US/China Economic Cold War
Letter's from O'Brien #74
Dear Mr Smith,
Recently many westerners awoke to their respective markets being in the red. This sea of red was a freak response to (or rather a response to a response to...) the emergence of DeepSeek's open source LLMs. As most are aware, DeepSeek has caused a huge stir primarily because their large language models can perform on parity with the most advanced (publicly, at least) western counterparts, while operating at a fraction of the cost due to breakthroughs in efficiency on the Chinese side. On top of this, their software is almost completely open source. The cherry on top was that DeepSeek emerged as a force to be reckoned with, completely undetected, despite China being in the midst of US sanctions, specifically under sanctions to limit the sale of Nvidia cards and other semiconductors from TSMC.
Against the odds, China has essentially countered the US in one of the few areas America was claimed to have an absolute lead in; artificial intelligence.
This outcome paired with the efficiency of the end product has resulted in a market freakout. Trust in the success of US companies to lead the world in this new sector is faltering, despite the new US administrations commitment to AI, but this was - in my mind - evident from the start.
Although the emergence of DeepSeek itself was surprising, the general trend, I think, was predictable. This is a Cold War race, in my estimation, similar to the space race or the leaps in ICBM technology. And just like the emergence of new technologies in the 40s, 50s, and 60s, it reveals disparities between the major powers at play.
The reason I feel America will struggle to win in this AI space, is that the US no longer has the edge in the long term. I believe most of the best minds are still in the US, and in the short term America still has the capacity to build outstanding technology. However, China can - as has been shown - produce similarly capable products but with more efficiency (cheaper & faster). If we were to take into account classified technology, I would guess that the US still leads by a significant margin, but in conceptualisation and small-scale production. This is commendable, but if not harnessing consistent, scalable, commercial production, this is a big problem.
America may have the best minds at the moment, but many are disappearing to take advantage of faster to-market opportunities in countries that don’t suffocate innovation with red tape (a situation hopefully the current administration will address). Innovation is one thing, scaling up that innovation is another, and this is what China does so well, and the US needs to get its act together. Or China will continue to take US innovation and do the commercially advantageous thing with it, to the detriment of Americans and the US economy. The US cannot out-compete China in the Milton-Friedman-free-market. This is a basic logistical equation; China has more people, they have a huge manufacturing base, and as such their cost of living is lower, even if their standard of living improves. The US does not have a strong manufacturing base, there are less people at work, and due to inflation, a housing crisis (among many other factors), employment is more expensive and there’s a mountain of self-imposed hurdles for the innovation-to-market pipeline.
China can produce goods at a far lower cost, retailing at a lower price while retaining a health margin. Contrast this with the very high production cost of goods in the US that some must sell at a deficit to compete with China. Thus the continual consumption in the West of third-world alternatives to domestic products. I think we are all well aware of this basic economic conundrum of the West.
How is the political establishment in the US addressing this issue? The Democrats are against tariffs (this originated as a contrarian policy, of course) and would rather bring the cost of US manufacturing to parity with China by subsidising the production cost of goods, so manufactures can retain some financial margin. Clearly the Democrats haven’t even given a cursory glance as the most basic theories of economics.
On the other side of politics, the Republican strategy pushed by Altman, Musk, and Vivek - is also flawed in my opinion. As far as I understand it, they are looking to migration from India as the silver bullet, because in theory this will allow them to compete 'on the international market'. The state will then fund startups (such as Altman’s AI projects) and staff them with this cheap labour. Immigrants may work for less, but their cost of living is the same, meaning the state has to offset this with welfare. In the US, the lifetime fiscal impact of a single immigrant is over $250,000 USD. This is insane, and only hypothetically benefits multinational organisations, not domestic companies or the American population. On a national level, there is no 'cheat code' or hack, good things do not come for free, and economically this is also true. (And I’m not even going to get into the obvious demographic crisis this has and will cause).
The only solution I can see, that will actually work, is tariffs - Trumps favourite card to play on the international stage. No one will purchase US goods until they are on parity with goods from China. This is the harsh truth, and everyone deep down understand this. The only reasonable remedy is trade tariffs; harsh tariffs would be needed to bring the price of Chinese goods up to parity with US produced goods. This has two outcomes; China will not be able to undercut the US, and tariffs will offset the need for taxation. The US literally used to supplement tax with trade tariffs, and it worked. Trumps 10% on China because of illegal drug imports is a good start, but it probably needs to be continually monitored and adjusted for each sector. But I’m sure they will get there.
It will - on paper - result in a short term price hike for goods. But understand that this is somewhat of an illusion; the longer the US remains a services economy, the weaker the purchasing power of the dollar becomes. This means that while Chinese goods may remain the cheapest, they will proportionally cost more over time. In contrast, with strengthened domestic manufacturing, inflation is tempered and purchasing power goes up. In the long term this means that higher quality US goods will be produced for less, the power of the dollar will go up, and the creation of domestic jobs will lead to an upwards effect as the national economy is stimulated. This sounds simplistic because it is, yet for a variety of reasons it hasn’t been implemented. Let’s hope the new administration bites the bullet and does what needs to be done.
ON DEPORTATIONS
One of the policies Trump was elected to execute was to stop the border crisis and initiate mass deportation of illegal criminals. True mass deportations (thousands per day is necessary to clear out the Biden admins 10,000,000 immigrants). If he ramps up the deportations to this level, there will be huge economic repercussions in the short term. Like ripping off a band-aid, the short term economic response may hurt, but in the long term it is necessary to fix both the demographic situation and the economy.
Now pair this with the previously mentioned tariff solution. If both of these are implemented together, it will be painful in the short term for the working class American, despite being necessary in the long-term for his survival. But there is another economic driver to throw in the mix and that’s primary energy production (“Drill baby, drill!) that may take a little while to ramp up, but will, in the long term, make these rip-off-the-band-aid pains insignificant in a few years from now.
Will Team Trump stay the course?
The problem is that shortsightedness, and the political drive for immediate outcomes could push the Trump administration into taking a more impulsive 'AI war with China' approach. I can foresee the admin dropping billions on AI research and systems development, without ever implementing the actual long term necessities like mass deportations or extreme game-changing tariffs. Why? Because from a short sighted perspective China is 'winning', and to willingly weaken the economy in the short term would be seen as political suicide, even if it is necessary. Let’s hope the current administration has the gumption to stay the long-term course, despite the short-term pain, and place America back into an economically robust and competitive state.
Sincerely yours,
O’Brien