Chinese leader Xi Jinping, the politburo and the entirety of the ruling class have clearly envisaged a Chinese century, shaped to their liking and belonging to them, similarly to how the previous century saw America rise as a world superpower.

To be fair, China has tried to open up, both politically and financially. But it was just enough to allow it to grow economically, without giving up any real political control. And as Chinese leaders would soon discover, there can be no free markets and enduring growth without democracy and political freedom.

The COVID-19 Crisis

The coronavirus crisis, both the medical and economic parts, proved to be a turning point in the West’s relationship with China. It was an awakening to a reality that has existed for decades, but which economic and political interests had hidden and obscured. Whether the release of COVID-19 was intentional or accidental remains to proven. And it will, if leaders such as Donald Trump and Boris Johnson remain true to their words. Nevertheless, the virus caused a shakeup in the status quo that will have deeper adverse ramifications for the Chinese dragon than for the US, as this analysis deduces from the facts that are present.

In the past two decades, China has grown at a remarkable pace. After the crisis of 2008, it helped the world economy get out of the abyss it had fallen, while also looking after its own interests. The two pillars of the Chinese growth have been ultra-high investments and a rapid debt accumulation. In 2008, China responded with the biggest ever peacetime stimulus program, an investment program of 12.5%. As the Financial Times reports, between 2004 and late 2008, the Chinese debt was between 170 and 180% of the GDP. Currently, it is estimated to be close to 300% of the gross domestic product (GDP).

China’s Export Dominance

China’s rising debt has been supported and offset by exports. Chinese companies have been known to engage in dumping, which means exporting products at a price that is lower in the foreign importing market than the price in the exporter’s domestic price. This form of price discrimination has been sustainable all this time because the Chinese government was supporting its enterprises, with the aim of gaining market share. Yet, exports have been declining. In 2007, net exports were 9% of GDP, while a decade later they were down to 2%, the same level as in 2000. Investments continued to increase during the same period, from 41% to 44% of GDP, as the debt soared to frightening levels. While until now, the expansive policies and the unfair trade practices of the Chinese government could be financed with debt, its current levels are far from sustainable and risk crushing China’s economy.

Moreover, debt has not been used to finance productive investments. In many cases, the Chinese government has used it to construct their so-called ghost cities, that are a remainder of the same occurrence happening in the Soviet Union, to maintain zombie companies, and to finance political projects to increase its own influence. Currently, debt is continuing to rise, while GDP is not only slowing its growth, but for the first time even declining. Also, the return on investment has also been deteriorating. Thus, economically the Dragon is much weaker than normally thought with an unsustainable debt, lower net exports, unprofitable investments and a relatively low private consumption of 39% of GDP, as at 2017. For comparison’s sake, the private consumption in the US, in March 2020 was 67.5%.

The West’s Illusions About China

When the West, under the leadership of the United States, welcomed China into the fold and allowed its participation in international organizations, they believed deeper global integration of the Asian country would lead to a gradually higher degree of democracy and capitalism within the country. This has been the pillar of the West’s China policy. Major international companies opened plants and factories in China due to its lower costs, especially in terms of human capital. Over the years, supply chains with China became deeply integrated and dependence on the communist country increased.

All the parties involved were happy with the established status quo. The Western countries lied to themselves that China was becoming a friendly competitor, perhaps a soon-to-be ally, and gradually opening up. Corporations were quite content with being forced to give up their intellectual property and share their secrets with Chinese state-owned companies, because they benefited from lower costs. Meanwhile, China had set its course for world domination. It was increasing its sphere of influence, especially through the Silk Road initiative, in Europe and particularly the Balkans. Under Xi Jinping, who recently declared himself ruler for life and has accumulated more power than any leader since Mao Zedong, China moved away further from democracy. Its ethnic and religious persecutions are performed on a massive scale. In addition, it has strengthened its cyber-warfare programs and reinforced its nuclear weapons and ballistic missiles.

The US, mainly during the Obama administration, closed its eyes in front of the horrendous human rights violations, the persecution of the Muslim minority, the Uighur, Christians and those seeking democracy. The United States and Europe did not react to the intellectual property theft, currency manipulations and unfair trading practices. The West continued down its appeasement path even as China’s intentions in the South China Sea became clear and its behavior more aggressive. The UK was open to treat China as a partner as recently as February with regards to the 5G technology. Italy’s government signed a Memorandum of Understanding last year with President Xi. France was just as welcoming of the Chinese President and his projects of expansion.

Trump Bucks the Trend on China

Donald Trump has been the only voice of dissent that attempted to break the siren song’s magic. The coronavirus proved the truth of his words. Currently, we have a Europe that is more aggressive towards China, at least in rhetoric. Leaders such as Boris Johnson and Emmanuel Macron are also talking about seeking indemnities from China for the damages caused by the virus. The European Commission has also reviewed its relationship with China, considering it more as an adversary than a partner, as it had previously been. On the other hand, just as the West is finally accepting China for the dictatorship, human rights violator and economic rival that it actually is, China has stopped hiding its true intentions. Rightly so, many national security and geopolitical experts are calling the new status quo, a Second Cold War. In this context, it is important to understand the strengths and weaknesses of both sides, to come to a conclusion as to who has the highest potential to emerge as a winner.

Europe is quite weak both economically and geopolitically. Therefore, it will be up to the US to take on the mantle of lead fighter for the West. After all, the US has been complaining for years for the high trade barriers other countries – China first and foremost – have put, with the World Trade Organization doing nothing. To make matters worse, the WTO, a supposed protector of free trade has allowed China’s mercantilism to thrive. The trade war that happened last year showed that while painful for both sides, the US can engage China and emerge as the least hurt. Europe, which until now has been torn with its allegiances, should take a side. It appears that it is on this path. China’s aggression towards Hong Kong and the coronavirus were the fundamental issues that turned Europe away from the Asian giant.

Decreasing Dependence on China

There has been a willingness recently to make the European countries and the US less dependent on China and to change supply chains. This is a process that will take years. However, the trade war proved that it is possible, with many companies moving their factories into other low-cost countries, such as Vietnam. It will be a painful process, albeit a necessary one. If China will be considered an adversary from now on, it stands to reason that we cannot be dependent on it for medical supply, for food and/or clothing. Just recently, medical supplies from China to the US were delayed, while other products they sent were expired. This will be the first weapon the West will use, which will take quite a few years. Without the intellectual property thefts, the hacking and declining dependence of the West on it, the declining exports and the lower investments, China will be substantially weakened. China is far more dependent on the trade surplus it has with the US, than the US is dependent on China. If anything, this may prove to be the policy that will finally force it to open politically and economically.

The High Impact of IP Theft

Intellectual property accounts for 38% of the US GDP, according to the US Department of Commerce. |Seventy percent of the software in China is stolen from the US. The negative impact from the theft of IP is estimated to be $600 billion, which is double the amount of the trade deficit the North American country has with China. Referring to the analysis made by Lacalle on the topic, “If China complied with the minimum anti-dumping and intellectual property respect rules, it would lose more than $1 trillion of GDP by eliminating illegal subsidies to state-owned companies, financing of working capital for companies with overcapacity, as well as the purchase of patents from its market cost”. If that stops, the benefit for the US would be immense, while the damage to China substantial.

Furthermore, a currency war with China, has proven a winner for the US. The dollar remains a safe haven, and the beating heart of the global financial system, being used in 87% of all global transactions, compared to the 4% of the Chinese yuan. Whoever controls the world currency, has the upper hand well before the war starts. On the currency front, China can devalue the yuan with the aim of boosting exports, but it will not work. It has not done in the past. As the economist Daniel Lacalle points out, devaluations are a form of price controls and disguised reductions in wages. So, they would hurt China substantially more, especially with rising debt, higher inflation and misguided price control and lack of structural reforms. Cost of living for the Chinese would rise, while their incomes decrease.

China’s Dilemma

China is torn between two policies: devaluing the currency to try and boost the so-desperately needed exports, or have a strong currency that protects its people’s savings and purchasing power. In the end, devaluation is not a viable weapon for China in the coming conflict. Nor will the excessive bailouts and the hundreds of billions of dollars the government has been injecting to save its deeply indebted corporations save it.

It is said that the biggest weapon that the Chinese government has is its ownership of American bonds. It has threatened more than once that in case of an escalated conflict it would sell all the debt, driving their prices down. However, this is an empty threat. The biggest buyers of the US debt are North American investment funds that own more than China. The demand for the United States’ debt is much higher than its supply. In any case, if China were to sell the debt it owns it would be bought within days, having little impact in its price. This would be a self-inflicted wound for China because the US debt serves as reserve for its currency.

Hitting China’s Banks

Another big weapon the US has against China is the ability to put sanctions against Chinese banks. According to the Wall Street Journal, of the $2.215 trillion in international claims that Chinese banks have overseas, 63% are denominated in dollars. Also, in the next two years, approximately $321 billion in US dollar-denominated debt issued in China and Hong Kong will mature and may need refinancing. So, to limit the ability of Chinese banks to do business in dollars would be terribly destabilizing, whereas the US has little exposure to the Chinese currency. As per the Journal’s reporting, three unnamed Chinese lenders were found in contempt of court related to a probe concerning North Korea. They could be sanctioned under this pretext.

The Achilles heel for China stands in its economic and demographic situation. Just a small change in the trade balance with the US, would cause a debt crisis of huge proportions in China, because there will be nothing to finance the high debt. China’s population is an ageing one, and as such is more prone to save rather than consume. With declining exports, unproductive investments driven by political ambitions of influencing countries and continents, a weaker currency compared to the dollar and an unsustainable debt level, the Chinese geopolitical and technological threats become far less threatening.

Undoubtedly, the ongoing clash and separation from China will be a costly conflict for the US and Europe. Yet, it is a necessary one because China remains the greatest threat of the century and if left unchecked it will become even more dangerous and more difficult to handle later on. Currently, it is not unbeatable. The US is and will remain a free, attractive, safe and strong economy which calculates every economic move it makes, especially if Trump wins a second term. As for its military might, it is unrivaled even by China. Nevertheless, the true cold war will have a chiefly economical nature, and the US has the biggest odds of success. The only path forward for China is through liberalization of its markets; removing capital controls, exchange rate manipulation and unfair trade practices; boosting domestic productivity through true structural, legal and political reforms that would attract foreign investments.

China must be made to understand that without political freedom, without democracy and the rule of law, it will never be the global superpower it so desperately desires. Chances are that if it continues down this path it will end up as a failed Soviet Union 2.0.

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