[The] future has arrived, and it is nothing less than a new cold war.
… this situation will last decades and will only get worse, whatever this or that trade deal is struck between smiling Chinese and American presidents in a photo-op that sends financial markets momentarily skyward.
… because the U.S.-China relationship is the world’s most crucial—with many second- and third-order effects—a cold war between the two is becoming the negative organizing principle of geopolitics that markets will just have to price in.
– Robert Kaplan, in Foreign Policy magazine last week
Apart from all the new tech, it’s the interconnected nature of the global economy that will differentiate Cold War II from Cold War I.
The global economy has been powered for the past three decades by a “friendly” US/Chinese economic relationship. This is something the US and Soviet Union did not share prior to the first Cold War, and so when the two powers turned on each other, little in the US economic engine had to be changed.
But today, the East and West are bound so tight that each side has been financing the other’s military. China has been lending its surplus dollars back to the US, which the US have been spending on defence. But China has been earning enough interest on those loans (through coupon payments on US Treasury bonds) to finance its own military. But it gets much more explicit than this.
Last year, a company by the name of Poseidon Finance borrowed a billion dollars from the debt market by issuing a load of bonds. The company is based in the Cayman Islands, having been set up in late 2017, and was assisted through the bond issue by the French bank BNP Paribas. However, this company is solely owned by the Chinese Shipbuilding Industry Corporation (CSIC), which itself is wholly owned by the Chinese government. CSIC is China’s largest manufacturer of naval vessels, making destroyers and submarines that can be armed with nuclear missiles.
The investors wanted a higher yield. The Chinese Navy wanted shinier ships. Both seem to have got what they wanted… unless the CSIC defaults on the bonds when the US and China become ever more openly aggressive.
The strange situation certainly gives new meaning to the phrase “reach for yield”. Who would have thought that bond yields would get so low, that investors would begin directly financing the military expansion of the Chinese Communist Party?
Something tells me that Western investors will not get many more such opportunities, as US aggression against China becomes as overt as it was against the USSR.
With US stealth bombers now deployed in the Pacific in their largest numbers ever for “training” exercises, it is only a matter of time before a black shadow sweeps over global finance as well. Mark Carney’s warning against the “weaponisation of finance” that he issued last year will fall on deaf ears. Though investors have hung on the word of every central banker in recent years, governments threatened by the rise of a foreign military power are not so enamoured of them.
The economic weapons such as sanctions are blunt instruments however, and investors in companies with large exposure to Chinese, or Chinese allied supply chains are set to take a bruise, or much worse.
The US/China impasse is not a product of the current administration, and would be faced by any other president (although another might kick the can down the road, like the Obama administration). It has become a national security priority for the US to take back its national industrial base from China, while it’s a matter of national security for China to keep it. This intractable problem cannot be solved simply, and instead will be solved through Cold War competition.
To persuade the US government to begin countering China now, the National Defense Strategy Commission, a bipartisan group of military experts brought together to advise US Congress, illustrated a future scenario in which it is too late:
In 2024, China undertakes a surprise attack to prevent Taiwan from declaring independence. As Chinese forces launch air and missile attacks, cripple the Taiwanese Navy, and conduct amphibious landings, it becomes clear that decisive U.S. intervention will be required. Unfortunately, America can no longer mount such an intervention at acceptable cost. China’s missile, air, surface, and undersea capabilities have continued to grow as U.S. defense spending has stagnated. Large parts of the Western Pacific have become “no–go” zones for U.S. forces. The Pentagon informs the President that America could probably defeat China in a long war, if the full might of the nation was mobilized. Yet it would lose huge numbers of ships and aircraft, as well as thousands of lives, in the effort, in addition to suffering severe economic disruptions—all with no guarantee of having decisive impact before Taiwan was overrun. Allowing Taiwan to be absorbed by the mainland would represent a crushing blow to America’s credibility and regional position. But avoiding that outcome would now require absorbing horrendous losses.
After years of globalisation in a unipolar world, the global economy will return to a multipolar flux, where politics will become ever more important than fundamentals in the pricing of investment assets.
All the best,
Editor, Capital & Conflict