My concern is that because the Chinese models are open source, it will not be Chinese models used in China and US models used in the US. It'll be Chinese models used in China and everywhere else in the world and US models used in the US. It's possible the US may try to corral European countries into using only US models, but that would be a big heavy lifting operation if the US was to try to do that.
Well, welcome to China Decode. I'm Alice Han.
In today's episode of China Decode, we're discussing China test firing a ballistic missile with a dummy warhead into the Pacific, a Chinese AI model that rivals Anthropic, and a new ethnic unity law drawing criticism. That's all coming up. But first, let's do a quick check-in with how the markets in China are starting the week. On Monday, the CSI 300 was mostly flat, while the Shanghai Composite was down slightly 0.06%.
The Shenzhen component, however, fell 1.16% to a three-week low. Bank stocks saw gains, with the Industrial and Commercial Bank of China up 1.14% and the Agricultural Bank of China up 1.19%. Notable falls were with Eoptoink Technology down 3.6% and Victory Giant Technology down nearly 5%. All right, let's get into it. On Monday, China test fired a ballistic missile with a dummy warhead into the Pacific Ocean, only the second time it has done so in two years. The launch coincides with Australia and Fiji announcing a new mutual defense treaty, showing how China's growing missile capabilities are accelerating a broader regional defense buildup.
Meanwhile, in China-Europe relations, the EU's ongoing attempts to balance the trade deficit with China have hit a new hurdle: soaring temperatures. The bloc's worst ever heat wave is driving unprecedented demand for imports of Chinese-made air conditioners, which is making serious inroads at undercutting the deficit reduction push. Cooling demand has been pushed to its highest level in at least 45 years. James, I'm in Spain at the moment, which is quite sweltering. It's in the sort of 35 region. But the UK a few weeks back, you know, we were both based there, was also close to 40. We were seeing record temperatures across Europe, and I was just looking at some of the figures of Chinese air conditioners being imported by the Europeans. So, in the first five months, we saw a 10% rise in household air conditioners imported from China to Western Europe, and apparently a 70% year-on-year rise in that same period of portable fans, portable air conditioners from China to Europe. And I see a lot of those on the trains in the UK, I have to say, on the London trains where they're very much needed. But the reason this image is so startling is that on the one hand you have Europe undergoing blistering heat, but also undergoing record trade deficit with China. We just saw the Chinese commerce minister Wang Wentao in Brussels. A bit of a nothing burger in terms of what came out of it, but they're apparently engaging in strategic dialogue for a framework that will probably be unveiled in October. But it seems like the Europeans haven't really been on the offensive in terms of trying to seriously address these deficit concerns. James, we'll go to the Europe and heat dimension in just a bit. I want to start firstly in terms of this ballistic missile launch with a dummy warhead that China's just made. And it's obviously riled a lot of the Asia-Pacific countries, Australia, my own country being one of them. What was your read of that? Because the Chinese readout was, hey, this is a very bog-standard military exercise that we do in the region, nothing to worry about, but it certainly has caused a lot of consternation amongst some of the surrounding countries.
Yeah, absolutely, Alice. I mean, I think, you know, the world is getting hotter geopolitically, climatically, and in terms of trade tensions. And yeah, as you say, I mean, it is pretty tough in the UK at the moment without air conditioning. But we'll come to that in a minute. I think this issue of this long-range ballistic missile that was fired by China with a dummy warhead, in other words, it wasn't armed, of course, and it landed somewhere in the Pacific Ocean. We don't exactly know where, but this happened, as you mentioned, just hours after Australia had signed a defense pact with Fiji. I think it definitely shows assertive behavior by China. And that assertive behavior we can see in so many other domains right now. I think that's, to me, the theme that binds together what we're seeing in European trade, what we're seeing in China's military assertiveness. And I also think that this is particularly relevant to the United States, because if you look at the detail of this missile, it does appear, at least to me, that this was also a veiled warning to the United States. And that's because, according to the official Chinese media, the missile that was fired from a submarine was likely to have been the JL-3. Now, that is, as I said, a submarine-launched missile. And the point is that this missile could reach the continental United States from Chinese coastal waters, according to the Pentagon. So although we're talking about a missile that was launched into the Pacific and it had a dummy warhead, not a real warhead, we can see that in terms of signaling, this is basically saying to the West, to the United States, and certainly to Australia, Fiji, and anyone else who cares to watch, it's saying, don't mess with us. We are a growing and increasingly assertive military power. And for that reason, I think that the context around this is also key. China has been launching many, many more combined military exercises with different countries, in fact more than 45 partner countries in the decade that ended in 2025. It's conducted more than 154 of these combined exercises, and mostly with Russia. And the scope of the exercises has also increased. It's done exercises in the Pacific, Indian Ocean, and around Africa, and it's had extensive voyages, naval voyages, this is around Australia. So to me, this is part of the same picture. This missile test into the sea somewhere in the Pacific. Obviously, it's part of another big picture, which is China's very rapid expansion of its missile arsenal. China is supposed to have, we think, estimates say, around 500 ballistic missiles currently. But by 2035, it is projected to have about 1,500 nuclear warheads which could be delivered on ballistic missiles by that time. So this is part of a much bigger picture. It's part of the rise of an assertive China. And, you know, to flip that to the trade domain, we've got another side of an assertive China emerging, and it's showing in China's trade surplus with Europe that is really hitting the big time this year. Last year it was 360 billion euro, and this year the estimate is that it will top 400 billion euro. So I don't know what you think of the trade side of things, or maybe if you want to talk about ballistic missiles, Alice, but on the trade side of things, you came in talking about these air conditioners. This is just one example of the way that Europe seems to be ineluctably drawn to importing Chinese stuff. And I suppose that's because Chinese stuff is so much cheaper. It's often better in terms of technology than what the Europeans can produce. But structurally, it seems to me, sitting here in Europe, that Europe is really very weak when it comes to industrial production and producing things that Europeans can buy. And that's simply why, whether it's a heat wave causing us to import air conditioners or in the middle of winter if there's a cold snap, we'll be importing Chinese heat pumps. I'm sure of it. It just seems that these days we turn to China for all of our needs. What do you make of it, Alice?
Yeah, I know that on the surface these two stories don't look too interlinked, but hopefully if we can convince people that they somewhat are, right? Because on the one hand you see China that is worried about the geopolitical situation. I think that that exercise is more of a deterrent strategy than an offensive, you know, saber-rattling one, to show, hey, we have long-range missiles with capabilities to reach Australia, to reach the US, and, you know, don't mess with us in a period where we've seen a lot of geopolitical uncertainty and uncertainty that's increasing. And I don't think it's a coincidence that Fiji and Australia signed that mutual defense treaty. China has been, you know, engaged in an influence campaign with the Pacific Island countries. And, you know, my counterparts in Australia have been worried about that, the amount of Chinese investment that's gone into, say, Fiji, which was the first Pacific island country to diplomatically recognize China, by the way. But also the telecommunications and infrastructure development that, you know, is almost completely Chinese at this point in a lot of these countries, including Fiji. So I think that there is one side which is, from a Chinese vantage point, we want to maintain influence in the Pacific. We also want to deter any kind of, I know, coalition building or, you know, offensive coming from the Quad or coming from the US by showing that we have these ballistic missile technologies and capabilities. On the one hand, it's trying to strategically deter. On the other hand, it is showing that it is still very much embedded in the multilateral trade system. The numbers that you just cited in terms of the trade deficit that Europe is running with China now, almost close to 400, it could be this year, billion euros of trade deficit between EU and China. The EU is 15% of Chinese exports in terms of market destination. It's a huge market for Chinese manufacturers. So China is still heavily dependent. We've spoken previously on this export engine, exports of 30% of total GDP growth. You know, in a way, I think they're kind of playing this balancing act of being tough on the geopolitical issues, but really still, I would argue, somewhat vulnerable on the trade issues. But the big question here is why isn't Europe doing more? Because I think that they have some leverage to bear given what I've just noted, China's trade dependencies in its total, you know, macro machine, but is also a dependency on Europe as a huge market. So all I can point to is this structural fragmentation in Europe as this supranational body to try to get its act together and put in legislation that is smart in terms of, you know, maybe price minimums on Chinese exports, limitations on the amount of exports that come into certain markets, getting smart about IP development being based in Europe and not just assembled in Europe. But the big question, and here I defer to you, James, as the expert, is why isn't Europe doing more? Because I think it could have a lot of leverage.
That is absolutely the key question, Alice. I do note that the EU and China recently released a rare joint statement that aims at balancing trade and addressing market access issues. And the two sides said that they would set up a bilateral working group to monitor trade flows. And Beijing offered reassurances that existing rare earths and permanent magnet export controls will not disrupt EU supply chains. So that's the official sort of picture. But to be honest with you, my feelings on this are similar to what you just described, Alice. I feel that Europe is fatally disunited on this issue. They cannot get consensus among the member states of the European Union to actually impose stiff tariffs or other forms of restrictions on Chinese imports. And they don't seem to have the political clout to push European exports to China either. And so the reason why this is important is that we're not just talking about trade balances here. We are talking about the endgame for European industry. Europe stands to lose its industrial base. And I don't make any apology for speaking in such blatant and blunt terms. It really is that simple. The reason is that China has overtaken Europe when it comes to technological advancement, and the technology products that China's producing are way cheaper than the nearest competitors in Europe. That's why we've seen this flood of high-tech products. Everybody knows about the EVs that the Europeans are buying from China, but this is happening in almost every sector. And this is why we are in a very important moment. It seems to me that Europe has not yet embodied the necessary sense of crisis that attends this situation. And while it remains fairly flabby, sort of talking around the issues like Europe always seems to do without coming out with strong, staunch action, it is presiding over the, well, I won't say extinction of its industrial base, but certainly the weakening and erosion of its industrial base, which is going to take decades to build up again if it loses it. So this is a vitally important, and as I said at the top, it's a geopolitical question. Therefore, I think it does belong with the story about the ballistic missile landing in the middle of the Pacific.
Yeah, because in the question which we've discussed in, you know, previous episodes of this Taiwan crisis risk and what will be the corollaries or outcomes or responses from some of these other countries, whether it's the US, we've talked about Japan and Korea, Australia in the past, but another question is what is the EU going to do, right? Because China is a huge, obviously, market, but it's also a big exporter of a lot of goods that the Europeans require. We haven't discussed rare earth yet, but that's another choke point that the Chinese have over the Europeans that they have not yet weaponized, but they have with the Japanese. The big question for the Europeans will be what will you do when there is a Taiwan crisis? If there's an invasion, a blockade or a quarantine, will you put economic, financial, you know, technological sanctions on China? And then will China react in kind? And here I think Europe could be quite vulnerable to a China counter response, which is, I'd imagine, something in the vein of we'll cut off exports of critical technologies and rare earth commodities. I can imagine that that would be hugely disruptive for the Europeans. Oh, and we'll also import less agricultural products and chemical products from the Europeans. Again, very, very disruptive for European business.
Yeah, I fear that you're right there too, Alice. I think China's got so much coercive power that it could use. It is easy to imagine a scenario under which China does something that Europe doesn't like, and then China threatens to use these coercive powers, and Europe backs off. I think that's also highly possible.
Okay, we'll be back with more after a quick break. Stay with us.
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Welcome back. Speaking of AI, there's more exciting news coming from Chinese models, specifically GLM 5.2 from Z AI. It was released in mid-June, but just last week, ZAI launched Zcode, a harness for its model that lets it function as an autonomous coding agent. The model is said to rival ChatGPT 5.5 and Claude. So James, a lot of chat on the news about how Anthropic just cut off its latest Claude Fable and Mythos models from non-US users. They were clearly worried about the fact that the Chinese have been distilling a lot of their cutting-edge models. They're also worried about the national security risk and pressure from Washington to make sure that this is indigenized, this technology is indigenized as possible so that American businesses and the military intelligence community have a step up or a leg up relative to other countries. And they have been forced to comply with the US Department of Commerce's export controls that are now not just applied to chips and equipment but also to increasingly AI models. Right. But the big news that came out of China just recently is there's a couple of models that are purported to be competitive in this space. There's one, for instance, a cybersecurity firm called 360 Security Technology has apparently unveiled two AI-powered cybersecurity tools that could rival Anthropic's Mythos. And then obviously, as I've mentioned, you've got Zhipu's GLM 5.2. This is an open-weight model that people can download and use that is supposed to be as competitive as a new cutting-edge Claude Code or even Cursor Code. So the big question then is how accurate are these statements? Can we test them out? And how do we compare them even against the cutting-edge models that may or may not be available to a lot of non-Americans because of the Department of Commerce's shadow on export controls? I find this exceptionally hazy and opaque and would welcome anybody to come and tell me what the best benchmarks or testing mechanisms are to really compare. But this whole world seems to be moving so quickly and yet it's so opaque.
Yeah, I couldn't agree more, Alice. This is really hard work to keep up with all of this. As I see it, basically we have a couple of trends going on here. First of all, the AI race between the US and China is kind of diverging. We're getting a separation, certainly in terms of the users of these models. The other thing that's happening is that China is catching up. It's producing more and more very impressive pieces of technology. I think this is a very considerable move by China, and as you mentioned, Alice, it takes this Zhipu GLM 5.2 into the arena with some of the best, like the Claude Opus 4.8. Almost all of these Chinese LLMs and agents are open source, and this means that they can be downloaded pretty much anywhere in the world and used by anybody who wants to develop their own AI products. And so what we're seeing is vast numbers of people all over the world downloading these very good Chinese LLMs. Alibaba's Qwen, for instance, appears to have surpassed 1 billion downloads worldwide. And this Zhipu GLM 5.2 has climbed to the top of the Western usage charts on third-party development platforms such as OpenRouter. So we can see that the Chinese open-source approach, as opposed to the US approach, which is much more closed, is creating a really big following internationally. I'm not going to call it, I never call the AI race between the US and China. I think that's a mug's game. Basically, China seems to be ahead in some areas, the US is ahead in other areas. It's basically neck and neck as I see it. But what I would say is that this latest GLM 5.2 is another reminder that China's doing some very impressive stuff.
And you see this in Chinese tech companies. They basically subsidize usage, make it a premium model to try to get subscribers to get onto their platform. They've done this with developers. They increased their data quotas for existing subscribers by 50%, offered 5 million free tokens to new users. And at the same time, you know, shout out to my friend Kevin Xu, who writes the great AI blog Interconnected. He's saying that this is a bigger deal than the DeepSeek moment. And if he says that, I'm listening. Apparently, he's noting that according to the Arena's agent leaderboard, that Zhipu AI's GLM 5.2 is the only open model that is competitive with OpenAI and Anthropic's latest LLMs. And, you know, it reportedly, according to this leaderboard, bested Claude Fable on Design Arena. So there are areas in which they seem to be as competitive. But I think when I broaden it out to this geopolitical question, and I made this prediction probably a few episodes back, it's only a matter of time before Washington starts cracking down on this. You know, they probably don't like the fact that so openly you've got developers in Silicon Valley and elsewhere that are using Qwen and Zhipu and Chinese open source, right? And so, and on the other side, there seems to be these guardrails that Anthropic is now putting in because they're very worried about distillation, and they've made it very clear compared to OpenAI that China is the strategic threat or strategic challenge for the US AI community. And so apparently, they're able to covertly track now Chinese users of their Claude Code platform. They've got this hidden tracking code that is basically able to pick up on, you know, Chinese users using it. And the idea is to prevent future distillation efforts. So this space is getting politicized or geopoliticized very, very rapidly. And wouldn't surprise me if we end up with some kind of AI iron curtain being, you know, pushed by both Beijing and Washington.
Absolutely, Alice. That's a very interesting, thought-provoking phrase, and I have to say you did predict this several episodes ago. And it does seem that if this trend continues, there will be this divergence between the US models and the Chinese models. My concern is that because the Chinese models are open source, it will not be Chinese models used in China and US models used in the US. It'll be Chinese models used in China and everywhere else in the world and US models used in the US. This is the big concern because I can't see a country in Europe, let's say, which has none of its own AI LLMs or very, very few and none of them nearly as impressive as the Chinese or the Americans are producing. I can't see countries over here, let's say, saying, okay, you're not allowed to use Chinese LLMs because we simply don't have other choices. It's possible the US may try to corral European countries into using only US models, but that would be a big heavy lifting operation if the US was to try to do that. So I feel that your iron curtain analogy actually may come to pass in some shape or form.
But don't you think, James, that in a way Washington under this administration is killing the golden goose, so to speak? Because if it's telling Anthropic, hey, you're not allowed to release latest Fable or Mythos to foreign nationals. If you're European going back to Europe, what are you going to do, right? And then there is no real clear argument that, hey, we're going to pick American models because Americans are also national securityizing this AI issue. And Chinese models are cheaper. You know, we do run some kind of a security risk, but what can we do because we don't have models that are as competitive as the two countries, right? On the open source question, which I think we shouldn't take our eyes off of, is Nvidia getting into the mix? Nvidia is now offering open source LLMs because it's a big believer in that ecosystem. So maybe it's not fair to say that the bifurcation or breakdown between China versus the US on the AI front is open source versus closed source. Maybe it's more an idea of, yes, China has predominantly open source, but there are some important open source players. You know, Hugging Face in Europe, Nvidia now is a big one in the US. And I'd imagine that with the frustrations that people have because of Washington politicizing the closed models like Anthropic, there may be some more entrants into the market like Nvidia in the open source space where things are harder to control politically.
