DeepSeek’s shock in wider US vs China perspective
Will DeepSeek’s AI revelation shift broad investor confidence away from the US and back to China?
The most interesting thing about the DeepSeek-driven stock reckoning is what this moment says about the globe’s two biggest economies.
To dispense with the obvious, neither Donald Trump’s 2017-2021 trade war nor Joe Biden’s more targeted curbs these last four years halted Chinese leader Xi Jinping’s tech ambitions. While encountering some speed bumps here and there, Xi’s “Made in China 2025” extravaganza arguably just scored its biggest public-relations win.
DeepSeek’s shock in wider US vs China perspective
The shockwaves that Chinese artificial intelligence startup DeepSeek sent through global markets generated the best headlines Xi’s economy has had in a long while.
Its promise of a cost-effective AI model using less-advanced chips has America’s Nvidia and Dutch giant ASML reeling. It also knocked the chips off the shoulders of Silicon Valley bros cozying up to US President Trump. Suddenly, US tech dominance is in question as rarely before.
DeepSeek’s arrival also managed to relegate Trump’s big AI moment below the fold. On January 21, Trump stood with OpenAI’s Sam Altman, SoftBank’s Masayoshi Son and Oracle’s Larry Ellison to declare an AI victory for America. Now, that US$500 billion Stargate AI infrastructure project looks like old news and a potential monumental boondoggle.
Yet it’s the economic takeaways that stand out most. In China’s case, Xi’s big win should provide an even greater incentive to accelerate moves to build trust in the Chinese economy. For Trump, this moment is a stark reminder that tariffs won’t revitalize US tech innovation in ways that equalize the China threat – only bold policy moves can do that.
On the same day DeepSeek was shaking global markets, new data showed that China’s factory activity shrank unexpectedly in January, ending three consecutive months of expansion.
China’s official purchasing managers’ index slid to 49.1. The non-manufacturing PMI gauge, which includes services and construction, slowed to 50.2 from 52.2 in December. Industrial profits, meanwhile, are now down for three consecutive years, dropping 3.3% in 2024 alone.
“The disappointing PMI data underscores the difficulty policymakers face in achieving a sustained recovery in growth,” says Zichuan Huang, China economist at Capital Economics. Despite hints in late 2024 that stimulus efforts were gaining traction, China is struggling amid intensifying headwinds – and those to come as Trump mulls tariffs, Huang said.
Risks emanating from abroad are colliding with numerous pre-existing conditions at home. China’s property crisis resulted in the longest deflationary streak since the 1997-98 Asian crisis. Weak household demand and near-record youth unemployment are slamming confidence.
“To even have a chance to improve inflation and confidence,” says Hui Shan, chief China economist at Goldman Sachs, Beijing must deploy “a large stimulus from the government” to generate a real “turning point.”
Zhiwei Zhang, president at Pinpoint Asset Management, notes that “part of the slowdown may be due to weaker external demand, as the new export orders index dropped to the lowest level since March last year.”
Things may soon get much worse if Trump makes good on threats to slap 60% tariffs on all mainland goods. So far, Trump has moved much slower in deploying trade curbs than global investors expected.
“A lot of what Trump pledged to do was carried out on day one with the absence of concrete tariff measures are a significant relief, but a delay does not imply no tariffs,” write analysts at Singapore-based UOB Global Economics & Markets Research. “There is, after all, another four years of Trump to go.”
These risks only increase the urgency for Xi’s team to stabilize China’s financial system. Immediate priorities include repairing a weak property sector fueling deflation, building more vibrant capital markets, reducing youth unemployment, addressing runaway local government debt, curbing the dominance of state-owned enterprises and increasing transparency.
Team Xi also must create a vibrant network of social safety nets to encourage consumption over saving. Last week, Xi’s government intensified efforts to support China’s volatile stock markets. That included encouraging pensions and mutual funds to invest more in domestic stocks and prodding mainland households to buy more shares.
“This means that at least several hundred billion yuan of long-term funds will be added to A-shares every year,” notes Wu Qing, chairman of the China Securities Regulatory Commission.
Such steps are only necessary, though, because Team Xi has been too slow to address the economy’s pre-existing conditions. One big debate in financial circles is whether Beijing might resort to weakening the yuan to boost growth.
The pros are obvious. A weaker exchange rate would further boost exports, a key reason why China reached 5% growth in 2024. In December alone, overseas shipments jumped 10.7% year on year.
Yet the cons are stopping Team Xi from going the weaker yuan route. For one thing, it might make it harder for highly indebted property developers to make payments on offshore bonds. That would increase default risks in Asia’s biggest economy. Seeing #ChinaEvergrande or #ChinaVanke trending again is the last thing Xi’s Communist Party needs in 2025.
For another: the monetary easing required to depress the yuan could squander years of deleveraging efforts. In recent years, Beijing has made important strides in reducing China’s financial excesses and improving the quality of gross domestic product. As a result, Xi and Premier Li Qiang have been reluctant to let the People’s Bank of China ease more assertively, even as deflation deepens.
Increasing the yuan’s use in trade and finance might be Xi’s biggest reform success over the last dozen years. In 2016, China won a place for the yuan in the International Monetary Fund’s “special drawing rights” basket, joining the dollar, yen, euro and pound. Since then, the currency’s use in trade and finance has soared. Excessive easing now might damage trust in the yuan, slowing its progression to reserve-currency status.
It also might trigger a broader Asian currency war that’s in no one’s best interest. Tokyo might go all-in on an even weaker yen, pulling South Korea into the fray.
Memories of 2015 are clearly entering into Beijing’s equation. China’s move to devalue the yuan by nearly 3% a decade ago triggered a destabilizing capital flight that still haunts party bigwigs. Over the next year, Xi’s team had to draw down Beijing’s foreign exchange reserves by US$1 trillion to restore calm.
Yet this week is also a wake-up call to Trump World to reconsider its top economic policy plans. Exhibit A is a giant trade war that might’ve worked better in 1985 when economic power was more concentrated among a handful of industrialized economies.
This same stuck-in-1985 problem helps explain why Japan’s efforts since 2012 to increase competitiveness and rekindle innovation came up short. The enterprise, led by former Prime Minister Shinzo Abe, is largely about bringing back the trickle-down economics of the 1980s Ronald Reagan era.
Abe placed a bet that monetary easing and currency depreciation would fuel a surge in corporate profits and kick off a virtuous cycle. The plan was for booming stocks to encourage CEOs to fatten paychecks, catalyzing increased spending and faster economic growth.
Japan got the stock boom part of the plan right. Aggressive Bank of Japan easing, a plunging yen and some steps to improve corporate governance saw the Nikkei 225 Stock Average top its 1989 highs last year.
Yet wages didn’t surge as hoped, ending the year on average or below the roughly 2.5% inflation rate. All so-called Abenomics proved is that Reaganomics is even less effective in raising living standards now than 40 years ago.
This is the way Trump 1.0 went, too. The centerpiece of Trumponomics was a $1.7 trillion tax cut largely aimed at the top 1%. The maneuver did more to put the national debt on a path to reach today’s $36 trillion than increase competitiveness or reduce income inequality.
Now, Trump 2.0 is angling to make the $1 trillion-plus tax cuts from his first term permanent while adding new ones to the books that will inevitably exacerbate Washington’s already serious debt woes.
The magnitude of the US net foreign investment position – the difference between foreign assets that Americans own and those assets owned abroad — is now nearly the size of US gross domestic product. It’s negative $24 trillion compared with negative $18 trillion when Biden entered office in 2021.
A big dilemma now faces Trump: widen Washington’s investment imbalances or reduce its addiction to imports and capital inflows. For now, Trump’s new economic team is more interested in protecting the status quo than disruption.
Additional tax cuts that may explode Washington’s budget would increase its reliance on the savings of Japanese and Chinese households as well as Global South nations. Trump’s tariffs and trade barriers would boost US inflation and undermine consumption at home.
Many economists think Trump should focus more on building economic muscle at home. Biden, for all his policy missteps, paved the way for the US to compete with China more organically.
Biden’s 2022 CHIPS and Science Act, for example, deployed $300 billion to strengthen domestic research and development. Biden took other steps to incentivize innovation, raise America’s semiconductor capabilities, improve infrastructure and increase productivity.
It was only a start, though. For all his deregulation talk, Trump has yet to articulate a plan to supersize Biden’s tech upgrade policies.
As Trump prioritizes old-school tariffs, lower Federal Reserve interest rates and a weaker dollar, Xi’s China is engaged in a multi-trillion-dollar effort to lead the future of electric vehicles, semiconductors, renewable energy, robotics, biotechnology, aviation, high-speed rail and, of course, AI.
The dividends that this last priority is now paying are turning US heads China’s way as rarely before. And serving as a wake-up call for both Xi’s party and Trump 2.0 that it’s time to raise their games.
Follow William Pesek on X at @WilliamPesek