The China Game

“Engagement” Or Appeasement?

On 25 April, James Cleverly MP, the foreign secretary, gave a speech at Mansion House in the City of London, setting out the UK government’s current thinking on China. Normally, such white-tie dinners are opportunities for the government of the day to allay the concerns of the great and the good who attend these events. But Cleverly was in no mood to play down the challenge we face from the East:

“China is carrying out the biggest military build-up in peacetime history,” the foreign secretary declared. But he also said that no significant global problem can be solved without China. No doubt he was thinking of the war in Ukraine where, according to a growing consensus across Europe, only the Chinese have the inclination and the clout to intercede with the Putin Kremlin. And of course, he was thinking about the climate change/global-warming conundrum too, in that any efforts we may make to achieve the chimera of “net zero” will be cancelled out by yet more Chinese, coal-fired power stations.

Cleverly has faced criticism from the Tory benches over his refusal to classify China as a “threat” – not least from former Tory leader Sir Iain Duncan Smith, who is a subject of Chinese sanctions. But the foreign secretary said in the speech that it would be unwise to use such a word and promised to “engage with China where necessary.” This approach will be unpopular with China ‘hawks’ such as the Inter-Parliamentary Alliance on China.

Recently, the former prime minister, Liz Truss, said that western democracies should “get real” about China. She warned western leaders not to appease China, given the undoubted oppression of the Uighur population; the brutal suppression of democracy in Hong Kong in defiance of international treaties; and the persistent, bellicose attitude towards Taiwan − not to mention the country’s systemic abuse of human rights and its refusal to cooperate on biosecurity during the pandemic. In their defence, foreign-office types argue that engaging with China does not mean agreeing with China, and that it is about keeping the dialogue going. But to what purpose?

The Cambridge historian Robert Tombs has compared our tendency to assuage China to the French and British policy of appeasing Nazi Germany in the 1930s. The policies of Neville Chamberlain and Édouard Daladier – known to modern historians as “appeasement” − were intended to avert the horrors of another European war. But by allowing Germany to rearm and to expand, they made that war more probable.

Whether the diplomats choose to describe China as a “threat”, an “adversary” or even, as Cleverly has done, a “partner”, it is notable that the upshot of appeasement in the 1930s in the UK and France was a policy of rearmament. As Cleverly said in his speech: “Prudence dictates that we should assume the worst.” The inevitable consequence of that position is that we and our allies must increase our defence expenditure, as Chamberlain did after Munich in 1938. It is therefore reassuring that the chancellor has pledged an additional £11bn to the UK defence budget over the next five years – although whether that money actually materialises is questionable given recent form. The sum of £3bn has already been earmarked for the new Aukus nuclear-submarine programme and another £2bn has been committed to replenish arms stockpiles depleted by our support for Ukraine.

In February this year, CIA Director William Burns said that it was “a matter of intelligence” that President Xi has ordered Chinese military commanders to be ready to invade Taiwan by 2027. These comments came weeks after US Air Force General Mike Minihan predicted that the US would be at war with China within two years. The most recent leak of US intelligence secrets reveals that US insiders judge that Taiwan is still unprepared to defend itself against a Chinese attack.

The UK government’s foreign-policy and defence review published in March described an “increasingly authoritarian” Beijing as representing a “systemic challenge” to the everyday lives of British people. The Prime Minister, Rishi Sunak, admitted recently that the “golden era” of relations with China, once promulgated by David Cameron and George Osborne, was over, and that we should now pursue a policy of “robust pragmatism” (whatever that means). Duncan Smith dismissed the document as “Project Kowtow.”

Why Taiwan Matters

Alicia Kearns MP, who is chair of the House of Commons foreign affairs select committee, says that British business should not ignore the mounting tensions in the region. Companies should instigate a thorough review of their supply chains. Taiwan, with a population of just 24 million people, has emerged in recent years as the number-one producer of microprocessors, (also known as semiconductors or just computer chips) which are required to manufacture almost all goods these days – not just laptops, smartphones and telecommunications equipment. The country produces 63 percent of all the world’s computer chips, 37 percent of all logic circuits and 92 percent of all nanochips (that’s chips under 10 nanometres wide, which are increasingly important). These are all produced in four facilities (sometimes referred to as “gigafabs”), located on the west coast of the island – that is, facing China.

Taiwan Semiconductor Manufacturing Company (TSMC) is the world’s largest contract chip maker and supplies all the tech titans, including Apple and Qualcomm. If China were to invade Taiwan, supplies would inevitably be disrupted, possibly indefinitely. Moreover, a lot of Japanese and Korean exports of semiconductors pass through sea lanes adjacent to Taiwan. Some analysts think the disruption of the flow of computer chips would be equivalent to the most extreme oil shock, and that the global economy would come juddering to a halt.

That said, TSMC largely manufactures chips designed by others – including the likes of the UK’s ARM, based in Cambridge (and currently being listed by its owners, SoftBank, on Nasdaq). Silicon Valley in California remains the hub of global chip design and development. Moreover, TSMC has been strong-armed into building two gigafabs in Arizona at a cost of $40bn.

Last year, BT staged a two-day “war-game” exercise to stress test its ability to continue to function in the event of war in the Straits of Taiwan. Virgin Media O2 has admitted to stockpiling chips. BMW is seeking to establish long-term relationships with chip manufacturers outside east Asia. But if companies hold larger inventories of chips there will be a cost to that, which is likely to feed through to retail prices at a time when inflation is already entrenched. Resilience always carries a cost. Economic integration with potential adversaries now seems to have been a critical strategic mistake.

President Biden unveiled the $280bn Chips and Science Act last summer, aimed at boosting domestic semiconductor manufacture in the US in order to reduce dependency on foreign imports. The EU followed suit with its own €43bn programme, aimed at doubling the bloc’s chip production to 20 percent of consumption by 2030. Currently, the EU manufactures only eight percent of its own chips. The UK’s long-awaited semiconductor strategy is yet to be published but will be on a much smaller scale.

Janet Yellen, the US Treasury Secretary, has spoken of “friendshoring” – the idea that supply chains should be routed through friendly countries. Again, there will be a cost to relocating production to more expensive jurisdictions, which is likely to manifest itself in further inflation over the medium term. I have previously referred to this process here as The Great Bifurcation.

Last month China launched a three-day dress rehearsal for an attack on Taiwan. Under the rule of Xi – who has effectively become president for life, like his friend Vladimir Putin – China has become increasingly confrontational.

Hence the US is establishing new military bases in the Philippines and beefing up its military cooperation with South Korea. The Aukus pact has set Australia on a new path: it was announced last week that it seeks “longer-range strike capability.” I think that means investment in missiles. Josep Borrell, the High Representative for the EU in foreign affairs, has called on EU states to deploy warships to the straits of Taiwan – but that seems unlikely, given President Macron’s stance.

The Race For Technological Superiority

The new head of GCHQ’s National Cyber Security Centre (NCSC), Lindy Cameron, warned an audience in Belfast last week that the “dramatic rise of China as a technology superpower… [poses] an epoch-defining challenge to the West.” She said that China is seeking technical supremacy over the West rather than parity and aspires to be “the predominant power in cyberspace.”

Spy chiefs are concerned that China is forging ahead in the two key frontier technologies of artificial intelligence (AI) and quantum computing (which are in fact closely linked since one will facilitate the other). There is a kind of arms race now underway between the West and China in AI, says the geopolitical analyst, Ian Bremmer in his most recent GZERO newsletter. No one wants China to pull ahead. And the fear is that the first power to achieve “quantum supremacy” (also the title of an important new book by Dr Michio Kaku) would be able to subvert the digital encryption technology that currently protects us (as well as the spy masters) from hostile third parties.

Korean President Yoon Suk Yeol arrived in Washington for a high-profile state visit on 26 April. South Korea is the most long-standing of US allies in east Asia. The US is concerned that South Korea’s chipmakers – principally Samsung Electronics and SK Hynix − will supply China if the Chinese ban US technology giant Micron Technology from operating on Chinese soil in a tit-for-tat response to US sanctions. Other US chip producers include Texas Instruments and Intel.

While much has been made of China’s emerging scientific pre-eminence, it still imports most of the computer chips it needs. That gives us a clue as to why China wants so badly to dominate Taiwan – to secure supplies of an essential technology. Yet, let’s suppose the Chinese military were to seize TSMC’s factories by force. Would those gigafabs continue to function? Even if TSMC personnel were to collaborate with the Chinese invaders, they would still be deprived of essential inputs and design technology that comes from outside. Chip production would therefore simply grind to a halt.

China And Ukraine

Judging by his comments during and after his state visit to China last month, Macron does not seem to think that Taiwan is Europe’s problem. He purported to speak in the name of Europe but in fact there is no such consensus on the issue within the EU. The Germans understand that Taiwan is Europe’s – and America’s – problem too. Lithuania was given the cold shoulder by China when it consented to open a representative office of the Taiwanese government in Vilnius.

Over the last year or more China has been allowed to style itself as a peacemaker while gaining further leverage over its northern neighbour, Russia. Russia is much bigger than China, geographically speaking, but its economy is roughly one tenth the size of China’s. And now its destiny is to become an oligopolistic supplier of hydrocarbons to its much more populous and richer partner. Geopolitically, that is a high-risk strategy.

Having acted as an honest broker between Saudi Arabia and its adversary, Iran – and thus hopefully bringing about a ceasefire in war-torn Yemen − China is now posing as an international peacemaker. The US could not have brought about a reconciliation between the Saudis and the Iranians because it is losing influence over the former and is an implacable adversary of the latter. Both states, exasperated by western platitudes about “net zero”, will now continue to supply China with inordinate quantities of hydrocarbons – probably for the rest of this century. To underline his role as a peacemaker, Xi offered to broker talks between Israel and the Palestinian Authority too.

On 26 April, Xi and President Zelensky of Ukraine spoke on the phone. Zelensky described the conversation as “long and meaningful.” However, he warned that a Chinese peace deal was probably unworkable: “There can be no peace at the expense of territorial compromises,” he said.

China may talk the talk of peace, but it does not want to see Russia humiliated in Ukraine. Russia, like China, is a formidable power which is also a revisionist state, determined to overthrow the US-led, post-1945 world order: “Change is coming that hasn’t happened in 100 years,” Xi declared in April, at the end of a visit to Moscow: “And we are driving this change together.”

China does not want to risk Putin’s downfall with a consequentially disorderly Russia. And if Russia is seen to lose the war, that will be a victory for the US-led West, which will undermine Chinese influence in the developing world. China was invested in Ukraine before the war began and will no doubt want to have a role in the country’s eventual reconstruction. It might even invite a post-war Ukraine to join the Belt and Road initiative. But an outright Ukrainian-Western victory against Russia would make the Chinese dream of taking Taiwan less attainable.

The question is whether China might actively supply Russia with the weaponry that could overcome the valiant Ukrainians. Thus far, China has proved reluctant to back up its “no-limits” friendship with Russia, with anything more than words. China knows that any direct involvement in the war would provoke a hitherto unparalleled regime of sanctions led by the US. And even Chinese weaponry would not resolve Russia’s problems of weak military leadership and poor morale amongst its troops, so Chinese military aid would not necessarily be decisive. Thus, the risks still outweigh the potential rewards.

The massive loans extended by China’s Belt and Road initiative have enabled China to expand its influence across the developing world. About 150 countries and territories have signed up to receive China’s financial largesse. The G-7 democracies have belatedly decided to reach out to the “global south.” Despite decades of “foreign aid” having been bunged in the direction of Africa by western democracies like the UK, it is China which has established its economic footprint across the continent with the Belt and Road Initiative. That is why so many African countries – including Africa’s biggest economy, South Africa − have gone lukewarm on Ukraine.

Last week, China’s ambassador to France, Lu Shaye, said in a TV interview that “former Soviet countries don’t have an effective status under international law.” This was news not just to the people of Ukraine but to those of central Asia where significant countries like Kazakhstan have been assiduously cultivating close diplomatic and economic links with China. A few days later, a Chinese foreign-ministry spokeswoman, Mao Ning, announced that China respected the sovereignty, independence and territorial integrity of all countries. But then again, China’s ambassador to the EU, Fu Cong, recently opined that China’s “no-limits” friendship with Russia was “nothing but rhetoric.”

Chinese diplomacy – like the Chinese state and the political party that controls it – is actually much flakier than we suppose. And so is European diplomacy when directed by the French. The Baltic states and Poland believe that the repulsion of Russia in Ukraine is a matter of existential importance – just as it is now for Taiwan.

So far this year, about $16bn of new overseas money has flowed into Chinese equity funds, encouraged by China’s reopening after more than two years of a zero-Covid policy which paralysed the economy. Apparently, a lot of western fund managers think that China is investable again. After all, China accounts for about 18 percent of the entire global economy, so many institutional investors fear missing out on the action.

It would not be the first time that the fund managers are actually missing the bigger picture – and fundamentally mis-calibrating the prevailing level of political risk.

Afterword

According to BBC Weather, the maximum temperature on Coronation Day tomorrow in central London will be 16 degrees Celsius and it will most likely be spitting rain for much of the day. Good luck to King Charles and Queen Camilla – and to the cheering crowds. But the weather tomorrow will be more clement than on the day of the late Queen’s coronation on 2 June 1952, when it rained and the temperature barely got above 11 degrees. And it will be drier than it was on the day of the coronation of King George VI, King Charles’s grandfather, on 12 May 1937, when 8.2 millimetres of rain fell in London.

I shan’t be in London on Saturday – though I shall be at a splendid lunch at my City livery company today and am supposed to host a barbeque in Norfolk on Coronation Sunday when the weather promises to be even duller and cooler. We may have to retreat inside − but that will not stop us toasting their Majesties’ good health.

I wish all my readers a royally festive weekend.

Listed companies cited in this article which merit analysis:

• Samsung Electronics (KRX:005930)
• SK Hynix Inc. (KRX: 000660)
• Micron Technology (NASDAQQ:MU)
• Texas Instruments (NASDAQ:TSN)
• Intel (NASDAQ:INTC)
• TSMC (TPE: 2330)
• Apple Corp. (NASDAQ:AAPL)
• Qualcomm (NASDAQ:QCOM)
• ARM Holdings (listing on NASDAQ shortly)