Welcome to the new Cold War

The trade war between China and the USA has entered a new and more dangerous phase which could have serious implications for the global financial system. What’s more, it presages the start of something graver: a New Cold War, writes Victor Hill.

The historical context

Last week markets from Beijing to New York juddered after the US-China trade war intensified. What is really going on?

The first thing to understand about the trade war currently underway between the USA and China is that it is really about much more than trade: though America’s perception that China has been allowed to exploit the WTO architecture for too long is the proximate cause. But this so-called trade war is actually a manifestation of the rivalry between the existing global hegemon (the USA) and the rising superpower that threatens to eclipse it (China). If China overtakes the USA in 2030 as the world’s largest economy – as the extrapolation of current growth rates suggest – then how long will it be before China overtakes the USA in military might? And in technology – even in soft power?

These questions are particularly acute right now because the US perceives itself to be on the back foot. China has overtaken the US in communications technology – the US is still living with 4G but many Chinese cities already have 5G. China may even have the advantage in artificial intelligence (AI).

The USA effectively became the leading global power when she entered WWII in December 1941, relegating the British Empire to a junior partner. The Soviet Union, though a military colossus, never had America’s economic clout. At the end of WWII America designed a global financial and diplomatic order with America at its centre. Now many prominent Americans believe that China is a greater threat to America than the Soviet Union ever was – and that China is challenging the world order created by America in an attempt to usurp the leadership of the world.

Rising temperatures

On 10 May President Trump announced a dramatic escalation in the trade dispute. US tariffs on over $200 billion of Chinese goods imported into the USA will rise from 10 percent to 25 percent. The Shanghai index suffered its steepest fall – 6 percent – for two years. It has made a modest recovery since then but still looks fragile.

The new tariffs apply to goods leaving Chinese ports from 12:00 on 10 May. Such goods will not arrive in US warehouses until mid-June – and some have speculated that they may be reversed by then.


Last week, the People’s Daily – often referred to as the mouthpiece of the Chinese Communist Party – accused Washington of trying to blackmail China. In an editorial the newspaper said it was a lie to suggest that China had reneged on promises and that America should “stop playing tricks”. Clearly, the Chinese hierarchy is stung by Mr Trump’s tactics. Some Chinese economists estimate that the new tariff regime could cost China one percent in GDP growth per year. The official growth target for this year is 6-6.5 percent.

Mr Trump knows that America is enjoying its lowest level of unemployment (3.6 percent) for 50 years; the US stock market is near a record high, interest rates remain low and real incomes are rising. What’s more, the US trade deficit is coming down – at last! Figures released in March showed that China’s share of US imports was down to 15 percent from a peak of 23 percent previously, according to ABN Amro. The President enjoys an approval rating of 45 percent and is thus likely to be re-elected next year. Roughing up China may not look like diplomacy – but many Americans enjoy it.

Cold War rhetoric

Early this month the US “think-tank” or pressure group (depending on your point of view), the Committee on Present Danger convened in Washington to discuss the topic of “countering China’s rising imperialism”. The Committee was formed in 1950 to galvanise US politicians to take a firmer stance against the Soviet Union. It regards China as a totalitarian communist state (true) which seeks the destruction of the United States (questionable – that would be to lose its largest market). They believe that “the Chinese government is committed to undermining the United States”[i]. Steve Bannon was one of the speakers.

This group probably articulates what Mr Trump believes. Their view is that China has no intention of joining the American-led world order based on free markets and democracy but instead wants to create an alternative totalitarian world order led only by China. One of the ways they intend to achieve this is the Belt and Road programme which is effectively bringing dozens of countries in Asia and Africa (and now in Europe too e.g. Greece) into orbit around China.

Frank Gaffney, the Vice-Chairman (who was a member of the Reagan Administration) described Huawei’s participation in the roll-out of the 5G network across the Western world as a “masterstroke” that had created a fault line between America and its allies “without firing a shot”. However, James Millward, Professor of History at Georgetown University, worries about “neo-McCarythism”, evidencing the recent FBI crackdown on Chinese students at American universities.

The bigger picture: China under financial pressure

The big flaw in China’s plan to drive into much of Asia and Africa in a post-colonial power grab is that the country is running out of cash. The Belt & Road (B&R) Programme (I wish they had stuck to the original moniker of the New Silk Road with its intimations of Marco Polo) will cost a headline $8 trillion. That may have been affordable when China was running a 10 percent current account surplus before 2008 – but not now.

What did China do with its extraordinary surplus on its capital account? It piled money into the world’s favourite risk-free asset (then offering half-decent yields): US Treasuries. In fact, China owns about $1.1 trillion worth of them – about 7 percent of all outstanding Federal government debt. Beijing’s foreign reserves ballooned to $4 trillion in 2015 but have since fallen to about $3 trillion, further to restrictions imposed after the currency scare. That caused a capital flight: at one point China was losing an estimated $100 billion a month.

As I reported last week, Hu Xijin, the editor of the Chinese-government-controlled Global Times, tweeted on 13 May that China “may stop purchasing US agricultural products and energy, reduce Boeing orders and restrict US service trade with China.” And then he added: Many Chinese scholars are studying the possibility of dumping US Treasuries and how to do it specifically. In fact, this is likely to happen anyway, quite apart from the trade war, as China’s capital account deteriorates.

This year, according to the IMF, China’s capital account will amount to just 0.5 percent of GDP. It is likely to go negative in the early 2020s. That is not good news for China: but it is worse news for America because it will no longer be able to rely on China as a fail-safe mechanism to hoover up all the new debt papers it issues.


The Americans are going to have to find other buyers for their debt papers – which implies rising interest rates. That, paradoxically, would induce more global investors to buy Treasuries, so the Fed doesn’t really have too much to worry about. What would be more worrying is if China countered Mr Trump’s tariffs by devaluing the yuan, thus making its exports cheaper in dollar terms.

Total “Belt & Road” investments peaked in 2017, falling by four percent last year. The figures are blurred, however: it seems that President-for-Life Xi has instructed that China’s penetration of the Arctic, its space programme and its cyberspace infrastructure be considered part of the B&R programme. Some have described the B&R as “elastic”. Some signed-up members like South Korea have received zero capital from China; whereas India – an outspoken opponent – receives massive investment from China anyway.

The Chinese economy has matured to a point where it has become a net importer of capital – or will be very soon. According to Morgan Stanley, China will require net capital inflows of $400 billion by the end of the next decade. That is why China has sent out a plea for more joint ventures of late.

Some of the B&R investments are a disaster for their recipients – for example the highway in Montenegro linking the Adriatic port of Bar through mountainous terrain to Serbia was deemed unviable by the traffic studies. But the Export-Import Bank of China opined otherwise. Under the final contract disputes must be settled by the courts of China. And in case of default, China can seize Montenegrin land. According to the IMF, Montenegro’s debt-to GDP-ratio has gone from 63 percent to 80 percent thanks to Chinese intervention. This means that it can no longer join the EU, at least for now.

Another example is that of Sri Lanka. After failing to pay back loans on which the interest rate was 6.3 percent (about three times the World Bank rate), the country was forced to sign over to the Chinese the port of Hambantota on a 99-year lease.

The Institute for Energy Economics and Financial Analysis (IEEFA) recently claimed that Chinese banks are funding $36 billion of coal powered energy which will add 102 gigawatts of new coal capacity in countries such as Vietnam, Bangladesh and Pakistan. Many of these plants will have a productive life of 30-50 years, so the effect on future carbon emissions will be considerable. The IEEFA thinks that it requires “active distortion” to keep coal going in countries when solar power is a perfectly viable alternative. Unperturbed, President Xi is launching a so-called “international green development coalition”.

Can China afford this largesse? On current projections China will have a fiscal deficit of 6.1 percent this year. That is likely to fall over the next five years – but only slightly. China’s overall debt-to-GDP ratio is projected to soar from 55.4 percent today to 72.4 percent in 2024. Like its adversary, the USA, China now has a debt problem. In the event of a downturn, that debt pile will become more difficult to service.

Huawei: claims and counter-claims

Three weeks ago I explained why the UK is caught between a desire to cultivate good commercial relations with China and the necessity to maintain close intelligence relations with our closest ally, the United States. Since then, much has been revealed about the nature of the Huawei threat.

In a report published by the Henry Jackson Society during the week of 13 May the electronics expert Dr Peter Varnish, formerly a senior official at the Ministry of Defence, claims that Huawei’s inclusion in the roll-out of the 5G network in the UK, even if restricted to the “dumb” or “non-core” elements, could allow Beijing to shut down parts of the internet of things (e.g. signals emitted by cars to traffic flow systems). Dr Varnish warns that a manufacturer could interfere with antennae and block signals to individual devices. He writes:

The possibility of Beijing weaponising its operational control of the UK’s national infrastructure in pursuit of its national goals in a form of state blackmail on a strategic and global scale cannot and should not be discounted.

Dr Varnish explains that antennae are key to the 5G network. Malicious actors could re-programme the antennae such that signals are denied to the intended recipient. Huawei, of course, has disputed the report. Previously, US Secretary of State Mike Pompeo had indirectly criticized the decision of the UK National Security Council (NSC) to allow UK service providers such as Vodafone (LON:VOD) and BT (LON:BT.A) to install equipment supplied by Huawei.


On Monday (20 May) Alphabet/Google (NASDAQ:GOOG) announced that it would no longer supply Huawei (SHE:002502) smartphones with its Android operating system. That means that users of Huawei handsets will not get access to Google Chrome, Google Maps, Gmail, YouTube and so forth. Current Huawei device owners will not be affected immediately but they will not get access to future software updates.

This was determined by the Trump administration which issued an executive order last week banning Huawei from all US networks. Qualcomm (NASDAQ:QCOM) and Intel (NSDAQ:INTC) will also have to comply. Since then, a slew of corporations on both sides of the Atlantic have turned their backs on Huawei. Microsoft (NADAQ:MSFT) has quietly removed Huawei’s laptops from its online stores this week. It is currently unclear if Microsoft will deny Huawei users licenses for the MS Office suite.

This means that if you buy a Huawei handset tomorrow it will not have the functionality that it did previously. Some 2.7 million Huawei smartphones were sold in the UK alone last year and a new model, the Honor 20, was launched on Tuesday (21 May).

The US intelligence establishment is convinced that Huawei’s involvement in the roll-out of the 5G network in the UK and elsewhere is a threat to their security. But it is legitimate to ask: why is American intelligence not so openly concerned about the fact that nearly one hundred million Americans carry iPhones, designed by Apple (NASDAQ:AAPL) but manufactured in China? Surely, the Chinese contactors which assemble iPhones are subject to the same notorious laws as Huawei that compel them to do the bidding of the Chinese security apparatus?

Moreover, let’s not forget that even networks which run on Ericsson (NASDAQ:ERIC), Nokia (NYSE:NOK) and Cisco (NASDAQ:CSCO) equipment are also susceptible to hacking. Nicholas Weaver, a computer security expert at the University of California, writing on the Lawfare blog concludes:

I don’t believe these risks are unique to Huawei: the dirty secret is that most of the world’s computing infrastructure is a similar nightmare.

The EU has yet to take a stance on the question of Huawei. It has asked each member state to submit an assessment of the threat of Huawei to cybersecurity by the end of June. Yesterday (23 May), a senior Chinese diplomat warned the UK that there would be substantial repercussions for China’s investment in the UK if Huawei were to be banned from Britain’s 5G network[ii].

A clash of civilisations?

Some commentators foresee an online iron curtain – the idea that the internet will split between American-dominated and Chinese-dominated cyberspaces, each inaccessible to the other. That is an apt analogy – the USA and China are effectively now in a state of Cold War of which the trade war is one symptom while global strategic rivalry is the underlying driver.

In 1996 the American academic Samuel Huntington wrote a hugely influential book entitled Clash of Civilisations. The main theme was how militant Islam was on a collision course with the democratic, liberal West. At that time it was assumed that as China developed economically and socially it would liberalise and morph into something similar to the pluralistic West. This was the period also in which Francis Fukuyama’s The End of History predicted that all countries would end up as liberal democracies in the Western mould, shaped by the Enlightenment.


That did not happen. China used capitalism to develop its economy but remained a totalitarian one-party state. Chinese civilisation, writes Cristopher Coker in The Rise of the Civilisation State (2019) “is the most culturally sufficient on the planet”. Its official posture is pacific and harmonious. Yet its cultural expansion through the global network of Confucian institutes, its territorial claims in the South China Sea, its huge B&R investments in Africa, Latin America and Central Asia suggest a concealed hegemonic ambition.

The primary clash of civilisations may not turn out to be between the Islamic world and the West. While Islamic terrorism is a macabre and vicious nuisance, the dream of the Islamic State and others to conquer the West remains contemptible. Rather, the clash is likely to be between closed China and the open West. Only the latter is founded on respect for human rights, the rule of law, the supremacy of facts and a free press (though some will argue that all of these are under threat).

Clausewitz said that war was the continuation of diplomacy by other means. We are nowhere near military confrontation yet – thank heavens – but erecting tariff barriers on your principal opponent is itself a form of diplomacy. Mr Trump is not an intellectual but he understands the principles of game theory intuitively. Nor is he a historian but he understands perfectly the nature of the long-term historical forces that threaten American hegemony.

How can investors best ride out this New Cold War? I’ll put forward some ideas about this at length shortly – but for now I’ll just mention one four-letter word: gold.

I do not anticipate a trade deal to be agreed soon – on Tuesday (21 May) President Xi told the Chinese to begin a new long march…The world will continue to bifurcate into two mutually hostile camps…

China or America? You have to choose – you cannot be best friends with both.

[i] See Cold War hawks in new flap about China by John Glancy, Sunday Times, 05 May 2019.

[ii] See: https://www.bbc.co.uk/news/business-48377235