Seeking Truth From Facts: AI, China, Tariffs, Geopolitics — #84

Steve Hsu: Once you're there, it may turn out that the very best use of someone's high intelligence is in the pricing and trading of those assets.

And so instead of figuring out how to make a hypersonic missile work in a wind tunnel, you spend your days solving the black shoal equation to make sure that the bunch of derivatives that you're tracking are properly priced. It's very tough to avoid that.

You know, I mean, the people who want money, you know, it just happens with computers and, and financialization and quantification of the data that's used in trading.

All those things combined mean that the way people can make the most money is typically in finance.

Alf: Hello, and welcome to a brand new episode of Seeking Truth from Facts. Today I am very glad to be joined once again by a good friend from the show. Steve Hsu, how are you doing, Steve?

Steve Hsu: I'm great, Alf. How are you?

Alf: Not bad at all. Thank you.

So just to kick off, since we last spoke, there have been some considerable developments out of China, in particular. In January, the Chinese AI firm Deep Seek, unveiled its first model, which was more efficient than and developed at a fraction of the cost of Open AI's ChatGPT. What is your assessment of how this moment will be viewed within the wider US China tech war?

Steve Hsu: Well, I think, as has been widely reported, it was a bit of a shock to people on the Western side who follow ai. I think there was a perception that the Chinese AI labs were significantly behind the leading Western labs. I think people who were following what was going on in China didn't necessarily believe that.

And also for people who are closely following the field. Deeps Seek is very good about publishing its research results. So there were already several papers, for example, describing deeps seek 2.5, I think, which came out maybe six months before the deeps seek moment in January. and so people who read those papers realized that this lab was quite impressive and there wasn't really that much of a gap between what they could do and what the best US Labs could do.

I would also just add that, if, if you follow Chinese AI at a more superficial level, you might know that there was something like five or six national champions that the government sort of officially listed as the, the main, you know, AI champions for China. And, those were AI labs usually attached to either very prominent startups or big internet companies that have deep pockets, sort of the analog of, you know, Microsoft or Google or Facebook. And, those companies also in the last few months have released models, which are more or less at par with the leading Western models.

if there is a gap, it's probably relatively small. It could be something like six months or less. and it's not just deep seek that has closed the gap. There's a lot, there are lots of models from Chinese companies that are high quality. Yeah.

Alf: That seems very accurate. And it seems to me that the deep seek announcement in January was as it's been described by many observers, something of a Sputnik moment, and that it took the, both tech and foreign policy establishment in the US somewhat by surprise.

Apart from those, as you say, who were following, the Chinese sphere a bit more. Intensely. And I mean, furthermore on the, on the point of deep seek, to what extent do you think that its story, of a company whose founders include former traders represents somewhat of a vindication of the Chinese government's?

Often criticized, attempts to redirect human capital from finance into other fields, especially STEM fields. Or is this a misreading of the situation? And if so, to what extent do you think that western countries which suffer brain drain of STEM graduates into finance may learn from China's approach?

Steve Hsu: Yeah.

So, a little background for your listeners. So the company, the Parent Company of Deep Seek, which was called High Flyer Capital, is a quant trading fund that reportedly was quite successful. And they have always been a quant fund. They've always used machine learning and AI in their trading strategies.

And the founder, Liang, I. Created deep seek as a kind of subsidiary, with the goal of doing GI research. And this subsidiary, you know, really was not well known. As I said, it wasn't regarded by the Chinese government as one of their main labs or national champions. and so it was just kind of a thing that these, this group of quants, and, and additional researchers that they hired, later hired it.

It's just a thing that they were doing. And, They really were committed to the goal of pursuing a GI and also, of, of steering open source models with the rest of the world. Now, as you pointed out, there was an under XI a few years ago. There was a bit of a kind of explicit crackdown on speculative finance in China.

I think they even went so far as to cap the maximum compensation. That, a fund manager or trader could, could make in China to something like I think 600,000 US dollars, which, although it's a lot of money, especially in China, but also in other parts of the world, that is a very small sum compared to what the top traders, say in the US make trading and financial markets.

And so I think some people wanted to interpret the creation of deep seek and the success of deep seek. As a policy outcome of the Chinese government clamping down on or discouraging speculative finance, I think that might be going a little bit too far. I think probably the circumstances were quite special in the case of deep seek.

The, the, the original parent fund had been quite successful. Leon Mang is very. Special guy, very idealistic guy, and a guy who happens to have extremely strong technical, and scientific capabilities. So I think they might've gone the same way, regardless of what the government stance had been on speculative trading.

Now, the larger question that you ask, you know, what, what would happen in the US. We discouraged our brightest young people from going into quant finance, and, and sort of encouraged them to go into what I would consider more non-zero sum, positive sum, activities like engineering, fundamental science research, AI research, et cetera.

You know, this is something that people have talked about a lot. Like Charlie Munger talked about this. He, he actually said explicitly, you know, it's a disgrace that we have a set up and, I think he said we, we've set up an elaborate gaming system and we encourage the incentives are such that they encourage our most talented people to, head into this gaming system rather than doing something more positive, some.

So I think that that has definitely happened in the United States and I, you know, in my career as a physicist, You know, I've been a, I, I, I did, I finished my PhD in the early nineties, and for most people with my background, you know, it's, it's quite a competitive field, theoretical physics, and so it's the minority of people.

Even if you consider people who got PhDs at a top program, it's the minority that would get permanent jobs that would allow them to really do physics research the rest of their lives. I. Most of the people, even with a PhD from a top school, have to leave the field mostly against their will. And most of them during my lifetime went into quant finance.

And, the second place destination was probably Silicon Valley. and so a lot of our top brain power, which in the past would've gone during the Cold War, would've gone into defense research. Instead of going into defense research or to Silicon Valley, is trading derivatives or, or designing algorithms for high frequency trading.

And, yeah, it probably would be better for the United States if, if that did not occur. Of course, you always want to be careful about interfering with, you know, the markets, right? So it's a, it's the market for human capital and the amount of compensation that people make that sort of determines where they go.

Alf: Okay.

And do you think there are any? Policy avenues that the US or similar western countries could go down to encourage, a redirection of, or at least a partial redirection of human capital, given how heavily weighted it is towards finance. Obviously it probably couldn't be to the extent that it happened in China, but is there, is there anything specific that you think could be done?

Steve Hsu: One thing that both Donald Trump and Warren Buffet, as well as Charlie Munger, you know, interesting, trio of people there, something that all three of them have, publicly spoken out against. Is the tax treatment of gains made by hedge fund traders. So if you're a partner in a hedge fund, there's this sort of carried interest tax loophole, which means that the money that buffet makes, or the money that some hedge fund trader makes is taxed at a lower rate than ordinary income.

So in the US system, you actually have an incentive which works in the opposite direction, that financial activities actually are treated. Certain financial activities are, are treated. more favorably by the tax code than just someone, you know, working a day job for Microsoft or for Los Alamos National Lab or something.

So, so we, it's kind of strange. You could, you could close that loophole. I think Trump in his first campaign in 2016 actually campaigned on getting rid of that loophole. Of course he didn't do it because, uh, so much of his money comes from people who benefit from that loophole. So, I, I think around the margins.

You could change things. You, you have this fundamental problem that if, if,the fan, the, the fancy way people like to talk about it, and the very theoretical way people like to talk about it these days is, is once you allow the quote financialization of your economy so that everything is at root tied back to finance and the trading of securities and things like this, right?

You know, whether you're doing a startup or you run a public company, all of these things are just securities at base, right? The things that are valuable, the stock options and all this stuff are, everything is financialized. Once you're there, it may turn out that the very best use of someone's high intelligence is in the pricing and trading of those assets.

And so instead of figuring out how to make a hypersonic missile work in a wind tunnel, you spend your days solving the black shoal equation to make sure that the bunch of derivatives that you're tracking are properly priced. it's very tough to avoid that, you know, I mean, the people who want money, you know, it just happens with computers and, and financialization and quantification of the data that's used in trading.

All those things combined mean that the way people can make the most money is, typically in finance.

Alf: It's quite interesting, especially what you said about the fact that there are government incentives such as the loophole that you mentioned towards moving those people into finance. And it's a somewhat similar phenomenon in the UK when Margaret Thatcher was in office in the 1980s, obviously she's very much remembered for taking a.

Deregulation is an approach to the economy, however heard deregulations were, or not universally, but very heavily focused towards finance. So that really indicates that there was a government that wanted to push finances as an. As a sector and, remaining on the issue of China. but moving on to the broader question of how human capital is utilized in China, there has been a debate amongst some as to whether China's approach of distributing many top gau graduates to the more peripheral regions of the country so that they may compete to prove themselves worthy of promotion within the party is an efficient use of human capital.

Some claim that it allows for the maximum meritocratic selection of officials at all levels of government. While others claim that it is an excessive government intervention in the allocation of human capital, which misdirects human capital from the more productive private sector into the public sector.

What's your view on this debate?

Steve Hsu: Yeah, so there's a couple of different factors here. So number one, if you have a system where you are attracting some of the most talented college graduates into government. You know, which, for example, Singapore does, as well as China. if, you know, conditional on that being your system, right?

The alternative system would be like the US system where civil servants are poorly paid, are not that highly respected in the general population, and certainly don't attract the most talented graduates. I'm not saying civil servants are untalented, it's just that they don't necessarily, they don't typically attract the most talented people from the pool of graduates.

but conditional on you having a program like that where you're committed to deploying some of the most talented people within the government, then the question becomes, do you want to put them in places where the economy is already very highly developed? Maybe they will have the most. The best impact in places like Beijing and Shanghai and Shenzhen where things are already super, highly developed, or is it better to rotate them through the hinterland, the regions that still need, more development and, you know, maybe have, over the long term potential for further development and catching up with the coastal areas.

But at the moment, there isn't that much going on that is a little bit sleepy and backwards. And so whether that's a good idea or not, you know, I'm not, I don't have a really strong opinion. I, I can understand why you'd wanna do that. I think it's good for someone who's eventually gonna lead the country to have rotated through the hinterlands and have an understanding of it, like she himself.

I also think that there's an older reason for this, which is to prevent corruption. So, they used, I think there's this very old system, which goes back to imperial times, that the emperor would deliberately allocate. civil servants to regions, which were not their original home so that they would be going to a new place.

There wouldn't already be like a sort of sort of family or, you know, other nepotistic networks existing that, you know, that official would be ensnared in. They would be sent to some completely different place where they never spent any time. They have no relatives, et cetera. And I think there's something to be said for that.

Just to, just to keep the officials, you know, honest and, limit some of the temptations for nepotism and corruption.

Alf: And, I mean, and on your, on your point about the effort to prevent corruption, I mean, to what extent? Would you describe China's system of promotion within the party as a truly meritocratic one, or would you say that as some have alleged Chinese political meritocracy exists more in theory than in practice?

Steve Hsu: I, I think this is a hotly debated topic, and especially among, among actual Chinese people, right? Because two things can be true at the same time. Actually, maybe even three things can be true at the time. So number one. They definitely have the trappings of a meritocratic system. So there's a specific party office that actually evaluates the performance of these government officials.

And, and they do have the trappings of a meritocracy. They're trying to measure quantitative things that were accomplished by a particular official and that apparently all goes into their file or something. So, so at least has the trappings of meritocracy. It could also be true that there's a sincere effort, and by that I mean both the leader, she, the top people want the processes below them to be meritocratic.

And there's even a longstanding shared cultural value, like going back to Confucius, that government officials should be upright and extremely bright and. Hardworking, and you know, among the most able people in the population. So I think that's actually true in China. But in addition to those two things, a third thing could be true, which is that the system is far from perfect and so therefore there is still a lot of corruption, right?

All three of those things could be true. At the same time, I think they are all true. So if you talk to like an average Chinese businessman or something, or whoever, they'll be able to point to many, many circumstances where, you know, one of their relatives was asked to pay a bribe or, this particular government official, you know, he and his entire family got really wealthy while he was in power.

You know, all those things for sure happened. I. but I think it's also true that at least at times the, the party there has really tried to make things meritocratic. So, it's always this thing where they want to do something and maybe they do succeed to some degree, but you're always gonna be able to find counter examples.

Alf: I mean, to what extent would you say that China is relative to the West, more or less meritocratic in the selection of its bureaucrats?

Steve Hsu: I think it's very hard to say I, because it's such a big country and you're, you're averaging over many different eras. I think for sure the era before Xi Jinping came in, there was tons and tons of corruption going on, that that was a sort of very freewheeling, sort of 2010s era.

Mm-hmm. And I, I spent time in China during that era and yeah, it was totally different and there was plenty of corruption going on. Right. And, so would you say it's

Alf: genuinely been lessened on the Xi.

Steve Hsu: That's my impression. At least. At least it's gone. If it hasn't been lessened in magnitude, it's been driven underground much more.

it's very tough to, you know, like how would we imagine that we had infinite resources to try to figure this out? What would we do? We'd probably have to commission like. Large scale surveys and academic studies and even higher levels like private detective agencies or investigative journalists to track down the net worth, you know, of families associated with high officials and then plot that over time.

Right. I mean, it's incredibly hard to figure that out. I don't even really know how much, you know, well I don't wanna talk about the West right now, but, but you know, we don't even quite know exactly how much of that goes on in the west. but I just think it's very challenging. Now you could take a, a, a smaller case.

You could say, oh, how about Singapore? Right? I think most people accept that on average, Singaporean officials are smarter and more capable than the average western, bureaucrat, and that there's a limited amount of corruption. A, because it's a smaller place, but also B, because they compensate them quite well.

And so the incentive, like the marginal, extra income you earn from being corrupt, you know, it doesn't, you know, you're already quite comfortable and affluent as a high government official there, and then, so maybe the incentive is less to cheat. And of course you're taking a big risk to cheat. So I think that is an example of a system that actually works well.

Whether it can work well in a, you know, huge mega country with over a billion people. I don't know. I think this is one of those really fundamental questions about, the sort of traditional way, Chinese way of organizing their civilization versus, you know, the more sort of modern Western approaches.

Although I think one has to say, to be fair, that a lot of what was done in the 18th, 19th century. To establish the bureaucracies in places like the UK and, and France. Yeah. Was at the time done in explicit emulation actually of what they perceived to be Yes. There was a

Alf: Confucian influence on the enlightenment, wasn't there?

Steve Hsu: Absolutely, yeah. There was, I think this is something that, like, some, some western thinkers, philosophers and such denied for a long time, but I think the evidence is pretty overwhelming that it's true. There was a time. Say around the time, I'll give you a specific example that I, I, I came up with, not, not that I'm an actual historian, but I was curious about this.

So I was digging around, around the time of George Washington. Okay. The establishment of the United States of America. I. at that time, the Chinese economy was still enormous and there wasn't really much of a technology gap between the east and west. In fact, maybe the Chinese were even ahead at that point.

And so, for example, there was a huge trade between North America and China where unfinished goods like fur pelts were sent to China. And, the whole fur trade was basically going to China and in return, you know, they would get. They would send fur and silver and, and other like, raw materials and they would get back like porcelain, which couldn't be made in the west, some other fine, you know, silks, things like this, other, other fine finely produced goods that, that, that the Chinese had but other people didn't have.

and at that time, if you read the accounts of the captains ships, captains from the uk, from Britain or the United States or other countries who went to China to, to apply this trade. So not just Marco Polo from centuries before that, but this was already sort of late 18th century. The accounts that those sea captains wrote about what they saw in Canton or other places in China often said China is much more advanced than the rest of the world.

The legal system, the system of justice is extremely good. The officials are extremely upright and meritocratic and et cetera. So all these things that, you know, we would like to have an ideal government, at least the Europeans. Now, maybe they were mistaken, maybe they only had a superficial understanding of how things were really working in China, but they did spend time there and write books about it.

so they had this very positive view, as recently as, you know, a couple hundred years ago. Maybe 250 years ago, a very positive view of China and that did influence the enlightenment in the West. And, and things like civil service exams and even entrance exams to Cambridge and Oxford were actually deliberately copied from the Chinese system and that, that's very clear.

Historically, I.

Alf: That's fascinating. 'cause I'm aware that specifically people like Voltaire, Leitz Wolf, people like that, they were very interested in Confucius and Confucian philosophy and Yeah.

Steve Hsu: Now.

Alf: Yeah.

Steve Hsu: So for example, Leitz was a genius and was very in, and, and, you know, and, and he, people like he and Voltaire were very interested in China, but I, as far as I know, Leitz never went to China.

Whereas these are the memoirs of real sea captains who went to China, traded with Chinese merchants, spent time there were, you know, were invited to banquets and other kinds of meetings with real Chinese. People and government officials, and they, wrote memoirs about this that were quite popular at the time.

You know, there were books that sold widely at the time. They're just forgotten now by the Moderns.

Alf: And I'm pretty sure that Leid knits and, and Voltaire's views on China and everything were often quite heavily influenced from in the European world by accounts, from Jesuit missionaries who had returned.

From

Steve Hsu: Yes, exactly. Exactly. So, so, so from that earlier era, which involved, you know, Marco Polo and Jesuits, there, there's, there is, was a lot of information flowing back to Europe from China. but there, there's, there, there are other sources that extend even, you know, even later, like, even more recently in the past.

And, those, those generally people are not aware of, I think.

Alf: Moving on to the issue of US strategy.

What impact, if any, at all, do you think that President Trump's heightened tariffs will have on China? And, and you can tell, I wrote, I wrote this question before, um, before Liberation Day, because I, I just specifically, I just specifically to China.

Many are predicting that they'll have,relatively minor impact on the Chinese economy, such as the tariffs of the first trade war in the 2010s. And do you agree with that assessment? And if so, could you maybe delve into some of the reasons why China is so economically resilient to Trump's trade wars?

Yeah,

Steve Hsu: so, you know, just judging by what's in the news media and on YouTube and in the newspapers, you know, everybody in the world is talking about Trump's tariffs. This weekend as we have this conversation, we're having this conversation on a Sunday. The markets were down, you know, the S&P was down like 10%.

Yeah. on the tariff news last week. And then the question is, you know, is it near the bottom or are we gonna see more? Are we gonna see a really Yeah. Bloody opening on Monday in a while. So, I don't know. But, here, here are the numbers that should be cited if you're trying to think this through.

In terms of direct exports to the United States, they constitute a little bit less than 3%, 2 to 3% of Chinese GDP. So, you know, I think a rough estimate would be something like, oh, half of that spray just goes away because of these tariffs. Right. Like maybe it'll settle out in some way that like, oh my God, Chinese exports to the United States go down by a factor two.

Right? So that would be like the Chinese losing 1 to 2% of GDP. Now it's very concentrated in Manu, the manufacturing sector. So, so people, for people who actually own factories that make toys or shoes or, you know, even higher end electronic goods. They're not gonna be happy about it. This is gonna be a huge shock to them, but to the overall Chinese economy, I think you're talking about one or 2%, decrease in GDP, due to, you know, those exports going away and, you know, you would think they could absorb that since they, you know, even last year they, GDP grew by about 5%.

So I think the optimistic argument from the Chinese side is, yes, this will be unpleasant, it'll be unpleasantness, which is particularly concentrated in certain industries. but in no way will it, you know, tank the entire economy. I think that's the optimistic case from the Chinese side.

The pessimistic case from the Chinese side is like, well, we're still coming out of this property bubble. The things still are not back to normal. There's a big overhang of bad debt from real estate loans. The individual consumer is already pretty gloomy. And the government, you know, prior to the Trump tariffs, there was a, a, a bit of optimism. There was a rally in 2024 in the Chinese stock markets where things went up quite a bit actually.

And there was some sense that the government was gonna intervene in the economy to stimulate demand. And that, consumer demand in China was, on its way up, you know, finally recovering from covid and the property bubble burst, but that maybe could be derailed by, you know, the psychological impact of the, of this trade war.

Alf: And, I suppose the question is, which of those two readings of the situation do you think most aligns with reality? Or is it too early to tell?

Steve Hsu: I think it will be painful for China, but it's not a, it's not an existential risk for their economy, I would put it that way. There are many, many second order effects that are hard to sort out, like, how are Walmart and, you know, consumers in the US gonna react to, you know, what is li likely to be?

Quite a lot of inflation that comes from. These tariffs, not, not just on Chinese goods, but on, you know, other goods as well to the country. Could Trump basically be in trouble by the midterms? So could there be a big swing toward the Democrats by the time the midterms roll around and then Trump maybe can't sustain these tariffs?

I mean, there's even, there's even some activity in the Senate and Congress to, you know, pass legislation, putting tariffs back into the, under the control of the legislature, so it doesn't become just the sole authority of the president. Right? So, that's a way, like if popular support, if there's not enough popular support for what he's doing, the Congress could act and just take this power away from him.

So, it's not clear, it's really not clear how, how long can Trump really sustain this and how, you know, the, the benefits that he's trying to get out of this are, you know, reshoring of manufacturing to the United States. That will take a really long time to do. I, the, the main problem for me is the, is the mismatch in timescales.

Like, I, I think it's okay for, it's reasonable for a China, uh, an American policymaker to. We should really have more manufacturing in the United States, and we should, we should take steps to make sure that we're competitive in key industries and you know, if we have to put tariffs on to bring some of this manufacturing back to the US we should just do it, et cetera.

So, I think you could defend a lot of that. The problem is that you have to sustain it politically over what could be a very long time. And, and you know, just not clear there, the infrastructure and the human capital is here for a rejuvenation of US manufacturing. It just could take a long time.

Alf: And, um, similarly on the issue of the Trump tariffs, we, on this podcast, you and I have discussed the issue of the Asian, the East Asian, export led development model. And with this rise in tariffs, some have said that that model is now dead. What do you make of that assessment?

Steve Hsu: Yeah, that's a good question.

So, if you are from South Korea or Japan, you're used to running big trade surpluses. Although I think Japan might not be running trade surpluses anymore. I'm not sure we should look into that. I think that, that, that might no longer be the case. But to the extent that you are a lower wage East Asian country and you're trying to grow based on exports and the biggest consumer market in the world, the United States, is not taking it anymore. It definitely causes a problem. I haven't run the numbers to see really what, you know, what this would do to these East Asian economies if, for example, the amount that they can export to the US drops by a factor two or something, and then they have to rely on the rest of the world for demand.

What does it really do? I, I just really think most economists, you know, that we don't really have sophisticated enough models to really figure out how this is all gonna play out. It's just way too complex.

Alf: Yeah. I do agree with your assessment that it's just too early to tell on these. Things with tariffs and this Trump administration in general. But our past shows us to move to a different area of policy. We discussed the potential for Ukraine fatigue to set in in the West, and it appears that under the second Trump administration, it has set in in the US with Ukraine essentially being, by all accounts cut off from all meaningful US support and the administration recognizing that a Ukrainian military victory is unlikely, leaving a negotiated settlement is the only remaining option for an end for the war. It seems to me that this is a shift in the US and that it's indicative of a collective west, which has lost the proxy war in Ukraine, with the more strategic time for a compromise having been in Istanbul in 2022 when negotiations were scarce.

To what extent would you agree with that assessment?

Steve Hsu: Yeah, I, I think Ukraine will probably get a worse deal than what was on the table in 2022. And in the calculus of that one has to consider, you know, roughly a million casualties that have occurred since 2022. So it's really a horrible outcome. I would say this may not be the right way to say it, but people who I think are realistic, but you know, realism tends a little bit more toward the Russian side of the story than what most people in the West here do. People who are more in that sort of realist camp, I think even before Trump came on the scene, were saying Russia is winning this war, and the Ukrainians are nearing exhaustion, and Putin is likely to drive a hard bargain. And so the Trump people who came in, it's clear they wanted to do a deal. They wanted to just pivot away from this whole conflict.

They wanted to perform a reverse Nixon or reverse Kissinger, or at least normalize relations with Russia. But the obstacle to that from the sort of realist, what I call the realist perspective, is that Putin, if he doesn't deviate from his earlier demands, it, it's, it's actually quite hard for the Trump people to accept those terms. And I think that's the kind of situation that we're in. I think Trump wrongly expected Putin to show him more flexibility. I think Trump, the Trump people thought, we'll come in. We're not the Biden people. We didn't start this proxy war. We'll make a good faith effort to the Russians to show that we want to end it. The Russians will compromise with us a little bit, and help us end it. But because from Putin's perspective, the things he was asking for were pretty, were principled things like, you know, we, we, we can't have Ukraine and nato. We need guarantees on that. The regime in Ukraine is a quote, Nazi or fascist kind of regime.

And, you know, we have to, I think they had a very, vague component in their demands that they wanted to quote de-Nazi-fy Ukraine, right? Which, in a way, means removal of the existing government. So a lot of those, a lot of those, um, terms that, uh, Putin continues to ask for are very hard for the Trump people to agree to.

So, I'm not sure how this is gonna end up. It may, it may take a while for the cease fire to actually come to be.

Alf: And to me, the European response to Trump's, uh, peace process ideas and the ideas from the wider administration seem to be, I mean, I had Andrew Collingwood on the podcast recently and he said that it's somewhat like the leaders of the central powers in the closing months of 1918 who couldn't really come to terms with the fact that they had lost a war.

And it seems to me that, even though this is a proxy war, unlike World War I, this seems to me to be the correct assessment of the situation. I don't know what you think about it.

Steve Hsu: Yeah. I think the European leaders, number one, I think they really drink their own Kool-Aid.

You know, I think some more realistic man in the street is European, or even, uh, you know, I attended a meeting in Frankfurt, I guess it was last summer. where a lot of European elites were present, and with the exception of some actual EU officials, like if it were just some rich business guy from Germany or you know, billionaire from Germany or something, those guys could be quite realistic and say like, yeah, this is an American proxy war.

It's not good for Germany what's happening there. We should just settle it. Uh, we need energy from Russia. Those people I thought to be reasonably realistic, but, but the actual government officials, the people who lead the EU and lead individual nations in Western Europe, those people seem to have more or less drunk their own Kool-Aid.

So we went through this whole spasm of them, you know, briefly talking about supporting the war themselves, putting French and British troops on the ground in Ukraine. I mean, just crazy stuff. It doesn't make any sense. Now, maybe they've backed off from that just this weekend. I heard something about Macron being appointed the diplomatic representative, you know, for the Europeans to, to, to, to treat with Putin and that he's going to visit Putin in Moscow, if I heard that correctly on the news. That seems to be, you know, maybe a sign that they're coming to their senses a little bit.

Alf: Yeah, I think there are some, if relatively few in number there are. Some European governments are pursuing a real line on this. I mean, I can think of all bands, government in Hungary, or government in Slovakia as an example, and, a question which I have posed before on the show with Andrew calling Wood, one to which I'd be interested to hear your answer.

To what extent do you think that Europe has in capacity to build up its defense capabilities to the extent to which it will be able to not only regain strategic independence, but also to plug the gap in Ukraine's military capabilities left by the withdrawal of US support or potential withdrawal, full US support in order to keep the proxy war with Russia going?

As has been suggested by some of,

Steve Hsu: Yeah, so the, you know, the typical homo economic view of all this stuff is that, you know, Europe's GDP and population size dwarfs that of Russia. And so surely by just increasing the allocation to defense by individual governments in Europe, they should be able to defend themselves, right?

I mean that, that, just in terms of numbers, just numbers alone, that seems to be correct. Now you have a bunch of obstacles like, you know, do Europeans have a taste for fighting anymore? Maybe not. Do they have a hard time? Manufacturing capabilities to really, really rebuild their defense capability. I think they, I think they can, if they, if they really have the will to do it, they have the technical and manufacturing capability.

So my view of it is that Putin is not really a threat to Western Europe. He may, he might be a threat to the, you know, to the Baltic states or something like this, but, but to France and Germany, the UK and Spain, Italy, is he really a threat to those countries? No, absolutely not. and if they were, you know, and except in a scenario where they were just completely ineffectual and not able to do the basic things that governments and corporations are supposed to be able to do, then I think they can easily defend themselves against the Russians.

Alf: Absolutely. And as you say, there's all this talk of Europe needing to re-arm in order to defend itself, presumably from Russia. And to me that that very notion just seems to completely beg the question of, is Russia genuinely a threat? I mean, as you say, with the potential exclusion of the Baltic countries. To anyone in Europe, to me, it just doesn't seem that they are. I. What are the chances of Russia successfully marching into Finland or Poland? To me it's, it's zero.

Steve Hsu: Yeah. Yeah. I mean, especially not Poland, I mean, the Poles will really fight them, right? Yeah. And, it'll be a lot like Ukraine probably. yeah. So not an easy

Alf: Finland, not, I find doubt they want to run a repeat of the winter war.

Steve Hsu: Yes. I mean, so let me, let me, just to be completely balanced. I was talking to someone, another physicist, theoretical physicist I know who actually does a bunch of work for US defense. He consults for the National Labs and Defense Department on security issues. And his perspective though, was that what the Russians will do, you know, imagine that sort of NATO goes away or, or the, you know, the US it's, it's clear that even if the US remains in NATO, that, you know, we don't have that much commitment to it.

He said, countries like Sweden as an example. They would immediately be subject to certain kinds of blackmail from the Russians. So if there were negotiating some agreement or you know, some disputed island or you know, some something, you know, that the Russians wanted, the Russians would go to the Swedes and just threaten them and just say, you don't wanna mess with us and look at all these nuclear weapons we have and you know, we have submarines going up and down your coastline 24 7.

Why don't you just give us what? And he claimed that these things do go on. So the Europeans do have a reason to want to feel more secure vis-a-vis the Russians. And until now, that has been mainly by relying on the US presence. So if the US decreases its commitment to European security, there will be a vacuum to be filled.

It's, it's not just, it's not that they, it, it's not completely crazy that the Europeans are worried about the Russians on the margins. But, Russian armies rolled into Berlin. No, I, I don't think that's in, as long as the Europeans don't do really stupid stuff, right? I mean, if they, if the US pulls out and then they just react properly by increasing their defense spending, revitalizing their defense industries, you know, just basic stuff, then I don't see any, you know, fundamental reason why they can't defend themselves against an actual invasion by the Russians.

Alf: Again.

Um, lastly to round off our brilliant discussion, which I've very much enjoyed, it's growing increasingly clear that the US or at least the present administration is no longer really interested in playing an active role in Europe as Europe's security guarantor. What do you think is the possibility of Europe reevaluating it, seemingly, ideologically motivated? I mean, I can't really see any practical reason for it, belligerent and hawkish stance towards China.

Steve Hsu: You know, it's a very interesting question, and this question was also open by this, the tariff, actions by Trump. You know, is there space for Europe and China to develop somewhat warmer relationships?

I think that the idea that the Chinese are gonna come and take over Europe is even more farfetched than that the Russians would do. It's quite far away. And the Chinese have not really focused on power projection, military power. Yeah. What are they gonna do?

Alf: Send their ships to the suez?

Steve Hsu: Yeah. Yeah, exactly.

So I think most of Europe's fear of China, number one, there's a legitimate fear of their industries being hollowed out through trade. So, there'll always be some tension there. And, and that, that tension actually will be increasing because, you know, for example, Germany is heavily reliant on the auto industry. And the auto industry is in real trouble, due to Chinese competition. To, to expand on that a little bit, I mean, these German companies in the past have made huge, sometimes over 50% of their total profits came from selling cars in China. And that market now, in that market, they're longer competitive. They're being outspeed by domestic companies.

And even worse for them, the domestic companies like BYD and China are getting ready to export huge numbers of cars to Europe. So, there'll always be those tensions between Europe and China. But for it to reach this kind of fever pitch that, you know, under Washington's direction, you know, you have like people like, You know, the, Vander Lion and others just, insulting China, you know, directly insulting China, you know, you know, while in China, you know, things callous

Alf: the, from the EU, she was saying that if we can't defeat Russia, how are we gonna defeat China? right,

Steve Hsu: Exactly. I think these people are just very dimwitted. But, but, I, there's no reason, there's no reason to have that.

Right. They could just have a trading relationship with China, you know, not a completely open, free trade relationship because obviously there are domestic reasons to protect certain industries, et cetera, et cetera. But it could be more collaborative, than it is now. And in particular, like, I think this is happening in Spain, you know, you know countries that want to cooperate with China can get some tech transfer out of it so that Spain could end up with its own battery manufacturing and, and maybe solar panel manufacturing. You know, Spain has, because of its climate, has, you know, could become like this huge solar farm for the rest of Europe. And so I think there are things like that that could move forward if the US alienates Europe too much, that that sort of thing could happen.

I think the Chinese are hoping that that's what happens. It's a little bit hard to know how it will play out.

Alf: And on that note, I think we'll round off this discussion. It's been very enjoyable, very informative, and I'm sure our listeners will feel the same. Thank you so much for coming on. Once again, Steve and I hope to have you back on the show.

Steve Hsu: Yes, always a pleasure. Happy to come back.

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Stephen Hsu
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Stephen Hsu
Steve Hsu is Professor of Theoretical Physics and of Computational Mathematics, Science, and Engineering at Michigan State University.
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