Zongyuan Zoe Liu: Capital, Consumption, and Competition in China’s Economy

Richard Gray

On today’s episode of Pacific Polarity, we’re talking with Dr. Zoe Liu, who’s the is the Maurice R. Greenberg Fellow for China Studies at the Council on Foreign Relations. Previously, she held post-doctoral fellowships at the Columbia-Harvard China and the World Program and the Fletcher School at Tufts University. Dr. Liu is the author of “Sovereign Funds: How the Communist Party of China Finances Its Global Ambitions” and “Can BRICS De-dollarize the Global Financial System?”. Dr. Liu, welcome to Pacific Polarity.

Zongyuan Zoe Liu

Thank you for having me.

Richard Gray

So to begin this conversation, I want to turn first to the Chinese bond and stock markets. In November, China’s issuance of $4 billion in sovereign bonds, denominated in US dollars, was oversubscribed by about 30x. And since September 2024, when China instituted a support package incurring buybacks and overall stock market liquidity, Chinese stocks have outperformed American stocks in that period. And so this carries over to the national champions revenue growth for the BATX, which is Baidu, Alibaba, Tencent, and Xiaomi has outperformed the Magnificent Seven in the United States during the same period. And so what do you glean from this demand for Chinese assets? And what does that tell us about where the two economies are heading?

Zongyuan Zoe Liu

First of all, thank you, Richard and Jersey for having me. Now, I would say China’s stock market was designed in a different way. Back in the early 90s, when the Chinese government started to launch China’s stock market, especially in Shanghai, the idea was not necessarily to support the growth of private companies. It was not about successful startups getting an IPO. Instead, the whole idea was to help state-owned enterprises to restructure themselves and to raise money.

Now, fast forward to today, China’s stock market, especially Shanghai and Shenzhen, the composition has changed. You have more companies, not necessarily just state-owned enterprises. But if you look at companies, especially the large capex companies, or in the more successful companies, as well as take a look at what kind of companies are allowed to or being green-lighted to be listed. I’d say many of those are in strategic sectors prioritized by the Chinese government. So from that perspective, I’d say China’s stock market or Chinese equities are less uncertain in terms of returns, as long as investors are putting money along the side of the national team. One of the largest shareholders of BYD is Central Huijin, which is one of the national team.

So from that perspective, I’d say, regardless of timing, demand for a Chinese asset, or for that matter, demand for emerging market assets fit into the theme of investors’ diversification strategy, portfolio diversification. And this works especially well in times of returns are low elsewhere.

But if we specifically talking about today, like why now, right? I think this speaks to two different things: one is the bet on China’s innovation and high-tech sector, especially sectors that are prioritized by the Chinese government, and then on the other side, it also speaks to investors diversifying amid rising geopolitical tensions, as well as the fragmentation of technology standard between the United States and China.

Yes, Chinese equity market so far outperformed, in some measures, outperformed the US, but this does not necessarily mean the equity market is more dynamic and more private market friendly.

Richard Gray

And so as a follow up, do you see it likely that the Chinese government will continue to encourage a bull market or do you think it will eventually be reined in? It seems that there are some general concerns about within the United States over financialization and potentially unsustainable price earning ratios of the American national champions, if you will. And then as a sideline of this, between Baijiu, BATX stocks, bonds and golds, what are your favorite Chinese assets of choice?

Zongyuan Zoe Liu

Yeah, this is a good—you know, as we are talking, as we are chatting now, I think gold price is at a record high now, right? And again, here is not necessarily an endorsement of any other currency or any other asset. It’s more about investors’ shaky confidence in the US dollar as well as dollar denominated asset. Part of the reason is because of concerns about U.S. physical conditions as well as central bank independency and policy uncertainty overall, right? But if you look at U.S. tech sector, I’d say, S&P 500 is doing pretty well, if you just compare S&P 500 with itself.

And since we’re talking about concerns about over-financialization or the bubble, I’d say China is not the only concern. I think here in the U.S. as well. So if you let me zoom in on China, I’d say the Chinese government has a good track record to deploy national champions to stabilize equity prices. During covid and in the run up to the trade war, every now and then you see news headlines saying that China’s national teams is being deployed to prop up equity crisis. But I would say these recent years, COVID and now, these are not the first time that national teams have been doing it: 2015, 2016 stock market crash, that was also when the national teams were being developed. And on top of that, China has dedicated domestic-oriented sovereign funds with the goal to finance equity market. So from that perspective, I’d say it really depends upon how you define a bubble. And if we define bubble purely from the perspective of retail investors’ speculation or listed companies’ share buyback or cross-holding, or the unconventional financing model, such as OpenAI and its suppliers or its users, then I just say, this kind of a concern about a bubble less applicable to the Chinese market.

Part of the reason, and perhaps very important reason, Richard, is what you were talking about, is the national champion. And more importantly, the Chinese government has been encouraging long-term patient capital to be deployed in China’s equity market. One such example is the encouragement of insurance companies and pension fund to invest in equity market.

Jersey Lee

So over the next few months, we’ll likely see a number of meetings between Xi and Trump as they attempt to hash out a broader trade settlement to the kind of now more low-level trade war going on. But that period will also see the start of implementation for the 15th five-year plan. So there’s a lot of talk about the ways that America’s domestic and international policies are increasingly interconnected and intertwined. What is the case for China, particularly in the economic realm?

Zongyuan Zoe Liu

Yes, Jersey, you’re right. At least President Trump is scheduled or is supposed to go to China for a state visit in April. But from now to April, there is quite a few months. So things can happen. But hopefully there is no drama, no unexpected accident so that the two leaders can meet. And I think that would inject momentum at least in the near term to investors as well as policy working level bureaucrats, to work on stabilizing the relationship.

But on the other hand, if we recall 2017 during President Trump’s first term, he visited China and the trip was largely considered as successful. But when he came back to the United States shortly after that, what happened was not just trade war 1.0, but also a global campaign against the Chinese tech companies from ZTE to Huawei. So I would say regardless of how successful or how great the trip is, there are structural forces in the bilateral relationship. That means we cannot be overly optimistic about how the trip can improve the relationship. It’s just not realistic.

Now, what this means for the Chinese economy, especially considering that this is also the time for the new five-year plan or the 15th five-year plan? I think so far the message has been very clear, right? The message is continued focus and commitment to self-sufficiency, to technology advancement. And on top of that, China has also been identifying the strategic sectors that it wants to develop, from quantum computing, AI and semiconductors, which basically means the China’s economic model remains largely unchanged, which is investment oriented, combined with a government set using industrial policies to achieve self-sufficiency and advancement in dedicated strategic sectors.

This means that, despite there has been a growing attention to boost household consumption, it is very hard for government to actually implement policies to achieve the desired goal of boosting household consumption. And let me be more clear here. The goal is not to necessarily boost the consumption. The need to boost household consumption comes from two things. One is the recognition of rising trade attention, and then the second one comes from the realization of overcapacity and the international consequences of overcapacity. So that is to say, attention to boost household consumption is not the goal in itself. The goal is really to continue to achieve self-sufficiency. And why China is so committed to achieve self-sufficiency? A very important reason comes from the realization of the bottleneck, especially with regard to technology that the United States have had over China and the strategic insecurity that the party as well as Chinese companies have experienced since the first Trump administration.

Richard Gray

You were talking about industrial policy just a moment ago. I guess in your mind, what are the things that make the ways in which China mobilizes capital unique? We all know some of the general downsides of industrial policy. Sometimes there’s misallocation of capital. Certain sectors are supported at different variants of time. So one sector might get support for one year, another for 10 years. So that means investors have a level of policy uncertainty about the stability of those investments for a long term. But it seems like a lot of the Chinese industrial policy bets have generally worked, across any number of areas in AI, biotech, EVs, lithium ions batteries, and things of this sort. And so how do you think about the ways in which China mobilizes capital, its ability to take on some of these tradeoffs and costs and ways in which, say, India hasn’t been able to achieve the same levels of success?

Zongyuan Zoe Liu

Yes, that is a great question. I’d say industrial policies are never efficient, so it would be inaccurate to say the use of industrial policies is to improve capital allocation efficiency. So that has never been the goal. But the use of industrial policies could achieve at least two things. The first is to create incentives for private sector as well as for international investors. And the second thing that industrial policies can do is to remove uncertainties. No capital, whether it’s green, whether it’s red, whether it’s blue, no capital likes uncertainty.

Now, the interesting thing about industrial policies from the perspective of private sector is that it removes the uncertainty. So from that perspective, I’d say, once the government give this give a clear goal saying that we are going to prioritize these areas—China, the banking sector in particular, it remains the dominant financial mechanism and the banks are state owned, especially the four largest banks. And they lend to not just state-owned enterprises. They also give preferential treatment to companies that make investment or companies that are dedicated to achieve certain advancement in sectors that are prioritized by the five-year plans or by government policies. So from that perspective, I’d say what China’s industrial policies can achieve is to create the incentive, remove uncertainties so that international investors as well as domestic private entrepreneurs are aligned with the government goals so that once your incentives are aligned, everybody just to march towards the same goal.

The downside of this, however, is that China is a big country and China is not a unitary actor. There is a central government, there are also local governments. So once the central government says prioritize the area, prioritize the sectors, you end up having all these local governments across different administrative levels follow through. And one of the performance metrics is how much, not just the GDP growth, but also how much you have achieved in delivering advancement in these dedicated strategic sectors. So you ended up having local government also compete with each other to attract investment, attract talent, attract resources to develop these exact same sectors so as a result you ended up having a very highly competitive domestic market in exactly the same sectors prioritized by the government.

The good thing about high competition is that the technology advancement would move forward very fast because only the best and the most efficient firms get to survive. But then the downside of that is, of course, waste of overinvestment, overcapacity, profit killing competition, or the so-called involutionary competition. So I’d say the net effect of China’s industrial policies is that multiple things can be simultaneously true. On the one hand, it’s extremely capitalistic. Competition is extremely high. But then on the other hand, firms’ profitability level is also very low. You have highly innovative companies, especially if you measure them by the number of patents they file. Chinese companies file like patents filed by Chinese scientists. Companies, universities are more now than the United States, but not all of them are making money. In fact, you have extremely innovative companies, but they don’t really make much profit.

Jersey Lee

So over the recent years, we’ve seen the U.S. government increasingly adapt various tools of Chinese economic statecraft, such as subsidies, industrial policies. And this trend has accelerated over the past year as the U.S. government is now taking direct stakes in companies in strategic sectors. And this is framed by some as learning from the Chinese. However, that may only be part of the Chinese model. As you say, the Chinese model is also underpinned by ruthless capitalistic competition between Chinese firms, which may play just as important a role in helping China become the manufacturing and export powerhouse it is today. So can Washington’s attempt to copy China work? And why is the U.S. seemingly not even trying to emulate the more capitalistic aspects of China’s success story?

Zongyuan Zoe Liu

Yeah, that’s the interesting part, which is oftentimes people are saying—at least if we take a step back by thinking about the time when China first joined the WTO, right? At least, many American policymakers’ idea at that time was as China becomes richer, China will become more like us, meaning converge economically and politically towards the West. But it looks like they are wrong. Not just China is not converging politically, but it looks like even on the economic arena, we are converging and we are more like China: using industrial policies and trying to have government ownership in private companies now.

I wouldn’t say the US or the West is less capitalistic than China. After all, the Chinese policymakers remain committed to call China as a socialist economy, building socialist with Chinese characteristics rather than pure capitalist. And the goal of the Chinese or the Communist Party of China and the Chinese policymakers is to use Western means, learn from the West without becoming it. They learn the management style, management quality, institutional design, and the technology in particular. But the goal is never to become politically or even economically like the West. And you see this in the policymakers extreme skepticism and suspicion about Western ideology. And you see this especially reflected by the party’s emphasis called for confidence. and the idea of building China as a cultural power. They import the emphasis of China’s traditional value rather than a wholesale copy of Western ideology.

And then on the other hand, I’d say the American government’s copying, whether it is Republican or Democrat in recent years, it seems that we are borrowing a page from China’s playbook, especially the use of industrial policies to achieve some goals such as green development, or in the name of Making America Great Again, and trying to do all sorts of things. I’d say a lot of this is not necessarily copying China per se, or considering China as the model that we wanted to follow. Quite the contrary, I’d say, it’s purely because America’s sense of defeatism among some of the politicians, as well as their constituencies, because in the past four decades, you see a dramatic change when you compare China and the U.S., there is a sharp convergence in terms of the number of billionaires in China and in the United States. That’s a sharp convergence. Over the past 40 years, China has, yes, you hear China become the second largest economy, but if you only look at the number of billionaires, over the past four decades, China produced more billionaires than the United States now. So that’s a very sharp, dramatic convergence.

But on the other hand, you also see the dramatic rise of inequality and the job loss, deindustrialization in the United States. And with China’s rise, with China taking a larger market share, it makes China the target or the boogeyman to be blamed. As a result, from America’s domestic politics perspective, there has become this bipartisan consensus of blame China. And it’s very easy to say, okay, so this is what China does. And because China has a government and the government is very powerful to make decisions, to do things, so let’s just do it.

I think that’s a narrative, that’s an oversimplified narrative without realizing that actually, in China there are also interest groups, there are also bureaucratic politics, there are also state-owned enterprises fighting against each other. And I’d say the idea of America is copying China’s industrial policy also overlooking the fact that our political cycles is very predictable, at least up until now, right? It’s every four years we go through an election cycle, whereas in China, it’s different. You see consistencies across different leadership. So from that perspective, and it’s already very clear now, not all Biden era policies are carried through in the current administration. So in short, I’d say the major difference between America’s so-called industrial policy versus China’s is that we are very much fragmented and short-term oriented. It’s very much about interest group and domestic politics oriented rather than a clear goal going forward: This is five years, 10 years down the road, this is the market share that we are going to achieve in our industrial policies. This is not how we design it. This is not how things are implemented. We don’t have the capacity to implement or to carry out industrial policies in terms of decades.

Jersey Lee

So the other side of the ledger, you talk about China’s need to boost domestic demand. In the lead up to last year’s fourth plenum, I saw some pretty serious suggestions that China might consider changing the incentive structure for local government officials so that they are promoted for boosting consumption instead of the old model of promoting them because they attract new investment. But this change doesn’t seem to have occurred at all. So what’s the state of play on that?

Zongyuan Zoe Liu

So I have to say, I have been skeptical about all the optimism about the government measures to boost consumption. Don’t get me wrong. Should China rebalance its economic growth model by less relying upon export-oriented and investment-driven, yes, sure. In terms of rebalance the growth model, such that it’s more sustainable, it ought to boost household consumption by increasing household income, allowing household to invest in different types of asset, and also boost social security, sure.

As you correctly observed, especially since last year, I’d say even since around COVID time, the Chinese government has put out several plans, several documents prioritizing household consumption ahead of investment. And hence, a lot of commentators suggested that the Chinese government will boost household consumption. This is going to be their priority.

I have been very skeptical about such optimism, and there are three reasons. The first reason comes from numbers. The fact that economists and analysts debate whether China has an under-consumption problem, reveals that the number, the statistics are very messy. There is a lack of good numbers to accurately measure the contribution of household consumption to GDP growth. Now, based upon Western standard, which is also adopted by a measure that a lot of Chinese economists use, as well as National Bureau of Statistics has its kind of number. By this kind of measurement, household consumption is merely 36 to 38 percent of Chinese GDP. But the critics would say, this is under-measurement because you did not take into consideration of the in-kind consumption and the in-kind support. Fair enough. But even if you get everything all together, is the Chinese household consumption world average 60%? Many people’s measures suggested that no, actually not. So either way, I would say we have a numbers problem which basically means the government understand, we ought to solve this measurement problem first, so that’s the first place. That’s the first reason why I think boosting household consumption is very challenging, if you do not really have a good understanding of how much actually household consumption is contributing to your GDP, then you don’t really have a good idea of how much exactly you want it to boost, to which level, so that’s that.

And then the second part has something to do with numbers, but it also comes down to the cost of living or purchasing power across China. Purchasing power is not equal across Chinese cities or provinces. And this speaks to a lot of the cause of optimism about government stimulus, especially direct deposit or direct stimulus check. I have long doubted that they are going to do this. And it’s not because they don’t have the mechanism—[everyone] has a bank card with one of the four major banks and your social security card is with one of the major banks. So they have the mechanism, but why they have the mechanism and yet they haven’t done it? I think this is politically very sensitive, make sure that you are you are doing it right, you are not making people angry. And the reason I say this has a lot to do with the purchasing power inequality across China. For example, for people living in Shanghai versus the people living in Sichuan or the Chinese rust belt in Dongbei or Dongbei provinces like Jilin or other places. If you give everybody, say, a hundred, a thousand RMB a month as a stimulus for consumption, then people living in Shanghai would say, well, this is unfair because our cost of living here is much more expensive. So they would make the unfairness argument. But if you say, okay, so given that cost of living in Shanghai is more expensive, we give Shanghai people more money, say give them like 2,000 or 3,000, whereas other cheaper places, we give them less money. Now, of course, this is by definition unequal distribution. And of course, other people will be not happy, would make the argument saying that people in Shanghai already have a higher salary, their average income is much higher, why are you making richer people richer, right? So I think that’s so that is politically very difficult to make sure you can do this without making people not happy.

Then the last bit has to do perhaps with other concerns of physical capacity and embezzlement. Because local government fiscal situation is already very constrained. And we are going through cycles of cleaning up the off-balance sheet debt problem, largely due to the collapse of property market. And then the other part of that is, okay, so realizing that the local government has fiscal constraints, then if we rely upon central government delivering this payment, then it’s hard to avoid embezzlement or misallocation, misappropriation problem. So I’d say the calling for optimism for the Chinese government to boost the household consumption is perhaps a little bit too over the top. And so far we haven’t really seen any concrete measures the government has taken to boost the household consumption. But I’d say they have been doing something in the right direction. Meaning, for example, the government has been asking the statistics department to do a better job understanding the numbers. So once they have a better understanding of the numbers, that would help them to develop a mechanism as well as a benchmark and a standard so that we have a better understanding of how to distribute, whether it’s direct stimulus, or which area and what are the mechanisms more suitable for each province.

So I think going forward, I’d say with a better number and a better mechanism, they might develop a province-by-province model plan to boost the consumption; rather than central government have a centralized plan, it might be a more likely scenario would be central government to provide a guiding principle and then all the different localities, they have their own way to boost the household consumption. Now, would the government make this a leading KPI to promote local officials? It’s hard to tell because again, promoting household consumption is not a strategic priority, strategic priority is to achieve technology self-sufficiency. So even if they are going to change the composition of local officials’ KPI measurement, perhaps the measurement or the indicator that will carry more weight would be how much progress you have made in terms of achieving technology progress. It’s unlikely going to be how much you have boosted household consumption.

Jersey Lee

So my personal theory for the lack of concrete measures boosting local consumption is that it might entail rather radical reform, particularly the change KPIs of local officials. And this goes against Chinese political culture, which has especially recently trended towards ever greater conservatism and caution. Specifically, even though an export-led growth model is not sustainable in the long term, it has taken China this far already, and there’s probably a bit more juice to be squeezed globally. Meanwhile, China is at a critical stage of its competition with the US, and now would be the time to move steadily forwards based on what’s worked in the past, instead of rocking the boat and introducing uncertainty to a trajectory that has broadly favored China. Some others have also argued that demand-side consumption boost will largely end up helping foreign firms make more profit, given that Chinese firms lack profit margins, given what we said before, so perhaps if China were to do something serious, it might be as a concession to the U.S. in the ongoing trade negotiations. What do you think of this?

Zongyuan Zoe Liu

I think that is valid, those arguments are certainly valid from a broader geopolitical point of view, right? The idea that, oh, you know, like China cannot be viewed as yielding to external pressure to boost consumption, like because boosting consumption is something that in the U.S.-China bilateral dialogue, overcapacity has been a concern. But up until recently, I guess last year, Chinese officials had been consistently saying that China didn’t have an overcapacity problem. The global market is big enough. There is a lack of capacity, no overcapacity problem.

But since last year, the Chinese officials have been talking about, have been acknowledging China’s overcapacity challenge. And I think this is a realization, of not just external pressure, but also they realized the inefficiency and the cost to Chinese economic growth. And think about it. Given that technological upgrading in China is so fast, we are literally talking about, especially in EVs and batteries and solar panels, we are talking about, we are measuring the timing of progress in terms of weeks, not years, which basically means massive fixed asset investment is immediately going to become outdated. So that is a risk, right? So from that perspective, I’d say, China realized probably they do have very capable and very informed policy makers as well as policy analysts and economists. So they do realize the risk of out-of-date fixed asset investment. So from that perspective, I’d say they need the domestic market to consume some of these redundant industrial capacities.

But to what extent this relates to boosting Western firms’ profitability at the cost of Chinese firms’ profitability? I’m kind of skeptical in the sense that, you know, Chinese companies and Western companies, they have different business models, right? And companies have different ways to make profit. And in a way, the most innovative companies are not necessarily the most profitable because companies can get revenues from different sources. Chinese companies have long been operating on I build, I invest, they are very good at process streamlining so that they can lower the cost and sell it at the international market. And you sell big. The whole idea is you can sell at a cheaper price, but production capacity is massive, you can sell at a lower cost, then ultimately, pure quantity means you can get more profit.

But Western companies’ business model seems to be different, especially American companies, through technology innovation, they focus on higher quality than next generation. They focus on making, say, not mediocre product, but perhaps the best of the best. As a result, through innovation, the price would be high, but we are not selling massive quantities. And on top of that, American companies also dominate for a long period of time IP. So American companies, especially the high profit margin companies, they are light in asset, but they are high in IP in value. And then for those companies that have already achieved near monopoly status like Boeing. Even if you are not necessarily as innovative as you were before, because of a monopoly, because of a high entrance barrier, it also means that you can at least make money up until you destroy yourself.

So from that perspective, I’d say I’m skeptical about the argument of if Chinese people are consuming, then Western companies are benefiting. In fact, I’d say if we really do unleash Chinese middle class consumption power, there will be global consequences because China has a lot of people, and Chinese companies also absorb a lot of industrial input. So if Chinese consumer’s consumption power get unleashed, you ended up having a big country with 1.4 billion people consume a lot. A natural consequence of that would be rising commodity prices here and there, right? And remember the times when Chinese people just discovered avocado, and global avocado prices went up. And when Chinese people discovered, started to like adding cream, heavy cream and milk into their tea, then of course global dairy price went up. So I’d say, we ought to be careful of what we want China to achieve.

Richard Gray

So I guess a lot of what we’ve talked about is how the United States and China mobilize capital to build different industries and sectors. And one of the complications of this, of course, is it gives leverage and tools in which can be utilized against other actors. And so as you think about the economic statecraft dimensions, one of the big problems now is there’s a high level of incompatibility between, say, American sanctions and Chinese anti-sanction mechanisms between American export controls and Chinese export controls. American trade agreements, which have transshipment stipulations, that like Malaysia, Indonesia and Cambodia have signed on to, which now China wants to look into; and so for third actors and multinational companies, the ways of interacting with both the Chinese and American global economic footprint is getting quite complicated. So how do you think about the future of both the US and China tit for tats, but also the way that other actors try to build resilient companies and economies in such an environment?

Zongyuan Zoe Liu

That is a very tough question to answer, Richard, I have to say, because as a result of these two countries’ tit-for-tat retaliation against each other, the world now becomes this regulatory labyrinth. It becomes more and more difficult, if not entirely impossible, for multinationals to be able to be in compliance with regulations in China and the United States, especially in sensitive sectors that are very likely to be subject to either export controls or some other types of regulatory issues, regulatory change.

So for multinationals, I’d say the bottom line is that both the United States and China are a very important market that no multinationals would want to lose, and if you are a consumer goods product producer, or you operate in not so sensitive sectors, that’s fine. Consumer goods or necessities, fine. The chance of being subject to export controls are less. But that also means these kind of companies, especially if they are massive, they are likely to become the target of boycotting, for example Walmart or some major airlines, and another example would be Japanese or Korean companies; whenever there is a national interest conflict going on, you end up seeing China weaponize its consumer power, boycotting foreign companies, whether it’s Toyota or Lotte.

But then on the other hand, the weaponization of either China’s dominance in industrial supply chains or critical minerals or inputs or the weaponization of market access, or the US weaponization of its dominance in payment system or financial infrastructure, all of these overuse of power have led other countries to build their alternatives. From companies’ perspective, this also means that they simply would have to hire more experts in compliance; this is not necessarily good news, because it raises operational costs but then on the other hand companies may eventually develop a strategy of you just separate your China and the US operation. Rather than have a global operation, you ended up having a US operation and a China operation and the rest of the world. So what that means is we ended up having, especially for companies operating in sensitive sectors, their operation cost and their legal compliance cost would likely to go up.

Jersey Lee

So in 2022, you authored a report on the role of BRICS as a coalition to build out de-dollarization initiatives. What’s interesting is that with Trump’s threats against allies, even Western countries are now whispering about de-dollarization, with Denmark at one point threatening to dump off its treasury bonds. So where do we stand today on de-dollarization and how have these risks escalated over the past year? And is it even in the U.S. interest to maintain dollar dominance, which some argue might run counter to the goal of re-industrialization?

Zongyuan Zoe Liu

Yeah, I’d say the dollarization is a trend that has been going on for a long time, especially among countries that are subject to U.S. sanctions, financial sanctions in particular. But right now, when we are talking about U.S. allies, their motivation is not necessarily because they wanted to avoid sanctions, but rather it’s an expression of their frustration and lack of confidence in the current U.S. government, as well as more broadly in the predictability of American politics. Again, no capital likes uncertainty. So especially for allies in the name of improving their own economic security, it’s natural for them to diversify away from a type of asset that they thought or used to be risk-free, and once they perceive the risk increases, it’s natural for them to at least threaten to diversify.

But so far, I’d say there is no alternative to the US dollar. The so-called TINA phenomenon is still there. But by no means, this means the dollar’s dominant currency status would last forever. And the lack of an alternative, whether it’s euro or renminbi or yen, doesn’t mean other countries would be content to be subject to U.S. dollar’s exorbitant privilege.

De-dollarization has different goals for our allies. Their goal might be risk mitigation, not necessarily financial sanction risk, but really the opportunity cost. But for countries like China, like Iran, like Russia, it is not that they are willing to de-dollarize their system, because major commodities are still being priced in US dollar, and it’s also way easier to just use dollar in international transactions. But for countries that are subject to sanctions, diversify away from dollar is like buying insurance; you buy insurance hoping that you don’t have to use it, but in case you need it, you have this alternative payment and settlement system, so that you can keep your trade going. I think this is a fundamental motivation for countries like China and Russia to develop an alternative system. China does not want to dethrone the US dollar, but it does want to make sure that it can continue trade and international settlement, because after all, China remains the world’s largest trading economy.

Richard Gray

One of the, I guess, more macro concerns as the Chinese state thinks about its economy and economic reform is the risk of capital outflow. And there were some uptick of this during COVID, where consumer spending dropped, when Chinese firms were internationalizing as their position solidifies within their domestic market. And so how do you think the Chinese government might deal with trade-offs between making inbound investment more accessible without encouraging capital flight?

Zongyuan Zoe Liu

I’m not exactly sure the Chinese government, or for that matter Chinese companies are as eager to take free money as before. China, in the name of self-sufficiency, a lot of companies in strategic sectors get a lot of government support. And China also has a very booming domestic venture capital space and PE and all that. So they are no longer eager to take foreign money from many years ago. The idea is that if you take foreign money, especially American money, there is a chance that either the money will pull away or you get sandwiched in between. That has become a phenomenon.

But in terms of the capital flight, that is always a concern for the Chinese government. And over the years, we have been consistently tightening capital control. And a perceived game changer is the stablecoin, because that becomes a very convenient vehicle for Chinese exporters to store their asset in a system that outside of the Chinese government purview, so easy to move asset overseas. And that’s why I think very carefully studying what is going on in the stablecoin market—And Hong Kong is tentatively trying its own stablecoin experiment, but so far they haven’t really moved forward yet.

[The problem] here is that, yes, they are concerned about capital control, but they need to figure out how to maintain capital control while have a competing vehicle to the dollar backed stablecoin. I see latest development is they allow the E-RMB to take interest; that’s a very interesting uh move for move by the Chinese financial regulators; the idea is that you allow to pay interest, so that at least incentive for banks to promote it can be higher. But will this be successful? It is questionable, because the incumbent digital payment format is WeChat pay or Alipay, and it’s just hard to for people to switch platforms.

Richard Gray

All right. Well, thank you so much, Dr. Liu, for your time.

Zongyuan Zoe Liu

Thank you guys for inviting me and good luck with everything.

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