US Cannot Fight a Three-Front War: Rapprochement between US and China

Podcast here: https://soundcloud.com/user-280580802/207-us-cannot-fight-a-three-front-war-rapprochement-between-us-and-china

The recent APEC summit involved an important bilateral meeting between the US and China in San Francisco. The US administration has worked toward facilitating such a meeting by dispatching several US officials like Secretary Antony Blinken and Janet Yellen to Beijing since summer. The bilateral relations were at a low-point after the US suspected China of having sent a surveillance balloon to the US in February of this year.

The US and China find themselves in a great power competition given that they are the world’s largest economies. The US seeks to preserve its world hegemonic status built on the universal use of the US dollar for trade transactions and reserve currency, a large economy and a powerful military with bases all over the world. China tries to catch up with the US economically, is building up a large military and tries to consolidate military control in the Asia-Pacific region. The US has been countering China’s rise with semiconductor sanctions to hobble the development potential of the Chinese economy and increasing tariffs on US imports of Chinese goods, which is a tax on US consumers. Based on these structural considerations, one should not have too much hope about the outcome of the current APEC meeting.

On the other hand, I argue that both sides need each other and would be wise to take steps to de-escalate bilateral political and economic tensions. One could argue that the summit outcome was quite modest, but the fact that high-level meetings are taking place is already setting a more positive tone in this vital bilateral relationship. As part of the meeting, both sides resolved to resume high-level military communication to prevent future accidents in the air and seaspace, which nearly happened in the Eastern Chinese sea earlier this year. They also agreed to increase the number of flights between the two countries, and streamline visa issuing, which would increase bilateral exchanges in education, business and culture. This is very much to be welcomed given that so many Chinese students prefer to stay in their own country than study in the US due to the China-hostile political climate (Ma 2023).

The US China summit also formulated cooperation on artificial intelligence to prevent military harm from autonomous robots. This is particularly important as both countries have the most advanced AI production sites. They also agreed on climate change cooperation, which involves meeting CO2 reduction targets by promoting renewable energy. This would presumably involve the easing of Chinese solar panel and windmills to access US markets. Climate change is the most important global problem that requires international cooperation, and the two largest emitters are the US and China.

There are other significant areas of mutual concern that are unlikely to be effectively addressed. The US wants China to stop Chinese companies that export the fentanyl raw material to Mexico, where drug cartels mix the ingredients, ship them across the border and sell it to American drug addicts, whose lives are destroyed by fentanyl. The number of fentanyl deaths in the US skyrocketed from 3,000 to 73,000 between 2013 and 2022 (USA Facts 2023). China has announced that they will work on restricting fentanyl exporters, though whether that will happen has to be observed. China wants the US businesspeople to return to China and deepen their partnership with Chinese firms. Xi Jinping paid a visit to Silicon Valley businesspeople to lure them back into China following the reopening from the pandemic, but many US capitalists are skeptical following the CCP’s business raids and the arbitrary detention of US businesspeople for “national security” reasons (Palmer and Zhang 2023).

But it’s not just the US that is making demands on China, but China also wants to convince the Americans to lower their tariff barriers to Chinese products. The trade war was initiated by the Trump administration in the belief that this would lower the US trade deficit and weaken China economically. China also wants to have access to the latest semiconductor technologies that are developed in the US, and hopes that the Biden administration will reverse the sanctions on Chinese semiconductor firms who can no longer access the latest US chips. US nationals have also been prevented to work with Chinese firms and share know-how with them. The US claims these semiconductor restrictions are about preserving national security and preventing the Chinese military from building equipment that could threaten the US (the same reason the Chinese are using to raid foreign businesses), but it’s primarily about hobbling China’s dominance in the technology and economic sector. It is not clear whether the US would back down on tariffs or semiconductor restrictions.

China’s economic vulnerabilities are presently larger than what the US is experiencing and would make them very interested in a detente with the US. GDP growth figures are below the levels experienced before the pandemic. China’s GDP has been stagnating for about three years at $17 trillion (2021-2023), while the US has been going from $23 to 27 trillion in that time span (China Power 2023). There is one positive news, which is that goods exports keep on rising. After staying stable at $2.5 trillion until 2020 it climbed to $3.5 trillion in 2022 (Statista 2023).

There are further issues: demographic aging due to lack of fertility and immigration is happening faster than anticipated; foreign direct investment has turned negative for the first time in decades; real estate investment is no longer a reliable driver of further economic growth, especially after the defaults of the two real estate giants Evergrande and Country Garden. 70% of people’s wealth is tied up in real estate and declining home prices have reduced the wealth and consuming behavior of homeowners (Glover 2023). The government itself had decided to tighten lending standards in real estate companies to prevent a further financial bubble, but at the cost of bankrupting these companies and sliding real estate prices and the economy (Dorn 2023). A quarter of the national economy is tied up in real estate (Raisinghani 2023). Youth unemployment affects about a fifth of the workforce in that age range in June 2023, when the authorities decided to stop tracking that figure (Steil and Harding 2023). The poor employment prospects have created many young Chinese, who have become receptive to rejecting hustle culture and “lie flat”. No more highly exploitative office jobs that require long hours, in part, because these jobs have become so scarce. The focus is now on minimizing work and doing gig economy jobs to make a living. This economic attitudinal change has a negative effect on mating and reproducing, which is reinforcing the demographic crisis.

China’s further economic rebound is limited by the lack of rule of law. In the early period of economic development, this was less important because China could attract foreign capital via its low labor prices. But this easy means of obtaining growth is no longer available as the labor force keeps shrinking and wages are rising, putting the country into the middle-income category. With a lack of rule of law, capitalists can easily be punished for violating the party line, which encourages them to minimize their investment and transfer as much capital as possible abroad. Capitalists fear arbitrary punishment and expropriation which makes it less likely for them to start businesses. Capitalists also lack reliable information to assess whether investments are going to pay off, as government statisticians publish data based on meeting administrative criteria as opposed to the actual figures. Researchers are also guarded in pursuing their research, fearing violation of government policies. Self-censorship results in distorted and less usable research, which limits R&D efforts.

In that case, economic development is still possible but becomes increasingly dependent on state-owned firms who operate according to administrative criteria rather than profitability and efficiency (Dembowski 2023). The CCP is clearly sacrificing further economic development in exchange for political stability that must be increasingly purchased by authoritarian control given that the economic goose stopped laying the golden eggs that kept the CCP popular. With all these economic headwinds, China has very good reasons to reengage more with the US.

In contrast, US economic recovery appears to be strong. Inflation has been elevated but is now decreasing, as supply chains adjust to the Ukraine war and the pandemic is pushed into the rearview mirror. The Inflation Reduction Act involves significant expansion in renewable energy sources, which lowers the long-term cost of energy bills. Tapping the strategic oil reserve has limited a rise in oil prices, which partly explains the lower energy inflation in US compared to Europe, which found it more difficult to wean itself from Russian energy (Khattar and Vela 2023).

Elevated Fed interest rates have made the cost of government borrowing significantly higher, but the Fed can always do deficit-financing, which it did not have to do as it’s domestic creditors, i.e. pension funds, wealthy investors, the Social Security Trust Fund, the Military Retirement Fund etc., that are holding more and more government debt (Figure 3 in Bertaut et al. 2023). The effect of the rising interest rate is more expensive mortgages that have reached levels last experienced in the end of the 1990s (nearly 7.5%, see FRED 2023), which could dampen consumer spending. Some positive news is coming forth with wages, which are now rising faster for high school graduates than for college graduates, which diminishes education-related earning inequality and broadens economic opportunities (Federal Reserve 2023).

The US dollar remains by far the primary currency of international trade especially outside the Euro-area. About 70% of all transactions in the world use the dollar, a stable share over the last few decades, while China’s has been modestly increasing since 2015, but is still less than 5% of the total (Figure 10 in Bertaut et al. 2023). As such, the Fed can issue billions of dollars in new currency without that by itself being a major driver of inflation. But with the increasing political hostility by the US and fear of US sanctions, Chinese banks doing international lending have increasingly shifted loan issuance toward their own currency. Now more than half the Chinese loans to low- and middle income countries are done via the yuan (Economist 2023). China reduced US treasury holdings by 40% from a decade ago reaching a little more than $800 billion (Nikkei 2023), although China is using some of these sales to prop up their weakening currency, and that figure does not account for US Treasury holdings outside the US, e.g. in Belgium and Luxembourg (Fox 2023). But the US reacts to the Treasury sales by simply increasing the internal financing of deficits, e.g. by tapping domestic investor funds and the Social Security Trust Fund, as noted above. Arguments about decoupling are somewhat premature as the monthly US goods imports from China still range $35 to $40 billion (Census 2023).

While China needs the US on trade and economics, the US needs cooperation with China because of the geopolitical conflicts it finds itself in. The US, through its proxies in Ukraine and Israel, is essentially fighting a two-front war already. Why should the US add to this headache by waging a full-on economic war against China and thereby destabilize global value chains, and raise the cost of living for western consumers, while encouraging the Chinese leadership to threaten Taiwan militarily? Ever since Biden took over in 2021, US geopolitical influence continues to be pushed back: in 2021, Biden completed the US withdrawal from Afghanistan, bringing the Taliban back to power. The US believed that this would free up national resources to strengthen its military capacity in Asia-Pacific, e.g. by building new bases in the Philippines or Australia, and this could be used to counter China’s influence in the region.

Vladimir Putin in Russia put a wrench in this calculation. The US and the Europeans decided to back Ukraine militarily, which helped the country survive the Russian onslaught but produced a very long war that remains without conclusion. The high cost of the war is continuing, although the Americans are pushing the Europeans to shoulder more of it.

The Middle East produced a new crisis with the Hamas terror attacks against Israel on October 7. Only a few weeks before that, US National Security Adviser Jake Sullivan had claimed that the Middle East had never been as peaceful as now. That statement clearly did not age well. In order to back Israel, the Americans have been diverting some military resources destined for Ukraine toward Israel. While most of the non-western countries look at the Ukraine conflict with largely neutral views that is not the case for Gaza, where Israeli bombing campaigns have resulted in over 10,000 Palestinian deaths, involving some Hamas fighters but mostly unarmed civilians. The US as the biggest financial and military backer of Israel could force the Israelis to call off the Gaza annihilation campaign, but is deciding to remain silent and bringing even the Arab US allies in the region (Egypt, Jordan, Saudi) against it. The Gulf countries led by Saudi Arabia are now hoping for China to become more assertive in the region and mediate in the conflict. Could the next step be to ask China to dispatch naval vessels? The US still dominates the Middle East via military bases and alliances, but this could change with the unresolved Gaza conflict.

The main beneficiary of the Gaza conflict is Iran, which supported the Hamas terrorist attacks to evoke the extreme Israeli reaction and thereby undermine the Abraham Accords that would have normalized Israel’s relations with Saudi Arabia, and thereby create a US-led Middle Eastern alliance. The normalization has been put on ice as long as Israel continues the bombing campaign in Gaza. Iran is supporting Hezbollah, the Syrian Assad regime, the Houthis in Yemen and Hamas in Gaza. It also supplies attack drones to Russia to fight in Ukraine. The US geopolitical retreat is, thus, resulting in costly wars in Eastern Europe and the Middle East, in which the preferred Asia-Pacific confrontation with China is taking the backseat.

Thus, the US wants to desperately avoid further tensions with China for now. The US is quite happy to stick to the one-China principle, and keep its Taiwan support low-key. The US is well-advised to pursue a “Nixon goes to China” strategy, where the US normalized relations with mainland China in the early-1970s to split the Moscow-Beijing-Hanoi axis while the US was desperately failing in its quest to prop up the corrupt South Vietnamese regime. The US ended up losing the Vietnam War anyway. Today, the US cannot afford a Beijing-Moscow-Tehran axis, even though its very own sanctions regime is bringing about this end state.

A Chinese analyst might now counter why China should make any deal with the US if the potential defeat of Iran and Russia would simply result in the next target being China. According to the US, China should supposedly undergo a democratic “color” revolution which would end the one-party rule of the CCP. China was very worried about the Arab Spring, which the west had goaded on, especially with the toppling of Muammar Gaddafi in Libya and Hosni Mubarak in Egypt. It is not surprising that China hedges its bets by continuing to back Iran and Russia by not participating in any western sanctions aimed at regime change in those countries. Chinese vehicles are now used by the Russian army to fight Ukraine.

But perhaps there is no other choice for now: the demographic and economic challenges in China are insurmountable, and the US remains an indispensable power to help relieve some economic tensions in China. The best deal that China can hope for is to re-adopt Deng Xiaoping’s great caution that previously served it well: hide your strength, bide your time. Do whatever is needed to get western capital flowing in again, develop the military gradually without threatening neighboring states, retain the status quo in Taiwan, build up more economic and military partnerships with the global South. Whether the US can be coaxed into such an accommodating arrangement given their hitherto hawkish position remains to be seen.

China needs the US economically, while the US needs China geopolitically. Chimerica was about the tight trade interdependence between US and China in the first decade of the twenty-first century (Ferguson and Schularick 2009). That was when China was economically smaller and not seen as a threat to the US. For the sake of global political stability there is no other option but to embrace a new albeit weaker and more fragile form of Chimerica.