Chinese economists recruit Ray Dalio and MMT in their battle over deficit spending

Bank of China's Xu Gao wants Beijing to step up debt levels.

Economic debate continues to simmer in China between deficit hawks and doves, as Beijing lifts its deficit ratio to record highs and embarks upon its biggest fiscal stimulus campaign since the Global Financial Crisis.

Partisans on either side of China's fiscal policy debate have drawn inspiration from heterodox macroeconomic opinion derived from overseas sources.

Chinese deficit hawks find support for their arguments against fiscal spending in the popular works of storied hedge fund manager Ray Dalio, who contends that excess debt accumulation inevitably results in financial crises.

Doves, on the other hand, are making recourse to Modern Monetary Theory (MMT) to support their arguments in favour of deficit spending as a safe means of sustaining the Chinese economy.

This divide is best embodied by a vicious attack against Ray Dalio's works that was recently launched by Xu Gao (徐高), chief economist at Bank of China International.

Xu cites MMT in arguing that China needs to dial up its debt levels, instead of pursue a "beautiful deleveraging" as prescribed by Dalio.

Dalio's works gain traction in China

The views of Ray Dalio have found a receptive audience amongst many economists in China, amidst concerns over fiscal policy that has been in an expansive state for much of the period since the Global Financial Crisis.

The Chinese translation of Dalio's "Principles" topped Douban's annual list of best-selling books in the business category following its release in 2018.

Since then, Chinese translations of Dalio's works have been published to widespread popularity, including "Big Debt Crises" in 2019, and "Principles for Dealing with the Changing the World Order: Why Nations Succeed and Fail" just earlier this year.

Ray Dalio is the founder and co-chief investment officer of Bridgewater Associates - at one time listed as the world's largest hedge fund.

His basic macroeconomic thesis is that cycles of excessive debt creation are the chief culprit for financial crises since the Second World War.

"Over the long run, debts can’t rise faster than the incomes that are needed to service the debts, and interest rates can’t be too high for borrower-debtors or too low for lender-creditors for very long," Dalio writes.

"Big debt crises come about when the amounts of debt assets and debt liabilities become too large relative to the amount of money in existence and/or the amounts of goods and services in existence."

Dalio contends that "debt crises are inevitable," given imperfections in the lending process, as well as the tendency of the debt cycle to generate asset bubbles and busts due to their psychological effects on investors.

He advocates the use of a "beautiful deleveraging" to reduce debt burdens without triggering economic crises.

This involves both the restructuring of debt to spread repayments over time, and having central banks print money and buy debt.

The goal of a "beautiful deleveraging" is to reduce debt burdens and produce nominal economic growth, so that debt burdens shrink relative to incomes.

Xia Chun (夏春), chief economist at Forthright Financial Holdings (方德金控), says that few have openly disputed Dalio's assertions in the Chinese economics community since the publication of Mandarin-language editions of his works.

"In the Chinese language world, public criticism of Dalio's research and viewpoints is extremely rare," Xia writes ("夏春：不要轻易否定达利欧的国家债务认知").

This has recently changed, however, with the publication of a 9000-word essay entitled "Where the errors are in Dalio's understanding of national debt" ("达利欧的国家债务认知错在哪里?") by Xu Gao, chief economist at Bank of China International.

Xu is scathing in his assessment of Dalio's debt-cycle thesis, accusing the hedge fund legend of "inability to recognise his own ignorance of macroeconomics" and "misapplication of macroeconomic analytical methods."

Xia Chun points out that Xu's attack on Dalio is part of the ongoing debate between deficit hawks and doves in China over debt-fuelled fiscal spending.

In 2023, Xu Gao and Zhao Yanqing (赵燕菁) from Xiamen University took part in protracted online debate with Zhao Jian (赵建) a renowned macroeconomist and head of the Xijing Research Institute, over the issue of China's debt levels.

The debates drew the participation of many other Chinese economists on either side of the fiscal policy divide.

Xu Gao's recent criticism of Dalio extends the themes of his debates against Zhao Jian in 2023. The Bank of China economist is now calling for Beijing to engage in further debt-fuelled fiscal spending to deal with its current economic challenges.

Why Xu Gao believes Dalio doesn't understand macroeconomics

Xu argues that Ray Dalio has failed to grasp macroeconomic realities for two primary reasons.

The first is that Dalio uses a "microeconomic mentality" when it comes to the macroeconomic issues of national debt.

The second is that Dalio views the macroeconomy as a machine subject to inflexible laws.

Xu instead considers it to be a dynamic and mercurial beast, responding differently to the same policies depending on supply and demand conditions.

1. Microeconomic principles do not apply to monetary sovereign nations

Xu's first argument is that Dalio has made the error of using intuitive microeconomic approaches - which are applicable to individuals and companies - to the economic challenges of sovereign nation-states.

"Dalio's problem is not just that he makes a number of biased conclusions on the matter of government debt, it's also that he misapplies methods of economic analysis," Xu writes.

"He makes improper use of a microeconomic mentality to contemplate macroeconomic problems, thus obtaining incorrect results from incorrect methods."

Xu highlights the fact that the debt of nations with monetary sovereignty is fundamentally different from the debt of individuals and businesses that depend on external cash flows.

"At the micro-economic level, the debt of individuals or businesses is easy enough to understand and fundamentally intuitive," Xu writes.

"Their cash flows need to be able to cover the principal and interest payments for their debt at any time in order to be sustainable.

"If this isn't the case, then these individuals or businesses will default on their debts.

"If we change the object of analysis to the debt of macroeconomic entities (national), then the microeconomic approach is no longer applicable."

The critical distinction for Xu is that nation-states possess central banks or monetary authorities that are capable of creating money ex nihilio.

"The government possesses the right to issue its own sovereign currency, he writes.

"The government can always use printing of bills to repay debt in its own currency, and will never reach the point where it defaults on such debt.

"In theoretical terms, if it wants cash flow in its own currency then it can just print it.

"The cash flow of individuals and businesses is to a very large extent exogenous in supply, while the cash flows of a government are endogenous."

Xu acknowledges that exceptions to this rule exist in recent history - the Asian Financial Crisis of 1997, and more recently the European sovereign debt crisis which ran from 2009 to 2018.

He argues, however, that these are exceptions that prove the rule, because in both examples sovereign nation-states found themselves unable to print the money needed to discharge their debts.

In the case of the European debt crisis, this was because countries such as Greece and Spain had ceded monetary sovereignty to the European Central Bank when they became EU members.

For nations hit by the Asian Financial Crisis, a copious volume of their debts were owed to foreign lenders, which meant their central banks were unable to print the currency needed to pay these liabilities.

2. “The macroeconomy is not a machine”

Xu's says that Dalio's second cardinal error lies in his conception of the macroeconomy as a mechanical entity which is ruled by invariable laws.

"Dalio erroneously imagines the macroeconomy to be a machine," Xu writes.

"In 2008, Dalio wrote 'How the Economic Machine Works.' The first line of it is that 'the economy is like a machine.'

"2025's 'Why Nation's Fail' also uses this concept in the first section of the first chapter.

"Consequently he is unable to see the differences in macroeconomic logic under different macroeconomic conditions."

According to Xu, "the mechanistic research method that views the macroeconomy as a machine was long ago proven false, and is a methodology that was abandoned by economists over half a century ago."

He cites in particular the fate of the Phillips Curve, which was advanced in 1958 and postulates an inverse correlation between inflation and rates of unemployment.

The Phillips Curve emerged as an "iron law" of macroeconomics by the 1970s, when it came to inform key policy decisions by leading economies.

It was just at this juncture that the phenomenon of stagflation overturned the assumptions of the Phillips Curve, by bringing about high inflation and high unemployment simultaneously.

"The disappearance of the Phillips Curve spurred the rational expectations revolution in macroeconomics in the 1970s, causing macroeconomists to thoroughly abandon their mechanistic view of the economy," Xu writes.

"The lesson for people trying to understand the macroeconomy was this - to absolutely not think of the macroeconomy as a machine.

"The macroeconomy has various cause-and-effect linkages and contrary forms of behaviour, all of which can change due to changes in the macroeconomy.

"This machine is strange because it's alive - it has expectations of the future, and is comprised of people whose behaviour will change once their expectations change."

“Nations can rack up debt indefinitely without fear of crisis”

Because the macroeconomy is not a machine subject to fixed and immutable laws, Xu argues that the same set of policies can have different outcomes depending on different macroeconomic conditions.

It's for this reason that Xu believes national economies can engage in debt-fuelled spending almost indefinitely under the right circumstances, without fear of inflation or financial crisis.

"Because Dalio views the macroeconomy as a machine, he erroneously believes that set behaviour will produce set consequences," Xu writes.

"He believes that the central bank printing money to deal with a debt crisis will inevitably lead to depreciation of its currency.

"However, in real circumstances this isn't inevitably the case. Printing money by the central bank can lead to depreciation of the currency or appreciation.

“What the outcome will be depends on the macroeconomic conditions"

According to Xu, the conditions that permit the issuance of money without risk of inflation or financial crisis are i) inadequate domestic demand and ii) oversupply of productive capacity.

Both of these conditions happen to characterise the Chinese economy at present.

"When domestic demand is inadequate, increasing the money supply will not bring about inflation - in fact, it will help to ease deflationary pressure, and will not trigger macroeconomic instability," Xu writes.

Under such circumstances, Xu believes "the government can use money creation to repay domestic debt denominated in the national currency" without the need to worry about breakneck inflation.

Xu’s view is that the fundamental condition that restricts a nation's debt levels is not its cash flows, but its productive capabilities.

"As long as a nation's productive capability is larger than its domestic demand (and the nation's domestic demand is inadequate) then its debt is sustainable...it can completely avoid a debt crisis" he writes.

For this very same reason, money printing can have severe inflationary consequences for nations where demand is excessive while production capacity remains inadequate.

"If a country has excess domestic demand and production capacity is insufficient - that is domestic production capacity is less than domestic demand, then issuing money will further increase domestic demand, and bring about strong demand-driven inflationary pressure."

The rise of MMT in China

Xu says the macroeconomic conditions that make for safe debt growth are already aptly described by Modern Monetary Theory (MMT), which has recently risen to the fore in China’s economic discussion circles

"This is the situation described by MMT, which has become popular in the past several years," Xu writes.

Xia Chun says MMT first made its debut in China at the start of 2020, when it was viewed as an intriguing school of heterodox economics.

Unlike Dalio's views, which were broadly accepted, Xia says MMT was criticised by nearly all Chinese economists who held mainstream economic opinions.

"It was mistakenly simplified as 'debt monetisation'," Xia writes. "It was [viewed as] the government expanding fiscal spending without restraint, before using money printing to solve the problem.

According to Xia, his May 2020 article "Mainstream economics vs Modern Monetary Theory - whose defects are greater" (主流经济学vs现代货币理论：谁的缺陷更多？"), is perhaps the first article in China to support MMT thinking.

Xia Chun argues that Xu Gao's viewpoints in his broadside against Dalio are fundamentally consistent with the core arguments of MMT.

Can China increase debt levels indefinitely

The conclusion of both Xu Gao and Xia Chun that derives support from MMT is that China can engage in debt-fuelled fiscal spending in its current macroeconomic states, without much fear of adverse consequences in the form of inflation or a debt crisis.

China is currently host to all the conditions that are supportive of worry-free fiscal expenditure, including:

• Inadequate domestic demand.

• Excess productive capacity.

• Low inflation.

Beijing’s top policymakers have explicitly pointed to each one of these conditions as major challenges faced by the Chinese economy at present.

Beijing has launched a "cash-for-clunkers" campaign to subsidise consumption by Chinese households, with the goal of boosting domestic demand.

The goal of Xi's second-half crackdown on "involuted competition" and his campaign to create a unified national market is to reduce excess productive capacity in key industrial sectors.

Chinese officials have also voiced concern about ongoing deflationary pressure that has arisen as a result of the supply-demand mismatch.

PPI fell 3.6% year-on-year in July, while CPI only edged into positive territory in January and June during the first half of 2025.

For this reason, Xu vehemently argues for China to ramp up debt-fuelled spending, contrary to Dalio's macroeconomic prescription of a "beautiful deleveraging".

"Dalio says that under ideal conditions, China's policymakers will vigorously, bravely and rapidly achieve a beautiful deleveraging," Xu writes.

"He obviously believes that China's debt size is already too high, and that it needs to use deleveraging to reduce debt risk.

"But when he makes this judgement, he has not at all noticed China's current environment of inadequate demand and excess savings, which makes debt accumulation rational and necessary."

Xu instead believes that efforts to deleverage the Chinese economy are the true cause of its woes, and that the best solution for its problems can be found in greater debt accumulation.

"In actuality, it's precisely because in recent years China has excessively and strictly deleveraged and restricted rational growth in leverage, that domestic savings have been prevented from transforming into investment via debt,” he writes.

"This has added greater pressure to China's inadequate demand, and put heavy downward pressure on economic growth and prices."

"In recent years, the reason that China's domestic debt has seen problems isn't because the debt is so great that it will lead to a debt crisis, but because of strict deleveraging measures that have artificially created liquidity problems for debt extension.

"Given the severe shock created for the macroeconomy by deleveraging, what China needs isn't more deleveraging, but a correction in its deleveraging mentality."

China's current policy settings

For the time being at least, China's economic helmsmen appear aligned with the views of the deficit doves who have found succour from MMT.

In order to fund 2025’s out-sized stimulus plans, Beijing’s policymakers lifted the official deficit ratio to 4%, for a single percentage point rise compared to 2024.

4% is the highest level on record, and a major breach with the long-standing convention this century that China keep its deficit ratio at the Maastricht Treaty benchmark of 3%.

Lian Ping (连平), an academic at East China Normal University, points out that this official deficit ratio falls far short of the overall government deficit, as it does not include major forms of debt raising.

Chief amongst them are special treasuries issued by Beijing, and special purpose local government bonds issued by regional authorities.

These are excluded from China’s "narrow deficit" on the grounds that they are for investment in projects that generate cash flows or have assets as collateral.

Lian expects the “broad deficit” - which includes special treasuries and special-purpose local government bonds, to approach 10% in 2025.

“The super-large scale of government spending and debt arrangements has exceeded market expectations,” Lian wrote.

“It shows the massive determination to accelerate the recovery of demand this year and achieve 5% economic growth.”

Lian expects Beijng to keep fiscal and monetary policy loose until at least 2035.

He argues that China’s current fiscal and monetary loosening differs greatly from its shock GFC rescue plan, because this time it involves “medium and long-term considerations.”

Chief amongst these is fulfilling China’s long-term economic goal of achieving per capita income at middle-developed nation levels by 2035.

This means keeping per annum GDP growth at around 5% for the next decade.

“In the next several years, maintaining GDP growth at around 5% will require the adoption of intense loosening of macroeconomic policy,” Lian Ping writes.