The US-China Stability Wildcard

The perils of myopic stability fixations

I was taught one basic thing when I first began studying China: Stability is everything. Whenever a deep question arises about Chinese strategy, I was counseled, the answer can be found in the implications for stability — stability in economic terms, social terms, or political terms.

Similarly, I was taught one basic lesson as a US economist working for the Federal Reserve Board in the 1970s: Stability is everything. The Great Inflation of that era led to the Fed’s dual mandate of maximum (or “full”) employment and price stability. Answers to policy questions invariably hinged on the risks to both dimensions of stability.

This is more than just a coincidence. From ancient dynastic breakdowns to the Cultural Revolution, Chinese history is riddled with countless examples of instability that posed grave threats to its system of governance. Its current economic slowdown is only the latest example. The same has been the case in the much shorter history of the United States, especially now as a disruptive president shreds alliances, initiates wars of choice, and starts a cult-like political movement that polarizes American society.

Why would two stability-focused nations entertain the very real risks of instability? Leadership hubris is a key part of the answer. Fifty years of “hide and bide” as per the low-profile credo of Deng Xiaoping doesn’t cut it for the über nationalism of the Chinese Dream espoused by Xi Jinping. The same is the case for the nationalistic exhortations of Trump’s MAGA movement; the American body politic apparently has little institutional memory of the Global Financial Crisis of 2008-09, the stagflation of the late 1970s, or even the Great Recession of the 1930s.

In effect, leaders in both nations have come to believe in the new moral hazard of rejuvenation. The Chinese Dream is a dream of rejuvenation — framed explicitly by Xi Jinping as a restoration of China’s rightful place as one of the world’s greatest nations. MAGA is framed in a similar vein of restoring the greatness of the United States again. Fixated on the nationalistic appeal of rejuvenation, political leaders in the two nations appeal to the notion that both systems are too big, too consequential, to fail. No wonder they are such “good friends,” as Donald Trump wistfully claims of Xi Jinping.

This new moral hazard gambit has permissioned disruptive policies in both the United States and China. As can be seen on the chart below, this has resulted in sharply elevated reading of economic policy uncertainty in both the United States and China since 2017 — not by coincidence the first year of Trump 1.0. The two lines measure economic policy uncertainty indexes for the United States (blue) and China (red). They are taken from the EPU website under the direction of Scott Baker (University of Wisconsin), and Nick Bloom and Steven Davis (both from Stanford). Since the uncertainty gauges are quite volatile on a month-to-month basis, they are smoothed in the chart as 12-month moving averages.

I, and many others, have long stressed that uncertainty is the enemy of decision making. It clouds economic prospects and hobbles business commitments to hiring and capital spending. It also inhibits consumer spending on long-lived durable goods. The unmistakable impacts of heightened uncertainty have been evident in recent trends for both the US and Chinese economies.

US employment has been essentially unchanged over the past year and apart from the AI-related data center construction bubble, capex has weakened. A similar pattern is evident in the Chinese economy: weakness in public and private sector capex; stagnant entry level hiring resulting in persistently high youth unemployment; and ongoing weakness in consumer demand notwithstanding persistent policy efforts to stimulate durable goods spending via never-ending trade-in campaigns. Moreover, it should be stressed that both uncertainty indexes in the chart above run only through February 2026; as such they do not capture the impacts of the major global energy shock triggered by the US-Israeli attacks on Iran that are bound to elevate policy uncertainty considerably further.

The collateral damage from heightened uncertainty seems to be very much on the minds of Donald Trump and Xi Jinping. Their on-again, off-again, and now hopefully back-on-again Beijing summit (latest dates: May 14-15) has been framed around the stability objectives of another short-term trade deal. Rumor has it that in return for freezing tariffs for another year at still elevated levels, China seems willing to agree to yet another purchases agreement of US products such as agricultural (soybeans), energy, and aircraft, along the lines of the failed efforts of the Phase I deal of early 2001. There has been some talk of establishing new working groups in the form of trade and investment “boards,” but that remains to be seen.

Stability fixations often backfire. That is because they are inherently myopic in agreeing to kick the proverbial can down the road, without addressing more serious underlying issues. This leads to a twin paradox — the stability focus of two increasingly unstable nations, the US and China — that has an important bearing on the relationship between them. China continues to view America’s “China containment strategy” as a threat to its growth imperatives. The US continues to view the “China shock” as a threat to a manufacturing sector that once made America, and its blue-collar work force, great. Both nations see the other as a principal source of its instability that threatens rejuvenation.

Never mind, as I argued in Accidental Conflict, that these perceived threats are largely premised on politically expedient false narratives that mask serious problems at home: China’s failure to rebalance the structure of its economy and America’s failure to invest in basic research, infrastructure, and new manufacturing capacity. It’s easier to blame the other side than accept responsibility for your own actions or inactions. This blame promotes disruptive policies and heighted uncertainty. It continues to sow more seeds of conflict between the United States and China.