At a time when many think that China has the upper hand in controlling important “choke points” that prevent Trump from taking counteractions against Chinese mercantilism and attempts to undermine US economic and political leadership, my recent report for the Hudson Institute takes a different view. I argue that because of the way China’s economy is structured, the US and allies, if they muster the political will, can upset the Chinese model and eventually weaken and undermine that model. Whether Donald Trump uses this economic leverage when he meets with Xi Jinping in Mid-May is an open question.
Following the near-complete collapse of the real estate bubble in China, and the saturation of the infrastructure buildout to support a modern economy, China now relies on exporting its enormous production capacity to maintain some level of growth. In 2024 net exports added over 3% and in 2025% over 4% to final reported growth of around 5% for China. A realistic expectation for growth is much lower than the “near 5% number” set as the current goal. Xi Jinping’s “China dream” relies on building out modern production dominance in traditional industries such as steel and chemicals, and new industries such as EVs, robotics and pharmaceuticals. The IMF, the World Bank and, surprisingly, even the US Federal Reserve Boad have all published papers noting the role of various forms of subsidies and industrial policies to drive China’s dominance of global trade in manufacturing.
And most importantly China maintains a somewhat closed market to protect its nascent industries, including the financial sector which is one key to the overall model.
Directing available investment resources to the favored industrial and technology sectors comes at the expense of building out a modern social safety net in China, especially for the still impoverished rural sector. Xi Jinping is famously averse to “welfarism” and because of the persistent favoring of subsidized state-owned enterprises and advanced technology investments, little is left to invest in human resources and social welfare. Individuals and families saw much of their savings disappear with the real estate bust, as this sort of investment once accounted for 60-70% of wealth. The Shanghai Composite Stock index in March 2026 is still about one-third lower than its high point in 2007, further weakening household savings. Indices of wage growth have also faltered in China and unemployment among young people remains in the high single digits. Forced to save to take care of elderly, pay for decent health care, and build their own pensions, there is little left to increase consumption that in most developed economies is a pillar of growth. Household consumption remains mired at about 40% of GDP, far behind that of Japan and even developing countries like Mexico (70%) and Peru (60%).
Seriously compounding the problem of shifting growth away from exports is the weak profit and productivity performance of Chinese industry. Despite heavy subsidization, some 30% of Chinese firms operate at a loss. The capital efficiency ratio (how much investment is required to produce additional growth) has plummeted in China, both absolutely and compared to leading competitors, especially the US. A measure of bank loans to GDP shows that nearly twice as much in loans is now required to support growth as compared to 2008. Xi’s shift against the private sector and toward state-owned enterprises (SOEs) in the last decade is one cause of this decline in capital efficiency, which is also reflected in slowing productivity growth. To a large extent, new financing in China often supports money losing enterprises whose only outlet is external markets.
The need for increasing amounts of capital and loans, along with slowing productivity and profitability, has led to weakness in both public finances and the state-dominated banking sector, which is the instrument used by Beijing to support growth. Banks are forced to lend at sub-market rates and prop up failing enterprises and overextended local governments. The IMF characterizes local government finances as “combustible.” The IMF also calculates the total budget deficit of all government finances to be around 13% of GDP in 2025 and beyond, forcing the banking sector to struggle to meet the needs of the economy for stability, let alone growth.
Beijing has met the need for increasing financing and avoiding serious deterioration of the economy in part by printing money. China’s monetary stocks have grown 6 times faster than those in the US since 2000, and the ratio of China’s debt to GDP since the Great Financial Crisis of 2008 has grown by 153%. In 2025 alone the PRC printed $4.5 trillion in M2-equivalent (liquid assets), while the US only increased its stocks by $700 billion. China, with an economy smaller by one third than the US, now has more money in circulation than the US and the EU combined.
China avoids the inflationary impact of such amounts of debt and money supply profligacy by tightly controlling bank interest rates (contributing to their loss of profitability), discouraging consumption, and limiting foreign competition for the financial services industry. It tightly controls access to foreign currency and manipulates exchange rates. It also maintains a closed capital account. In principle, most foreign currency (recall that China had a $1.2 trillion foreign trade surplus in 2025) must be turned over to the state, facilitating its ability to control exchange rates. Beijing in essence maintains an undervalued currency but keeps the dollar exchange rate just strong enough to permit purchase of dollar denominated commodities and high technology products.
The undervalued yuan is a special problem for the EU as the Euro has appreciated by 40% vs that currency this decade and led to a huge and growing Chinese trade surplus which is undermining the European industrial sector. Other exporting nations in East and Southeast Asia also suffer from the undervalued yuan.
The undervalued yuan is of course one key to supporting China’s export oriented, mercantilist economy. Expansion of the money supply at an elevated level as persistently done in China also allows a real economy that destroys capital through subsidization and financial repression to avoid reckoning with the growth of debt and money-losing “zombie” companies. In a more market-oriented system with an open capital account, the yuan would appreciate and lead to a more balanced trade outcome. A more open capital account would undoubtedly work against the ability to print money while avoiding its inflationary impact.
The US, hopefully in conjunction with other market economies damaged by Chinese mercantilism and currency manipulation, does have agency to weaken or undermine the existing economic model. The US, Europe and other countries are now pushing back against the relentless growth of the Chinese export machine. Based on the principle of reciprocity and grounded in existing domestic and WTO rules (despite the overall weakened role of this multilateral institution), tariffs targeting China and access to market economies, especially in the financial sector, are showing results in combatting mercantilism. Malign Chinese activity such as intellectual property theft, money laundering, and sanctions evasion for illicit drug trade and support for adversaries such as Russia and Iran are additional reasons for anti-mercantilist actions.
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Chinese money laundering as well as currency manipulation and failure to open the Chinese financial markets as promised when China joined the WTO 25 years ago also ought to be sanctioned by cutting off access of Chinese banks to the SWIFT and CHIPS system. The US could start with a few selected banks or partial measures such as pressing for the ability to trade in China’s foreign currency market, again as authorized by the terms of admission of China to the WTO.
Sanctioning Chinese banks, the more draconian freezing of access the US-dominated financial clearance systems, closing off Chinese access to Western stock and bond markets, and gaining real access to trading in Chinese currency exchange markets would all have a quick and substantial impact on the entire Chinese economic model perfected by Xi Jinping. The existing Chinese economic model could not survive such measures.
The big question is whether and to what extent there is the political will in Washington to initiate such a process, which requires close coordination with the other major advanced economies.