A must-read paper on USA vs. China

If you are a geopolitics fan like I am, you might have heard by now of the paper published by the Atlantic Council and Politico last week called The Longer Telegram: Toward a new American China strategy. It has been picked up by Martin Wolf in the Financial Times, lauded in the US Senate, and even elicited a rare rebuttal by the Chinese Foreign Ministry. And on Sunday evening, Joe Biden used language about China that indicates that the paper has been read by his staff as well.

Over the weekend, I took the time to read it and I have to say it is recommendable for everyone who is interested in the drivers of the increasingly assertive behaviour of China on the global political and economic stage. I have spent a chapter in my recent book on geopolitics for investors explaining why I think the rivalry between China and the West together with climate change will be the dominant influence on politics, economics, and financial markets over the coming decade. 

The Longer Telegram makes some of the same points more explicitly and from a political standpoint rather than an economic standpoint. For example, it is clear both politically and economically that a campaign of maximum pressure and containment of China is not going to work. That is Cold War thinking that has worked with the USSR, but it is going to backfire dramatically in the case of China. Why? Because of economics. 

China today, is much, much bigger economically than the USSR ever was and if you read the first part of the China chapter in my book, I lay out the economic consequences of a Chinese economic collapse on developed economies. In short, while the United States is going to be fine, Europe and the UK as well as the developed countries of Asia and the Pacific and all developing nations will experience an economic crisis larger than the financial crisis of 2008. What will be particularly damaging is the global financial crisis that is going to develop if China breaks down economically because so many Western banks (and here in particular the UK banks with close ties to China like HSBC and Standard Chartered) are extremely vulnerable to a wave of defaults in China. 

In this respect, your ears should perk up when I tell you that in 2020, the number of bond defaults from State-Owned Enterprises (SOE) has risen fivefold compared to the previous year. The Chinese government is no longer protecting SOE from defaults and is increasingly letting Chinese and international investors hold the bag full of bad debt.

Amount of debt in default in the Chinese corporate bond market (RMB million)

Source: PIIE

Pressuring China economically is only going to backfire. And that is why in my view nationalism and populism in the West have been the greatest gift to China over the last five years. The trade war with China initiated by the Trump administration has led to China re-directing its supply chains and trade relationships from the United States towards Europe, thus making developed European countries even more dependent on trade with China and even more reluctant to engage in a strategy to limit Chinese economic influence.

Brexit, meanwhile, has put the UK in an extremely vulnerable position. As I write these lines, Prime Minister Johnson is trying to fight off a bill that would allow the UK High Court to define which country engages in genocide. If passed, it would seriously limit the ability of the UK to negotiate a trade deal with China. China knows this and will use the passage of such a bill as a lever to enforce more favourable terms for itself. Johnson knows this, but he also knows that if the UK hadn’t left the EU, he wouldn’t so desperately need a trade deal with China in the first place. The UK needs China today far more than it did only five years ago.

But if China is too big economically and too integrated into world trade, how can we hope that a strategy of containment or maximum economic pressure is going to work? 

Furthermore, to think of China as a Communist regime that needs to be toppled is dangerously naïve. China’s leadership is communist, but its economy is not. And the Chinese Communist Party (CCP) had decades to learn from the demise of the USSR to structure the economy in such a way that political or economic pressure against the CCP will not lead to economic decline. Why do you think the term “socialism with Chinese characteristics” has been coined?

In my view, the key to Chinese “containment”, if one can call it that way, is part of what the author of The Longer Telegram also suggests: We need to outcompete China. At the moment, the West still has an advantage in modern technologies like AI and robotics, but China is in the process of overtaking the West. The West needs to spend more on infrastructure and modern technology, including research and development of the crucial technologies of the 21stcentury. And then the West needs to export these technologies as far and wide as it can.

While the West is reducing its spending on international aid and its investments in countries in Latin America, Asia, and Africa because we think we have to first invest in our domestic problems, China is literally buying itself allies around the globe. No matter how concerned you are about corruption in third world countries, every study on the subject has shown that foreign aid is highly effective and leads to more wealth in the developed countries that spend the foreign aid. Typically, for every dollar spent on foreign aid, businesses can increase revenues in the target countries by three to five dollars. So, it’s good for business in developed countries. 

Additionally, it creates political allies and “dependencies that inoculate these countries from influence from competitors like China. And to top it all off, in a world of rising climate change, increased investment and foreign aid in the Global South leads to lower migration to developed countries through improved infrastructure in developing countries and a better ability to deal with droughts, floods, etc. caused by climate change. If you want to keep foreigners away from Europe or the United States, send money to Africa and Latin America. China is doing it and is reaping the rewards. If we don’t compete with Chinese investments in these countries, we shouldn’t be surprised if, in ten years, these countries will support China not just economically, but on all kinds of political issues we don’t like.