So, Donald Trump and Xi Jinping are

meeting in Beijing this week. And if the

footage is anything like prior summits,

we'll be treated to two men in suits

walking very slowly through a building,

shaking hands at a slightly

uncomfortable distance, and staring at

each other like two people who've been

set up on a blind date by a mutual

friend who has since left the country.

Now, to recap how we got here, because

it has been quite a journey. Last year,

tariffs between the United States and

China hit levels that hadn't been seen

since the 1930s.

The US put tariffs of up to 145% on

Chinese goods. China retaliated with

tariffs of 125%

on American goods. And then, just to

keep things interesting, restricted

exports of rare earth minerals, which

are used in basically everything from

vacuum cleaners to fighter jets, but

mostly vacuum cleaners. This went on for

a while. And then, both sides appeared

to quietly realize that they were

running out of things to put tariffs on.

So, they agreed to a 90-day truce, which

is the one currently in effect, and

which expires in November. Now,

expectations for this summit are, to put

it generously, modest. The press have

taken to calling it the beans and Boeing

summit, which tells you something about

the level of ambition. Both leaders

arrive at this summit under considerable

domestic stress, but for very different

reasons. China is dealing with a

property sector that has been falling

for years and shows no real signs of

stopping, youth unemployment that the

government briefly dealt with by not

publishing the numbers anymore, and a

demographic decline that no amount of

government encouragement seems to be

fixing. The US president is dealing with

the inflationary consequences of his own

policies, falling approval ratings, and

a military situation in the Middle East

that's not going particularly well. So,

this is the backdrop two economies under

strain, a temporary truce that expires

in a few months, and a summit that will

be mostly remembered for the

photographs. But, the thing that almost

nobody on the news will explain because

it requires about 10 minutes of patience

and some basic accounting is that the

problem these two leaders are trying to

solve is not really a political problem

at all. It's an accounting problem, and

the reason it never gets fixed is not

that politicians are unwilling to fix

it, it's that most of them don't appear

to understand what's actually causing

it. And that's what this video is about.

To understand the current trade dispute,

we need to look at what trade is

actually supposed to be. About 6 months

ago, Robin Harding wrote a piece in the

Financial Times about a trip he took to

China, where he posed the same question

again and again to the economists,

technologists, and business leaders he

met with. His question was simple. Trade

is an exchange where you provide

something of value to me, and in return,

I offer something of value to you. So,

what exactly does China want to buy from

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The answer consistently was nothing.

Harding came away with the understanding

that there is nothing China believes it

cannot make better and cheaper

domestically, and nothing for which it

wants to rely on foreigners for a single

day longer than it has to. A few of the

economists he spoke to, who had perhaps

pondered the issue already, jumped ahead

to a different point altogether. Their

answer to the question of what China

would like to buy from the rest of the

world was you should let Chinese

companies set up factories in Europe,

which is not really an answer to the

question, but it does tell you quite a

lot about how they see the problem. Now,

to a certain type of politician, this

might sound like a triumph of national

strategy, until you remember how trade

actually works. The basic idea, going

all the way back to David Ricardo, is

that trade is supposed to be mutually

beneficial. The entire purpose of

selling your goods abroad is to acquire

foreign currency, so that you can buy

the foreign goods that you need. If you

accumulate foreign exchange that you

never intend to spend, you're not

running a brilliant economic strategy,

you're just collecting pieces of paper.

And if your goal is to systematically

put the rest of the world's

manufacturing out of business, you

eventually run into a problem. Your

customers won't have any money left to

buy all of the goods that you're hoping

to sell them. This makes no sense. It's

the equivalent of a town's baker

aggressively pricing the butcher, the

brewer, and the candle maker into

bankruptcy, and then looking around a

few years later wondering why nobody in

town can afford bread. During the first

China shock in the early 2000s, China's

exports surged, but so did their

imports. They were buying up the

sophisticated equipment needed to build

their factories. Today, as Samira Khan

has pointed out in the FT, China's

import volumes are comparatively anemic.

They are selling, but they're not

buying, which raises a fairly obvious

question. If the strategy eventually

makes everyone poorer, including

yourself, why would you do it? To

understand why a country would do this,

it helps to look at the work of Michael

Pettis, a finance professor at Peking

University and a senior fellow at the

Carnegie Endowment. Pettis has been

writing about this for years, and his

core argument is that trade surpluses

and deficits are not really caused by

trade policy. They're the automatic

consequence of domestic savings and

investment decisions. Here's what he

means by that. When a government

suppresses household income through low

interest rates on savings, an

undervalued currency, weak labor

protections, and other policies that

effectively transfer wealth from

ordinary people to the state and to

manufacturers, it forces up the national

savings rate. Households earn less than

they produce, so they can't consume

enough to absorb everything the economy

makes. This is what economists call

financial repression, and it's the

mechanism by which countries like China,

and before it Japan and Germany,

subsidized their industrial growth at

the expense of their own consumers. Now,

all of that excess saving has to go

somewhere. It goes into investment, and

building infrastructure that you

actually need does generate real

economic growth. But once your

investment exceeds your productive

needs, once you've built enough

high-speed rail and enough apartment

blocks, continuing to invest doesn't

create economic value. It destroys it.

The money is spent, the GDP figures look

impressive, but the underlying projects

generate less value than they cost to

build. The difference shows up as debt.

President Xi has reportedly spent a good

portion of his career studying Japan's

lost decades. Apparently, he found them

inspiring. In the 1980s, Japan

suppressed consumption to fund

investment-led growth, built spectacular

infrastructure, achieved extraordinary

technological advances, and was widely

expected to overtake the United States.

Then, the debt caught up with them, and

they spent the next 30 years dealing

with the consequences.

Pettis argues that the only way out of

this is to shift from investment-led

growth to consumption-led growth. You

have to stop subsidizing factories and

start giving money to households so that

your own citizens can actually afford to

buy the things your economy produces.

But politicians generally hate doing

this because shifting wealth to

households means that the state has to

give up control over where capital gets

allocated. So rather than making that

difficult choice, they keep subsidizing

production. Their domestic consumers

can't absorb the output, and the excess

has to go somewhere. It goes abroad as a

trade surplus, not because anyone

planned it that way, but because the

accounting leaves no other option. So,

if China is producing vastly more than

it can consume, and doesn't want to buy

anything from the rest of the world, who

is absorbing all of this excess output?

Well, let's look at who else is at the

table. Europe is running a trade deficit

with China of roughly 1 billion euros

per day, which is a number that sounds

made up, but isn't, and is driven by a

massive imbalance in manufactured goods,

particularly electric vehicles and

electronics. The EU is simultaneously

trying to deregulate its own economy. A

recent survey found that German firms

alone had hired an additional 325,000

people over 3 years whose entire job was

to tick regulatory boxes. Europe is also

preparing legislation that would force

Chinese companies to hire European

workers, buy European components, and

transfer their technology as the price

of market access. This is, of course,

exactly what China did to Western

multinationals a generation ago, and

Chinese officials have apparently

noticed the similarity. They're not

finding the imitation flattering. But,

Europe is not absorbing all of this

happily. The EU's trade commissioner has

compared Europe's dependency on Chinese

minerals to its former reliance on

Russian energy, and has warned that

without action, Europe risks losing

whole sectors of industry within a

couple of years. The IMF estimates that

selling goods across EU borders costs

firms the equivalent of a 44% tariff on

goods and a 110% tariff on services.

These are not tariffs imposed by a

foreign adversary. These are tariffs the

EU has imposed on itself through

paperwork.

The EU has essentially conducted a trade

war against its own economy and

impressively appears to be winning.

So, Europe is already uncompetitive and

it's now being flooded with cheap

Chinese goods on top of that. This is

not a combination that ends well for

European manufacturing.

That leaves the United States. The US

has the deepest, most liquid, and

historically best governed financial

markets in the world. When surplus

countries like China and Germany

suppress domestic consumption and

generate excess savings, those savings

have to go somewhere and roughly half of

the world's excess savings end up in

American financial markets. Not because

Americans invited them, but because

there's nowhere else for that volume of

capital to go. Now, here's where the

accounting gets important. When foreign

capital flows into the United States,

the US must, by definition, run a

corresponding trade deficit. This is not

a choice, it's a balance of payments

identity. The foreign money is being

used to buy bonds and financial assets,

not goods. The US becomes the consumer

of last resort for the global economy,

not because it wants to, but because the

accounting leaves no alternative. As

Pettis puts it, the US doesn't fund its

trade deficit, surplus countries force

it to run one.

Now, you might think that all of this

foreign capital pouring into America

would be good for the economy and that

it would fund new factories and lower

interest rates, and that might be true

if American businesses were desperate

for capital, but they're not. US

corporations are sitting on trillions of

dollars in cash. They don't lack access

to funding. They lack customers who can

afford to buy more of what they already

produce. So, the foreign capital doesn't

flow into productive investment.

Instead, the economy has to absorb it

some other way. As Pettis points out,

there are really only three options. The

excess capital can push up unemployment

as cheaper imports put American

factories out of business. It can push

up household debt as consumers borrow to

maintain their spending. Or it can push

up the fiscal deficit as the government

borrows to keep the economy from

contracting. Since no politician wants

the first option, the US has

historically chosen some combination of

the second and third. And here's the

part that almost nobody in Washington

seems to understand. Running a massive

fiscal deficit doesn't fix the problem.

It feeds the monster. The bigger the

deficit, the more Treasury bonds you

issue. The more bonds that you issue,

the more attractive your debt markets

look to surplus countries with excess

savings to park. The more capital flows

in, the stronger the dollar gets, the

less competitive American exports

become, and the wider the trade deficit

grows. And of course, all of that

government spending is stimulative,

which means it's inflationary, which

pushes up interest rates, which makes

the debt even more expensive to service,

which requires yet more borrowing. It's

a feedback loop, and it's one that no

amount of symmetry in Beijing is going

to break. Now, being the consumer of

last resort has not been entirely

unpleasant. The US economy is remarkably

productive. Labor productivity has been

growing at about 2% a year over the last

5 years, the fastest rate in two

decades. Cheap domestic energy means

Americans pay about half what Europeans

pay for electricity. The US economy is

flexible, dynamic, and has been

absorbing these imbalances for decades

without anything obviously breaking.

But, the bill has been accumulating. A

few days ago, the FT reported that the

US government sold 30-year debt at a 5%

yield for the first time since 2007.

Financing the growing national debt is

getting meaningfully more expensive. In

a video a couple of weeks ago on

inflation, I discussed how the US

Treasury under Scott Bessent has been

funding long-term obligations with

short-term borrowing, a strategy that

the economists Stephen Roach and Nouriel

Roubini described as activist Treasury

issuance and compared to stealth

quantitative easing. Bessent, as it

happens, criticized Janet Yellen for

doing exactly the same thing before he

took office and then adopted the

strategy himself, which is the Treasury

Secretary equivalent of mocking

someone's cooking and quietly asking for

the recipe. This is essentially a

massive bet that long-term interest

rates are going to come down, which

seems like a rather aggressive gamble

when you consider that the US government

is simultaneously pursuing tariffs,

running a massive fiscal deficit,

reducing the labor supply through

deportations, pressuring the Federal

Reserve to cut rates, and fighting a war

in the Middle East that has driven up

the price of fuel and fertilizer.

It's not entirely obvious why long-term

interest rates would fall while the

government is actively engineering

inflation. Betting that rates will come

down while you borrow a trillion dollars

a quarter to fund a trade war is a

strategy that relies heavily on

optimism. None of this is a new problem.

As Martin Wolf pointed out in the FT

this week, clashes over how to adjust

these imbalances have reoccurred roughly

every two decades. The 1920s, the 1960s,

the 1980s, 2008, and now. The 1920s

version ended with a global depression

and a world war. The 1980s version was

resolved through the Plaza Accord, where

the major economies agreed to coordinate

their exchange rates. The 2008 version

was resolved by, well, a global

financial crisis. So, the two available

options appear to be international

cooperation and economic catastrophe.

And historically, we've tended to go

with the second one.

Economists have understood the

structural problem since at least the

1940s.

As Daron Acemoglu outlined in the FT

last week, when the global financial

architecture was being designed at

Bretton Woods, Keynes proposed a system

built around a neutral international

currency that he called Bancor. The key

innovation was that it would penalize

countries for running either persistent

surpluses or persistent deficits,

forcing both sides to adjust. As the

economist Robert Triffin later pointed

out, any country that supplies the

world's reserve currency is essentially

trapped. It must run persistent deficits

to meet global demand for safe assets.

Keynes saw this coming and designed a

system to prevent it. The United States

rejected that proposal at the time. The

US was the world's largest creditor

then, and its dominant manufacturer. It

was basically the China of that era, and

it had no interest in signing up to a

system that would penalize its surplus.

In doing so, it consolidated the dollar

as the anchor of the international

monetary system, which is the very thing

that now forces it to run the deficits

it's complaining about. So, that worked

out well.

Wolff also makes a point that surplus

countries tend to overlook. They are not

in a stronger position as they think.

Japan ran enormous surpluses in the

1980s, and the pressure to boost

domestic demand led to a property bubble

that when it burst produced three

decades of stagnation.

China ran huge surpluses after 2008, and

the pressure to reinvest them

domestically produced a property bubble.

Germany ran persistent surpluses within

the Eurozone, and when the deficit

countries had crisis, Germany had to

choose between financing them or

watching the Euro collapse. They chose

to finance them, but they did want

everyone to know that they were not

happy about it. The pattern is fairly

consistent. Surplus countries build

their economies around selling to

others, and when the music stops, they

discover that they needed those deficit

countries more than they thought. So,

what happens when the global consumer of

last resort, the United States, is

running a 5% cost of capital and starts

looking for ways to stop absorbing

everyone else's excess production? Well,

historically, it ends in either one of

two ways. Either the major economies sit

down and negotiate a coordinated

adjustment, which requires a level of

international cooperation that is, to

put it politely, not obviously

forthcoming at the moment, or the

adjustment happens through crisis. If

the US stops buying, American consumers

will face higher prices and fewer cheap

goods. That will be unpleasant, but for

the surplus economies, countries that

have built their entire economic model

on the assumption that foreigners will

endlessly borrow money to buy what their

factories produce, it will be

significantly worse. A consumer can find

a more expensive substitute or do with

less. A factory with no customers has a

much bigger problem.

This brings us back to the handshakes in

Beijing this week. Expectations for the

summit are, to put it generously,

modest. Both sides appear to be looking

for just enough progress to justify the

photographs. The US wants China to

commit to buying those beans and

bowings. To oversee these purchases, the

two sides are expected to announce a

board of trade, a committee of senior

officials from both countries whose job

will be to make sure that China actually

follows through this time. This is

necessary because China made similar

purchase commitments in the phase one

trade deal in 2020 and then didn't

follow through. So, the solution to

China not honoring its commitments is a

new committee to monitor whether China

honors its commitments. I'm sure that

this time it'll be different. Now, the

board of trade will sit alongside the

already existing board of peace, which

was established earlier this year to

promote peace building, which Trump will

chair for life. So, we now have a board

of peace and a board of trade, and all

we really need next is a board of good

intentions and we'll have the complete

set.

There's also the small matter that Trump

arrives in Beijing having largely been

disarmed by his own courts. In February,

the Supreme Court struck down his IEEPA

tariffs, the ones he had been raising

and lowering on a near daily basis last

year. He immediately pivoted to a

different legal authority, Section 122

of the Trade Act, which allows temporary

tariffs to address balance of payments

crises. Last week, a federal trade court

ruled those ones illegal, too, on the

grounds that the US is not actually

experiencing the kind of balance of

payments crisis the law was designed

for. The administration is appealing,

but the tariffs expire in July

regardless. A third set of tariffs under

Section 301 is being prepared, but those

investigations won't be complete until

the summer. So, the US president is

sitting across from Xi Jinping at a

negotiating table, and his most

prominent negotiating tool has been

taken away from him by his own judiciary

twice.

His domestic position isn't helping,

either. Approvals ratings are at 34%,

the lowest of his second term. And with

midterm elections in November,

Republican members of Congress are not

exactly lining up to support

inflationary trade policies in an

election year. Several were reported to

have quietly celebrated when the Supreme

Court struck down the tariffs. Xi

Jinping will be aware of all of this.

When your negotiating counterpart's own

party is relieved that your signature

policy has been overturned by the

courts, it does somewhat reduce the

credibility of the threat to bring it

back. Both sides are really just trying

to buy time. The US wants breathing room

to build domestic rare earth processing

capacity because China currently

controls those supply chains and use

them as devastating leverage during the

tariff war. China wants time to develop

its semiconductor industry and reduce

its dependence on Western technology.

And Xi has his own grievances to raise,

too. China imports roughly 40% of its

oil through the Strait of Hormuz. So,

the American military situation in the

Middle East is not just a US political

problem, it's costing China money. And

Xi will want to make sure Trump knows

it. As Eli Ratner, who served as the US

Assistant Secretary of Defense for

Indo-Pacific Affairs until last year,

pointed out in the FT, "The US has made

this mistake before. The pattern is

consistent. When Washington backs off,

Beijing doesn't reciprocate. It

consolidates its gains." When the Obama

administration declined to challenge

China's island building in the South

China Sea, artificial reefs became

military installations. When Trump

paused tariffs in his first term in

exchange for the phase one trade deal,

China missed its purchase commitments,

and the structural reforms were deferred

to a phase two that never came. Ratner

argues that the time being bought isn't

being used to strengthen America's

position, particularly given that the

war in Iran has drained military

readiness for any potential crisis in

the Pacific. And all of this will happen

while the much larger geopolitical

issue, the future of Taiwan, hovers in

the background. A senior Taiwanese

official told Bloomberg last month that

what they fear most is being put on the

menu at a Trump-Xi summit.

China would very much like rhetorical

concessions on Taiwan in exchange for

those beans and Boeings. Whether they

get them is another question. So, the

two leaders will shake hands, make

announcements, and fly home. The

photographs will look very serious, but

the underlying problem, the one we've

spent this entire video explaining, will

not have changed. Trade imbalances are

not caused by lack of summits. They're

caused by domestic policy choices that

neither side appears willing to change.

China will continue to suppress

household consumption. The US will

continue to absorb the resulting

surplus, and the accounting will

continue to do what accounting does,

regardless of what anyone announces at a

podium in Beijing. If you found this

video interesting, you should watch my

video on China's rare earth chokehold

next. Don't forget to check out our

sponsor Mometrix AI. There's a link in

the description. Have a great day, and

see you in the next video. Bye.

>> [music]