What China is Really Doing With Its “Giant Surpluses” | Brad Setser on China’s Export Dominance, Trade Strategy, and Capital Flows
Timestamps are as accurate as they can be but may be slightly off. We encourage you to listen to the full context.
Podcast Summary
In this episode of Monetary Matters, host Jack sits down with Brad Setzer, the Whitney Shepherdson senior fellow at the Council on Foreign Relations and expert on balance of payments. The conversation examines China's massive trade surpluses that have grown to over $1.2 trillion, representing a fundamental shift in global economic dynamics. (01:22) Setzer explains how China's exports have increased by a trillion dollars over the past five years while imports have barely moved, creating profound imbalances affecting manufacturing globally from Germany to emerging economies like Chile and Indonesia. (02:59)
- The discussion spans China's evolving currency intervention mechanisms, the effectiveness of Trump's tariff strategy, and the implications of massive capital flows on global financial markets and dollar strength.
Speakers
Brad Setzer
Brad Setzer is the Whitney Shepherdson senior fellow at the Council on Foreign Relations, specializing in balance of payments and international economic analysis. He previously served as a senior advisor to the US trade representative in the White House and as deputy assistant secretary for international economic analysis at the US Treasury, bringing extensive government experience to his current role analyzing global trade flows and currency dynamics.
Jack (Host)
Jack is the host of Monetary Matters, a podcast focused on global economics and financial markets. He brings expertise in tracking capital flows and market dynamics, particularly in ETF flows and international investment patterns.
Key Takeaways
China's Manufacturing Dominance Creates Global Imbalances
China has fundamentally restructured the global economy through its massive manufacturing expansion, with exports rising by a trillion dollars over five years while imports remained essentially flat. (03:04) This has created a $1.2 trillion customs goods surplus that represents more than a percentage point of world GDP. The impact is profound - it's deindustrializing parts of Europe like Germany, forcing emerging economies like Chile to close steel foundries, and making it difficult for countries like Indonesia to compete even in lower-end manufacturing sectors like apparel and textiles. This represents a deliberate choice by President Xi to support manufacturing over household consumption, creating structural imbalances that affect global trade patterns.
Currency Intervention Has Evolved Beyond Central Banks
China's approach to currency intervention has shifted from direct central bank action to a more sophisticated system using state commercial banks. (05:28) Rather than the People's Bank of China directly buying US treasuries, Chinese state banks now accumulate foreign currency and invest it more diversely through their own balance sheets. This creates a trillion-dollar foreign currency balance sheet among Chinese banks, making them major players in global funding markets similar to Japanese commercial banks. The mechanism operates through daily currency fixes that coordinate state bank buying, creating a more distributed but equally state-controlled intervention system.
Tariffs Have Created More Optical Than Real Trade Shifts
Despite significant tariff increases, the fundamental trade imbalances remain largely unchanged, with most shifts being cosmetic rather than substantive. (10:36) The primary effect has been moving final assembly operations from China to countries like Vietnam and Malaysia, but using 95% Chinese components. This "assembly shifting" doesn't reduce China's trade surplus, doesn't significantly enrich the assembly countries, and doesn't reduce dependence on Chinese manufacturing capacity. The real changes in US trade volumes came in categories that won't be tariffed - pharmaceuticals and gold - while heavily tariffed sectors show only modest import reductions without corresponding increases in US production.
Corporate Absorption of Tariff Costs Is Temporary
Companies are currently absorbing most tariff costs rather than passing them to consumers, but this is unsustainable long-term. (16:44) With tariff revenue representing about 1% of GDP and import prices not falling, the burden falls on corporate margins rather than foreign suppliers or consumers. Ford and GM's struggles exemplify this dynamic as auto companies face significant profit pressure. Economic research suggests 60-70% of these costs will eventually pass through to consumers, potentially adding roughly half a percentage point to inflation. This corporate absorption represents a temporary buffer that will likely erode over time.
Investment Deals Represent Misguided Policy Priority
The administration's focus on massive investment deals with countries like Korea ($350 billion) and Japan represents a fundamental misunderstanding of economic policy according to Setzer. (56:58) These deals essentially give foreign countries control over US investment profits while requiring continued currency weakness to function. Rather than addressing currency undervaluation directly, which would naturally incentivize foreign investment through market mechanisms, the deals create government-managed capital flows that lack congressional oversight. For critical national security sectors like rare earth magnets or advanced semiconductors, Setzer argues the US should fund its own industrial policy rather than relying on foreign-controlled investment vehicles.
Statistics & Facts
- China's manufacturing surplus has grown from $400-500 billion to $1.2 trillion over recent years, representing changes of the magnitude of a percentage point of world GDP. (02:43) Setzer emphasizes this represents exports up a trillion dollars over four to five years while imports have barely moved at all.
- US tariff revenue currently represents about 1% of GDP, collected on roughly 10% of GDP worth of imports excluding oil. (16:00) Despite announced tariff rates, the US isn't collecting everything expected due to numerous exclusions and deals.
- China's currency has depreciated 15-20% in real effective terms since roughly 2021, which translates to 2.5-3 percentage points of higher trade surpluses using standard trade elasticities. (54:41) This depreciation coincides with China getting 1.5 percentage point average contribution from net exports.
