>> from our studios in new york city, this is "charlie rose." >> kevin rudd is a former prime minister of australia.

he is also a diplomat and mandarin speaker. he became the first president of the asia society policy institute. i spoke to him recently. we spoke about the chinese prime minister and u.s. policy. >> i have heard lots of stories. people have come to my table to talk about how he is exercising power, talking about how to exercise power. tell me your impressions of him. who and what enabled him to become the president of china. >> the first thing to bear in mind with xi jinping is his family background. he is the son of politburo member.

he was entrusted with an important task, to oversee the implementations of the four special economic zones. that is what he set out to do. he was put in charge of what in china was a highly controversial project. those four special economic zones coincided with the 19th century treaty ports where foreign countries, namely the british but others as well demanded exclusive access to the ports in what was called the unequal treaties between china

and the west. to go talk to these after the revolution of 1949 and say, 30 years after that, we are going to open the door to these treaty ports the left of the party said, you are going to do what? this is the vehicle through which chinese exploitation initially occurred in the internal historiography. so he was given this job. the economic zones were expanded in scope. the number of zones grew. in time, the policies adopted across the country. his father represents a liberal reformed agenda. the other thing

about his father. he was a revolutionary commander for the red army. in the lead up to the 1949 revolution. he is a party loyalist. strong in the party's role in bringing about a revolution. you have this combination of a hard-line. a political supporter of the chinese communist party. at the same time, somebody that sees the future hinges on the continued reform of the economy. that very much explains in part the political worldview and economic worldview of his son. >> and as a leader, what have you seen so far? >> i have met him a number of times.

i first met xi jinping when he was vice mayor to one of the treaty ports. he did not know me but i knew he was a significant figure in municipal politics. rolling the clock forward, since he has been president, he is one of the few chinese leaders who i have seen conduct his engagements with foreigners without speaking notes. he does not speak to a brief. he speaks off-the-cuff career those scribbling furiously are those around him.

what you discover is he is steeped in his own country's history and that of his party. there is a profound historical frame of reference, which affects his current worldview. namely that china, having been first occupied by the british after the opium war, when hong kong was ceded, through to the defeat of the japanese, what they call the century of foreign humiliation, this is burned deep into his worldview. therefore, the need to cause china to go through its own national reawakening renaissance rebirth. the chinese word for that is a

core part of his view for the future. bringing it back to a respected place in the global council of nations. the last thing i will say about him as a person. beyond his self-confidence, not using notes. his historical frame of reference. he is a deeply committed party loyalist himself. many in the west and u.s. as well assume that what we have seen in china -- >> when he visited houston. >> which i understand is in a state called texas. i am beefing up on my american knowledge. the bottom line is, we often assume since the leader wore a cowboy hat, through tiananmen

square, through the 1990's and the next decade, there is a slow evolution of an open economy creating a more open system. under xi jinping, the opening of the economy will continue. there will be a continued openness to the society. his political frame of reference is a conservative party view. what he will seek to advance is what he calls the china model. the china development model is not a liberal capitalist model. it is more of a state capitalist model. it is important that we understand that. >> what do you think misconceptions are among western leaders about him and his intent? >> there is always a predisposition on the part of any nationstate looking at

another to think the worst. that is how diplomats keep in business. i have been one of those. themselves, intelligence agencies, and defense departments. whatever the country over there says is one thing. we are paid professionals to assume the worst case scenario. often, you see that around the world in relation to china. the largest misperception is this. somehow, china has a growing military capability and military ambition to occupy in time parts of its region.

the bottom line is, whatever negative things you can say about the chinese tradition, it is not a substantial part of the chinese tradition as it was with the europeans to say, now we have wealth and power. how do we conquer the next territory? there is a deep civilizational view alive in beijing that there's enough to manage here to not go and conquer the other half of the world. that is a misconception. >> we see here, clearly in the 21st century, the rising power. a country that has not yet decided it is a stakeholder in the world, but seems to want to increasingly be perceived as such.

>> what are they up against? can they make it work? where do they think they are going? a lot gets lost in translation when we are dealing with chinese friends. you mentioned the word stakeholder. bob zelig, a good friend of mine and head of the world bank in days past, and it is good to see my compatriot here, he coined this phrase. china should become a responsible global stakeholder. this led to two lines of mistranslation. one around barbecues. like i have to hold a steak and what does that mean? >> they were confused when they heard that. >> there was a long pause.

the concept is a strong concept. but that is how things get lost in translation. on my core point, it is worth understanding that we have an expectation that china will increasingly follow and comply with the rules of the global system. we the collective west half of -- have evolved for ourselves. towards the chinese would say, that is terrific. we were not even there, thank you very much.

to which we say, you were. they were one of the victors in 1945. to which they say, that was the kmt, not us. if i look at some of the more recent speeches of xi jinping, he says the rules need to be reformed in a way that makes the system more just and equitable between states. that is a big challenge for us. we, the collective west, much of the developed world, that is accept the status quo. china is saying something quite different. we are engaged in the business of reforming, changing, the system as our power grows. >> the obvious example i see is the dollar as a reserve currency. what else? >> at this stage of their public pronouncements on all of this, it is opaque. let me give you one clear example.

there has been a great debate about china's decision to establish the asian infrastructure bank. the response from the u.s., the west, and the rest has been along the lines of, why do we need that? we have the asian development bank. a system of multilateral development banks around the world. they are run according to international rules and have gone fine and dandy. to which the chinese say, no not really. they established their own asian infrastructure bank. they are establishing an institution outside of the u.n. and brenton woods. the capital is $100 billion. it is not going to shake the world in one go. but i would not be surprised if it expands.

my own view, given the global investment of infrastructure deficit around the world multiple sources of capital should be welcomed into the system so long as the governments of these institutions -- we have not raised objections to the thing called the islamic development bank, though it operates across the middle east. we have to be careful about saying no to any chinese initiative on the condition that governance is a properly formed instituation. >> what about militarily? >> it is a phenomena which is unfolding. military expenditure in terms of annual growth has outpaced the u.s. for arguably the last 25 years.

>> annual growth. >> and with increasing intensity. if you look at some of the international data released on this, say that put out by the international peace research institute, which is regarded as a neutral, credible institution assessing the hardware of each country's military, they would put china's total aggregate expenditure at about one quarter to one third of the u.s. we need to be mindful of where that heads in the decades ahead. even the chinese military planners do not conceive of a spot where u.s. conventional power could be exceeded by china.

the role of the foreign policy is different. they see themselves as having expanding foreign policy footprint. >> how is the military somehow part of that? or the expansion of chinese interests? >> if you go to the military the core interest which xi jinping has in the military is to make sure it is modern, sophisticated, and capable of engaging in and prevailing in a military conflict in and around china's periphery. the first function of the military is to protect the party. under the party and state constitution. contingencies for which the chinese military plan are primarily those associated with

the long-term scenarios for the recovery of taiwan to the mainland's tender embrace. they wish to do that by diplomatic means, but if that is not possible, their wargaming is around how to secure taiwan. stop the u.s. military or naval action in the taiwan strait. planning for that, you acquire additional capabilities which add complexity. the u.s. defense and naval planners in the pacific. >> is outlook for china less than when they were growing at 10%? or was it to be expected, as they got larger, the growth would slow?

>> any of us who are students of economic history know that an expanding continental economy, engaging in growth you will have rapid growth. as you did with the history of the u.s. when it began exporting and trading with the rest of the world. effectively becoming the largest economy in the world. this is natural. slowly, with the maturation of the economy, the growth rate narrows to a historical medium between 2-3%. like your economy and the australian economy. they are trying to avoid what they call the middle income gap.

here is the kicker. on the way through, can they sustain growth at sufficiently high levels to provide the buffer necessary for the transformation to occur? that has been tough. global demand has been so flat. look at europe at present. look at the u.s. net exports have turned out to be frankly a minor or even negative contributor to chinese growth. what they have done historically to fill that gap is engage in massive capital projects, which has had the consequence of creating asset bubbles in the property sector.

>> real estate. >> real estate and redundant state construction. i give the government credit, as growth slows, not to engage in that on the way through. there are seeds of a positive way to look at the model for the future. one piece of data that has emerged since they adapted to these new blueprints for long-term economic performance moving from manufacturing and investment to services and consumption, the phenomenal increase in new business registrations. a phenomenal increase. this has been achieved in part through regulatory changes which do not require you to mortgage or life, wife, and house. if you want to start a new business. the driver for growth is through an emerging small business sector. greater opportunity for private firms. if the reform goes according to plan a contracting size of the state enterprise sector.

>> leveling the -- >> you went through a list of what can go wrong. take most of those boxes you raised including this one. the real question for the leadership is will they continue to shrink the state owned enterprise sector? given the sub optimal performance and distorted resource allocation in the economy? will they allow that sector to contract and yield more space to

private firms, or does that create too much of a political problem because the state owned sector becomes too small and their ability to affect decisions on the ground is reduced as a result? >> what is the threat to the future of the communist party? what might be a threat? where is their paranoia justified? >> this is a very deep and searching question. let me hazard a couple of answers. if you are looking at the world from xi jinping's perspective, the number one priority is keeping the party in power. what are they mindful of?

threats to the party position from within. you are seeing a tightening of the environment from the perspective of the activities of universities, cultural dissidents, political dissidents. this is occurring as we speak. the second source of concern is through the emergence of alternative centers of power. that is why authorities look with great skepticism at religious organizations which from their perspective become potentially sources of dissent. not all, but some. that leads me to my third point. they are very much focused on the separatist tendencies in tibet and other regions. a great crescent of instability brought about by violent jihadism. if you're putting together the hierarchy of concerns.

finally, a deep view held within china is uncle sam is out there actively fermenting a lot of this. he is also engaged in a de facto policy of containment to prevent china's rise and emergence. i'm not going to rights and wrongs of them, i am describing them. i would say that is what animates internal party concerns. they are big concerns, together with the environment. your ability to breathe the air. >> they are spending a lot of money on the search for alternatives. >> if you look at the seachange in chinese environmental policy in the last three or four years, i remember sitting in the room with president obama and chancellor merkel, 20 other global leaders in copenhagen five years ago. we tried to bring about a global agreement on climate change. it did not work. i went to copenhagen.

i have a t-shirt that says, i survived copenhagen. for a while, anyway. >> life after being a prime minister. >> yeah. political exile in the u.s. [laughter] it is a good place to be in exile. when i contrast the position chinese negotiators took then on climate change, to where they are now, the shift has occurred because of the combination of air pollution and its partner in crime, greenhouse gases. the science is in within china.

they know it is happening and they see the evidence. if, to start with, you only had 10-12% of your country constituting arable land and it becomes degraded through the absence of water, pollution into the soil, other factors, this has brought about a seachange in chinese policies. the world will wait with anxiety because china is now the largest emitter. >> what ought to be a constructive american policy toward the rise of china? that would serve both countries? >> i have been to china about a dozen times and washington a lot. chatting with leaders, those who advise them behind the scenes, i think there is a way through this. it might sound naively

optimistic, from a happy and sunny country like australia. there is a basis for my optimism. if i was to give it a name, it would be for both sides to adopt a posture of constructive realism. what do i mean by that? be realistic about where, at this stage, the two countries cannot agree. on fundamental geopolitical questions. political values questions. and some others as well. also agree on a mechanism by which those differences can be managed short of conflict. the constructive bid, the other

side of your brain engaged on, there are a number of things we can work on together in order to advance not only our national interest but bilateral interests in the world's interest. that list is formidable. we have been talking about the change in chinese position on climate change. two of the largest emitters in the world, the u.s. and china, they will decide effectively between them whether the paris conference succeeds or fails. india will also be important. another question is whether there is an institution that can build confidence and security building measures. working together on natural disasters. to avoid an issue when a submarine or airplane runs into another.

how to avoid that from escalating? down to a range of other bilateral cooperative issues. an investment treaty. that will be good for both economies. if you start investing in each other's economies, you have a big interest in the economy succeeding. a bunch of cash there. that is what i describe as the constructive dimension. the final dimension, to have in the back of our mind a view that, if you develop sufficient political capital and dramatic capital from the things you work on together constructively over time, as circumstances allow you to draw on it, to solve some of the unfixable problems in the first place.

these three elements i believe you can hold together in a common, strategic view. we are human beings. we go to one side of the brain and say, problems, difficulties, thank you. the others, which can be pie in the sky people, is into the wonderful. let's forget about the development of the navies facing each other off each day. you need a strategic view that embraces both realities. we are capable of doing that. the mechanism evolving between president obama and xi jinping it gives us an institutional capacity to make that work over time. >> how is that relationship? do you think it is a healthy relationship? comparison to the relationship

to the prime minister of israel? >> i'm not even going to go there, charlie. between president obama and president xi jinping, the truth is, when president obama invited xi jinping to the first working level summit in california last june, it was a start. most people would say it was not necessarily the biggest backslapping start you could have had to bilateral summits. but when you are dealing with china and the u.s., you cannot really expect that. then it is fair to say the relationship went into a series of problems between june and november past. which centered around the east china sea and south china sea.

but i find interesting, in the most recent summit in beijing, the two leaders spent at least eight hours or nine hours talking to each other with a limited number of people around. my advice is that the two leaders got down to thin tacks on these questions of, are you --america -- trying to destabilize us domestically? are you containing us? frankly, i know enough about international relations to know that unless you get down to tin tacks, unless you are dealing with those, you cannot get to the second levels of cooperation. my sense is there is a working level of respect now between the two presidents. which i hope we can turn into

something more. >> what are they prepared to do to make it better? >> the first priority is to see the president's priority to bring about a global agreement on climate change. the chinese could have said, we have decided for national reasons to act on climate change. here is what we are going to do. we are going to announce a peaking year when our emissions will peak. the chinese could have announced that unilaterally. they could've announced it at the non-alliance summit. they could have announced it at

the copenhagen conference. but i think, as a significant gesture to the president, given the intensity of the two way negotiations, they chose to make this a core part of the announcement of the outcomes in november. at the viscera of the military relationship, the agreement on two transparency initiatives between the chinese armed forces and u.s. armed forces on how to prevent and manage incidents at sea. we have been chipping away at that for decades. the u.s. had an agreement with the soviets dating back to the 1970's.

we never have been able to crack that between the u.s. and china. the two militaries are able to come together on that. that is one of a number of stabilizing elements. >> how do they view russia? >> tip o'neill famously reminded us that all politics is local. i imagine an active conversation between putin and xi jinping are the color revolutions of the eastern and central europe. the extent that they have concluded that either the europeans or americans were complicit in that. aimed at toppling their governments and systems. that is an active element of the conversation. that is true, as are their respective attitudes towards the censoring of the internet. the relationship between china and russia is of a deeper complexity. sometimes we lose sight of the

strategic shifts. what did nixon do? you in this country know better than i. he fundamentally rewrote the strategic rulebook by engaging china strategically and militarily against a common soviet adversary. this altered the strategic equation and is one of many elements, given that that began in 1972, and the soviet union collapsed in 1991, it is one of a number of elements which rattled the pre-existing concept of the strategic status quo. what worries me, as we look back

at the u.s. - china relationship since 1991, the collapse of the soviet union, we have not put effort into constituting a long-term rationale for the u.s. china relationship. if i look at the 1990's and next decade, there is no evidence of a new strategic rationale. leave that to one side. you roll into the present. >> you are describing it as a missed opportunity for the u.s. they did not take that moment to build a new relationship with china. >> with a new global strategic rationale. the glue which held china and the u.s. together in the previous 20 years was a common position against the soviet union. take out the soviet union and what do you have left? we can make a lot of money together.

that is what held together for a season. there was not a grander strategic narrative capable of uniting these two countries. maybe it would have been impossible. i don't know. when you start to see this fundamental rift emerged between russia and the u.s., the west and the rest, it did not take long for strategic corporation to emerge and strengthen between moscow and beijing. that is the other part. >> they have shown a bit of that in afghanistan as well. >> it is a complex question. there's an aspen strategy group comforts on this in august. i went up and participated. there is little paper about it. both these countries have a long view of each other.

the russian long-term view, i went to moscow last march, to ask the question, what do you really think about china? they said, it is the best it has been in 450 years. ♪

>> 25 years from now, it will be 2040. what will china be and what will we be? >> this is a fundamental question for how we view these two countries. critically, what we do in the interim. the conditionality attached to your question, on the assumption of no policy change. it is important to have that as an assumption. if that is the case and we do not have policy change, what i do worry about is incremental, slow drift towards one form of conflict or another. the alternative narrative after 2040 is where the two countries develop a common narrative.

along the lines of the principles i was seeking to express before. constructive realism. here's what we agree on and what we disagree on. let's minimize the latter and maximize the former. that way, i can see asking much better to guarantee the long-term peace and security the neighborhood. one final point, if you're going up to 2040. china will have to, in order to emerge as a global great power have to deal with 6-7 major challenges around the economy. its demography. in order for its rise to continue. that involves a range of assumptions which assume smart chinese leadership and a bit of luck prevail.

i am into the realist business how do you maximize the prospects of peace and stability? in asia, where my country is located, we want to see the emergence of a common narrative. >> a prime minister said, this is the asian century. what we don't know whether it it is china's or india's? >> india's place is huge. the society represents the totality of the region. and its five subregions. china is just one, northeast asia. india and to some extent indonesia, represent two other huge parts of the jigsaw.

as well as the continued significance of japan. the world sits with bated breath to see if prime minister modi succeeds. if you follow indian politics, the good citizens of delhi said, thank you very much but not too far too fast. managing an economic program with the complexities of that indian democracy and federation will require a high level of sainthood in order to navigate your way through. that is before you encounter the indian bureaucracy. i think the world wants prime minister modi to succeed. my first visit as president of the society will be to delhi. we want to work as actively as we can with the indian government to make sure we can cooperate on their policy success. >> what is your favorite chinese proverb and what does it teach

us about chinese culture? >> i assume that precludes rude statements. the asian society is a family society. the one that captures my mind is a saying of mao's. [indiscernible] bloomberg.com it represents all that china represents not to be the case. he said the following. there is chaos in heaven. there is chaos under heaven. the political situation is excellent. mao, the great revolutionary was

in the business of permanent revolutions. if you look at the antithesis of that, a progressive and orderly systematic reform program under regular forms of political leadership with no great surprises on the way through that is what the chinese are seeking to do. whenever you quote that phrase our chinese friends freeze because they know what it was like to come out of the cultural revolution. >> xi jinping talked about mao. but people believe he most resembles deng xiaoping. >> there is a bit of symbolism attached to this. the day or two after he became general secretary of the party or it may have been after he

became president of the country, he flew south in order to lay a wreath at the tomb of deng xiaoping. he was simultaneously honoring his father. there is a reverence and respect for deng. deng was a hardliner and reformer economically. seeing economic reforms were necessary for economic power and the improvement of living standards. >> there seems to be, in some circles, the chinese are, to put it mildly, displeased with the north koreans. what are they prepared to do about it? >> that is a good and sharp question. the first part of it is true. the second part is hard to answer.

on the first part, it is beyond doubt there has been a considerable rupture in the relationship between beijing and pyongyang. that is because kim jong-un, the new leader of the dprk, when he so early decided to demonstrate his statecraft by letting off an underground nuclear test, around chinese new year, 2013, this made china grumpy. capital "g" grumpy. they are saying the stability is

to grow the economy. now we have a renegade neighbor, trying to blow things up. we appreciate it. thank you in particular for doing it on chinese new year. i enjoy spending my new year cleaning up a political mess because of what you have done. this has led to deep angst on the part of the chinese leadership. madame park, the president of the south, has visited beijing. and xi jinping has visited seoul. there is a deep rupture. we have seen indications from beijing trying to improve that. the north is reaching out to russia to achieve more strong leverage. your description of displeasure is correct. what can china do about it?

i have a personal view that horrifies most chinese and american strategists. given i am now working for the asia society and therefore all collateral damage lies with me. that is, there is only one way we can deal effectively with north korea over time. on the two big policy interests of reunification and denuclearization. that is for there to be a grand strategic bargain between china and the u.s. about how the korean peninsula is to be governed in the future.

what is the base line chinese concern? that american troops south of the parallel will find themselves north, bordering mainland china. a unified korean peninsula. one thing that is toxic to chinese is the idea of the u.s. being on a land border with china. that has to be dealt with. if you can arrive at a compact which deals with the security of kim and his regime, the

condition of which is the denuclearization of asia of the weapons program, of which the quid pro quo is the withdrawal of american forces, you might able to cook with gas. >> a southern expression. >> i have used it at harvard and they just look at me. >> it is harvard's problem, probably. >> they say, please explain. if you are looking for an overall strategic concept, that is possibly it. there's having about xi jinping's leadership style and his authority within the system that says big strategic thinking like that should not be discounted. he sees himself in the mode of great little leaders. deng was the leader who did the final deal with the soviet union. the chaos of tiananmen square, 1989, what did deng do? he sealed the soviet-chinese border. that, more than anything else,

determined the future of russia china relations. xi jinping sees himself in a similar mode. if there is any leader who could entertain a grand strategic bargain, it might be him. >> that is a great way to end. a grand strategic initiative. on behalf of everyone here thank you so much. it is a pleasure. ♪

cory: welcome to "bloomberg west.” federal reserve stress test shows the biggest banks are adequately capitalized to survive a sharp and prolonged economic downturn. it's the first time since the stress test began in 2009 that no firm fell below the mean capital threshold. the annual test posed hypothetical scenarios and are a key part of the fed's effort to prevent a repeat of the 2008 financial crisis. a delta flight skids off the runway after landing at new york's laguardia airport.