The Origins of World War III

The coronavirus pandemic of 2020 has been the catalyst for a dramatic deterioration in relations between China and the USA and its allies – including Britain. This would have happened anyway; but history is speeding up, writes Victor Hill.

Globalization takes a handbrake turn

For 30 years or more large Western corporations cut costs and expensive local labour by outsourcing manufacturing to cheap, developing jurisdictions of which China was the largest and most popular. By the second decade of the 21^st century all supply chains seemed to begin in China, driven by inventory minimisation and Just-In-Time (JIT) manufacturing – even though China remained an opaque autocracy.

While the corporate globalists outsourced manufacturing to China the politicians mumbled platitudes about convergence and shared interests. Some even thought it was only a matter of time before the country became a pluralist democracy. China, they said, despite being a one-party police state with a shocking human rights record, would become more like us. Eventually, the ancient country which very few Westerners understand deeply, would open up. This was part of the End of History delusion which took hold in the late 1980s and which was not even perturbed by the massacre in Tiananmen Square on 04 June1989 when an estimated 2,700 democracy protestors were slain.

The outsourcing and off-shoring mania, driven by the business school boffins spouting their three-letter acronyms, became the orthodoxy of modern capitalism. Even the financial crisis of 2008-09 which put in question the way the financial system was managed did not undermine this orthodoxy. Messrs Cameron and Osborne aspired to a Golden Age of Sino-British relations. The first Western politician openly to question this consensus was Mr Trump who was elected President of the USA on a ticket of Make America Great Again – i.e. reverse globalisation and bring jobs home.

Well, something is now afoot which will unsettle the globalists. As early as in March, Resilinc, a consultancy which maps supply chains, reported that the world’s largest 1,000 companies and their suppliers were considering re-shoring out of China. That was in response to first phase of the global pandemic when the epicentre was Wuhan in Hubei Province. Since then there have been numerous developments which will send Western investment in China into reverse.

Buying locally

China accounts for about 18 percent of all global manufacturing exports – more than any other country. Buying inputs locally it is not only patriotic but is also more environmentally friendly. Logistics and geopolitics are intimately related. At the same time, China has state-of-the art production facilities with highly trained personnel which are not easy to replicate elsewhere in short order. Moreover, China has come to control the supply chains for strategic elements like lithium (used in EV batteries) and other rare earth metals.

There will be costs associated with re-shoring out of China. Manufacturing costs will rise, even given expected progress in the domains of robotisation, AI and 3D-printing. In countries with aging populations (much of the West but especially Italy and Japan) healthcare costs will rise just as demand increases. As a result, re-shoring might become near-shoring: that is to say American corporates are already relocating production from China to Mexico; while French and German corporates might relocate from China to Slovakia or Poland.

America and its allies still have the technological advantage. China is not yet capable of manufacturing the most advanced semiconductor chips used for the famously upcoming “5G” networks. They are thought to be about ten years behind Silicon Valley in design terms. The USA controls the global semiconductor development process, working closely with partners in Japan, Korea and Taiwan. (Advanced semiconductors are also manufactured by ARM in Cambridge – though Mrs May allowed the company to be sold to Japan’s predatory Softbank (TYO:9984) in 2016). This is, of course, another reason why China wants to bring about “reunification” with Taipei.

In May the US Department of Commerce forced Taiwan’s TSMC (TPE:2330) to cut off the supply of semiconductor chips to Huawei. In return, TSMC will be allowed to build a $12 billion new plant in Arizona. That made the decision of the Johnson government in mid-July to block Huawei in the UK after all (second time around) much easier. (And if China is to be blocked from the UK’s 5G network – why is it involved in our nuclear power industry?). The emasculation of Hong Kong began immediately thereafter.

So it seems that Mr Trump’s trade war with China was about much more than cars, soya beans, tariffs and the US trade deficit. And in the UK semiconductor manufacturing is at last back on the agenda with IQE (LON:IQE) set to build a new plant in South Wales.

Giddy markets

China may still be a country which describes itself as following the path of socialism with Chinese characteristics – yet its stock market is unbound. The Shanghai Composite Index reached a three-year high on 09 July and is only a few percent below that peak as I write – despite the pandemic. Apparently, the Chinese market is being fuelled by margin traders. But then just three percent of Chinese citizens own shares and Chinses shares are extremely sensitive to buy/sell signals coming out of the Chinese Communist Party (CCP) apparatus.

There is more excitement to come. Later this year, Jack Ma, the billionaire founder of Chinese e-commerce giant Alibaba (HGK:9988), will launch a second tech start-up on the stock exchange. Ant Group, a mobile payments platform with over one billion users, is expected to be valued at around $200 billion, making it easily the largest IPO globally of 2020.

China’s fiscal deficit is heading for 15 percent of GDP this year, with a government stimulus package underway equal in scale to that which followed the financial crisis of 2008. China’s public plus private debt ratio as a percentage of GDP has ballooned to 330 percent. Its current account (trade) surplus peaked in 2007 at 10 of GDP (surpassing even the mercantilist Germans). Since then, it has been declining. China is still very much a middle-income economy in World Bank terms (along with much of Latin America and North Africa) and shows no sign of reaching South Korean levels of prosperity in the short to medium-term.

China’s friends

Just 53 countries out of nearly 200 backed China’s treatment of Hong Kong in the UN Human Rights Council during the first week of July. That may sound significant; but they were nearly all small nations which are already in China’s sphere of influence. (Though Saudi Arabia was amongst them, for whom China is a massively important market for its only export. There will be pay-back for that which I shall examine elsewhere).

Virtually all these 53 countries are in China’s much vaunted Belt and Road Initiative – and they collectively account for four percent of global GDP. That tells us something. Apart from Russia (a large country with a declining population which is entirely dependent on hydrocarbons), China doesn’t have any allies with any military prowess. Indeed, bullies do not naturally make friends. In fact, under President-for-Life Xi who has propagated the doctrine of civil-military fusion and who has behaved much more belligerently than his predecessors, China is increasingly acting like a nation which wants to be feared more than respected.

On 06 July China even extended the Hong Kong sedition law to apply to anybody anywhere in the world. Anyone who criticises China is theoretically subject to this law. And China’s spies and henchmen are everywhere.

Deteriorating relations

If China-UK relations are at a low ebb after the developments in Hong Kong and the Huawei about-turn, relations between China and the USA are even worse. During the week of 20 July the Trump administration announced the immediate closure of China’s consulate in Houston, citing espionage, the theft of industrial secrets and medical research and the intimidation of Chinese dissidents in the US. Shutting down an entire consulate is unprecedented. Last Friday (24 July), in a tit-for-tat response, the Chinese ordered the immediate closure of the US consulate in Chengdu (Sichuan Province).

There is no doubt that the administration is becoming more hawkish in its China policy. That is only partly a function of the presidential election, which will ignite next month into a gladiatorial contest between the two septuagenarian candidates. Clearly, Team Trump will attempt to brand Mr Biden as soft on China. But it is also true that the entire democratic world seems to have changed its perception of China this year.

In recent weeks, National Security Adviser Robert C O’Brien has described the Chinese Communist Party as “a threat to our very way of life”; FBI Director Christopher A Wray has stated that China is “engaged in a broad, diverse campaign of theft and malign influence”; and Attorney General William Barr has claimed that China aims to “exploit the openness of our institutions in order to destroy them…and overthrow the rules-based international system”. And on 23 July, Secretary of State Mike Pompeo gave a thoughtful speech at the Nixon Library in California in which he called on the US and its allies to “engage and empower the Chinese people…to induce change in the CCP’s behaviour.”

Any reader who has the time to watch the video of Mr Pompeo’s speech in full will get a clear picture of the administration’s current thinking on China. Many people in the US security establishment have distrusted China for a long time with good reason. What is new is that America is now loudly articulating its concerns about China for the benefit of its own domestic audience and for the Western alliance. Mr Pompeo reflected that it was 50 years since Henry Kissinger’s secret visit to China which opened the way for President Nixon’s visit in 1972 but that the era of a “blind engagement” with China was over. President Trump has said: “enough”. If President Reagan’s policy towards the USSR was trust but verify, President Trump’s policy towards China will be distrust and verify.

Beijing is more dependent on us than we are on them…General Secretary Xi is not destined to tyrannize inside and outside of China forever, unless we allow it…Now, this isn’t about containment. Don’t buy that. It’s about a complex new challenge that we’ve never faced before. The USSR was closed off from the free world. Communist China is already within our borders…

What next? The US will probably impose financial sanctions against individuals engaged in implementing China’s new security laws in Hong Kong – just as it maintains sanctions on individuals within the Putin regime. It is likely that TikTok (owned by China’s ByteDance (private – but the subject of an upcoming IPO)) will be banned in the US just as it has been in India – the more so because it is alleged to have repeatedly allowed paedophiles to groom children via its portal. WeChat (owned by Tencent (HKG:0700)) is also in the firing line. Congress might even ban Chinese firms from listing their shares on US exchanges.

Until now multinational corporations have gamed the system – they have sucked up to China, sold in its markets and manufactured there, profiting from low wages and social costs. Secretary of State Pompeo observed in his speech how certain American corporations avoid any reference to Taiwan for fear of offending China; and how Hollywood, so keen on social justice issues in America, has nothing to say about human rights violations in China. (The odd megastar such as Richard Gere has spoken up for the Tibetans; but I’m not aware of any who have protested about the treatment of the Uighurs).

But from hereon in, corporations will have to choose between China and America and its allies.

Where China is now

Analysts – amongst them The Daily Telegraph’s veteran Ambrose Evans-Pritchard – think that China is now in trouble. It needs to get unrestricted access to global markets for its major corporates to reach economic take-off. Instead the USA, India and now Europe are slamming doors in its face – and with good reason. India has quite justifiably banned TikTok (along with 58 other Chinese apps) further to the Chinese incursion into Ladakh on 16 June during which 20 Indian soldiers were clubbed to death. The US has also commendably frozen out China Mobile.

We are accelerating towards a splinternet in which the Chinese and Western worlds will access mutually incompatible internet ecosystems. This will important consequences which I hope to explore soon.

China’s ungracious treatment of Australia and Canada has not gone unnoticed and has only brought the Five Eyes closer together in their determination to resist China’s campaign of cyber-attacks. China’s sotto voce threats against the UK have also changed the mood – even amongst the normally China-hugging British mainstream media.

What does China want? Some would say world domination – or, at least, the definitive replacement of America as the sole superpower. To that end, short-term, China aims to displace the mighty dollar, which confers on America so many advantages, with the renminbi. The international renminbi-based payments system that China has built is centred in Hong Kong. That is another reason why China thought it worth taking the risk of effectively tearing up the Sino-British agreement of 1984 which guaranteed “one country, two systems” for 50 years.

Anyway, the Bank of China’s gold reserves are huge – not least because China is the largest gold producer in the world. They may be planning a forced return to the gold standard for the international monetary system. That will be easier to achieve as western governments wrack up massive fiscal deficits during the pandemic largely financed by monetary economics – as I discussed earlier this week. I’m researching these ideas further.

America is not going to attack China: but it will increasingly try to contain – sorry, challenge it. But there are severe risks here on the downside. The best historical analogy that I can conjure is that of an expansionist and militaristic empire which, finding that it is running short of resources because others impose barriers, feels compelled by the internal logic of its closed and self-referring government to take a massive gamble against all odds in pursuit of the aspirant ascendancy that has become its lode-star.

Think of the Japanese Empire in December 1941.

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So – a no-deal WTO Brexit is to coincide with the de-coupling from China and with no sign of a trade deal with the USA (after all, Mr Trump might be gone soon). Where does that leave the UK? Increasingly, senior members of the Johnson government are eying up the Trans-Pacific Partnership (CPTPP) of which fellow Anglosphere nations Australia, New Zealand Canada are already members (along with Japan and Vietnam which are on China’s front-line). I’ll examine that prospect soon.