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On US-China relations - scenes of a marriage

Ties between the US and China are experiencing a major transformation. While the world has been baffled by the fallout from the tensions between the two, the fact that this has led, and will likely continue to lead, to a major wave of innovation and growth initiatives in both hemispheres has generally been overlooked. China will continue to develop its asset base and make its financial markets an asset class of its own in a global context. At the same time, the US dollar will remain the global reserve currency for this decade, if not for longer. Moreover, the US will thrive on its unique currency status in the usual tumultuous ways and flood the world with cheap dollars until growth and inflation pick up globally.




Things would never be the same again after that. A defining moment of my childhood was when my mother turned the key to our family car for the very first time in the 1970s – under the vigilant supervision of my father. What followed in the weeks and months thereafter were political and psychological manoeuvres of Machiavellian dimensions: traps, ruses, skirmishes, confrontations, escalations, war threats, back-pedalling, excuses, and reconciliations – all of which took place in front of us three baffled children sitting in the back seat. Looking back, I think I understand a lot more today about what was going on then than I did at the time. But the pure memories are still of the liveliest sort, with the deep notion of enigma about the ways of ‘grown-up people’. At any rate, the experience taught me some major life lessons, not the least about how to identify when mutually beneficial relations get a major revamp.

Now it may seem far-fetched to apply the metaphor of a marriage to US-China relations, and attributing the roles to the parties involved is a minefield of its own. Therefore, let us start with a different narrative that has grown quite popular in recent years to describe the relations of the two superpowers in the twentieth century: the Thucydides Trap.

This term, apparently coined by the American political scientist Graham T. Allison, refers to the Peloponnesian War between the incumbent hegemon Sparta and the new kid on the block, the rising power of Athens. According to the Thucydides Trap, history suggests that competition between hegemon and challenger ultimately results in outright war or war-like conflict, as the hegemon tries to rein in the challenger, who, in turn, tries to prevail. The term ‘trap’ refers to the fact that the outcome is as much predestined as it is undesired by the parties involved – Greek drama at its finest, so to speak. The more you try to avoid it, the faster you end up in your unwanted destiny.

Maybe if I did not have such difficulties in spelling Thucydides, let alone pronouncing it (try it yourself), I would buy into the narrative more easily. I discussed this with one of our retired, and formerly leading, diplomats in Switzerland before a joint television debate. He said “comparing US-China relations with Sparta and Athens has all the ingredients you need to understand both conflicts”. Well, does it? Who am I to tell? That said, I struggle with the comparison of the US, with its modern way of life, to Sparta (at least when you leave the US Marine Corps out of the picture), although that is just a side note in the bigger scheme of things. Perhaps more pertinent is the fact that while both Athens and Sparta were brawling back then, the ‘not always sleeping’ giant was just around the corner, i.e. Persia. Yet I cannot really see an equivalent to Persia when looking at the US and China today, though India may fit that bill by 2050 or so. In any case, I would be surprised to learn that Sparta was a prime investor in Athens and that, in turn, Athens financed the Spartan government deficit. In contrast, this is what is happening now in the supposed remake of the Peloponnesian conflict in the 21st century, as we will see below. And this makes all the difference, limiting the usefulness of the historical comparison.

The US is a prime investor in China, and in turn China is financing the US government deficit. Countries with deep economic links usually do not wage war against each other.

Christian Gattiker, Head of Research

This argument chimes with the view, held by some historians, that countries with deep economic links usually do not wage war against each other. Put more simplistically by Thomas L. Friedman in his ‘Golden Arches Theory’ there has never been a war between two countries that both had McDonald’s restaurants in them. On this score, it might be reassuring to know that China currently has 3,383 McDonald’s restaurants (according to

Symbiosis: the mutally beneficial business model
“All theory, dear friend, is grey, but the golden tree of actual life springs ever green”, as Goethe once said. So let us rather turn to the tangible facts to outline the symbiosis between the two modern superpowers. Starting with the US and its involvement in China as a production hub. US foreign direct investments in China were valued just shy of USD 120 billion in January 2019 – far higher than US foreign direct investments in Brazil, India, and Indonesia, and growing at a much faster pace too. In return, China is still the biggest creditor to the US government after Japan, with a US Treasury position of over USD 1 trillion (USD 1,062 billion as of the end of September 2020, to be more precise).

The Great Financial Crisis: a wake-up call
Beijing’s first wake-up call that the mutually beneficial relationship with the US also had major disadvantages was in the form of the Great Financial Crisis in 2008/2009.

Of course, the first breakdown was related to the collapse of global trade overall, but what followed in subsequent years looks like a targeted policy shift. China’s foreign trade dependence has almost halved over the past decade or so. That does not mean that China is exporting half of what it did before the Great Financial Crisis – far from it – but rather that the share of foreign trade as a share of national income has been shrinking constantly. This means that the domestic economy has been outgrowing foreign trade on a consistent basis and will likely continue to do so until China, like the US and Brazil, achieves a ‘90/10’ economy, i.e. 90% self-sufficient and 10% foreign-trade related. What does China need to achieve this ambitious goal? Quite simply, technology and capital flows.

The mutual ’Sputnik Moment’
The 4 October 1957 was a landmark event in the history of the Cold War. On that day, the Soviet Union launched a rocket carrying the first artificial satellite, named ‘Sputnik’. This triggered a major competition for technological supremacy between the two superpowers. The US tried to catch up in what was perceived to be a lag in the race for space, while the Soviet Union tried to keep its advantage. Again, as opposed to the current US-China rivalry, there were no strong economic ties between the two countries – neither in terms of trade nor capital flows. Yet there is an echo of the Sputnik shock in recent times, although, to be precise, it is rather a mutual shock. Some claim that, from a Chinese perspective, the fact that AlphaGo won against the incumbent world champion in the board game Go was a major wake-up call. It showed that the US had the means to do the seemingly impossible, i.e. to beat the Asians on their most complex turf (a board game that is much more complex than chess) with the help of artificial intelligence. From a US perspective, this was preceded by the unveiling of the ‘Made in China 2025’ plan, a Chinese plan to ramp up their industry to global dominance.

This mutual shock triggered a major reconsideration of the flourishing joint US-China business model. Although many think that it was the Trump administration turning the screws on China, the previous administration under Obama was in fact already doing this.

Taking a step back and looking at the Sputnik moment could prove revealing yet again.

The Sputnik moment is standardly taken to have led to major geopolitical tensions that culminated in the Cuba crisis in 1962 – which was again a major risk, especially between powers that did not have any major economic ties. But what often goes unnoticed is the fact that the space race also triggered major innovations at the time. Some claim that the space programmes and the technical developments related to them set the basis for the internet and many other technologies that we are still building on today. The world has become so used to the dark side of geopolitical rivalries – such as trade wars, technology bans, and geopolitical sabre-rattling – that the boost to innovation and the economy often gets overlooked.

Parting is the hardest part
China’s twin aims of achieving technological supremacy and building a self-dependent economy inevitably force it to ramp up intellectual property to facilitate a highly competitive corporate sector that no longer depends on cost advantages but has a technological edge. 

Case study: 5G and the Internet Of Things
To illustrate the race for intellectual property, it is worth looking at what is likely to be the defining telecommunications platform of the decade: 5G. The latter should facilitate much higher data transmission rates at a much lower ‘latency’ (the delay between sending and receiving information), which, in turn, should facilitate a new way of running global production and trade, with the inclusion of hardware across the globe – a development often referred to as the ‘Internet of Things’. China had no meaningful share in patents for the 4G technology (the most recent communications standard), but the country already accounts for almost a third of all 5G-related patents. This underpins the breathtaking change in the Chinese business model from that of a low-cost producer to that of a future-technology leader within barely three decades.

Attracting capital for China: making Chinese assets and asset class of its own
Capital markets are the missing piece of the puzzle. To replace the dominance of the export sector with a domestic-driven business model requires capital markets that are attractive for business partners to invest in. This means deeper and broader financial markets that are more liquid and more diverse than they could possibly be today. Some would claim that a global superpower requires a global reserve currency too, which would require opening Chinese capital markets completely, allowing a free-floating currency, and removing capital controls. From what we see today, it is far from certain whether China would like to achieve this goal at all. But what looks increasingly achievable is turning Chinese assets into an asset class of its own.

And the US: Modern Monetary Theory and exploting the strength of a global reserve currency
There is a well-established ritual of declaring the end to US supremacy in the world and an end to the US dollar as a reserve currency. We doubt that we will see either of these materialising in the decade ahead, nor even in the following decade. The simple reason is that such shifts take a long time. Take for instance the US itself. Its star rose after intervening in World War I, and the dollar started to gain in importance after that. But the real full-currency system was only established almost 25 years later, towards the end of World War II, with the Bretton Woods agreement. Then US President Nixon turned the US dollar into the first global reserve currency without any physical backing by dropping the gold standard overall in the early 1970s. Ever since, the US has enjoyed being the dominant power in the global economy (also called a ‘blank cheque’ provided by the rest of the world) while complaining about the burden of global policing.

The US-China relationship is experiencing a major transformation that will likely continue for a decade or so.

This is likely to continue in a bipolar world as well, although perhaps to a lesser extent. With a new government and the use of Modern Monetary Theory, which sees deficit spending as a way out of any growth shortage, the stage is set for another great American decade in which the world is flooded with cheap dollars and the US thrives on this in their usual tumultuous ways. “Americans will always do the right thing – after exhausting all the alternatives”, as Winston Churchill used to say. We rather suggest heeding these words of wisdom.

Conclusion: a car of their own for each of them
The US-China relationship is experiencing a major transformation that will likely continue for a decade or so. While the world has seen the dark side of this process, with trade warfare and technology bans over the past several years, the bright side may have been overlooked. The rivalry between the two superpowers may end up in an age of innovation and growth, as both sides spur their innovative power and apply nonconventional macroeconomic policies through spending to back their growth models. But maybe the US and China are following a different path than that suggested by my personal experience of having a car of their own after all and yet still building on a mutually beneficial relationship, as my parents did in the remaining 30+ years of their marriage.

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