“I consider Russia as a hurricane. It comes fast and strong. China, on the other hand, is climate change: long, slow, pervasive.”
Rob Joyce, director of the Cybersecurity Directorate of the National Security Agency (NSA) in 2019.
In late 2020, the director general of Britain’s MI5 security service, Ken McCallum, used similar terms when describing Russian actions as “bursts of bad weather, while China changes the climate”.
Joyce and McCallum were on the money with their assessment that Moscow was likely to shake up the geopolitical situation in the near term. However, China is currently also creating considerable turbulence for the global economy. Not because of overseas adventures, but via the coronavirus and government actions to contain the pandemic.
Xi Jinping and his entourage seem to doubt the best approach. Either way, and at all costs, Xi wants to avoid too much trouble before he is nominated for an unprecedented third term by the end of this year. The consensus among analysts was therefore that Beijing would stick to its zero-COVID policy at least until the fall. The major question is whether this can be maintained with the most contagious COVID variants.
In any event, officials also differ on how to absorb the economic impact of the coronavirus stimulus. For example, a number of high-ranking men – because they are all men – want to boost the real estate market, further reduce bank reserve requirements and provide monetary support.
On the other hand, there are policymakers who believe that, given the nature of the economic blow, there is not much that can be done about it now, and who warn of the dangers of burst even more bubbles in real estate prices, for example.
Team Boost has won the battle so far as, among other stimulus measures, another large-scale infrastructure initiative has been announced. In a sense, this is not surprising, as little power can be expected from other potential growth engines. China’s growth can essentially be attributed to three sources: business investment, household and government consumption, and trade surpluses.
Exports are suffering from weaker global growth due to the war in Ukraine and high inflation. At the same time, the so-called terms of trade have deteriorated for China. Additionally, Chinese consumer confidence is eroding and consumer spending is facing challenges due to the lockdowns. Businesses are increasingly reluctant to invest due to the deteriorating economic climate. This is particularly unpleasant, as investment activity normally accounts for a disproportionate share of Chinese growth. The real estate market has accounted for about half of these investments in recent years. If it stays that way, the real estate bubble will get even bigger.
Further supporting the real estate market and pumping ever more money into infrastructure projects means that future growth is increasingly relied upon to justify current investments. However, long-term challenges point to weaker growth. Demographic trends are far from favorable. While the population used to grow by about 10 million people per year, population growth has declined significantly since 2015 and is now at about zero. The population should even decrease. Moreover, China will rely heavily on technological advancements for its future growth. Over the past few decades, China has made tremendous progress by relying heavily on Western technological innovations. Due to changing geopolitical relations, China will increasingly have to go it alone. It is doubtful that it will work. Also because, under Xi, China is increasingly taking on the features of a planned economy.
This changing international political climate is largely caused by China’s enormous economic, diplomatic, technological and military rise. However, this upsurge is beginning to backfire in part on Beijing as the West has abruptly woken up from the dream that China will also democratize as it grows more prosperous. China is therefore increasingly actively hampered. And the country may be a giant, it remains very dependent on the rest of the world. It still relies on Western expertise in many areas, it needs foreign exchange reserves (especially in dollars and euros) as well as foreign capital.
These three factors are currently under threat. Before the invasion of Ukraine, Western countries were already much more concerned about the transfer of advanced technologies to China, but the war forced the West to face the facts in terms of the intentions and potential of autocracies. The West has since taken a much more critical look at the applications and technological products that are shared.
Regarding foreign exchange reserves, China will become more cautious about holding dollars, euros and possibly yen and Swiss francs, as it has witnessed the risks associated with a scenario in which Europe and the United States really decides to put the screw to an adversary: approximately half of the reserves of the Russian central bank were frozen.
The inflow of foreign investment will also decline. In light of global and social enterprise initiatives, Western companies are becoming more cautious when investing in countries with authoritarian regimes. Moreover, the Shanghai lockdown has made it clear that – in the words of Chinese expert Fraser Howie – “Shanghai has always been a creation of a state enterprise”. There is no free movement of capital and information and this now includes people.
This is far from clear, as China has certainly taken steps in recent years to further open up its economy, but it has become abundantly clear that the yuan will not be freely tradable for the time being, the legal system will remain an instrument of the Communist Party, and regulators and stock exchanges intervene arbitrarily if certain market movements do not please them. In short, China is no longer attractive.
Either way, uncertainty is growing for businesses and investors. The United States – combined with many allies and partners – wants to make things harder for China, in a political, military and economic sense. This is achieved, for example, by refusing to transfer knowledge and technology, a greater military presence in the region around China, and partnerships and organizations such as the Australia, United Kingdom, United States (AUKUS ), the Quad and the new Indo-Pacific Economic Framework (IPEF).
Tensions in the region are increasing dramatically. Developments surrounding the strategically located Solomon Islands – with a population of 700,000 – are telling: After the archipelago signed a security pact with Beijing, senior US diplomats rushed aboard a plane to change the opinion of the Government of the Solomon Islands. In short, tough battles for influence are fought by great powers around the world.
Reference is often made to a decoupling between the West and China in order to be able to win the geopolitical battle. The Russian example has been pointed out. However, the decoupling with China is of an essentially different order. Western economies and China are closely linked in many ways and in a massive way:
- Two-thirds of China’s foreign exchange reserves are held in Western government bonds, etc.
- By the end of 2021, foreign parties held $3.6 trillion in direct investment in China and $2.2 trillion in stocks, bonds, etc.
- Four of the 40 systemically important banks in the world are Chinese.
- Only a fifth of China’s trade is in yuan.
- China is the most important trading partner for more than 120 countries.
- Chinese products represent 18% of American imports and 22% of European imports.
In short, a decoupling between China and the United States and its allies may not be an impossible task, but the consequences will be quite different from the already very considerable consequences of the fight with Russia.
For now, a stable form of bloc formation is more likely, in which China and its partners on the one hand and America and its associates on the other gradually reduce their dependence on each other. In recent years, this has been evident in the shrinking of China’s dollar reserves (in 2005, dollars made up 79% of China’s foreign exchange reserves, down from 58% in 2019).
Andy Langenkamp is a senior political analyst at ECR Research, which provides independent research on asset allocation, global financial markets, politics, and foreign exchange and interest rates.