children is getting better. I think

it's getting worse because there's

intense labor market competition as

well. And deflation is a human feature

as well where there's not enough jobs

for skilled people and it's compressing

wages and causing all kinds of problems.

Will those pressures

be enough to really drive a shift in

economic policy direction? We just can't

say because it has to get mo channeled

through the political system and the

political system concentrates a lot of

power at the top. If they don't want to

listen co ordinary people, they don't

have to listen.

What did you make of the 2025 showdown,

if we can call it, between the US and

China? Let's start in April when

President Trump raised tariffs on China

to above 100% for a handful of days and

then there were a lot of extensions and

then I believe it was in November that

President Trump met with China's Xi.

What are the lessons? Yeah, give us your

summary. what are the lessons and how

are you thinking about USChina trade

relations in the new year 2026?

>> So again starting at the end it seems

that shortterm

both sides have decided to get along. So

I don't see any immediate storm clouds

but it's also clear that both sides have

decided to get along because both have

calculated hey we need more time to get

ready. The United States feels like it

needs more time to get ready in terms of

critical minerals and China feels like

it needs more time to pursue its

technology policies and in particular to

achieve some kind of real semiconductor

self-reliance which it definitely

doesn't have today in spite of the

progress that they've made over the last

couple years. So we're I think we're in

this short-term stabilization which is

basically a good thing. In terms of the

earlier stage in terms of the sort of

summer crisis really the astonishing

thing is that the US administration

didn't foresee the Chinese response.

It's very peculiar. We have known about

Chinese domination of supply chains

especially for rare earth for 10 years

and it's true that the domination has

become more focused and more critical to

our economy because rear magnets have

been playing an increasingly important

role during those 10 years. But the

basic threat has been there and we did

reopen rare earth mines in the United

States in California and so some

domestic production has been started but

we're just still moving so slowly and so

far behind and that but policy makers

apparently weren't aware of this and

they just fell right into it. So it

would primarily was that rare earth

export ban that caused the US to come to

the table and lower tariffs.

>> Yes, absolutely. I think it's fair to

say that was 80% of it and the other 20%

was probably the realization that there

were still several other critical

minerals that China could target next

that would also have a big impact. So

there was not a obvious bargaining

ladder short of making substantial

concessions which we did.

>> You write how China didn't really have

an industrial policy until 2006.

Before then it really was just

privatizing the economy and deregulating

stuff and that that led to a lot of

growth. But that you have a very

specific definition of industrial policy

that is the government actually

attempting to change the composition of

the economy that the waiting of the

sectors between different sectors

between investment and consumption trace

the beginning of China's

industrial policy why did it begin and

do you think that we are in a new

crescendo of industrial policy and that

this sort of Chinese meddling not to

make it a judgmental or a negative word

but Chinese interference in the economy,

the government interference in the

economy is only going to increase going

forward.

>> Thanks for those great questions and

thanks for reading the reading my work.

I appreciate it very much. Um, yeah, and

I want to stress that that I'm not

saying that's the only definition that

makes sense. I just think for a

productive discussion, it's good to have

a very clear discussion, a very clear

definition. And that's the one I think

is most useful in that sense. And of

course for China it's a little muddied

because Chinese local governments have

always been these very entrepreneurial

revenued employment driven thing. There

was a great article in the financial

times in December I think about the

growth of production of fuagra and

cherries and caviar in China and all of

these were stimulated by local

governments which were looking for high

value added products for their poor

farmers to start producing. So is that

industrial policy? Of course, you can

call it industrial house if you want and

that's fine, but it's it was really the

response of entrepreneurial government

looking for something that made money.

As you said, it didn't envision changing

the structure of the economy.

But then in 2006

as this period of very rapid growth is

starting to come to an end, Chinese

policy makers for the first time start

to say, "Oh, we should shift our

production into

higher technology industries that have a

more favorable chance of growing." And

so that's when what later come to be

called strategic emerging industries

start to be targeted. So that's what I

take it as the beginning of Chinese

industrial policy. And then it gets

ramped up after the global financial

crisis. They want to spend money to

stimulate the economy. So why not spend

it on strategic emerging industries?

And then it expands

because China in 2016 formally, a couple

years before that actually, decides,

hey, we've got to go all in on this

technological revolution.

Green, ubiquitous, smart technologies.

And if we don't ride this wave, we're

going to be followers forever. So it

expands into this let's push ourselves

to the frontier

and then in 2020 it had adds a whole

another layer says oh we have to be

self-reliant we have to be

self-sufficient so we're going to start

to derisk they hate that word they claim

they don't have a de-risisking policy

but of course they do and they claim

we're going to

make sure that our high-tech sector is

not dependent on on the outside world,

which of course means not dependent on

the United States. So that's the

background for why they felt they were

in a relatively strong bargaining

position in 2025 because they had

already begun to make these preparations

in different kinds of industries,

different kinds of supply chains to be

to fortify their economy. I see no

indication whatsoever that they're

stepping back from that now.

If anything,

you listen to David Saxs, President

Trump's advisor on AI, and he

essentially says, "Look, it's everything

is in the competition to have the most

capable AI stack and it's all about who

gets to

general intelligence first." Maybe the

Chinese believe the same thing and that

they need to foster the competitiveness

of their full stack of AI participants

in order to if not you know sort of

compete for world dominance at least be

able to protect themselves from an

emerging era of US AI dominance. So

that's the driver and they are not

taking their foot off the gas pedal.

>> Tell us about how innovation and

technology is how the capital is

allocated to that within China. How that

differs from the US. Many of our

listeners familiar with venture capital,

bank financing, the capital markets,

bonds, equity issuance, IPOs. Okay. But

within China, how is it different?

>> Great question. The simple answer would

be just that government role is so much

bigger. Obviously government role has

stepped up Biden and Trump too in the US

but still it's tiny compared to the the

big tech giants which really deploy

extraordinary amounts of capital. China

overall even with the government deploys

less capital total but government

influence is much bigger. State all the

big banks are stateowned and so bank

credit is the biggest source of

investment. They also have an

institution called government guidance

funds which are essentially their effort

to replicate something like a venture

capital fund but seated with government

money. They've had a mixed record to put

it mildly but certainly it's been big

enough to channel substantial amounts of

money. It has not fully offset the

retreat of American venture capital from

China which has happened over the last

five years which has caused their

overall venture capital scene to

contract rather dramatically actually.

And then the I guess the one last thing

to add there is they have recently been

rather successful with having some of

the startup funds especially related to

AI chips and other things in that area

having these firms do their initial

public offerings and they've been

wellmanaged overs subscribed and get a

nice pop when they're first listed. Now,

a cynic would say, "Sure, you can list a

company and let the world know that the

government supports it and it's a

favorite of the government." And so, of

course, you should invest in it for the

short term. It's going to go up for the

short term, but that doesn't really show

that it's going to necessarily be

successful from the medium, the long

term.

>> So, we'll link to your work on

government guidance funds. When you look

at the most important companies within

China, Alibaba,

10 cent, uh maybe Net Ease, BYD, and

I'll also include not publicly traded,

but um uh uh Deep Seek, which was spun

out of a hedge fund, you know, what what

h how many of the giant tech firms or

the most important companies are

actually funded by these government

guidance funds? And then also, yeah,

what is going with DeepSeek? How there's

a hedge fund in China that was so

successful that they're now developing

this technology that's could be better

than OpenAI and Google. What's going on?

>> So, we see this tremendous disjunction,

right? On the one hand, Chinese

government's pouring money into all

these high-tech sectors, and there are

some great successes, but most of those

great successes

really are driven by very individual

entrepreneurs who have their own vision

and are willing to overcome all kinds of

obstacles and don't necessarily just

benefit from Chinese industrial policy.

It's actually reasonable this I think

this goes beyond our knowledge but it's

actually reasonable to assert that China

would have come this far technologically

on the basis of the effort made by

Chinese households and private

businesses because it's Chinese

households who are investing in

education. It's Chinese households who

are sending their kids to the United

States and to Europe and Australia and

Japan to be to get advanced degrees. Uh,

and it's Chinese businesses that have

made many of these most important

breakthroughs. That's certainly true of

Alibaba. is certainly true of Deep Sea,

which is led by, as you said, a guy who

set up a a hedge fund, a quant fund,

made a bunch of money, and decided that

he could use that expertise to to train

a large language model. Now, there's a

lot there's a lot we don't know about

the total resources he used for this

training process. He certainly used

Nvidia chips that were purchased before

some of the restrictions were put in

place, but he seems to have done it far

more economically than any of our

models. Of course, for our models, since

they're fundamentally not economically

constrained, they're the optimal

strategy is to pour money into it. And

he was economically constrained. So, he

had to find other ways to do it. But

it's a very very impressive achievement,

but also quite idiosyncratic. The one

thing you can say, you have to give

Chinese government credit for expanding

the education of people in artificial

intelligence and most of the engineers

at Deep Seek who actually created these

solutions were trained in China in

particular at Jang University not far

from Shanghai where they built a very

strong AI department. It's a complex

picture, but you definitely don't want

to give all the credit to the Chinese

government.

>> And when you assess the US versus China

in the AI race, many people dispute that

it is a race, a competition to the very

end, but let's just accept as a premise

that it is. How do you assess the

various advantages and disadvantages for

each side? The way I simplify it for

myself is that the US still has a

substantial lead in large language

models and in the kind of core guts of

artificial intelligence processes, but

it's not a very long one. We're talking

about somewhere between six months and

two years, which is maybe a long time in

the AI world, but for most other things,

pretty darn short. And

China has a lot more experience

in the AI realw world interface.

So, Chinese robots and Chinese

industrial automation and even I saw a

story now we have to be a little bit

skeptical about all these stories about

a solar powered a AIdriven

tree planting device in China that you

could set up and it would plant a tree

and then walk 10 ft and plant another

tree and etc. Now, maybe it's just for

show, but I think it does show very

genuinely that China has this enormous

manufacturing base and they are not just

subsidizing AI and robots, but they're

also subsidizing the purchase and the

application of these things. And as a

result, they've learned a lot about how

to integrate AI applications in the real

world. And that's an area where as I

mentioned earlier now they're

accelerating that kind of byside

support to create and test new scenarios

where

high-tech is being actually implemented

into real world situations. I think

that's an area where you know my my

amateur assessment is US is still

lagging in that we don't see we see AI

everywhere but we don't see it making

our physical life more convenient much

yet I'm sure we will soon but there's a

lack there

>> and if you look at a lot of US

technology and software and intellectual

property I think a lot billions billions

of dollars of revenue and profit flows

every year to US companies just to

license that technology. Every country

in the world is licensing Microsoft

software. Every so many countries in the

world are licensing Visa or Mastercard

fees are very dominant around the world.

China is an exception to that. India I

think is also an exception to that. But

that is true of so many industries. I

say finance as well. You you could say

they they're licensing dollar

technology. We have all these

advantages. I imagine the current

administration and definitely the CEOs

of the AI companies envision or or yearn

for a future that is similar in that

regard. So in 2040 an Indonesian firm is

using OpenAI or Google large language

models or some other American country's

models and they're paying a fee. So

maybe in the future 20 240, America

still has a very chronic trade deficit,

but it will have a service surplus

because of these advanced technologies

and all the all the revenue is flowing

back to Rome, so to speak. Does China

want to avoid that world? Does China

want its models to to be to be dominant?

And is it really can you speak to the

scale of the China's demand to maybe

replace the US as the leader of the

world? Not even speaking militarily or

anything that's a different story but

just of in 2040 he wants a Nigerian tech

firm to be licensing Chinese software

not US. Yeah, abs certainly that is the

case. I mean and and um as as you know

well um most of these Chinese models are

open source models which is of course

some people are very strongly in favor

of open source as a technological model

but for me as an economist just thinking

about it as a business model this is

also a way that you facilitate adoption

lowcost adoption of your model because

people can customize it more easily. it

it's in a way a kind of price

competition, right? That they're able to

get this product in front of a customer

who's maybe not prepared to pay full

price for a an enterprise model for

athropic or open AI. So absolutely they

see this as a part of economic

competition and they want to at least

compete

head-to-head with American tech giants

for these ultimate revenues if they if

they pan out. And of course, I'm I'm not

qualified to be a grand strategist, but

I can certainly tell you that Chinese

leaders very much believe in strategic

rivalry, and they are trying to figure

out what the Trump administration's

policies about the Western Hemisphere,

about Venezuela mean for China and

Taiwan. Is the US retreating to the

Western Hemisphere, or is this something

different? They're staying up late at

night trying to work out those questions

and the implications for themselves. But

they are fully committed to

broadspectctrum competition with the

United States. No question about it.

Or I should when I say they, I guess we

should say the Xiinping administration

is committed to this kind of

broadspectctrum competition with the

United States.

And so throughout this interview, you've

reiterated your view that you don't see

it very likely at all that the Chinese

government is going to step back and let

markets allocate capital rather than the

government. I think you've indicated

that you think overall that over the

past 19 years since 2006 or 20 years has

not been good. What when the chickens

come home to roost, what does that look

like? or because it's government-run

economy, you never really see the the

chickens coming home to roost. It's

nothing bad happens. It's just that the

damage is hidden. That's that's

what I think is most likely. We

economists are very bad at predicting

bubbles bursting and discontinuous

change and things like that. And in

China, you've got a population that's

now predominantly urban. is now

predominantly middle class. It's not

predominantly upper middle class, but

it's these are people whose whose

grandparents

suffered scarcity and now they live

relatively stable middle class lives. So

I think there's a lot of social people

think of China as being potentially

unstable, but I think actually there's a

lot of social stability built into the

system because people's lives have been

transformed over decades. Now, I think

they're not particularly happy with, you

know, the way policy is right now, but

it would take a lot more, a lot worse to

really drive them to extreme extreme

situations. China is basically a

successful country. At the same time,

people aren't satisfied with what they

have. It's not a rich country. They want

more and they want more for their

children. So I think these tensions

are building and it's a question of

whether the political system will

decide, oh yes, we can take steps to

meet people's legitimate demands for a

better life, which is after all what we

claim to want anyway.

And when you look at China's trade

surplus,

how did it change in 2025 in reaction to

the US tariffs? I think the US China

trade surplus went down, but that's only

the bilateral numbers. If you look at

everything, the US total trade account

and the China total trade account, I

don't know if there were that many

changes. Can you give us your sense of

the rough sense of the numbers? And is

it still China's goal to be an export

powerhouse? Will that not change in the

next 5 10 years?

>> It's definitely is China's goal stated

repeatedly not only to be an export

powerhouse, but to be an export

powerhouse

in sort of all sectors.

In other words, they've specifically

said

just because we're so committed to the

high techch ind industrial pursuit, that

doesn't mean we're going to abandon

traditional

industrial sectors like garments.

Instead, we want to revolutionize those

sectors by

making them shifting to robots, shifting

to intelligent factories. And they've

got some very impressive dark factories

that are just staffed by a few

technicians working 24 hours a day

through automated processes. So they're

still committed to that. They do

understand that the size of the

imbalance is too big, but they're not

taking the steps to reduce it. So what's

happened to trade flows is the US has

reduced in relative terms the imports it

takes from China and but China's exports

have continued to grow through sort of

two channels. One is channels through

third countries of which the two most

striking are Vietnam and Mexico where

you sometimes it's just trade diversion

and misinvoicing but more often it's

China producing components or partial

partially assembled things depending on

what they are and then adding a layer of

processing so that the final goods

declaration comes from Vietnam and

Mexico. So that accounts for a very good

share.

Different an analyses differ about how

big the share. Probably a third of the

reduction in direct imports from China

is actually channeling through third

countries. And then the big effect is

increased Chinese exports everywhere

else. And that's the thing that is

really not sustainable because these

countries are looking carefully at ways

to protect their industry and present

prevent another China shock like the one

that that affected the US in the

mid200s.

>> And what happens if every country is

trying to improve their external

accounts at the same time? Do you think

we ever could have a smooth holly great

depression scenario? I know that was a

lot caused by the gold standard, but it

appears that the economy in 2025 did

defied many of the very bearish

recessionista, inflationista

prognostications from economists,

particularly in the US. Is it too early

to say that those prognations were wrong

given that trade is a slowmoving uh uh

uh fact force? It seems to me just as an

individual not trying to speak

authoritatively as the economists think

but just me as an individual that there

are very large risk factors in the

global economy. The US fiscal deficit is

very big especially for a country at or

close to full employment and the debt

level is increasing. US is trying to

reduce imports at when November seemed

to be successful. So who knows? But

absolutely there is all this contention

where you have all so you have

unsustainable levels of borrowing and

debt in certain quarters perhaps

including the United States plus a

situation where more and more countries

are trying to bring manufacturing back

home whether it's for military purposes

like Germany or for completely unrelated

purposes just for development. So I

think there are these profound risks and

tensions built into the whole global

economy and it's just really difficult

to predict what kind of a trigger it

would be. You know right now everybody's

very optimistic that we're going to get

through everything and that's nice but

you can't help but noticing the

submerged reefs could could some kind of

very serious challenge

>> and many economists absolutely loathe

tariffs and it's probably their least

favorite thing. I'd say there's a near

consensus. I think you have a slightly

different view. Is that fair to say?

>> I it's a little bit true. But I I guess

for the US since the US doesn't have a

value added tax and every other country

has a value added tax which it basically

rebates to exporters on some level. If

the US had a low but relatively uniform,

I don't think that would be terribly

distortionary. It's not first best, but

we obviously don't live in a first best

world. That would not be a terrible

thing. But we've got this crazy tariff

structure right now that makes no sense

whatsoever. So it's both inequitable and

inefficient.

Doesn't really contribute to solving our

economic problem.

>> By inequitable, you mean that a tariff

is very similar to a consumption tax and

consumption tax are regressive. Meaning,

you know, a billionaire pays a 5%

consumption tax and someone making

minimum wage or just doesn't have a job

at all also pays a 5% consumption tax.

That's for sure. And then plus on top of

that, the variation in tariff rates

across countries is crazy. India faces a

very high tariff rate. Why? It makes

absolutely no sense. So if you're going

to use tariffs as a sort of geopolitical

tool, which President Trump has

repeatedly said he he likes that, he

wants to do that, but it inevitably

means you're going to give up something

in terms of economic efficiency because

you're targeting a different objective

altogether. Do you think that the

Chinese government would ever look

favorably upon a strong stock mult

market culture in the same way that we

have in the US? Perhaps some people

would say in the US that we have too

strong of a stock market culture, but

the supposedly quoteunquote communist

Chinese government party was very okay

with there being a giant home and real

estate bubble and real estate culture.

What's different about a stock market

culture? I guess it is owning business

owning a share of businesses and being

entitled to their profits and via

dividends and the like. So I guess it is

a little bit different but in 10 20

years could the Chinese market look

similar to the US equity markets or

maybe other advanced economies? I would

say for China never say never. Could

that happen? Absolutely. It could

happen. What are the odds? Wow. It's so

difficult to say. I I think it's

probably a minority probability less

than 50% but not zero. There's a I think

there's a kind of a latent opposition

to the repoliticization of the economy.

There are a lot of people who are

welleducated, some of them are also

wealthy, who really want China to be

more of a market economy, a more relaxed

economy, not so much more democratic.

You know, I think the the the roots of a

sort of democratic opposition in in

China are unfortunately relatively weak.

But a more market friendly opposition,

that's not weak at all. There are lots

of people in China who feel that way,

including lots of people who are

bureaucrats in the system who have been

burned by Xiinping's anti-corruption

campaign and endless austerity campaigns

within the government. Lots of people

don't like that. So, how would this

change? The problem is we don't have

enough inside information to be able to

piece it together a scenario of how it

would change. But is it possible?

Certainly. Absolutely. You could easily

imagine a

a scenario of lesser strategic tension

and a more open and market friendly

China. But to predict that based on what

we see right now would be irresponsible.

But it's certainly possible. And so

Xiinping has uh been the leader of China

for 14 years. I don't know if their term

limits are still in effect. Is it the is

it your base case and is it the base

case of most people who are informed on

this issue that he's going to be leading

China for the rest of his life?

>> People have different base cases for

sure. My to me the question is will he

serve another term and then if he serves

another term then I think that would be

his last one. But another term would

mean being reelected in 27, 2027

and serving through 2032. That's a long

time.

>> It's no secret that Chinese demographics

are turning very downwards and that the

fertility rate, the births per woman is

way below the replacement rate.

Actually, I just did an interview on

this subject, so I have the figure in my

head that I believe the UN forecasted,

and again, forecast, who knows? But that

by 2080, there will be more senior

citizens over the age of 65 in China

than there will be adults between the

ages of 15 and 65. So, obviously, a

radically much more gray-haired society

than we have in China now. In the same

way, right now, it's much more

gray-haired than it was 40 years ago.

Just what does that look like

economically?

and what are the

what problems might result from that and

how could those potential problems be

avoided?

>> Yeah, it's it's a really difficult

question I think for two reasons. One is

what China is going through is

the same as what countries around the

world are going through. So whatever

China is doing, this is also what's

happening in Japan and Korea and Italy

and many other countries. But in China,

it's happening faster or at least as

fast as the fastest, which is I think

basically Korea. Yeah.

>> And and at a lower level of average

income, it might turn out not to be as

difficult as we think. If people live

healthier lives longer and work longer,

we'll see. There's a lot of doom, gloom,

and doom, which might be completely

right, but it might not be as bad as

people fear. But China's got to at least

do a couple of things, which so far it

hasn't done. It's got to reform its

pension system and put it on a sound

basis, which it has not done even though

people have been talking about it for 10

years. and it's just been bleeding

subsidies from the main government

budget into the pension fund to keep the

provincial pension fund solvent. That's

obvious. That can't last. You've got to

you've got to resolve just the mechanics

of the pension system. And then beyond

that, you have to figure out a way to

channel these new technologies into a

way that that makes life better and

easier for people who are 65 and over or

more importantly 80 and over. These are

going to be increasing very rapidly from

now on. As working aid share of the

population declines, which is somewhat

inevitable as the population ages is a

necessary consequence of that, the

decline in working aid share that

basically debt as a percentage of GDP

has to go higher because the government

needs to be borrowing and slprinting

more money to to fund social security or

the other other count's equivalent of

social security.

>> That's an interesting calculation which

I haven't made. Obviously, if you step

up your saving while the demographic

bulge still works to your advantage,

then you have that advantage of a stock

of savings that you can draw down during

the period of maximum demographic

crunch. So, that could be helpful. China

does have a lot of it does it still has

more saving than debt by a large margin,

right? So, that is something that that

can be drawn on. And also Chinese

seniors because they started off life in

such difficult economic conditions still

have pretty modest expectations and

they're willing to I think live pretty

frugal lives. So those two things would

give us a I think will help ameliate the

shortrun difficulties.

But yeah, long run just the transfer of

from actual income generating workers to

dependent

becomes really challenging if you really

do get to a state where you have one

retiree per one employed person. Boy,

that's going to be be a tough one.

>> And we've talked about real estate

through the course of this conversation.

I gave the official number 25 30%

decline in prices. You said the often

the number experienced the decline

experienced by often folks on the ground

in China particularly not tier one

cities is often a much greater decline

as high as 40 or maybe even 50%. It's

possible to predict the bottoming of

Chinese real estate but at some point

prices do have to stop going down I

imagine. Is it on the government Chinese

government's plan to halt fall in

prices?

Yes. And

there was actually a very interesting

article that just came out this month in

the sort of top theoretical journal of

the party that

it's one of these articles where if you

read it really critically, what it says

is, "Oh, everything we've been doing

doesn't work." But if you read it in a

more favorable terms might indicate that

the government is prepared to

really shift and give more support to

housing as a long run growth component.

In other words, accepting that it's

never going to be what it was before,

but trying to stabilize it. And which I

think only makes sense if they have a

conviction that it's near the bottom.

which it certainly wasn't in 2015. One

of the things about 2015 that was

worrisome to economists was that the

real estate prices took a significant

dip again, especially in the second half

of the year. They're certainly thinking

about this. They're certainly worrying

about it and they seem to be trying to

put a floor on things by saying, "Okay,

now for a middle income country like

ours where people are upgrading their

living conditions, we don't have to

necessarily house a bunch of new workers

anymore, but still people want to

improve their living condition. So what

does that look like?" And trying to use

that to drive a stabilization scenario.

And of course, stabilization would make

a huge difference. Once people decide

that price declines are over, then their

behavior is going to change and it will

change dramatically.

>> What are you working on right now in

terms of a a new essay or paper on China

or or a book?

>> I am trying to work on a short new book

on industrial policy maybe called China

Industrial Policy 3.0 because I think

we're there now. And of course always

looking back and trying to understand

and narrate what's happened so far

because I think we for so many years

people like me were just watching China

with the sort of tension are they going

to reform? Are they going to open? are

they going to move forward? And of

course they did up to a certain point

and so now looking back and

understanding that process and why it

changed is also super important with

brackademic

>> and okay sorry I'm trying to go through

your book you you have a table from your

book which was published in 2019 or 2020

industrial policy in China or that was

published in 2021 excuse me but you have

industrial policy 1.0 industrial policy

2.0 I thought maybe I'm misremembering

that industrial policy 2.0 was the

electrical via vehicles and AI plus and

all this stuff. So what would 3.0 be?

>> So 3.0 would be

the the things that happen after 2021

where self-sufficiency becomes crucial

and clearly drives Xinping's thinking

that we need to be self-sufficient so we

can be a independent strategic force not

dependent economically on the United

States. And then as they do that, they

start coming up with new kinds of

instruments. And those instruments are

specifically designed to get the

government back in the business of

organizing

the research and the engineering and the

management and the market and putting

all these steps of the innovation chain

together

and making it work which I think is in

some ways it's very insightful. It shows

their their deep commitment to this, but

it also means a really worrying increase

in government involvement in so many

different steps of the economy. And I

think it might

the jury is still out, right? whether

this really is going to transform China

into a high-tech superpower or whether

it's gonna intensify the problems

pushing other parts of the economy

towards stagnation are a huge question

and of course it's one on which our

immediate future depends to a

significant degree. Final question,

professor. In in your work, you've

emphasized the the phrase modernization

of the industrial system, which the

Chinese government points out. And as as

you've written, that sounds like a very

vanilla, bland phrase when at least when

in translating into English. But what is

the significance of this phrase

modernization of the industrial system?

It sounds so normal. If you hadn't

pointed and highlighted it with a red

Sharpie, I definitely would have gone

way over my head. Why is that? What's

the sign significance of that? So, um,

thanks for that question. That's a and

thanks for reading this stuff so

carefully. I really appreciate it. It's

a classic example of the Chinese using

this sort of bland, vague language. And

in this case, what it means is, oh,

we've been paying attention and we

understand that a high-tech

manufacturing base is not just a bunch

of key factories that make chips. say

it's also

high-tech services.

It's also industrial design services.

You have nimble small companies that

provide production side services and we

want to support all of these

domestically as well. So I mean in a

sense it's even more ambitious because

it's saying we should replicate within

China all the different components of

the whole global

high-tech system, which of course means,

well, we're going to have our own ASML.

Yes, sure, that's a hardware producer,

but it means we're also going to have

our own, you know, design chip design

companies. We're going to have our own

Qualcomm, we're going to have our own

Broadcom, etc., etc. So, um, so it's

it's a conception that's really broad.

It's funny because the name that I

mentioned earlier of sort application

scenarios

that's also really bland and and

slightly abstract right and but then

when you probe into it you realize no

this is actually a very concrete program

to do certain specific things it doesn't

mean necessarily work right because even

these concrete programs have to contend

with the complexity of China's

bureaucracy and and misaligned

incentives and all kinds of things. But

the biggest mistake we could make would

be to treat these kind of bland abstract

things as only being a kind of wishful

thinking. They're not. They're real

programs. Whether they succeed or not,

that's something we need to monitor. But

they're they really show the commitment

of Chinese policy makers to this effort.

>> That's interesting. Professor, thank you

so much for being so generous with your

time and insights. We'll leave it there.

We'll link to some of your work. Thank

you everyone for listening. Please leave

a rating and review for Monetary Matters

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Network YouTube channel.

Thank you.

>> Thank you. Just close the door.