A Guide to the U.S.-China Trade Situation

2020-12-27 • economics guides long

I've tried to narrate an enjoyable overview of the current US-China trade situation in the form of a story, intended for the casuals who don't want to comb through dry academic papers and textbooks. We start with the very basics of international trade and build the pre-requisite knowledge as the story unfolds.

We'll look at:

  1. How the U.S. is trading it's productive capacity for higher consumption
  2. How this leads to excess debt and inflation
  3. How China's monetary policy and government subsidies support this behavior
  4. How this can all collapse

The insights are all from Sridhar Vembu and his posts, this the result of me thinking through them. I also lean on Trade Wars are Class Wars by Michael Pettis and Matthew Klein for support.

The benefits of delayed gratification

My three roommates and I have a coffee problem. We each make only $50 a day, but we each spend $5 a day on artisanal coffee. That's 10% of our salary. In two years we'd have collectively spent $14600 on coffee. Ridiculous. Something must change.

I make a plan. I tell my roommates, "Hey, we should all chip in and buy an espresso machine for $800. Then four coffees would only cost $2 a day instead of $20. We'd save a ton of money."

The roommates agree. Problem is, we don't even have close to the $800 needed to buy the machine. We've been spending all our money on coffee.

So, I come up with an idea. "OK, for forty days, everyone skip their daily coffee. And put the $5 you would've spent in this communal jar. Let's call it the Tax Jar. If we do this for forty days, we'll have enough for an espresso machine. And we'll get cheap coffee for life!"

After forty days, we buy the machine. Before the espresso machine, we were basically "importing" coffee from the outside world into our house. The four of us brought $200 a day into our home, but $20 of that is leaked out to some chain coffee company, who'll probably spend it on something useless, like stock buybacks. But now that we're self-reliant, we can put that $20 towards something that'll make our lives better. Maybe a flat-screen TV or a better washing machine. Or maybe even a coffee roasting setup, so we can spend even less money on buying coffee inputs and save more money.

A few months into the espresso machine purchase, one of the roommates, Bob, gets really good at latte art. He's making $7 an hour as a Wendy's cashier, and realizes he can make way more money by running his own artisanal coffee shop out of our house.

So Bob starts selling coffee to the neighborhood at $5 a cup. He makes $500 a day instead of $50. Our house is now "exporting" coffee. Bob the Barista uses the extra money to buy brand new speakers, a touchscreen fridge, and a vacuuming robot. The rest of the roommates are thrilled.

Not only did the espresso machine help us save money, but it was also a business opportunity. Bob 10x'd his income, and his success spread to the rest of the house, through all the cool stuff he bought. We can see here the benefit of limiting consumption (the daily coffee) to invest in "productive capital" (the espresso machine). This is the long-term strategy of a certain country, as we'll later explore.

Forfeiting self-reliance, outsourcing

Three years later, Bob the Barista is getting tired of the coffee business.

He's acquired bougier tastes. A robot vacuums his floor. An Alexa turns off the lights. And yet he still has to dig out caked coffee grounds from his espresso machine, make espresso machine repairs, and mop up spilled coffee.

This work is beneath him. He ponders hiring an employee, but doesn't want to look or deal with the paperwork, the management troubles, and the training.

Fortunately for Bob, I stumble onto something big on the internet. Barstucks: an obscure coffee delivery website.

Barstucks is a Chinese company that promises to deliver crates of brewed coffee to your doorstep at $1.50 a cup. I call over Bob the Barista.

Bob is thrilled. Before, it cost him $.50 to sell a $5 cup of coffee. But he also had to work 12 hours a day to run the shop. Now, the cost per cup would rise to $1.50, but he could just kick back and watch Netflix all day, handing customers a pre-made cup of coffee whenever they showed up. No more messy coffee grounds, and he wouldn't have to hire any employees. Amazing. Definitely worth the extra dollar cost.

He doesn't need the espresso machine anymore, so he sells it, and spends the proceeds on a huge Barstucks order. The plan works perfectly. No one tastes the difference. He starts making money doing next to nothing.

He wonders, briefly, how Barstucks is able to make it's coffee so cheap. Are the Chinese really that much more productive? Do they just live off tiny incomes? Why would they? It doesn't make sense. But who cares. Bob has found the key to success.

From manufacturing to marketing

Things are going great for Bob until one day a rival coffee shop opens up, right next door to his.

Bob does some sleuthing and spies a Barstucks shipment on their doorstep. They're running the same business as him!

Since the coffee tastes the same, customers just choose to go to whichever shop has the smaller line. Revenue is halved. Bob can no longer pay for his HBO premium subscription. Something must be done. He knows he won't be able to compete on price, since his lifestyle is too luxurious for lower margins.

He considers buying back the espresso machine. With the espresso machine, his cost per cup would go down $1. He could charge a $4 a cup instead of $5, and undercut his rival while keeping the same profit per cup. But making coffee is so much work. And Bob doesn't even remember how to make coffee anymore. He'd have to re-learn, and who knows how much time that would take?

Bob's niece, seeing his predicament, recommends look into "online marketing" to sway customers away from the rival store. Genius.

Bob downloads Instagram, Twitter, and TikTok and spends his free time tweeting coffee jokes, setting up photo shoots with models sipping his coffee, and dancing to popular songs while his niece pours coffee on him. He also makes a beautiful website with sentences like "Witness the extraordinary depth and dimension of Bob's third-wave, small-batch, hand-crafted coffee."

It works. BuzzFeed makes a video on Bob's coffee shop. Now, rather than see Bob's long lines and thinking "maybe I should try the store next door", customers see Bob's long lines and think "wow, this small-batch artisanal coffee must be really good! Look at all those people waiting!"

Dollar signs in his eyes, Bob spends more and more of his time on "online marketing". He changes his LinkedIn byline from "barista" to "growth hacker" and embraces his new digital occupation.

Bullshit jobs, debt, and inflation

The other roommates, seeing Bob's success, decide to start their own businesses. They emulate Bob's business model: import cheap goods from China, then do a lot of online marketing in order to sell it at a high markup.

Soon the whole neighborhood is in on the secret. People are selling each other "artisanal, small-batch" shoes, bikes, cell phones, and window cleaner. But no one makes any of it. They just market Chinese products they found cheap online.

The neighborhood sells all their soldering irons and sewing kits in exchange for vacuuming robots and champagne, celebrating this amazing discovery.

Amidst the celebration, Bob starts to worry. He was perfectly happy running his own scheme, but this seems too good to be true. No one is really making anything, but everyone is successful. How is that possible? Can a whole economy really be based on arbitrage? Buying cheap abroad and selling high at home?

To quiet his doubts, Bob phones up his old college economics professor.

Professor: "Bob! Of course it's sustainable! Weren't you listening in class? What America has here is simply a 'comparative advantage'.

The Chinese are just extraordinarily good at making real, useful, things at low prices. Rather than try and needlessly compete, we should focus on things Americans are good at. Like, abstractions. Social media management. Customer analytics. Investment banking. Trans fats. Blood pressure drug patents. Let the Chinese handle the TVs, the phones, the clothes, the plastics, the steel, and whatever else they do.

Then we can TRADE with them. This way, we both get to SPECIALIZE in what we're best at, while still getting access to everything we need. It's a win-win!"

Bob: "But we're not selling much back to them, right? They don't seem very interested in our... social media management. So, we're buying from them, but they aren't buying from us. So money is flowing out of the U.S. to China, but no money is flowing back. So, over time, won't they, like, have all our money? What happens then? Where will people get the money to buy my coffee?"

Professor: "Don't worry, Bob, we'll never run out of money. First of all, China doesn't want all our money. They need us to have money so we can keep buying their stuff. If we're ever low on money, they'll loan 1 us more! Right now, they're lending us $1.1 trillion dollars."

Bob: "So, they're giving Americans money to buy their stuff? That doesn't make sense to me. How would they profit if, at the root of it, they're the one's paying for the goods? Why not just... not make the trade at that point? Just keep the money in one place instead of moving the same money back and forth?"

Professor: "Remember that China is not one entity. The Chinese government is loaning the money, but the people profiting and purchasing are private corporations. If Barstucks itself was lending you money to buy coffee-- yes, that would be ridiculous, but it's the Chinese government lending to the American government, which lends to your neighbor, so your neighbor can buy coffee from Barstucks. Also, these are loans. Chinese lenders collect interest on them. They aren't just giving us the money for free."

Bob: "Wait, my neighbor is in on this? The rival coffee shop? He's spending borrowed money?"

Professor: "Of course! You were only able to start this business because you already had the money to get started. Your neighbor started with nothing. What's he supposed to do? He wanted to start a coffee shop but couldn't afford the espresso machine, the bulk purchase from Barstucks, the health permits, or even rent. That's the magic of debt, Bob. A good loan gives someone with nothing but a dream a chance to make it."

"But no one even goes to my neighbor's coffee shop anymore. My growth hacking killed his business. How is he going to pay his loan back?"

"Don't worry about the bankers, Bob, they've made their money back a long time ago! That's the magic of compounding interest and late fees. Even if your neighbor never pays his principle back, they'll still profit! These loans are foolproof!"

"What? I don't care about the bankers, what's gonna happen to my nei--"

"Forget the loans, Bob! We're spending too much time on these loans. Loans aren't the only way money comes back to the U.S. Chinese businessmen will also buy American assets, like land, homes, and businesses. For example, the Barstucks CEO just bought a huge apartment complex in San Francisco. That's $50 million dollars injected straight into the local economy!"

"But that money won't really help local San Francisco businesses right? Won't that money just sit in the bank account of the rich person who sold the complex? Is he really going to spend it at the local bodegas? He'll probably spend it on a team of three hundred growth hackers to market more stuff from China. Or invest in software that recognizes patterns in customer search history to see what color of handbag they're most likely to buy."

"Uh-- but-- the growth hacker employees will spend their money at the bodegas! The money will trickle down!"

"I see. But meanwhile, all the rent payments from that apartment complex will flow out to China, making the fundamental problem even worse. On top of all the interest they're collecting on the trillion dollars of debt they already hold."

"You're disagreeing with someone from Harvard, Bob! Harvard!"

"I see that in the short-term the money comes back. But in the long-term it seems like a terrible idea.

It actually sounds a lot like how private equity destroys companies. They sell company assets for one-time gains, and then rent them back. They have huge profits the year they sold all their factories or whatever, and pay themselves big bonuses, but all the renting ends up killing them in the long-term.

How is America going to create the wealth needed to pay back our loans if we're selling all our capital and land? This makes no sense. China is giving us a bunch of money and products and all we do here is compete to see who can market them the best. How are we supposed to pay back loans like this? Where is the new wealth coming from?"

"Bob, you're just paranoid. You're making money, right? You're neighbor is making money, right? You guys both have vacuuming cleaning robots. Clearly there is wealth being created! Just look around you, look at our GDP-- it's huge! Stock prices are at an all time high! If you were right, it'd show up in the numbers, so you're clearly wrong."

Meanwhile, in China...

Barstucks employee, David Li, is craving a pizza.

He's been video chatting Bob the Barista, who has been telling him about the wonders of American cheese bread.

He steps into a Pizza Hut. An American fast food chain with locations in China.

"One small cheese pizza please."

The cashier looks up. "That'll be 150 yuan."

"150 yuan?!? That's all the money I made today!"

The cashier looks tired. "So do you want it or no?"

"Bob says Pizza Hut is shitty fast food! 150 yuan?? For this abomination?"


"The cheese doesn't even look real! I can get a full fancy meal for that price. This is robbery."

"Sir, it's an American chain. American stuff costs more."

"What? Why is stuff from America so expensive? Are they that much richer than we are? They don't even DO anything. I know an American. Bob the Barista. He spends all day posting stupid pictures of coffee WE MAKE on Instagram."

"Don't know what to tell you. It's a strange world."

"Whatever. Fine. I'll try the pizza this one time. Here. 150 yuan."

"Oh, hold on. With tax it's actually 180 **."

"180?? No way. You're joking. Why are taxes so high?"

"Didn't you read the espresso example from earlier? "The benefits of delayed gratification"? If we all pitch in to the government now, they can give the money to Barstucks to buy more coffee machines. Then we all benefit more in the long run!"

"You know what? Forget the pizza. It's not worth it."

** Note: sales tax in China was not actually 20%. It was at 17% until 2018, when it dropped to 13%. But, according to Chapter 4 of Trade Wars are Class Wars, they limit consumption on the working class and limit wages in a variety of ways. I just lumped it all into sales tax to illustrate a point. I'll discuss the specifics of the consumption tax at the end of the series.

If the Chinese are so productive, why is Pizza Hut so expensive for David? We'll try to answer that question by looking at China's monetary policy.

Apologies if this part is more confusing than the previous. It's hard to explain it in just a page or two without assuming some prior knowledge. But after this piece, it's all straightforward. I'll start with the key takeaway:

The Key Takeaway

China keeps it's currency artificially weak. This weakens Chinese buying power in the global market, meaning imports are more expensive. But on the other hand, Chinese exports would look cheap to Americans, who have a relatively strong currency. This encourages American imports from China.

OK back to the story: Currency Pegs

David walks home from Pizza Hut. Heads-down, hands clasped behind his back, deep in thought.

We sell all sorts of stuff to the U.S, but their quality of life is so much higher. Like, Bob eats Pizza Hut every day. How does he afford it? Is our population too large? A big workforce would push wages down, I guess. Everyone is competing for the same jobs. And the income from our exports looks great in absolute numbers, but I have to remember it's split amongst hundreds of millions of workers. That must be it.

A flash of green on the sidewalk snaps him back to reality.

"What's this? An American twenty dollar bill? Just laying here? It must have fell out of some CEOs wallet! This is enough for that cheese pizza! A miracle!"

David scoops up the bill and runs to the local money exchanger.

There's one person ahead of David in line at the money exchange. It's the CEO of Barstucks. What a coincidence.

The CEO gestures to the three gigantic trucks filled with dollars. "I'd like to exchange ten billion dollars please."

The man at the kiosk replies, "Ok, at 6.7 yuan per dollar, that's... 67 billion yuan."

David's heart drops. Ten billion dollars?

David knew the basics of supply and demand. The CEO had just dumped ten billion dollars into the foreign exchange market. The supply of dollars will go way up. High dollar supply with the same dollar demand means dollar prices are sure to go down.

On top of this, people who day-trade, or speculate on, foreign currencies, might see this huge sell and think, Oh no! The dollar is collapsing! I have to get rid of my dollars too before the price goes even lower! Then they'll all sell their dollars too, and the price will drop even further.

At this point, David would be lucky to get enough for bread-sticks.

While waiting for his 67 billion yuan, the CEO turns around and sees David.

"David! Didn't expect to see you here! Just getting rid of the these ten billion dollars."

"Yeah. I saw."

"You know, I used to really value dollars. Rather than convert them, I'd save them. Or use them to buy stuff in America.

But now, I have three apartment complexes in San Francisco, a deserted two hundred acre ranch in Iowa, and own half of Bob's roommate's customer analytics company. And you know what? None of it matters. None of it feels real. I have to fly across the world to see my own property. What value does it really give me? And it's all a pain to manage. I spend all this time and mental effort managing and paying attention to these properties-- for what?

I mean, I guess I collect some money from rent payments and stock dividends. But a lot of Americans can't even pay rent for my apartments anymore. More of my units are going vacant.

And what am I supposed to do with the extra dollars from rent? Buying more property means more headaches. I could buy bonds, which don't need to be managed, but if you adjust for inflation, bonds give you negative real income! I'd be losing money! But, if I just hold dollars, I'll lose money even faster!

I started to think, what's the point of keeping dollars at all? Is money even cool if I can't do anything useful with it? Maybe I could buy an analytics startup in Britain. But what's the point anymore? There's only so much more money can buy. At least here, I can use what I spend my money on. Yachts. Limos. Luxury suites. It's not the best use, but at least it's fun for a bit.

So, I stopped investing in America and started selling all my dollars. But then I was worrying for a bit. Like, hm, if I'm thinking all this, all my rich friends are probably thinking the same. And if we all start pulling out of America and selling our dollar incomes right away, the value of the dollar will tank, and all the dollars I rake in from Barstucks exports will be worth way less.

But, somehow, even though all of us are dumping our dollars, the price doesn't move. It's amazing. I don't know how the bank pulls it off. I mean, I'm not complaining though."

"Mm. Yeah." David isn't listening. He's too busy calculating how far the dollar price must've dropped after that ten billion dollar dump. If only he got here twenty minutes earlier!

"Anyway, I'll see you at work tomorrow!" The CEO ducks into a limo.

David steps up to the window, praying.

David: "So... how much per dollar?"

The money exchanger: "6.7 yuan."

David's eyes light up. "Really!?!? That's the same price as earlier!"


"Don't get me wrong... I'm happy about the price... but... the Barstucks CEO's ten billion dollar sell really didn't move the needle at all? Ten billion?"

Exchanger: "Nope. Nothing really moves the needle. 6.7 yuan per dollar, 1 yuan for 15 cents. The rates fixed. By the central bank.

It's kind of a free market, in that businesses can buy the dollars. It's not just the central bank buying it all up. But the bank sets the price they buy it at. The bank says, if you want to sell a dollar, you have to sell at 6.7 yuan."

David: "Hm. But what if no one wants to buy dollars at that price? From what the Barstucks CEO said, they don't seem too attractive anymore. Would you turn people away? Force them to keep their dollars? Do you have hordes of dollars you can't sell?"

Exchanger: "Nah, if we can't sell the dollars to other businesses, the bank will buy up the excess, at the fixed rate. This happens a lot, actually, since the dollar is pretty overvalued 2."

David: "So, even if everyone has way too many dollars and just wants to sell them, the price doesn't drop? Why would the central bank want that?"

Exchanger: "Well, let's say they stop doing it. Right now the yuan is fixed at 6.7 yuan to 1 dollar. Let's say they let the market decide the price for itself. The price of the yuan would probably rise to 3 yuan for 1 dollar.

Right now Barstucks sells coffee to Bob at $1.50. At the fixed rate of 6.7 yuan per dollar, that would exchange for $1.5 * 6.7 yuan/$ = ~10 yuan a cup. But if the yuan appreciates to 3 yuan per dollar, Barstucks would only get $1.5 * 3 yuan/$ = 4.5 yuan per cup.

Barstucks expenses haven't changed. The minimum wage is still the same. Rent prices are still the same. Coffee bean prices are still the same. But it's revenue is halved. So it'd probably need to double its prices to make up the difference. Sell Bob coffee for $3 a cup instead of $1.50.

But there's no way Bob is going to buy at $3 a cup. He can't afford his vacuum cleaner robots with those margins. So he'd try to find a different supplier, in a cheaper foreign country. Or maybe buy another espresso machine, and start brewing his own coffee again.

And like that, we'd lose all our American business. American demand is whats keeping Barstucks alive. If Bob stops buying, Barstucks would go under. American money would stop flowing into China. The economy would contract."

David: "Hm. I guess cheaper yuan is a win for me right now, since I just found a $20 bill. But, normally, doesn't this suck for all the Chinese workers getting paid in yuan? Since our currency isn't worth as much as it should be, foreign products, like Pizza Hut, are way more expensive."

Exchanger: "Yeah. If we didn't fix the rate, the real yuan price might be one yuan for seven cents, instead of fifteen. That means Pizza Hut, which is probably determining their costs and pricing in dollars, would be half as much. Everything priced in dollars would be half as much. You could probably afford a trip to Miami."

David thinks of cheese pizza and clenches his fists. "So the government is giving manufacturers more yuan than they should. So manufacturers are richer. So the Barstucks CEO can buy limos. Where's the Chinese Central Bank getting the money to buy all those dollars for artificially high prices?"

Exchanger: "They print it."

David: "Ok, so not only are taxes high and wages low. Not only is the central bank giving the Barstucks CEO, who has ten limos, crazy deals for his dollars. But you're telling me they're doing all of this by printing more money? So my money is worth less? And the difference goes to my boss??"

Exchanger: "Correct! But remember the espresso machine example from earlier. Your boss could use that money to buy more espresso machines, which will help the nation's economy in the long run."

David: "No, no, I've heard this before. From the Pizza Hut cashier.

I'd buy that argument twenty years ago, but do we REALLY still benefit from Barstucks buying more espresso machines? It seems like the CEO has more money than he knows what to do with. He doesn't need more espresso machines. He just spent a hundred million dollars on a laboratory trying to grow pink-colored coffee. It tastes disgusting. Complete waste.

And the espresso example from part 1 lasted, what, forty days? Forty days is reasonable. I can do forty days. But the government has been talking about delayed gratification for forty years. I'm ready for my gratification. I can't even afford Barstucks coffee myself. What's the point of all these exports if I still can't buy my own coffee? If I still can't buy ONE SMALL CHEESE PIZZA?"

Exchanger: "In the grand scheme of things, forty years is not that long. You're too young to realize how far this policy has taken us. Forty years ago, China was struggling. Now we're a global superpower. Our average income per person has gone from $200 to over $10,000 dollars. Fifty times! You've been having your gratification, you just don't realize it. 3"

Back to America...

Bob's conversation with his old economics professor didn't comfort him much. He doesn't stop buying Barstucks coffee, but he begins checking the news obsessively. SOMETHING is off, he thinks, something must eventually give.

And eventually something does.


The feature image is David Li, Bob's friend and Barstucks employee, happily munching on an extra large, extra cheese, pizza hut pizza.

There's an interview with David in the article.

Anchor: "David, today marks the climax of your two year campaign against the Chinese government pegging the yuan to the dollar. How are you feeling?"

David through bites of pizza: "Very emotional Jim. I've been waiting for this day for a long time."

Anchor: "Beautiful. Could you tell the readers what made you start this campaign?"

David: "Well, I get why we had the currency peg in the first place. When you're poor, you want to make lots and spend little. So, to get out of poverty, China wanted to export lots and import little. More espresso machines that promote business and industrial know-how and self-reliance. Less pre-made coffee that only briefly satisfies the tastebuds.

But today, China is in a very different economic position. Far from poverty, we are a global superpower. And so our policies need to be different.

Chian is raking in more dollars than it knows what to do with. The government ends up hording trillions of dollars 4 in reserves because no one in China wants them. Yeah, the government loans a third of it out to the U.S. and collect some interest, but interest rates are super low. We put all this money and effort into exporting more, but the returns are diminishing. So why do we keep hurting workers to subsidize exports?

Well, the Barstucks CEO might say he needs to keep exporting. Because his coffee will go to waste if Americans stop buying, because not enough Chinese people want it. But the reason Chinese demand is low in the first place is because the government suppresses wages and taxes are too high! No one can afford it!

So the government should redirect it's money and efforts from subsidizing business investments and buying up dollars to paying Chinese workers more. This way Chinese consumers create the demand instead of indebted American consumers. The Chinese experience a higher quality of life and Barstucks keeps its demand.

Barstucks wouldn't need Bob's business if everyone in China started drinking Barstucks themselves. We don't have to stop exporting, but why keep up all these expensive currency tricks? They're just making Bob lazier and dependent, and jack up the prices of cheese pizza."

By the end of the article, Bob's face is pale. Weaker dollar? Lower exports? This is bad. He rushes to the Barstucks website.

His heart drops. Prices have doubled, from $1.50 a cup to $3.00 a cup.

He hears his roommate sobbing through the wall. His roommate was running a shoe dropshipping business, but shoe imports have doubled in price as well. The business will not survive.

Bob walks to the store. Some shopping might clear his head. Cheer him up.

Bad idea. Everything is double the price-- nail clippers, cell phones, TVs, toothbrushes. He can't afford a single thing.

A Harvard economics PhD in Neo-Keynsian theory bursts into the store panting. Crazed and wide-eyed he grabs Bob's shoulders and shakes him ravenously.

"BOB! BOB! LISTEN TO ME! I have a 0.1% interest loan for a million dollars with your name on it! How does that sound? Then you can buy anything you want."

"What? Where'd you come from?"

"There's no time for these questions! Just buy something, Bob, please. No one's buying anything. If you don't buy anything right now this store will shut down. All of the stores are shutting down."

"Where am I supposed to get the money to pay that loan back? My coffee shop is going to die. You give me a million dollars to buy a home and some nail clippers. Ok, then what? I'm a million in debt still with no way to make money."

"Uh, ok, ok, what if you take the money and buy an espresso machine! That'll save your coffee business right? We can rebuild our foundations! Get back to self-reliance!"

"Where am I supposed to buy an espresso machine? The guy who used to make the espresso machines became a growth hacker years ago! No one buys espresso machines anymore. I could buy one from China, I guess, but I don't even remember how to use one. And the old barista training school is now an MBA program!

And the biggest problem: even if I did make coffee, who would buy it?? My roommate can't even pay rent. People have bigger problems. No one wants artisanal coffee right now."

"We'll give your roommate money too!" The economist starts to froth and turns red. ""We'll give everyone money! They'll all buy the coffee!"

"Get a hold of yourself! The whole reason we got into this mess was you distracting yourself with money manipulation and "stimulating consumption with debt" while ignoring what PEOPLE ARE ACTUALLY DOING.

My roommate needs a REAL JOB that makes something REAL. Loans and credit card advances to buy coffee will not save him. That's ridiculous.

He's dedicated his entire life to taking pictures of shoes for Instagram. And we've lost the capacity to educate him in any useful skill because all of our teachers are now selling dropshipping courses and "life coaching seminars". We can't re-train him to be a factory worker because there are no factories. AH! I knew something bad would happen. It was too good to be true."

Epilogue: Twenty years later

Bob the Barista is now a farmer.

He pooled together his meager savings to purchase a cheap plot of land in rural Wyoming. In addition to growing his own foods, he grows coffee beans. He roasts them, grinds them up, and sells them to neighbors so they can make their own coffee with their cheap coffee makers.

One day, whilst sitting on his porch whittling wood, the mailman throws him a postcard. It's from David Li. Attached is a picture of David on a yacht eating a cheese pizza. "Wish you were here!" is overlayed in bad word art.

There's a message on the back: "Bob! How's it going? Hope there's no hard feelings about the whole currency de-regulation stuff. Anyway, I heard your roasting coffee now. For really cheap prices.

Listen, Barstucks doesn't want to deal with roasting it's own coffee anymore. It's boring, slow, and a pain to manage. And with wages on the rise, it's getting kind of expensive here.

So, I have a business proposition for you..."

Let's recap what we've learned in normal economic language.

The Reality of this Story

The first three parts of this story represent my understanding of the current U.S.-China trade situation. Part four is speculation. It's a vision of one possible way this fragile interdependence can collapse.

Let's see how the story relates to what's actually happening today.

Taxing consumption to fund investment

In the last forty years, Chinese economic policy has been discouraging consumption (daily coffee) to fund long-term investments (espresso machines). Coming out of the century of humiliation, there was a strong national desire for greatness. And so small present lack of later large gain made sense.

China discourages consumption directly, through high sales taxes, and indirectly. An example of an indirect method is requiring high social security contributions, while denying benefits to certain groups of low-income rural migrants, employing the "hukuo system" to do this. So they collect from everyone, but save money by only giving benefits to some. Basically, an indirect tax on the poor. If you're interested in the specifics, the details are in Trade Wars are Class Wars.

Remember, poor people can't save. They're spending their whole paycheck on food, rent, and utilities to get through the month. Economists call this "high propensity to consume".

Chinese economic policies move money from the poor, who will spend most of it on goods and services, to governments, who will invest it in infrastructure or subsidize the long-term investments of business (espresso machines).

The strategy worked well in the 1970s, because there were a lot of important projects that needed funding, and these projects had high returns. By cutting coffee spending consumption, more low hanging fruit could be funded faster.

But, in 2020, investment opportunities aren't as obvious. The government aims to maintain the same rate of economic growth with the same strategy of lots of investments, but businesses don't know how to spend all that investment money. They end up wasting it (maybe on a 100 million dollar laboratory making pink coffee). That's why David believes that it's time to shift government support from businesses to consumers.

(This is all according to Stage 3 of Chapter 4 of Trade Wars are Class Wars, this article, and the paper it cites).

Currency considerations

The currency peg is another way of cutting consumption to promote production.

A weak currency means Chinese businesses can't outsource their manufacturing to another country (also called "deindustrialization"), like Bob did. It'd be too expensive. This ensures productive capacity stays in China, the manufacturing know-how stays in China, and business investments stay in China.

Part of America's problem is the dollar is too strong. It's strong for various reasons (though all are up to debate). Some say 5 it's because it's the world's reserve currency. Most international trade is done in dollars, so everyone needs dollars all the time, which increases dollar demand. Some say it's because the U.S. is seen as the safest place to invest. Though as we saw with the Barstucks CEO, people might be changing their mind. 6

Whatever the reason, the world clearly likes U.S. dollars-- at least for now. Whenever the price of dollars drop, people (central banks, commercial banks, and wealthy citizens) will buy up a bunch of dollars and save them for later. They assume dollars will always be useful, so they should stock up when dollars are on sale. This keeps the dollar price high.

It's already a strong currency, but, as we've learned, it's EXTRA overvalued relative to the yuan, because of China's currency controls.

An overvalued dollar encourages Bob type behavior. American entrepreneurs can exploit their artificially high purchasing power to buy foreign goods for cheap and sell them high at home. Production of real things is outsourced, and America becomes a country of people who specialize in selling, to each other, what foreigners make for them. A country of dropshippers and marketing analysts. This is what we saw at the end of part one, where Bob sells his espresso machine, starts importing pre-made coffee, and becomes a growth hacker.

In part four, we saw the consequence of this dependence. America is gutting itself of the ability to make physical things. Imports are cheap for now, but if the prices ever rise, we're helpless.

If the costs of inputs to our economy rise ("cost-push inflation"), no amount of monetary "stimulus" can save us. This happened with oil price hikes in the 1970s. Harvard economists tried to spend their way out of the problem, but it just led to the brutal phenomenon of stagflation, where prices go up because of money printed inflation but all the printed money doesn't help with the root cause of economic turmoil..

A country of imports

Note that the fundamentals in the 1970s were much better than they are today. Back then, we had a trade surplus. We were exporters. We made stuff. Our main dependence was on foreign oil, and oil is a scarce natural resource, so it's more reasonable to import it. And even if America weren't importing oil, domestic scarcity could've led to the same predicament.

But today, we're dependent on far more than just oil. We're also dependent on our foreign relations with China, their monetary policy, their minimum wage, and their government spending. A change in any of these things could affect import prices for manufactured goods and destroy our businesses. It's a fragile situation to be in.

The modern American business cycle

Let's say I want to start a mattress company. Call it Tangerine. Here's how it'd go down:

Tangerine takes a business loan from bank. Tangerine imports cheap mattresses from China. Tangerine starts selling mattresses domestically for high prices.

Later on, Tangerine must begin to pay back loans. Tangerine is pressured to grow quickly in order to stop compounding interest payments.

Since Tangerine doesn't manufacture it's own product, it can't increase profits by refining the production process, or by coming up with a new amazing type of mattress. It's stuck with the same trendy mid-range memory foam mattress every other direct to consumer online store is selling. It can't add more value through it's product.

The only way Tangerine can sell more mattresses is by upping it's marketing spend. So Tangerine hires marketers and salespeople that specialize in convincing people that their mattress are somehow special, even though they're not.

Then Tangerine tries to get people to like them by aiming for great customer service. So they start overly-generous refund policies that cut into profits. And they hire an army of customer service reps to try and eke an advantage on the customer service axis. Tangerine borrows the money to hire these marketers and customer service reps, hoping that it will pay off in the long run. The marketers build a tasteless website full of upsells and timer countdowns and flashing deals, and Tangerine crosses it's fingers praying it works.

To compete with Tangerine, the few mattress companies that do manufacture in America start dumping tons of money into their own marketing. Otherwise all consumers will see is Tangerine, and they'll cornering the market.

And where do they get this money? They borrow it. This bidding for ad placement increases the cost of ads, profits of which go solely to the monopolies of Facebook and Google. So everyone is just borrowing money to waste on inflated ad prices that go to tech monopolies. This is what's happening to Casper mattresses. They're spending ungodly amounts of money on marketing, to try and compete with Nectar (made in China), and eating losses every quarter.

Where does our money come from?

Who's buying these mattresses? Who was buying Bob's coffee? Where do consumers get money to buy stuff in a deindustrialized economy?

In the story, Bob's neighbors were buying his coffee. In America, many consumers either work at other foreign-good selling specialist jobs, where they are indirectly salaried through government loans, or they take on personal loans and credit card debt.

If the U.S. is running a trade deficit, Americans are, in sum, buying more than they're selling. Businesses, overall, aren't profitable.

Many people aren't worried because they think it's fine for the U.S. to be in debt. As long as we can make the interest payments, who cares if "we're in debt". It's just an abstract concept at that point. It only becomes a problem if we default on that debt. And since all our debt is in dollars, the government can just print dollars to pay it off.

Of course, printing all those dollars will lead to inflation, but people aren't worried about about that either, because they believe all the borrowing we're doing is going into long term investments that will make our nation more productive. Real wealth will increase to match the inflation.

The last line is especially suspect. Businesses say "oh, all this debt is ok because we're just investing in our future! Don't worry, we'll be profitable later!" Maybe it's true in some cases. But looking at private equity buyouts, stock buybacks, and the complete lack of profitability or even consideration of profitability in this new wave of companies (Uber, Bird, Slack, Airbnb), I'm skeptical. Looking at what happened with WeWork, I'm skeptical.

So these useless companies (WeWork, Juicero, etc) are all popping up, throwing buckets of borrowed money at talented young people, that could be doing something useful, to instead dedicate their life to growth hacking juice-bag squeezers, and dumping more buckets of borrowed money on tactics that actually HURT the economy, like anti-competitive predatory pricing.

Meanwhile, companies that actually wish to make a valuable physical good, like steel, are at a disadvantage, due to the currency situation. And companies that don't want to take on massive debts are at a disadvantage, because their competitors are all borrowing hundreds of millions to undercut and out-market them.

No kid wants to be an inventor or mechanical engineer anymore. They aren't reading The Invention of Hugo Cabret. They're scrolling through thousands of TikTokers getting paid to do meme dances in overpriced leggings.

Why would you spend 11 years studying differential equations when Buzzfeed will pay you to record yourself eating donuts? Of course more than half of them want to be "influencers" when they grow up.

Why aren't more people talking about this?

People aren't worried about all this because America still benefits from its "best country in the world" image. I'm not saying America is in ruins. It's still a great country. But it cannot keep going in this direction. This year has surfaced a lot of structural issues. The terrible investments, the income inequality, and the social unrest 7 .

If reading history has can teach us anything, it's that everyone thinks their kingdom will last forever. And they're always wrong. We can only expect the unexpected, the black swans. And to prepare for the unexpected, we must focus on robustness.

A country so dependent on foreign monetary policy, investments, delicate international relations-- a country that cannot produce it's own clothing, surgical masks, transportation, or medicine-- that is not a robust country. Robustness comes from stepping away from the graphs and the 2000 column accounting spreadsheets and *just thinking through, what is everyone really doing? What are these 328 million Americans spending their time on 8? How can so many people just make money "on Instagram"? Is it sustainable? Is it sustainable even if X, Y, and Z change? If China stops propping up the dollar? If import prices go up? If lenders stop lending?

I guess we'll find out, soon enough.

Further reading

Trade Wars are Class Wars by Matthew C. Klein and Michael Pettis

A New World Order by Ray Dalio


  1. Loaning it back to us = the Chinese government buying buying U.S. government bonds 

  2. This is honestly just an informed guess on how their currency exchange works. There's a lot of conflicting information online, and the details are much more complicated. They also change year to year. For example, currently, China actually has two currencies. The CNH, which trades in foreign markets, and the CNY which trades domestically. The exchange rate for the CNY is fixed by the central bank. The exchange rate for the CNH is up to whatever the market thinks it is. However, the central bank will intervene in the open market, by buying and selling a bunch of dollars or yuan, to influence the price of the CNH. I think it's reasonable, for our purposes, to treat their monetary system as a black box in which they somehow fix the price of the yuan to the dollar. 

  3. Refer to this graph of global national income per person in China over the decades: https://www.macrotrends.net/countries/CHN/china/gni-per-capita 

  4. China holds $3.15 trillion dollars in reserves as of 2020. 

  5. I'm honestly unsure of this. The IMF says the dollar is overvalued by 6 - 12%. But is it because it's the reserve currency? A lot of people are saying that right now, but the arguments seem iffy, and there is some dissent. We can be more confident, though, in our explanation for why dollar is overvalued relative to the yuan. 

  6. Looking at this graph, net foreign investment from China into the U.S. has clearly stagnated after 2015. 

  7. The curious can refer to Ray Dalio's exploration of America's current situation 

  8. Bullshit Jobs, by David Graeber is one deep dive into this topic. I don't agree with all of it though, and I'll do my own analysis on the labor bureau data later on. You can look at the data yourself here