The two most recent Capital Letters have been concerned with the economic threat China poses to the EU. The first was focused on the damage mercantilist Chinese competition was doing to Europe’s commodity chemicals industry but also touched on how Germany’s carmakers and engineering sector faced a similar challenge, a topic discussed in more detail in the second. The attacks on these key European sectors are themselves part of a more general surge in Chinese imports into the EU. This is likely to accelerate the pathway to deindustrialization already being paved by overregulation and the futile green “transition.” The implications for the finances of Europe’s more cash-strapped governments are grim, and, at least in certain countries, not too good for political stability either. None of this will sadden Beijing.
Mao, echoing Carl von Clausewitz and reflecting his own ideological obsessions, observed that “politics is war without bloodshed.” The same, under certain circumstances, can be said of Chinese mercantilism, a route down which Beijing has long since embarked. Deng’s reforms were never an embrace of economic and political liberalization. They were designed to replace the Maoist economic model with a system that could deliver the growth needed for China to catch up with the West and eventually establish the global preeminence Beijing felt it deserved. And, as was definitively established in Tiananmen Square, they were designed to do so in a way that did not disrupt the Communist Party’s leading role.
The result, despite red flags, Mao in his mausoleum and nods to the party’s historic heritage, is an economic model best understood as fascism with Chinese characteristics: Capitalism is harnessed to the ends of the state to yield returns that may be economic, political or geopolitical—it depends. China approximates a market economy, and a “private” sector is allowed to flourish, but, when deemed necessary, it is put to work in ways that advance the party’s or the state’s interests, a model well-suited to mercantilist trade policies.
Mercantilism goes back a long way in China. Writing for Engelsberg Ideas in September 2025, economist George Magnus notes that the Chinese idea of trade war (shangzhan) has roots that stretched back hundreds of years before being more formally articulated in the 19th century:
[B]y the 19th century and after – and perhaps not least as a response to the imperial carve up of China and the imposition of ‘unequal treaties’ – there was a clear emphasis on state support for commercial development. One of the leading advocates for a mercantilist political economy was one Zheng Guanying (1842-1922), who argued for state involvement in the revival of the domestic tea and silk industries, domestic cultivation of opium, subsidies for modern textile factories, and import substitution.
That’s not out of line with thinking—at least in principle— in much of the Western world at the time. Less convincingly, Magnus sees those ideas living on in the Maoist era. Maoist and, for that matter, Stalinist autarky had different intellectual, ideological and psychological origins, but Zheng’s thinking, described by Magnus as framing “trade as a mercantile tool and objective of states, rather than as an Adam Smith-type vehicle for mutual enrichment and the pursuit of comparative advantage” certainly applies to today’s China.
Whatever nice things Xi Jinping may say about free trade and open markets, he does not believe them. In the second of those two Capital Letters, I quoted Ian Williams, writing in The Spectator last month:
. . . the Organization for Economic Cooperation and Development (OECD) [had] calculated in a June report that nearly 60 percent of China’s gains in global manufacturing market share between 2005 and 2024 were driven by state subsidies. It says that Chinese companies in sectors including solar panels, cars and steel, received up to eight times more government subsidies than their peers in OECD countries over the two decades to 2024.
From Magnus:
China has always believed that, while it could exploit some features that come with more open markets, international co-ordination and the mutual benefits of reciprocal trade and commerce, its principal interests and focus should be on the mercantilist harnessing of trade and trade policy – the other side of the coin of industrial policy – in order to strengthen its military, industrial, financial, and technological power. . . .
China’s industrial policy is central to all policymaking, and anchors the so-called China Dream, which Xi first articulated in 2012 and according to which he has pledged the revival of China as an economic and military power, based around the centrality of the party, and his own role in leading it. Economic and trade policies and the accrual of currency reserves are joined by a broader strategy, based around a state-directed drive to make asymmetric economic gains at the expense of competitors and adversaries . . .
Thus, reported the Wall Street Journal’s Greg Ip in December:
Even as [China] imported critical technology from the West, its long-term goal was always self-sufficiency. In 2020, Chinese leader Xi Jinping codified this approach as “dual circulation.” This would, he said, “tighten the international industrial chain’s dependence” on China while ensuring China’s production was “independent” and “self-sustaining.”
And China will, one way or another, use that dependence to further its economic and political goals:
When the Netherlands took control of Dutch chip maker Nexperia from its Chinese owner for national security reasons, China barred the company from exporting chips from its Chinese operations, crippling auto-assembly customers. The Netherlands suspended its action.
Then there is the small matter of rare earths, an essential ingredient in an enormous range of modern products for which China dominates the supply and, even more so, processing. The Trump administration, the Europeans, and others are trying to break Beijing’s stranglehold in this area, but it will take time, and China won’t quietly watch its advantage erode. The next rare earths crisis is not far away.
Given China’s determination to pursue its export policy, it was somewhat surprising that the EU could seal a “shared understanding” with Beijing on hybrid vehicles. Under its terms, exports of Chinese hybrids to the EU are to halve. Perhaps China’s leadership doesn’t want to push the EU, a good customer after all (the EU’s trade deficit in goods with China rose to €1 billion a day last year), into a slump, at least until it is politically convenient to do so.
The EU’s economic commissioner Valdis Dombrovskis sees the agreement over hybrids as the first of many.
From Reuters:
“Those imbalances are not limited to the automotive trade. They go across a broad range of sectors and therefore indeed, we have to continue discussions on the rebalancing also across a range of other sectors,” Dombrovskis told Reuters on the sidelines of the International Monetary Fund meetings in Bangkok.
Dombrovskis did not name the other sectors, but EU officials close to the talks have mentioned chemicals, furniture, industrial machinery, steel and wind-turbine components.
“We need to deliver those, we need results, or we will have to take other measures. We have to address the imbalance,” Dombrovskis said, adding the EU was also keen on getting better access for its companies to the Chinese market.
It will, to say the least, be revealing to see how many other export “concessions” Brussels can wrest from Beijing. China is playing a long game and understands the virtues of patience.
Dombrovskis’s comment that the EU wants a greater share of the Chinese market is another reminder that Brussels still doesn’t understand the game the Chinese leadership is playing. If Brussels succeeds in that ambition, Beijing will use increased EU exposure to China to strengthen its hold over the bloc.
Economist Robin Brooks has been looking at what he calls a strategic repositioning by Beijing: a “complete reorientation” of China’s export sector away from undue exposure to the United States, but with no relaxation of its overall export drive. In Brooks’s view, any hope that Beijing might rebalance its growth strategy away from an export-led model is hopelessly naive.
In one post, Brooks sets out a series of country-by-country charts, almost all of which culminate in a near-vertical spike. The trend had been there for a while, but the pace typically picks up almost immediately after Donald Trump’s 2024 election. Beijing realized where things were headed (it wasn’t hard) and aimed to reduce its exposure to U.S. markets.
Brooks cites the following countries as examples of where this is happening: Hungary, Poland, Bulgaria, Jordan, Colombia, Paraguay, Ecuador, Suriname, Morocco, Mali, Liberia, Zimbabwe, Ghana, South Africa, Nigeria, and the Democratic Republic of Congo. Quite a few are small economies (making the spikes less of an achievement), but the range is notable, as is the presence of nations from Africa, a continent where China is making itself felt economically and politically in a way that the United States is not.
As Brooks emphasizes, this ramp-up is not cost-free. Breaking into new markets means discounting and margins taking a hit and, he argues, “a hit to margins and profitability in China’s export sector. It’s thus a deflationary shock.” Yes and no. Deflationary, yes. But to the regime in Beijing, it’s not so much of a shock. Its relative insouciance about China’s troubled domestic economy reflects its grip on the country and its priority of building industrial strength as the foundation of its geopolitical push and military might.
As discussed in a recent Capital Letter:
If the regime were pursuing a conventional (Western) economic agenda, it would boost China’s faltering domestic demand. Instead, it is weaponizing excess production by exporting at such low prices that competitors abroad will fail to thrive, or perhaps even survive, leaving China with the whip hand.
Brooks repeatedly emphasizes that China is playing a long game of which the broadening of its export game is a key part. Larger countries are not exempt. In a further post, Brooks looked at some more substantial economies, including the EU. Again, his charts show sharp spikes beginning not long after Trump’s 2024 victory.
From the Capital Letter, August 19:
China’s global trade surplus was $1.2 trillion last year. Of that, the EU accounted for €360.6 billion in 2025, a 15 percent increase over 2024, a trend bolstered by American tariffs as some goods that once would have been sent to the United States were diverted to the EU instead. Adding to the bloc’s pain, some of its exports to third countries have been displaced by the Chinese.
The UK is seeing the same thing. As are Malaysia, Thailand, Vietnam, South Korea, Taiwan (!), Mexico, and Australia. Even the United States is back to where it was in 2025. Some countries (including Malaysia, Mexico, Thailand, and Vietnam) are, Brooks believes, “transshipment hubs”:
It’s here that China’s export growth looks especially crazy, in a way that’s impossible to reconcile with consumer demand in these places. In my opinion, a good chunk of this is transshipment, so this stuff is going elsewhere, including to the US.
The biggest danger to China is that its strategy succeeds so well that it runs into resistance before Beijing is ready to cope. The WSJ’s Ip cited a recent report by economists at Goldman Sachs. It explained that previously a 1 percent increase in China’s output would raise the rest of the world’s output by 0.2% as China pulled in imports to “feed” the higher output. That calculation is no longer so straightforward. Countries that supply “outside” resources that China’s export industries still need (presumably a diminishing number) will benefit in the same way they always have. Other nations should see their purchasing power increase thanks to the increased supply of cheaper Chinese goods, but:
. . . that benefit is more than offset by the hit to their manufacturing sectors from Chinese competition. The upshot is that Goldman sees China growing about 0.6 percentage point a year faster over the next few years, but that will reduce the rest of the world’s growth by 0.1 point a year.
The biggest losers? Other industrial economies in Europe and East Asia, and Mexico.
As Ip notes, in the past other countries such as West Germany, Japan and later South Korea also built up large current account surpluses on the back of their export-oriented economies. This certainly caused friction. Longer term, however:
As part of the democratic West, they didn’t fear economic interdependence nor seek to eliminate imports. And as they moved up the value chain, they allowed lower-end manufacturing to migrate to poorer countries.
Including, one might add, China.
Moreover, those countries chased prosperity, whereas, as discussed above, China’s aims are far less benign: creating a Fortress China and building a trading advantage so strong it can be used to pursue geopolitical advantage and, in due course, hegemony.
And so, all but one of the G20 finance ministers attending a meeting in North Carolina at the beginning of September signed off on a statement calling on “countries with excessive and persistent external surpluses” to “remove distortions that constrain domestic consumption and that result in an over-reliance on exports for growth.” No prizes will be awarded for correctly guessing which country’s finance minister declined to go along.
America has already raised its drawbridge some of the way, and some emerging or middle-income countries also also beginning to push back.
Magnus:
China’s trade relations have become more equivocal or even worse in the last year or two across a swathe of emerging and middle-income countries. Mexico, for example, has raised high trade barriers on a range of imports from China, partly to help strengthen its US ties. Turkey imposed tariffs on Chinese EVs. Indonesia acted on cheap Chinese imports to protect local industries in labour intensive, low-value firms, while leaving untouched higher-value goods that Indonesia does not yet produce. Brazil has acted against Chinese steel and TVs to underpin local industrialisation programmes. Other nations including South Africa, Vietnam and Thailand imposed measures against Chinese e-commerce firms at the low end of the consumer goods shipments spectrum.
The pushback against China by emerging countries, even though China is such an important trade partner for many of them, is likely to persist. It shows rising international concern caused by China’s economic model, subsidies, overcapacity, and surging exports, and fears that nations harbour about either specific threats in key sectors, or more generally about premature deindustrialisation because of the flows of low-priced exports from the People’s Republic.
Magnus concludes that “it is hard to see how the fracturing of global commerce and the yielding to mercantilism can be stopped.” As far as the former is concerned, the die is already cast. While bilateral and multilateral (primarily regional) trade deals will continue, decades of momentum toward freer global trade have stalled because of geopolitical rivalry, anxiety over supply lines, worries about deindustrialization, and Chinese mercantilism. What matters for now is the extent to which countries can still protect themselves against Beijing. If they still can, they should not (and almost certainly will not) let free trade orthodoxy get in the way. Adam Smith would agree.
From an earlier Capital Letter:
Adam Smith argued against free-trading nations retaliating in kind against their mercantilist competitors unless retaliation had a real prospect of success. He believed that the benefits of even unilateral free trade (lower import costs, taking advantage of specialization, and so on) would outweigh the costs of dealing with a mercantilist counterparty.
But Smith also accepted that free trade’s advantages could be outweighed by a country’s need to be able to fight a war. “Defence,” he wrote in The Wealth of Nations, “is of much more importance than opulence.” He also understood how supply chains and national security were intertwined: “If any particular manufacture was necessary . . . for the defence of the society, it might not always be prudent to depend upon our neighbours for the supply.”
It is not prudent to be dependent on China. The question all countries should be asking themselves is how dependent they already are.
The Capital Record: Sound & Vision
We released the latest in our series of podcasts, the Capital Record. Follow the link to see how to subscribe (it’s free!). The Capital Record, hosted by financier David L. Bahnsen, makes use of two formats to deliver Capital Matters’ defense of free markets. The original podcast continues, but if you want to watch David talk, please click on the YouTube link.
The Crisis of Responsibility on the Right (Podcast/YouTube)
Whether it is woke-right groypers or “conservative” media pundits like Steve Deace who are supposed to know better, a movement is afoot to say that Gen-Z white men have been dealt a bad hand—and a spirit of victimhood is the way to reckon with it. But a free and virtuous society is not built by asking a politician to keep you off porn, and it is not built by blaming others for your problems. This episode of Capital Record is ground zero for how we think about society, and how we think of our own peace, joy, and opportunity within it.
The Capital Matters week that was . . .
AI
Foreign adversaries frequently manipulate American public opinion and policy toward their own interests by exploiting organic American concerns. The Soviets did that with American nuclear weapons and missile defense. Now, communist China is doing it with AI . . .
The U.K.
The U.K. has incentivized millions more people to fake or exaggerate disabilities to receive taxpayer money. Claims don’t even require a doctor’s diagnosis; just a government test of whether someone “can carry out a range of everyday activities.” Funds are handed out not only to replace the income of people who can’t work because of a disability, but also to those who can work but supposedly need help paying extra expenses from being disabled. Those latter payments are not means-tested, and they reduce Britain’s labor supply far below what it should be . . .
The Economy
Economic nostalgia has proven a potent force in modern American politics. Social media feeds are filled with decades-old receipts and price tags to show how cheap things used to be. Populists in both parties allege that most families can no longer support themselves on one parent’s income as they once did. Many claim that the essential components of a middle-class lifestyle have become less affordable over the past several decades . . .
Monetary Economics
Monetary policy has been described as the art of filling a bathtub to the brim without it overflowing — the tub being the national economy, the water being the amount of money within it. Fill the tub too low, and the economy lacks enough money to match its productive capacity, resulting in needless deflation and contraction. Fill it too high, and the economy suffers from overstimulation and inflation . . .
Immigration
For context, Microsoft has 121,000 employees in the United States. Nothing in that data suggests that the company’s immigrant workers hold the same positions as those who were laid off, or that there was any deliberate “replacement.” Vance also does nothing to distinguish “replacement” hirings of immigrants from regular turnover or entirely new roles. He lumps them all together and draws a misleading connection to company-wide layoffs . . .
The Deficit
The Congressional Budget Office (CBO) released its monthly budget review for September today, and the findings aren’t wonderful: “The federal budget deficit totaled $2.0 trillion in fiscal year 2026, the Congressional Budget Office estimates, $218 billion more than the deficit recorded in fiscal year 2025.” That’s up from February, when the CBO expected this year’s deficit to be only $1.9 trillion, and significantly higher than last year’s deficit of $1.8 trillion . . .
Inequality
The national inequality debate is asking the wrong questions. Pundits are cheering a recent Congressional Budget Office (CBO) report showing a decline in income inequality in the United States, but focusing on the mathematical ratio between high and low incomes distracts from more important questions: How are low-income people actually doing? Are they becoming better off in absolute terms? Effective poverty-fighters focus on real people, not ratios . . .
Trade
In August, the U.S. trade deficit hit a seasonally adjusted $106 billion, the highest total since President Trump announced his sweeping tariff regime and companies rushed to buy imports. Since those tariffs, the trade deficit has stayed around normal levels. But aside from the three months before Liberation Day, it has never been wider than it is now . . .
Tax
Last month, at a House Financial Services Committee hearing on international finance, Treasury Secretary Scott Bessent made a striking criticism. Asked about third-party litigation funding, in which outside investors, many of them foreign, bankroll lawsuits against American companies for a share of the proceeds, Bessent called it a “malignancy within our legal and financial system” . . .
ESG
By June 2024, BP was “pausing” its “offshore wind projects” amid investor discontent over its commitment to renewables. The discontent was that the company was decarbonizing too much, not too little.
Seven months later, the company announced that it was slashing spending on renewables while increasing it in oil and gas . . .
Housing
It must be viewed as courageous for Housing and Urban Development Secretary Scott Turner to announce an investigation of Wells Fargo for alleged racial bias in mortgage lending — bias that favors minority buyers. The bank, after all, had said as much when it described its initiative in 2022 as one that “will help close the homeownership gap between white and minority families created by decades of systemic inequities.”
Turner, himself African-American, said the bank’s “practice of dividing Americans based on race is immoral, unethical and un-American.” Moreover, “Wells Fargo and all of its employees that engaged in race-based decision-making should be ashamed of themselves” . . .
There is clearly a good case to be made that better use should be made of existing urban or suburban land, such as by easing the path for infill development, brownfield cleanup and redevelopment, and, with care, more flexible zoning rules. But the emergence of the technocratic obsession with “density” as an ideal rather than an option should not be allowed to stand in the way of greenfield development, too . . .
Tariffs
Fox News reported on a new Federal Reserve paper that finds that new tariffs have caused prices of U.S.-made consumer goods to rise in tandem with prices of imported goods. Without the tariffs, prices would have fallen moderately over the past year. Instead, they rose by about 2 percent . . .
John Puri notes the New York Fed study showing that tariffs have contributed to a rise in prices and says that is the point of tariffs.
It is true that the price mechanism is the tool of tariffs, but I’m not sure that higher prices are the point. In a free market (and our own market is the only one that we can, through our political efforts, make free), the price system should still work . . .
It’s true that if a tariff achieves its intended effect — boosting domestic production of a good — the price should eventually fall as supply rises. For Michael’s theoretical product, it might fall to $9 or $8.50, and it could hover around there permanently (assuming no general inflation). But tariffs cannot reduce the price of a good below its pre-tariff level. Prices may rise and then fall, but they won’t fall lower than where they used to be . . .
We learned from Hayek the principle of market dynamics, with “Competition as a Discovery Procedure.” Costs and production methods aren’t known in advance, they are discovered through competition. Puri’s argument assumes the opposite, American production costs are a fixed fact, and no amount of firm entry, scale, or experimentation will change it. This was the argument Hayek rejected, and now it is deployed to defend free trade. My argument is that market participants change their behavior . . .
Permitting
Congress is on the verge of fixing one of the strangest defects in federal permitting: an environmental review designed to be fast that has no time limitation.
Introduced on September 30, the Senate’s new Bipartisan American Affordability and Jobs Act (BAAJA) would, among many other permitting changes, impose a one-year deadline on federal permitting decisions for certain energy and infrastructure projects that do not require an environmental assessment or environmental impact statement . . .
Inflation
Elevated inflation still isn’t dead, even if the president, the Federal Reserve, and everyone else in America (except those who benefit from asset inflation) would like it to be . . .
International Economy
The IMF seems to be turning a blind eye to the real likelihood that the Treasury sell-off will accelerate in the year ahead. Next year, Treasury Secretary Scott Bessent will need to borrow $2 trillion to cover the budget deficit and roll over another $10 trillion in maturing Treasury bills and bonds. He will have to do so just as the foreign appetite for Treasuries is waning . . .
Antitrust
It may distress [Elizabeth] Warren that two of the hundreds of hot sauce brands available in the United States may be under the same roof, but that’s already the case: The spice giant McCormick already owns both Frank’s RedHot and Cholula Hot Sauce. So her real hang-up is that the maker of spices and two hot sauces may also soon produce (checks notes) a mayonnaise? Because hot sauce and mayo are interchangeable condiments, of course . . .
The Auto Sector
According to BloombergNEF, around 85 million new cars will be sold worldwide this year, a number that looks a little optimistic and a number that looks more than a little worrying.
Bloomberg’s Liam Denning notes that globally, car manufacturers’ capacity is estimated at 142 million cars, meaning that, treating the industry worldwide as an integrated whole, it is only operating at 60 percent capacity, far below the 80 percent rule of thumb required to break even (automaking is a capital-intensive industry) . . .
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