The newest National Defense Strategy just delivered to Secretary of War Pete Hegseth calls for refocusing the Department of War on domestic and regional missions instead of global adversaries like China and Russia. The document – supposedly the work of Under Secretary of War for Policy Elbridge Colby – overturns decades of received interventionist wisdom.
This may surprise many given our boy Colby had been a principal advocate for a robust and muscular “Strategy of Denial” to counter China. But perhaps our Under Secretary of War for Policy actually is a realist and not, against all prior evidence, a low-watt Washington nepo baby (see here).
In his confirmation hearings, young Colby did display surprising flashes of realism declaring, “Taiwan is very important to the United States, but… it’s not an existential interest.”
Should we be surprised at all? Han Feizi is not (see here, here, here and here). C’mon folks, what is this “Department of War” nonsense if not a desperate attempt to puff out one’s chest after realizing the deficiencies of the US military?
Did the Under Secretary get a look at proper intelligence and data once ensconced at the Pentagon? Or was the conclusion predetermined by the whims of a mercurial president? Does it matter?
China just put on a bravura military parade, showcasing whizzbang weapons systems which military nerds will spend countless hours analyzing and dissecting on social media.
China appears to have replicated the speed of its EV industry (see here) in its weapons programs, launching new military hardware across a range of applications – missiles, drones, fighter planes, helicopters, submarines, warships etc. – at an unfathomable pace (see here).
Of course, it is not unfathomable at all. Like China’s auto industry swamping the world with new models, the country’s defense industry is able to develop weapons at a blistering pace because China’s universities pump out 6.7 times the number of engineers as US universities every year.
A defense climb-down is not the only one in the offing. The Trump administration recently extended tariff negotiations with China by another 90 days (which, given the appellate court ruling against the president’s use of the “emergency” clause, may prove moot).
This comes on the heels of announced trade deals with Vietnam, Japan, the EU and Indonesia among others, as well as punitive actions against India, Switzerland and Brazil – for whatever reasons.
We will not expend too many brain cells trying to divine a method to Trump’s madness. What is fairly obvious is that Trump only clubs baby seals. And China is not a baby seal.
The 90-day extension is the third time Trump folded in negotiations with China. The first time was 90 days prior in Geneva, after multiple rounds of escalating tariffs threatened to empty US store shelves and freeze US industries for lack of intermediary industrial inputs.
The second time was the US walking back sanctions on Chinese international students, jet engine exports and access to semiconductor design software when China cut off rare earth exports. Rare earth exports have been partially restored and now hang over trade negotiations like a Sword of Damocles (see here, here, here and here).
In all of these gambits, the US showed more of its hand. The question is whether the Trump administration has developed a better understanding of the hand that China holds.
Readers of this column will be familiar with the contention that China’s GDP – both nominal and purchasing power parity (PPP) – are significantly underreported compared to developed economies, especially the US (see here and here).
The discretion allowed under the United Nations’ System of National Accounts (UN SNA) has come to a head. We have reached a point in transnational GDP incoherence where tragic policy mistakes have already been made.
American presidents have deemed the Russian economy smaller than Italy’s, derided it as “an army with a gas station,” and believed it could be easily sanctioned out of existence. All of this turned out easier said than done.
On a PPP basis, Russia’s economy was, in fact, twice that of Italy’s and larger than both Japan’s and Germany’s. The Russian economy, dominated by arms manufacturers and oil and gas producers, has proven to be both highly flexible and far better suited for waging war than economies that make expensive ladies’ handbags and trade Mag 7 shares on 24-hour exchanges.
GDP incoherence now has blood on its hands, contributing to the slaughter of hundreds of thousands on the Ukrainian battlefield. Fortunately, the most damage GDP incoherence can do in a trade war is economic humiliation.
China is NOT the world’s second-largest economy. Back-of-the-envelope calculations suggest that China’s PPP GDP is two to three times that of the US (with nominal GDP approximately 1 to 1.5 times that of the US). The entire premise that an American Goliath was going to push around a Chinese David had it completely backwards.
The International Comparison Program (ICP) is the periodic price survey conducted by the World Bank to “officially” determine PPP GDP. The data is publicly accessible through the World Bank ICP website (here).
Yours truly took one look at the clunky data dashboard and suddenly felt old and sleepy. Luckily for us, Dr Rafael Guthmann, economics professor at Alberto Hurtado University in Santiago, Chile, is masochist enough to sift through reams of ICP numbers.
In 2023, the year of the most recent ICP update, the World Bank determined that China and Mexico had roughly equivalent per capita PPP GDPs, with China at $22,687 and Mexico’s at $21,905.
Lazy analysts like yours truly can only engage in vocal fits of hand-waving, declaring the results prima facie ridiculous. “Doggonit, just look at the skylines of the top 100 cities in China versus Mexico City!”
A more rigorous analyst would sift through a representative basket of goods and services, compare the per capita PPP dollar amount assigned by ICP and reconcile that with physical quantities consumed gleaned from other data sources.
Performing this exercise for China and Mexico results in the assigned dollar value of goods in China coming in at less than half the same good in Mexico. This is not supposed to happen when the ICP data is specifically PPP values.
While quality differences can certainly account for differences in PPP-derived prices, it is highly unlikely that Mexican food, cars, housing, electricity and education are two to four times superior to their Chinese versions.
Food is a matter of taste and no matter how many times you’ve read “Like Water for Chocolate”, Mexican food cannot possibly be three times as good as Chinese food.
It is also unclear how one kilowatt-hour of Mexican electricity can be twice as good as one kilowatt-hour of Chinese electricity. Ditto for a square meter of Mexican housing. And Mexican universities are four times the quality of Chinese universities? Really?
According to ICP data, the derived average price of cars sold in China in 2023 was $12,131, less than half that of Mexico. This is also less than half the price reported by third-party data providers like Autohome and derived from China’s National Bureau of Statistics’ retail sales data.
Somebody has been lowballing the value of cars sold in China by a factor of more than two. That same somebody has possibly perhaps probably very likely almost for certain also been lowballing the value of Chinese food, housing, electricity and education by similar factors.
Professor Guthmann, tracking a basket of 50 PPP line items reported by the ICP, estimates that adjusting for data incoherence based on China/Mexico statistics more than doubles China’s PPP consumption.
According to ICP data, China has lowballed not only services (university education by a factor of four) but also material goods (cars, housing and electricity by a factor of more than two).
According to the professor, certain PPP statistics reported by China and other economies do not display the same data incoherence where reported dollar values are far off from physical data.
Industrial value add measured in GEKS PPP terms (a statistical method for price comparison developed by Gini, Éltetö, Köves and Szulc) reconciles closely with physical data, with China’s US$12 trillion in industrial value add roughly three times America’s $4 trillion.
A rough approximation of Professor Guthmann’s methodology, tracking the volume of 23 items consumed and produced, arrives at a similar conclusion. By volume, China’s consumption and production of most products are multiples of the US.
The good professor’s more extensive analysis of volumes and prices results in China’s manufacturing output (a subset of industrial output) over four times that of the US and China’s consumption of industrial output 2.6 times that of the US. Overall, Professor Guthmann estimates that China’s economy is twice the size of the US.
Han Feizi is somewhat more generous at 2.5 times, likely due to higher hedonic (quality) adjustments. The good professor likely has not experienced the transformation of China’s consumer experience in the past decade (see here, here and here).
The US is now reckoning with the “Skull Chart” – a darkly humorous meme passed around on social media. The Skull Chart is a visual representation of Vaclav Havel’s famous observation of China’s explosive growth, “We have not yet had time to be astonished.” Every US versus China chart is now the Skull Chart.
China’s trend lines are merciless. The American populace and institutions are just beginning to reckon with the Skull Chart and its implications. The new National Defense Strategy, if implemented, is surely the correct decision for an overstretched empire, given Skull Chart math.
It is long past time for America to come home, circle wagons, lick wounds and put out domestic dumpster fires. While soldiers patrolling American cities may be dystopian to many, it is hard to deny that vast swathes of urban America could use whatever resources are freed up from overseas military commitments.
Just as the Pentagon ruefully reckons with the limits of its capability, Trump’s economics team is wrestling with its inability to counter Skull Chart math in trade negotiations.
Any journalist, analyst or politician who still leads with the fallacy that China is the second largest economy beholden to American consumers will thus continue to err – and err spectacularly.
