Bi-Weekly Geopolitical Report – On Lessons Learned: China and Consumption Policy (August 24, 2026)
by Bill O’Grady | PDF
“From the errors of others, a wise man corrects his own.” – Publilius Syrus
China’s persistent trade surpluses have become an international problem. Through tariffs, the United States has reduced its bilateral trade deficit with China, but now Europe is facing an onslaught of Chinese goods. Simply put, China’s trade surplus is structural, a deliberate policy choice. When China joined the World Trade Organization at the turn of the century, its expanding trade surplus was called the “China Shock.” What’s occurring now is being dubbed “China Shock 2.”
Economists mostly argue that the reason for this policy is that China’s domestic consumption is too low. If China could lift consumption, more goods would be consumed at home, reducing exports. At this time, China has refused to make those sorts of changes.
In this report, we examine why we think Beijing has, thus far, refused to adopt consumption-expanding policies. First, we lay out the basic macroeconomic identities that show the mechanics of saving and investment. Second, we discuss the postwar economic structure that relied on the US providing the reserve currency and either supporting or actually supplying the reserve asset. We focus on Paul Volcker’s role in establishing the Treasury as a global reserve asset and how the US pressured Japan to reverse its export-promotion policies that it used so effectively from the 1970s into the early 1980s. Of course, Japan suffered a major bear market and three decades of economic stagnation as a result, and it’s logical to assume that Chinese officials are keenly aware of this history, which is likely why they have rejected the “advice” from the West. We conclude by discussing the ramifications of China’s rejection of an expanded consumption policy on the world economy and on markets.