Financial Cold War

A View of Sino-US Relations from the Financial Markets

James A. Fok

• Publisher: Wiley
• Year: 2021
• ISBN:
  9781119862789
• Edition: 1
• Topic: Politik & Internationale Beziehungen
• Subtopic: Handel & Tarife

A groundbreaking exploration of US-China relations as seen through the lens of international finance

Rising tensions between China and the United States have kept the financial markets on edge as a showdown between the world's two largest economies seems inevitable. But what most people fail to recognise is the major impact that the financial markets themselves have had on the creation and acceleration of the conflict.

In Financial Cold War: A View of Sino-US Relations from the Financial Markets, market structure and geopolitical finance expert James Fok explores the nuances of China-US relations from the perspective of the financial markets. The book helps readers understand how imbalances in the structure of global financial markets have singularly contributed to frictions between the two countries.

In this book, readers will find:

• A comprehensive examination of the development of financial markets in both China and the US, as well as the current US dollar-based global financial system
• Insightful observations of the roles of technology, innovation, regulation, taxation, and politics in the markets, and on their resulting effect on US-Sino relations
• Thorough explorations of the role of Hong Kong as an intermediary for capital flows between China and the rest of the world
• Suggestions for how, balancing the many varying interests, policymakers might be able to devise effective strategies for de-escalating current Sino-US tensions

Financial Cold War is a can't-miss resource for anyone personally or professionally interested in the intersection of economics and international relations, financial markets, and the infrastructure underlying the international financial system.

Chapter 1
Introduction

今天，我主要讲一个问题，就是解放思想，开动脑筋，实事求是，团结一致向前看。

– 邓小平，1978 年中共中央工作会议

Today, I mainly want to discuss one question, namely, how to emancipate our minds, use our heads, seek truth from the facts and unite as one in looking to the future.

– Deng Xiaoping, Central Party Work Conference 1978

On Christmas Day 1991, the hammer and sickle flag was lowered over the Kremlin for the last time. It was a dry, still Wednesday morning and the temperature hovered around one degree above freezing, mild by Moscow standards for that time of year. With that, the Cold War had ended.

History would go on to record it as a triumph of capitalism over communism, and of liberal democracy over dictatorship. The euphoria of the period was famously captured in Francis Fukuyama's 1989 essay and subsequent book, declaring ‘The End of History’, with America's brand of capitalist democracy standing as ‘The Last Man’.¹ Indeed, the US had become the sole superpower and the world basked in the glow of the Pax Americana. Even as the US was at the apex of its power, however, the seeds of future crises had been sown.

‘Free market’ ideology had been a major factor in America's victory in the Cold War and, by the fall of the Soviet Union (USSR), US financial markets, with the dollar at their core, had long since attained global leadership. The whole world had become dependent on an American-dominated financial system.

The victory of free market capitalism over communism was so convincing that political parties of the left had to become more centrist – if not outright right-wing – in order to win power. The epochal phrase ‘It's the economy, stupid’ was coined by campaign strategist James Carville during Bill Clinton's successful 1992 presidential campaign and summed up the prevailing mood in the US. Across the Atlantic, in 1995 Tony Blair's Labour Party in Great Britain abandoned Clause IV of the party's constitution, which had previously committed Labour to ‘common ownership of the means of production’. This was seen as a decisive step on the path towards Blair's election victory in 1997.

A significant outgrowth of this free market ideology were the monetarist economic policies advocated by Milton Friedman and economists of the Chicago school. Their popularisation was, in many ways, a reaction against the dominance of redistributive Keynesian economics that had prevailed since the end of World War II (WW2) but which had failed to meet economic challenges faced in the 1970s. The influence of monetarist economics was to have a profound impact on government and central bank policies around the world. The increased role for central banks in managing the money supply within economies de-emphasised fiscal policy and governments’ role in economic management.

Of course, the impact of the collapse of the Soviet Union was not just felt in economic and financial policy. As the sole superpower, the US was much freer to pursue and implement its strategic objectives across many spheres. When Saddam Hussein invaded Kuwait in August 1990, President George H.W. Bush took painstaking care to build broad international support through the United Nations (UN) Security Council and assembled a coalition of 35 nations before launching Operation Desert Storm to repel Iraqi forces from Kuwait. When his son, President George W. Bush, invaded Iraq in 2003, he did so notwithstanding explicit objections from UN Security Council members Russia and France, and amidst widespread international condemnation.

American military supremacy owes much to the role of the dollar in international trade and finance. US Treasuries make up roughly 60 percent of global central bank reserves,² enabling the US government to finance its fiscal deficits cheaply and without any currency mis-match risk between its revenues and liabilities. Gradually, US policymakers came to realise that, through effective control of the global financial system, the dollar itself could be wielded as a weapon against strategic rivals.

The use of financial pressure and ‘geo-economic’ power in international diplomacy is nothing new. When Britain and France supported Israel's 1956 invasion of Egypt in a bid to topple Egyptian president Gamal Abdul Nasser and regain Western control of the Suez Canal, President Eisenhower used the threat of dumping British Gilts³ to force the withdrawal of the British and French troops. However, in the post-Cold War period, the exploitation of the dollar to achieve US diplomatic and strategic objectives was extended significantly.

Meanwhile, unlike the leaderships of the former Warsaw Pact countries, the Chinese Communist Party (CCP) continued in power beyond the end of the Cold War. Nevertheless, the CCP had also seen a wave of protests that had threatened its rule in the form of the 1989 student movement. Deng Xiaoping's decision to crack down on that movement in Tiananmen Square on 4 June 1989 has been described as ‘one of the most consequential decisions in recent world history’.⁴ Whatever the morality of that decision, it was influenced both by China's own history of internal chaos when the central government had been weak, and by the experience of Gorbachev's Perestroika movement, which had led to significant political upheavals while failing to generate meaningful economic growth.

China had been pursuing gradual market and political reforms since Deng had come to power in 1978 and announced his ‘reform and opening up’ (改革开放) policies. In the wake of Tiananmen, however, the Chinese government significantly accelerated market reforms, or what China's leadership has called ‘socialism with Chinese characteristics’ (中国特色社会主义), while political reforms were for the most part shelved.

As China embarked upon on its own unique path of reform and growth, Chinese policymakers were able to draw on lessons learned from the West. They also paid close attention to developments in Russia in the years following the fall of communism, as well as to Japan's slump into economic stagnation following the end of the Japanese economic miracle. The resulting improvement in living standards for the Chinese population was unprecedented in history, with hundreds of millions of people being lifted from extreme poverty into the middle class within a generation.

The economic policies China has pursued since the 1990s have led to growth that has far exceeded the expectations of their original architects. Following its accession to the World Trade Organisation (WTO) in 2001, China's export growth accelerated rapidly, and the country became the factory of the world. For some in the developed West, this provided great benefits, including low inflation, access to reasonably priced consumer goods and, increasingly, a huge new market for goods and services. For others, competition from China has led to displacement, wage stagnation and unemployment. Some, including many in the US, argue that China has engaged in unfair trade practices, such as suppressing the value of its currency to make its exports more competitive.⁵ Others argue that it is America's high cost structure that has made its exports uncompetitive, so it has only itself to blame.⁶ The truth, as is often the case, lies somewhere in the middle.

It is not unreasonable for China's leadership to pursue policies that improve the Chinese people's standard of living. The path that China followed was not substantially different to that followed by Japan and West Germany during their post-WW2 recoveries. In this regard, the CCP has done a pretty good job. As China's prosperity has increased, the government has tightened environmental codes and raised minimum wages. These are hardly the actions of a government that is pursuing a narrowly mercantilist trade agenda. At the same time, as trade and other imbalances grew, China's leadership was not proactive enough in addressing other countries’ concerns. Escalating tensions were exacerbated by the 2008 Global Financial Crisis (GFC) and its aftermath.

Legacy of the GFC

The 2008 GFC was a watershed event in post-WW2 history. Its significance lies not in the crisis itself, which shared a pattern with countless other financial crises, but in its causes and consequences, as well as a major turning point that it marked.

The ostensible causes of the GFC were the excesses that had been allowed to build up in the US subprime mortgage market. It was a story of greed, hubris, regulatory failures and policy missteps. However, casting a broader eye over the history of the build-up of these excesses, it becomes apparent that the origins of the GFC lay in structural imbalances that had built up in the global financial system over many decades. These are explored in more detail in Chapter 3.

The consequences of the GFC have been far-reaching and, whether we are conscious of them or not, they will continue to impact societies around the world economically, politically and diplomatically for a long time to come.

First, the direct financial impact of the crisis was devastating to a huge number of people. Livelihoods, security and community all suffered. Faith in a financial and social system that had promised stability and prosperity for decades was shattered. And we have yet to identify a system to replace it.

Second, although America had already done much to undermine the legitimacy of its global leadership through unilateralist and aggressive post-Cold War international policies, the GFC brought issues into much sharper focus. Other countries began to question the status quo of the global order and it became a spur to action. Reduced willingness to follow America's lead has complicated and slowed down the process of decision making on matters of global importance. The pursuit by other countries of alternatives to US-dominated international organisations has also generated diplomatic tensions.

Third, policy actions during and subsequent to the crisis have, for the most part, treated the symptoms rather than the root causes of the disease. Regulatory reforms have made the banking system less vulnerable to financial shocks. However, more fundamental underlying problems have not been tackled. Continued reliance on monetary policy and market self-correction mechanisms has failed to revitalise key parts of the economy. In addition, the prolonged application of some treatments, such as extraordinarily low interest rates, have contributed to a widening wealth gap. This, in turn, has stoked greater societal tensions.

Fourth, as these domestic and international tensions have simmered, we have witnessed a descent into more populist and nationalistic politics in many countries. This is spreading tensions ...