The Last Chance to Defeat China and Win Back the Cyber Domain?

Two months ago, when Zooming In did a story on Huawei and global 5G deployment, Huawei was poised to take control of much of the world’s cyber domain. We talked about the national security implications of that prospect. And we observed the U.S. efforts to raise awareness of that risk. Two months later, when we did another story on this topic, we realized the world knows Huawei a lot better through these efforts, but Huawei’s momentum has not stopped. In fact, Huawei and China are playing a grander game. They have a brilliant strategy that is working well with the very nature of a crony capitalism. Can this battle still be won by the free world? And what does it take to win? Let’s find out in this edition of Zooming In.
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The Anatomy of the Coming Recession

Unlike the 2008 global financial crisis, which was mostly a large negative aggregate demand shock, the next recession is likely to be caused by permanent negative supply shocks from the Sino-American trade and technology war. And trying to undo the damage through never-ending monetary and fiscal stimulus will not be an option.

NEW YORK – There are three negative supply shocks that could trigger a  by 2020. All of them reflect political factors affecting international relations, two involve China, and the United States is at the center of each. Moreover, none of them is amenable to the traditional tools of countercyclical macroeconomic policy.

The first potential shock stems from the Sino-American , which  earlier this month when US President Donald Trump’s administration threatened additional tariffs on Chinese exports, and formally labeled China a currency manipulator. The second concerns the slow-brewing cold war between the US and China over technology. In a rivalry that has all the hallmarks of a “,” China and America are vying for dominance over the industries of the future: artificial intelligence (AI), robotics, 5G, and so forth. The US has placed the Chinese telecom giant Huawei on an “entity list” reserved for foreign companies deemed to pose a national-security threat. And although Huawei has received temporary exemptions allowing it to continue using US components, the Trump administration this week announced that it was adding an additional 46 Huawei affiliates to the list.

The third major risk concerns oil supplies. Although oil prices have fallen in recent weeks, and a recession triggered by a trade, currency, and tech war would depress energy demand and drive prices lower, America’s confrontation with Iran could have the opposite effect. Should that conflict escalate into a military conflict, global oil prices could spike and bring on a recession, as happened during previous Middle East conflagrations in 1973, 1979, and 1990.

All three of these potential shocks would have a stagflationary effect, increasing the price of imported consumer goods, intermediate inputs, technological components, and energy, while reducing output by disrupting global supply chains. Worse, the Sino-American conflict is already fueling a broader process of deglobalization, because countries and firms can no longer count on the long-term stability of these integrated value chains. As trade in goods, services, capital, labor, information, data, and technology becomes increasingly balkanized, global production costs will rise across all industries.

Moreover, the trade and currency war and the competition over technology will amplify one another. Consider the case of Huawei, which is currently a global leader in 5G equipment. This technology will soon be the standard form of connectivity for most critical civilian and military infrastructure, not to mention basic consumer goods that are connected through the emerging Internet of Things. The presence of a 5G chip implies that anything from a toaster to a coffee maker could become a listening device. This means that if Huawei is widely perceived as a national-security threat, so would thousands of Chinese consumer-goods exports.

It is easy to imagine how today’s situation could lead to a full-scale implosion of the open global trading system. The question, then, is whether monetary and fiscal policymakers are prepared for a sustained – or even permanent – negative supply shock.

Following the stagflationary shocks of the 1970s, monetary policymakers responded by tightening monetary policy. Today, however, major central banks such as the US Federal Reserve are already pursuing monetary-policy easing, because inflation and inflation expectations remain low. Any inflationary pressure from an oil shock will be perceived by central banks as merely a price-level effect, rather than as a persistent increase in inflation.

Over time, negative supply shocks tend also to become temporary negative demand shocks that reduce both growth and inflation, by depressing consumption and capital expenditures. Indeed, under current conditions, US and global corporate capital spending is severely depressed, owing to uncertainties about the likelihood, severity, and persistence of the three potential shocks.

In fact, with firms in the US, Europe, China, and other parts of Asia having reined in capital expenditures, the global tech, manufacturing, and industrial sector is already in a recession. The only reason why that hasn’t yet translated into a global slump is that private consumption has remained strong. Should the price of imported goods rise further as a result of any of these negative supply shocks, real (inflation-adjusted) disposable household income growth would take a hit, as would consumer confidence, likely tipping the global economy into a recession.

Given the potential for a negative aggregate demand shock in the short run, central banks are right to ease policy rates. But fiscal policymakers should also be preparing a similar short-term response. A sharp decline in growth and aggregate demand would call for countercyclical fiscal easing to prevent the recession from becoming too severe.

In the medium term, though, the optimal response would not be to accommodate the negative supply shocks, but rather to adjust to them without further easing. After all, the negative supply shocks from a trade and technology war would be more or less permanent, as would the reduction in potential growth. The same applies to Brexit: leaving the European Union will saddle the United Kingdom with a permanent negative supply shock, and thus permanently lower potential growth.

Such shocks cannot be reversed through monetary or fiscal policymaking. Although they can be managed in the short term, attempts to accommodate them permanently would eventually lead to both inflation and inflation expectations rising well above central banks’ targets. In the 1970s, central banks accommodated two major oil shocks. The result was persistently rising inflation and inflation expectations, unsustainable fiscal deficits, and public-debt accumulation.

Finally, there is an important difference between the 2008 global financial crisis and the negative supply shocks that could hit the global economy today. Because the former was mostly a large negative aggregate demand shock that depressed growth and inflation, it was appropriately met with monetary and fiscal stimulus. But this time, the world would be confronting sustained negative supply shocks that would require a very different kind of policy response over the medium term. Trying to undo the damage through never-ending monetary and fiscal stimulus will not be a sensible option.

U.S.-China ‘cold war’ threatens global recession and financial crisis by 2020, says Roubini

Dr. Doom lives up to his moniker

.. Roubini pointed to the ongoing U.S.-China trade conflict as the likeliest trigger of the next crisis. “There is a cold war between the U.S. and China,” he said. “We have a global rivalry . . . about who is going to be controlling the industries of the future: artificial intelligence, automation, and 5G.”

Because the standoff has evolved into a one about national security and geopolitics, Roubini predicted that “there will be a trade and tech war between the U.S. and China that’s going to get worse.”

Roubini dismissed the trade truce declared by U.S. President Trump and Chinese President Xi Jinpeng over the weekend as mere talk, though stock market investors appeared to think otherwise this week. The S&P 500 index SPX, -0.05%  closed at a record high Monday, while the Dow Jones Industrial AverageDJIA, -0.09%   and Nasdaq Composite index COMP, -0.11%   also gained to be within 1% of their record closes.

The uncertainty that the standoff has created is forcing businesses to delay or cancel plans to make additional investments, Roubini added. “There’s already been, in the data, a collapse in [capital expenditures] and once capex is down, industrial production is down, and then you have the beginning of a global recession that starts in

  • tech, then spreads to
  • manufacturing, then to
  • industry and then it goes to
  • services,” he said.

The Sino-American trade dispute will have even further consequences than just triggering the next recession, as it will cause “a complete decoupling of the global economy” as private entities and countries will have to choose whether to do business with China or the U.S., and it will lead to a reconstruction of “the entire global tech supply chain,” which will be a drag on economic growth going forward.

He compared the predicted U.S.-China “cold war” with that between the Soviet Union and the U.S. during the last century, arguing that the coming war will be more disruptive. “This divorce is going to get ugly compared to the divorce with the U.S. and the Soviet Union,” because there was little economic integration between America and Russia prior to the conflict.

U.S.-China Trade Standoff May Be Initial Skirmish in Broader Economic War

The United States is increasingly wary of China’s emerging role in the global economy and the tactics it uses to get ahead, including state-sponsored hacking, acquisitions of high-tech companies in the United States and Europe, subsidies to crucial industries and discrimination against foreign companies.

The Trump administration has begun trying to limit China’s economic influence in the United States and abroad, warning about China’s ambitions in increasingly stark terms. Mike Pompeo, the secretary of state, compared China’s ambitions to Russia and Iran in a speech in London last Wednesday, saying Beijing poses “a new kind of challenge; an authoritarian regime that’s integrated economically into the West in ways that the Soviet Union never was.”

China, whose ambition is to dominate industries of the future, is pushing back. A column on Saturday in the Communist Party’s People’s Daily newspaper stated, “The United States is again waving the club of tariffs after misjudging China’s strength, capacity and will, further escalating trade friction between our two countries.”

The piece was written under the pen name Zhong Sheng — the “voice of China” — a name used when the paper publishes comments on foreign affairs that are authoritative.

Restraining China’s ambitions and methods is a tricky task — and there is concern that the Trump administration’s effort is creating a new red scare, fueling discrimination against China and its citizens that could ultimately hurt the United States. As many as 30 Chinese professors have had their visas to the United States canceled in the past year, or been put on administrative review, according to Chinese academics and their American counterparts.

“We’ve got decades of painful negotiating with China ahead,” said David Lampton, a China scholar at Stanford University. Mr. Lampton said a trade deal, if reached, would do little to resolve the bigger conflict. “It’s just a skirmish in an ongoing battle.”

.. While a trade deal could calm some tensions and establish more good will between the two nations, it is unlikely to achieve many of the ambitious goals that the administration has set for itself. Mr. Trump’s advisers, in particular the United States trade representative, Robert Lighthizer, have been focused on what the administration calls China’s practices of “economic aggression.”

But the administration has struggled to address the immensity of the problems in the text of a trade deal. People close to the talks say that the negotiators appear powerless to force any changes that aren’t in China’s interest.

Mr. Liu, who is leading China’s team in the trade negotiations, hinted at that uphill battle in a video statement released by the official Xinhua news agency.

Instead, a trade deal between the two countries seems more likely to bring change around the margins — tens of billions of dollars of soybean purchases, some tariffs lifted and changes to the text of Chinese laws or regulations that the country might ultimately disregard, particularly once another administration occupies the White House.

This is a decades-long endeavor,” said Robert Daly, the director of the Wilson Center’s Kissinger Institute on China and the United States. “This can’t be waved away over cake at Mar-a-Lago.”

The notion that the United States has one last shot to change China’s behavior is held by an array of people on both sides of the political spectrum. But it is an aggressive notion of American power to upend a rival system that has delivered prosperity for its people and put China on course to be the world’s largest economy.

Many in China see the United States as a declining power bent on enforcing its will on a world that no longer cowers before its hegemonic might. The troubles in American democracy and the long economic slump after 2008 persuaded many in China that its instincts to chart its own course were correct. In the eyes of many Chinese, their country is simply reclaiming its historic status as a dominant regional power in Asia.

It has also projected power across Asia, Africa and elsewhere while the United States has, on many fronts, retreated from its post-World War II commitment to the global order. But it has done so with little application of military force, in sharp contrast to what many in China see as American militarism.

Many in China have sought to avoid a trade conflict, which could have a larger impact on their economy than the United States’. But they have long thought the United States would have a difficult time accepting a true peer in economic, technology and military power, so consider the management of conflict with the United States to be an inevitable result of their own rise.

While the Trump administration accused China of breaking a trade deal, China’s resistance to the emerging terms stemmed from its belief that the United States was asking too much and offering too little in return. Many of the changes the United States seeks would limit what Chinese officials regard as a tried-and-true approach of using tens of billions of dollars from state-owned banks and government investment funds to turn previously small industries like car production or solar panel manufacturing into the largest industries of their kind in the world.

And the Chinese view some of the Trump administration’s demands as infringing on their sovereignty and giving America too much power over their economy — including requiring the country to codify changes through legislation in the National People’s Congress. To the increasingly nationalistic public in China, the American requests are reminiscent of 19th century history of unequal treaties forced on the country by foreign powers.

Mr. Trump on Saturday suggested China was simply delaying a deal in the hopes that a Democrat would win election in 2020 and continued his pugilistic approach, saying “the deal will become far worse for them if it has to be negotiated in my second term. Would be wise for them to act now, but love collecting BIG TARIFFS!”

In the United States, China’s unwillingness to bow to America’s demands is uniting lawmakers like the Democratic Senate leader, Chuck Schumer of New York, and Senator Marco Rubio, Republican of Florida.

That is a significant shift from the prevailing view in the United States since the death of Mao Zedong in 1976 that close economic engagement with China would produce an increasingly democratic country that would be closely tied to an international economic order founded mainly on Western liberal ideals.

That has not happened.

China has indeed grown in prosperity, leaping into the ranks of what the World Bank defines as upper-middle income countries. Its economy is now bigger than any other country except the United States. Its manufacturing sector is now bigger than those of the United States, Germany and South Korea combined.

But in the last five years, China has veered toward increasingly repressive authoritarianism at home and a rapid military buildup. The State Department estimates that Beijing has put 800,000 to two million Muslims in hastily built internment camps ringed with barbed wire in northwestern China. The Chinese government has built an archipelago of air bases on artificial islands in the South China Sea in between Vietnam, Malaysia, Indonesia and the Philippines. And China now has the world’s largest navy and has conducted

China has indeed grown in prosperity, leaping into the ranks of what the World Bank defines as upper-middle income countries. Its economy is now bigger than any other country except the United States. Its manufacturing sector is now bigger than those of the United States, Germany and South Korea combined.

But in the last five years, China has veered toward increasingly repressive authoritarianism at home and a rapid military buildup. The State Department estimates that Beijing has put 800,000 to two million Muslims in hastily built internment camps ringed with barbed wire in northwestern China. The Chinese government has built an archipelago of air bases on artificial islands in the South China Sea in between Vietnam, Malaysia, Indonesia and the Philippines. And China now has the world’s largest navy and has conducted military exercises as far away as East Africa and the Baltic Sea.

On the economic front, the competition is even fiercer. Trump administration officials warn that China is trying to dominate the global 5G infrastructure that will be the basis for future mobile communications and is competing to set other technological standards that will determine which global companies win.

China is extending low-cost loans and building infrastructure around the globe through its One Belt, One Road program, which critics warn is making poorer countries beholden to China. It is out-investing the United States in some high-tech industries, and is gaining dominance in certain segments, like mobile payment, new energy vehicles and areas of artificial intelligence.

While American companies have long hankered for access to China’s growing market, their position has begun to shift as they see China’s practices and treatment of foreign companies. A survey released by the American Chamber of Commerce in China in February showed that the majority of its members favored retaining tariffs on Chinese goods while trade negotiations continued.

China’s own experts say that the Beijing leadership has been caught off guard by the pace of change in American perceptions of Sino-American relations.

“Even if there is some kind of agreement between Xi and Trump, in the long run the strategic bilateral relationship is already in trouble,” said Zhang Jian, a professor in the School of Government at Peking University. “There is no coming back, even if there is a deal.”