How Did China Create Global Trade Imbalances?
It is because the Chinese government suppressed household income, increased savings, and converted those savings into exports—effectively exporting debt and unemployment to the rest of the world through a “beggar-thy-neighbor” policy.
1. Michael Pettis’s Framework: The Rise of State Capitalism and Trade Imbalances
Over the past 40 years, the global free trade order that had been taken for granted is now breaking down, and state capitalism is emerging in its place. This shift is spreading as countries respond to China’s state-driven trade distortions and persistent surplus policies.
1.1. The Breakdown of Free Trade and the Rise of State Capitalism
Cracks in the Free Trade Order
In recent discussions, various experts have analyzed the transition of the global order.
Zoltan Pozsar described the fragmentation of the global financial plumbing, while Russell Napier discussed the growing role of the state in economic influence—namely, the rise of state capitalism.
Both share a core premise: the global system of free trade, free capital movement, and market-driven allocation of resources that dominated the past 40 years is now unraveling.
As of 2026, this trend is difficult to deny.
The United States, once the champion of free trade, is now using tariffs as a weapon, shaking the global system—something that would have been unimaginable in the past.
Differentiated tariffs by industry, and large-scale investment commitments tied to tariff negotiations between allies, show that governments are reasserting control over the economy.
This is not limited to the U.S. It reflects a global shift toward “we must secure our own survival first.”
Countries like Korea, Japan, India, and the EU are increasingly intervening in their economies—supporting stock markets, investing in strategic industries like semiconductors, shipbuilding, and defense.
1.2. Pettis’s Diagnosis: The Global Spread of China-Driven State Capitalism
Introduction to Michael Pettis
Michael Pettis has provided a consistent explanation for these developments for over 20 years.
He has lived in Beijing for more than two decades, served as an advisor to Korea’s Ministry of Finance after the Asian Financial Crisis, and has a unique background as a former Wall Street trader who also ran a punk rock club in Beijing.
Pettis focuses on the cause of the rise of state capitalism described by Napier.
His core thesis can be summarized as follows:
The global spread of state capitalism is a reaction to the shockwaves created by China’s state-driven economic model.
Pettis uses terms such as “state-driven trade distortion” and “beggar-thy-neighbor policies of persistent surplus countries.”
Impact of China’s Model
If U.S.-led liberal trade pressured the world for 70 years, the direction has now reversed.
China’s state-led growth model is exerting pressure globally, and other countries are forced to respond for survival.
This is not a recent idea—it has been consistent for 20 years and has even influenced aspects of trade policy under the Trump administration.
In short:
China is the main engine driving the global spread of state capitalism, and now other engines are starting to run as well.
2. Background and Forecasting Track Record of Michael Pettis
Michael Pettis was born in Spain and grew up in multiple countries including Peru, Pakistan, and Morocco. He studied development economics at Columbia University and spent 15 years on Wall Street specializing in emerging market debt.
He later moved to Beijing in 2002, where he has spent over 20 years analyzing China’s economy.
2.1. Cosmopolitan Background and Wall Street Career
Growing up across four continents gave him a unique perspective on cross-border capital flows and trade imbalances.
He entered Wall Street in 1987 and worked in sovereign debt trading during the Latin American debt crisis.
He also advised multiple governments, including Korea during the 1997 Asian Financial Crisis.
2.2. Move to Beijing and Rise as a China Expert
In 2002, Pettis left Wall Street and moved to Beijing, teaching at Tsinghua University and later Peking University.
This positioned him to directly observe China’s transformation after its WTO accession.
Side Note: Punk Rock Club
He also founded a punk rock club called “D-22” in Beijing, becoming a key figure in China’s indie music scene.
2.3. Core Question and Track Record
Pettis’s fundamental question is:
“Why is the world persistently imbalanced?”
Major Success: Commodity Crash Prediction (2012)
He correctly predicted the collapse of commodity prices due to:
Supply overshoot
China’s demand slowdown
Structural limits of investment-led growth
Oil and copper prices later collapsed exactly as he anticipated.
Misses
Overestimated the speed of China’s slowdown
Incorrectly predicted a financial crisis
He later revised his view, acknowledging China’s strong state control over financial risks.
3. Root Cause of Trade Imbalances: Balance of Payments Identity
Contrary to textbook theory, exchange rates do not automatically correct imbalances.
The key identity is:
Savings (S) - Investment (I) = Current Account (CA)
3.1. Theory vs Reality
Textbooks claim deficits lead to currency depreciation, restoring balance.
Reality:
The U.S. has run deficits for 50 years
China has run surpluses for decades
The adjustment mechanism does not work as expected.
3.2. Accounting Identity
If savings exceed investment, excess capital must flow abroad—creating trade surpluses.
If investment exceeds savings, capital must be imported—creating deficits.
Also:
Current Account (CA) + Capital Account (KA) = 0
This is an accounting identity—inescapable.
3.3. China’s Policy and U.S. Debt
China suppresses household income → increases savings → generates surplus production → exports it.
These surpluses are recycled into U.S. assets.
As a result:
China runs trade surpluses
The U.S. runs deficits
The U.S. must choose between:
Higher unemployment
Higher household debt
Higher government debt
In reality, it chose (2) and (3).
This imbalance contributed to the 2008 financial crisis.
Beggar-Thy-Neighbor Policy
China effectively shifted the burden of its domestic imbalance onto the U.S.
This is not about intent—it is a structural outcome of accounting identities.
3.4. Globalization Trilemma
Dani Rodrik’s trilemma states:
You cannot simultaneously have democracy, national sovereignty, and deep globalization.
China and Germany both created imbalances by suppressing domestic consumption and exporting excess production.
4. China’s Domestic Demand Problem and Pettis’s Solution
China emphasizes consumption-led growth, but structural barriers remain.
4.1. Limits of Domestic Expansion
Despite rhetoric, policies still favor production over consumption.
4.2. Why Chinese Households Save Too Much
Mainstream view: lack of social safety nets.
Pettis’s view:
The real issue is that households receive too small a share of GDP.
4.3. Four Solutions
Normalize real interest rates
Transfer SOE profits to households
Increase wages
Appreciate the currency
4.4. Structural Constraints
These solutions are theoretically possible but have seen little progress over 20 years.
Understanding China’s economic structure is essential to explain why.
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