Why Our Economy May Be Headed for a Decade of Depression

In September 2006, Nouriel Roubini told the International Monetary Fund what it didn’t want to hear. Standing before an audience of economists at the organization’s headquarters, the New York University professor warned that the U.S. housing market would soon collapse — and, quite possibly, bring the global financial system down with it. Real-estate values had been propped up by unsustainably shady lending practices, Roubini explained. Once those prices came back to earth, millions of underwater homeowners would default on their mortgages, trillions of dollars worth of mortgage-backed securities would unravel, and hedge funds, investment banks, and lenders like Fannie Mae and Freddie Mac could sink into insolvency.

At the time, the global economy had just recorded its fastest half-decade of growth in 30 years. And Nouriel Roubini was just some obscure academic. Thus, in the IMF’s cozy confines, his remarks roused less alarm over America’s housing bubble than concern for the professor’s psychological well-being.

Of course, the ensuing two years turned Roubini’s prophecy into history, and the little-known scholar of emerging markets into a Wall Street celebrity.

A decade later, “Dr. Doom” is a bear once again. While many investors bet on a “V-shaped recovery,” Roubini is staking his reputation on an L-shaped depression. The economist (and host of a biweekly economic news broadcastdoes expect things to get better before they get worse: He foresees a slow, lackluster (i.e., “U-shaped”) economic rebound in the pandemic’s immediate aftermath. But he insists that this recovery will quickly collapse beneath the weight of the global economy’s accumulated debts. Specifically, Roubini argues that the massive private debts accrued during both the 2008 crash and COVID-19 crisis will durably depress consumption and weaken the short-lived recovery. Meanwhile, the aging of populations across the West will further undermine growth while increasing the fiscal burdens of states already saddled with hazardous debt loads. Although deficit spending is necessary in the present crisis, and will appear benign at the onset of recovery, it is laying the kindling for an inflationary conflagration by mid-decade. As the deepening geopolitical rift between the United States and China triggers a wave of deglobalization, negative supply shocks akin those of the 1970s are going to raise the cost of real resources, even as hyperexploited workers suffer perpetual wage and benefit declines. Prices will rise, but growth will peter out, since ordinary people will be forced to pare back their consumption more and more. Stagflation will beget depression. And through it all, humanity will be beset by unnatural disasters, from extreme weather events wrought by man-made climate change to pandemics induced by our disruption of natural ecosystems.

Roubini allows that, after a decade of misery, we may get around to developing a “more inclusive, cooperative, and stable international order.” But, he hastens to add, “any happy ending assumes that we find a way to survive” the hard times to come.

Intelligencer recently spoke with Roubini about our impending doom.

You predict that the coronavirus recession will be followed by a lackluster recovery and global depression. The financial markets ostensibly see a much brighter future. What are they missing and why?

Well, first of all, my prediction is not for 2020. It’s a prediction that these ten major forces will, by the middle of the coming decade, lead us into a “Greater Depression.” Markets, of course, have a shorter horizon. In the short run, I expect a U-shaped recovery while the markets seem to be pricing in a V-shape recovery.

Of course the markets are going higher because there’s a massive monetary stimulus, there’s a massive fiscal stimulus. People expect that the news about the contagion will improve, and that there’s going to be a vaccine at some point down the line. And there is an element “FOMO” [fear of missing out]; there are millions of new online accounts — unemployed people sitting at home doing day-trading — and they’re essentially playing the market based on pure sentiment. My view is that there’s going to be a meaningful correction once people realize this is going to be a U-shaped recovery. If you listen carefully to what Fed officials are saying — or even what JPMorgan and Goldman Sachs are saying — initially they were all in the V camp, but now they’re all saying, well, maybe it’s going to be more of a U. The consensus is moving in a different direction.

Your prediction of a weak recovery seems predicated on there being a persistent shortfall in consumer demand due to income lost during the pandemic. A bullish investor might counter that the Cares Act has left the bulk of laid-off workers with as much — if not more — income than they had been earning at their former jobs. Meanwhile, white-collar workers who’ve remained employed are typically earning as much as they used to, but spending far less. Together, this might augur a surge in post-pandemic spending that powers a V-shaped recovery. What does the bullish story get wrong?

Yes, there are unemployment benefits. And some unemployed people may be making more money than when they were working. But those unemployment benefits are going to run out in July. The consensus says the unemployment rate is headed to 25 percent. Maybe we get lucky. Maybe there’s an early recovery, and it only goes to 16 percent. Either way, tons of people are going to lose unemployment benefits in July. And if they’re rehired, it’s not going to be like before — formal employment, full benefits. You want to come back to work at my restaurant? Tough luck. I can hire you only on an hourly basis with no benefits and a low wage. That’s what every business is going to be offering. Meanwhile, many, many people are going to be without jobs of any kind. It took us ten years — between 2009 and 2019 — to create 22 million jobs. And we’ve lost 30 million jobs in two months.

So when unemployment benefits expire, lots of people aren’t going to have any income. Those who do get jobs are going to work under more miserable conditions than before. And people, even middle-income people, given the shock that has just occurred — which could happen again in the summer, could happen again in the winter — you are going to want more precautionary savings. You are going to cut back on discretionary spending. Your credit score is going to be worse. Are you going to go buy a home? Are you gonna buy a car? Are you going to dine out? In Germany and China, they already reopened all the stores a month ago. You look at any survey, the restaurants are totally empty. Almost nobody’s buying anything. Everybody’s worried and cautious. And this is in Germany, where unemployment is up by only one percent. Forty percent of Americans have less than $400 in liquid cash saved for an emergency. You think they are going to spend?

Graphic: Financial Times
Graphic: Financial Times

You’re going to start having food riots soon enough. Look at the luxury stores in New York. They’ve either boarded them up or emptied their shelves,  because they’re worried people are going to steal the Chanel bags. The few stores that are open, like my Whole Foods, have security guards both inside and outside. We are one step away from food riots. There are lines three miles long at food banks. That’s what’s happening in America. You’re telling me everything’s going to become normal in three months? That’s lunacy.

Your projection of a “Greater Depression” is premised on deglobalization sparking negative supply shocks. And that prediction of deglobalization is itself rooted in the notion that the U.S. and China are locked in a so-called Thucydides trap, in which the geopolitical tensions between a dominant and rising power will overwhelm mutual financial self-interest. But given the deep interconnections between the American and Chinese economies — and warm relations between much of the U.S. and Chinese financial elite — isn’t it possible that class solidarity will take precedence over Great Power rivalry? In other words, don’t the most powerful people in both countries understand they have a lot to lose financially and economically from decoupling? And if so, why shouldn’t we see the uptick in jingoistic rhetoric on both sides as mere posturing for a domestic audience?

First of all, my argument for why inflation will eventually come back is not just based on U.S.-China relations. I actually have 14 separate arguments for why this will happen. That said, everybody agrees that there is the beginning of a Cold War between the U.S. and China. I was in Beijing in November of 2015, with a delegation that met with Xi Jinping in the Great Hall of the People. And he spent the first 15 minutes of his remarks speaking, unprompted, about why the U.S. and China will not get caught in a Thucydides trap, and why there will actually be a peaceful rise of China.

Since then, Trump got elected. Now, we have a full-scale

  • trade war,
  • technology war,
  • financial war,
  • monetary war,
  • technology,
  • information,
  • data,
  • investment,
  • pretty much anything across the board. Look at tech — there is complete decoupling. They just decided Huawei isn’t going to have any access to U.S. semiconductors and technology. We’re imposing total restrictions on the transfer of technology from the U.S. to China and China to the U.S. And if the United States argues that 5G or Huawei is a backdoor to the Chinese government, the tech war will become a trade war. Because tomorrow, every piece of consumer electronics, even your lowly coffee machine or microwave or toaster, is going to have a 5G chip. That’s what the internet of things is about. If the Chinese can listen to you through your smartphone, they can listen to you through your toaster. Once we declare that 5G is going to allow China to listen to our communication, we will also have to ban all household electronics made in China. So, the decoupling is happening. We’re going to have a “splinternet.” It’s only a matter of how much and how fast.

And there is going to be a cold war between the U.S. and China. Even the foreign policy Establishment — Democrats and Republicans — that had been in favor of better relations with China has become skeptical in the last few years. They say, “You know, we thought that China was going to become more open if we let them into the WTO. We thought they’d become less authoritarian.” Instead, under Xi Jinping, China has become more state capitalist, more authoritarian, and instead of biding its time and hiding its strength, like Deng Xiaoping wanted it to do, it’s flexing its geopolitical muscle. And the U.S., rightly or wrongly, feels threatened. I’m not making a normative statement. I’m just saying, as a matter of fact, we are in a Thucydides trap. The only debate is about whether there will be a cold war or a hot one. Historically, these things have led to a hot war in 12 out of 16 episodes in 2,000 years of history. So we’ll be lucky if we just get a cold war.

Some Trumpian nationalists and labor-aligned progressives might see an upside in your prediction that America is going to bring manufacturing back “onshore.” But you insist that ordinary Americans will suffer from the downsides of reshoring (higher consumer prices) without enjoying the ostensible benefits (more job opportunities and higher wages). In your telling, onshoring won’t actually bring back jobs, only accelerate automation. And then, again with automation, you insist that Americans will suffer from the downside (unemployment, lower wages from competition with robots) but enjoy none of the upside from the productivity gains that robotization will ostensibly produce. So, what do you say to someone who looks at your forecast and decides that you are indeed “Dr. Doom” — not a realist, as you claim to be, but a pessimist, who ignores the bright side of every subject?

When you reshore, you are moving production from regions of the world like China, and other parts of Asia, that have low labor costs, to parts of the world like the U.S. and Europe that have higher labor costs. That is a fact. How is the corporate sector going respond to that? It’s going to respond by replacing labor with robots, automation, and AI.

I was recently in South Korea. I met the head of Hyundai, the third-largest automaker in the world. He told me that tomorrow, they could convert their factories to run with all robots and no workers.Why don’t they do it? Because they have unions that are powerful. In Korea, you cannot fire these workers, they have lifetime employment.

But suppose you take production from a labor-intensive factory in China — in any industry — and move it into a brand-new factory in the United States. You don’t have any legacy workers, any entrenched union. You are going to design that factory to use as few workers as you can. Any new factory in the U.S. is going to be capital-intensive and labor-saving. It’s been happening for the last ten years and it’s going to happen more when we reshore. So reshoring means increasing production in the United States but not increasing employment. Yes, there will be productivity increases. And the profits of those firms that relocate production may be slightly higher than they were in China (though that isn’t certain since automation requires a lot of expensive capital investment).

But you’re not going to get many jobs. The factory of the future is going to be one person manning 1,000 robots and a second person cleaning the floor. And eventually the guy cleaning the floor is going to be replaced by a Roomba because a Roomba doesn’t ask for benefits or bathroom breaks or get sick and can work 24-7.

The fundamental problem today is that people think there is a correlation between what’s good for Wall Street and what’s good for Main Street. That wasn’t even true during the global financial crisis when we were saying, “We’ve got to bail out Wall Street because if we don’t, Main Street is going to collapse.” How did Wall Street react to the crisis? They fired workers. And when they rehired them, they were all gig workers, contractors, freelancers, and so on. That’s what happened last time. This time is going to be more of the same. Thirty-five to 40 million people have already been fired. When they start slowly rehiring some of them (not all of them), those workers are going to get part-time jobs, without benefits, without high wages. That’s the only way for the corporates to survive. Because they’re so highly leveraged today, they’re going to need to cut costs, and the first cost you cut is labor. But of course, your labor cost is my consumption. So in an equilibrium where everyone’s slashing labor costs, households are going to have less income. And they’re going to save more to protect themselves from another coronavirus crisis. And so consumption is going to be weak. That’s why you get the U-shaped recovery.

There’s a conflict between workers and capital. For a decade, workers have been screwed. Now, they’re going to be screwed more. There’s a conflict between small business and large business.

Millions of these small businesses are going to go bankrupt. Half of the restaurants in New York are never going to reopen. How can they survive? They have such tiny margins. Who’s going to survive? The big chains. Retailers. Fast food. The small businesses are going to disappear in the post-coronavirus economy. So there is a fundamental conflict between Wall Street (big banks and big firms) and Main Street (workers and small businesses). And Wall Street is going to win.

Clearly, you’re bearish on the potential of existing governments intervening in that conflict on Main Street’s behalf. But if we made you dictator of the United States tomorrow, what policies would you enact to strengthen labor, and avert (or at least mitigate) the Greater Depression? 

The market, as currently ordered, is going to make capital stronger and labor weaker. So, to change this, you need to invest in your workers. Give them education, a social safety net — so if they lose their jobs to an economic or technological shock, they get job training, unemployment benefits, social welfare, health care for free. Otherwise, the trends of the market are going to imply more income and wealth inequality. There’s a lot we can do to rebalance it. But I don’t think it’s going to happen anytime soon. If Bernie Sanders had become president, maybe we could’ve had policies of that sort. Of course, Bernie Sanders is to the right of the CDU party in Germany. I mean, Angela Merkel is to the left of Bernie Sanders. Boris Johnson is to the left of Bernie Sanders, in terms of social democratic politics. Only by U.S. standards does Bernie Sanders look like a Bolshevik.

In Germany, the unemployment rate has gone up by one percent. In the U.S., the unemployment rate has gone from 4 percent to 20 percent (correctly measured) in two months. We lost 30 million jobs. Germany lost 200,000. Why is that the case? You have different economic institutions. Workers sit on the boards of German companies. So you share the costs of the shock between the workers, the firms, and the government.

In 2009, you argued that if deficit spending to combat high unemployment continued indefinitely, “it will fuel persistent, large budget deficits and lead to inflation.” You were right on the first count obviously. And yet, a decade of fiscal expansion not only failed to produce high inflation, but was insufficient to reach the Fed’s 2 percent inflation goal. Is it fair to say that you underestimated America’s fiscal capacity back then? And if you overestimated the harms of America’s large public debts in the past, what makes you confident you aren’t doing so in the present?

First of all, in 2009, I was in favor of a bigger stimulus than the one that we got. I was not in favor of fiscal consolidation. There’s a huge difference between the global financial crisis and the coronavirus crisis because the former was a crisis of aggregate demand, given the housing bust. And so monetary policy alone was insufficient and you needed fiscal stimulus. And the fiscal stimulus that Obama passed was smaller than justified. So stimulus was the right response, at least for a while. And then you do consolidation.

What I have argued this time around is that in the short run, this is both a supply shock and a demand shock. And, of course, in the short run, if you want to avoid a depression, you need to do monetary and fiscal stimulus. What I’m saying is that once you run a budget deficit of not 3, not 5, not 8, but 15 or 20 percent of GDP — and you’re going to fully monetize it (because that’s what the Fed has been doing) — you still won’t have inflation in the short run, not this year or next year, because you have slack in goods markets, slack in labor markets, slack in commodities markets, etc. But there will be inflation in the post-coronavirus world. This is because we’re going to see two big negative supply shocks. For the last decade, prices have been constrained by two positive supply shocks — globalization and technology. Well, globalization is going to become deglobalization thanks to decoupling, protectionism, fragmentation, and so on. So that’s going to be a negative supply shock. And technology is not going to be the same as before. The 5G of Erickson and Nokia costs 30 percent more than the one of Huawei, and is 20 percent less productive. So to install non-Chinese 5G networks, we’re going to pay 50 percent more. So technology is going to gradually become a negative supply shock. So you have two major forces that had been exerting downward pressure on prices moving in the opposite direction, and you have a massive monetization of fiscal deficits. Remember the 1970s? You had two negative supply shocks — ’73 and ’79, the Yom Kippur War and the Iranian Revolution. What did you get? Stagflation.

Now, I’m not talking about hyperinflation — not Zimbabwe or Argentina. I’m not even talking about 10 percent inflation. It’s enough for inflation to go from one to 4 percent. Then, ten-year Treasury bonds — which today have interest rates close to zero percent — will need to have an inflation premium. So, think about a ten-year Treasury, five years from now, going from one percent to 5 percent, while inflation goes from near zero to 4 percent. And ask yourself, what’s going to happen to the real economy? Well, in the fourth quarter of 2018, when the Federal Reserve tried to raise rates above 2 percent, the market couldn’t take it. So we don’t need hyperinflation to have a disaster.

In other words, you’re saying that because of structural weaknesses in the economy, even modest inflation would be crisis-inducing because key economic actors are dependent on near-zero interest rates?

For the last decade, debt-to-GDP ratios in the U.S. and globally have been rising. And debts were rising for corporations and households as well. But we survived this, because, while debt ratios were high, debt-servicing ratios were low, since we had zero percent policy rates and long rates close to zero — or, in Europe and Japan, negative. But the second the Fed started to hike rates, there was panic.

In December 2018, Jay Powell said, “You know what. I’m at 2.5 percent. I’m going to go to 3.25. And I’m going to continue running down my balance sheet.” And the market totally crashed. And then, literally on January 2, 2019, Powell comes back and says, “Sorry, I was kidding. I’m not going to do quantitative tightening. I’m not going to raise rates.” So the economy couldn’t take a Fed funds rate of 2.5 percent. In the strongest economy in the world. There is so much debt, if long-term rates go from zero to 3 percent, the economy is going to crash.

You’ve written a lot about negative supply shocks from deglobalization. Another potential source of such shocks is climate change. Many scientists believe that rising temperatures threaten the supply of our most precious commodities — food and water. How does climate figure into your analysis?

I am not an expert on global climate change. But one of the ten forces that I believe will bring a Greater Depression is man-made disasters. And global climate change, which is producing more extreme weather phenomena — on one side, hurricanes, typhoons, and floods; on the other side, fires, desertification, and agricultural collapse — is not a natural disaster. The science says these extreme events are becoming more frequent, are coming farther inland, and are doing more damage. And they are doing this now, not 30 years from now.

So there is climate change. And its economic costs are becoming quite extreme. In Indonesia, they’ve decided to move the capital out of Jakarta to somewhere inland because they know that their capital is going to be fully flooded. In New York, there are plans to build a wall all around Manhattan at the cost of $120 billion. And then they said, “Oh no, that wall is going to be so ugly, it’s going to feel like we’re in a prison.” So they want to do something near the Verrazzano Bridge that’s going to cost another $120 billion. And it’s not even going to work.

The Paris Accord said 1.5 degrees. Then they say two. Now, every scientist says, “Look, this is a voluntary agreement, we’ll be lucky if we get three — and more likely, it will be four — degree Celsius increases by the end of the century.” How are we going to live in a world where temperatures are four degrees higher? And we’re not doing anything about it. The Paris Accord is just a joke. And it’s not just the U.S. and Trump. China’s not doing anything. The Europeans aren’t doing anything. It’s only talk.

And then there’s the pandemics. These are also man-made disasters. You’re destroying the ecosystems of animals. You are putting them into cages — the bats and pangolins and all the other wildlife — and they interact and create viruses and then spread to humans.

  1. First, we had HIV. Then we had
  2. SARS. Then
  3. MERS, then
  4. swine flu, then
  5. Zika, then
  6. Ebola, now
  7. this one.

And there’s a connection between global climate change and pandemics. Suppose the permafrost in Siberia melts. There are probably viruses that have been in there since the Stone Age. We don’t know what kind of nasty stuff is going to get out. We don’t even know what’s coming.

5G Is Where China and the West Finally Diverge

The rollout of speedy new cellular networks is a geopolitical turning point, but neither Trump nor the public yet recognizes this.

The rollout of fifth-generation cellular networks around the world will likely be a defining geopolitical dilemma of 2020. But American and European consumers could easily mistake 5G for just another marketing ploy for early adopters—to the detriment of democracies worldwide.

When the number in the corner of our smartphone screens changed from 3G to 4G, few of us even noticed. Ditto when LTE, another step in the evolution of cellular networks, appeared as an alternative to 4G. Still, for the better part of the past two years, wireless carriers on both sides of the Atlantic have been hyping 5G—which, they promise, will offer data speeds of up to 100 times faster than current connections. Tech futurists say fifth-generation networks will support a plethora of internet-connected sensors, vehicles, appliances, and other devices that will perform functions yet unimagined.

In Europe, the walls of nearly every major airport from Stockholm and Brussels to Lisbon and Madrid have been plastered with 5G-related ads. In the United States, network providers such as AT&T have even rolled out what they’re calling “5GE” networks—a pre-5G deployment that capitalizes on the vaguely futuristic branding of fifth-generation networks even before all the requisite new radios and chipsets have been installed. Still, 7 of 10 Americans tell PricewaterhouseCoopers they’ll wait patiently to receive a 5G device until they are eligible for an upgrade from their current provider.

Amid this much public indifference, 5G may seem like an unlikely battleground between China and the West. Yet the transition to 5G may mark the point, after decades of Chinese integration into a globalized economy, when Beijing’s interests diverge irreconcilably from those of the United States, the European Union, and their democratic peers. Because of a failure of imagination, Western powers risk capitulating in what has become a critical geopolitical arena. Simply put, neither the American nor the European public seems to view the networks that supply Snapchat clips and Uber cars as anything close to a security threat.

Some of the world’s leading telecom-equipment manufacturers, including Huawei and ZTE, are Chinese companies with murky ownership structures and close ties to China’s authoritarian one-party government. Many in the U.S. national-security establishment rightly fear that equipment made by these companies could allow Beijing to siphon off sensitive personal or corporate data. Or it could use well-concealed kill switches to cripple Western telecom systems during an active war. The mere threat of this activity would endow China’s leadership with geopolitical leverage at all times.

This is why Secretary of State Mike Pompeo recently exhorted EU allies not to “trust Chinese firms with critical networks.” China has fought back, threatening to scuttle a trade deal with Denmark’s Faroe Islands and, more recently, to retaliate against the German auto industry should European officials bar the use of Huawei equipment in 5G networks.

The framing of 5G primarily as a consumer-technology matter works to China’s benefit. “Choose 5G,” proclaimed one ad in the Brussels airport—part of a campaign that presents a false choice between Huawei and the 4G status quo. A focus on tech alone would also suit U.S. and EU telecom operators eager to deliver faster speeds while minimizing their own costs. The Huawei equipment they buy is typically cheaper than the gear produced by the three suppliers based in democratic countries—the European firms Ericsson and Nokia and South Korea’s Samsung.

Meanwhile, policymakers on both sides of the Atlantic, from European economics ministers to President Donald Trump, have viewed the 5G dispute first as a trade issue. Even as the Trump administration has taken steps, as The New York Times has described it, to “block China’s national telecommunications champion, Huawei, from operating in the United States and starve it of American technology as it builds networks around the globe,” the president has also hinted at a willingness to waive restrictions in exchange for economic concessions from China. In 2018, Trump backed down from national-security sanctions against ZTE as a sweetener in his trade negotiations with Xi Jinping.

Against these attitudes, Pompeo and others sounding alarms about Huawei can be perfunctorily dismissed as protectionists, xenophobes, or military hawks. The American secretary of state has become a particular target of criticism in China, where government officials and the media have described him as a font of “lies and fallacies” and a “Cold War warrior.”

Yet the West has ample reason for caution about Chinese 5G suppliers. For one, the recent Chinese National Intelligence Law requires these companies to comply with Communist Party demands to turn over data or otherwise engage in snooping or network-disruption activities. Party-backed actors in China’s public and private sectors also have a long record of cyberattacks on the West, including stealing intellectual property from companies and sensitive personal information on citizens.

The case against Huawei isn’t just guilt by association. The company itself is suspected of committing blatant corporate espionage: A Justice Department indictment from early 2019 cited highly specific demands by Huawei headquarters in China for information from engineers embedded in T-Mobile’s facility in Bellevue, Washington. An email exchange exposed Huawei’s pressure on employees in the field to steal even guarded equipment and trade secrets; according to the Justice Department, a bonus program offered rewards for the most valuable information stolen. One Huawei employee, the U.S. government alleges, literally walked out the door with a proprietary robotic arm in his bag.

And recent revelations about how China’s ruling party exploits the full panoply of personal information it has amassed about its citizens—facial-recognition images, mandatory DNA samples, 24-hour GPS coordinates, and search-history and online-activity tracking, as well as plain old eavesdropping—to quash religious freedom and basic rights should give major pause to Western governments and wireless carriers alike.

While Pompeo’s State Department has been pressing its case at one international forum to the next, his message has been met with some skepticism in Europe. Simply to acknowledge 5G as a security threat invites headaches that EU governments and telecom carriers would rather not contemplate. Ripping out Chinese gear would be a massive financial and logistical undertaking.

European regulators are used to viewing the American tech industry as a rival, and they bristle today at taking direction from Washington. And despite the fact that two 5G suppliers are European, and EU officials have argued for “technological sovereignty”—a term most reasonably construed to mean technological independence from the United States—member nations have not yet settled on a joint policy.

On top of that, the EU single market prides itself on principles of fair competition and an unwillingness to favor or reject a company because of its national origin, especially when its products are competitive, as Huawei’s are, on metrics such as price. The irony in this approach, of course, is that the Chinese state has subsidized efforts by Huawei to undercut its European and South Korean competitors, not least because of the possibility of obtaining geopolitical leverage. The Wall Street Journal estimated recently that as much as $75 billion in state support fueled Huawei’s rise. The failure to see 5G beyond the consumer lens is also a failure to understand Chinese companies as implements of state power as much as private entities in their own right.

The dispute over 5G isn’t the first time in recent history that economic infrastructure matters have overlapped with geopolitics in unhealthy ways. Nor is it the first time that overlap has caused problems for the transatlantic relationship. The European energy sector has long relied on cheap natural gas piped in from Russia, and deregulation has allowed Russia’s state-owned gas company, Gazprom, to buy or build a large share of the infrastructure used to transport and distribute it. American policymakers have implored European leaders to diversify their energy sources, for fear of increased dependence on an authoritarian Russia. These warnings are often dismissed as self-serving, since American energy firms compete with Gazprom for European business.

The Trump administration’s mixed messaging on 5G lends credence to the cynical view that the United States is not serious about China as a national-security threat but regards it mostly as an economic competitor. (Never mind that U.S. telecom firms do not compete with Huawei on 5G equipment.) And the president’s trade threats against Europe—targeting products as varied as cheese, whiskey, and airplane fuselages—are not helping. Such positions prioritize trade conflicts over common security interests and alienate allies that the United States needs.

Even as Pompeo and others in the Trump administration warn against Huawei, European policymakers don’t know if Trump is serious about 5G as a national-security problem or planning to trade away the issue in exchange for the reduction in Chinese tariffs against U.S. farm products. But they do think he is serious about tariffs on them. They see trade as the one issue on which Trump has been consistent from the start of his presidential campaign.

The United States can work with its European partners to reduce geopolitical dependence on China and protect privacy and human rights in a data-centered age. But that will require Western policymakers and the public alike to conceive of 5G as something more than a consumer issue or a trade issue and devise a shared solution to protect the networks whose importance in our lives will only grow.

 

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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China Finds It Can Live Without the U.S.

Hawks in Washington speak of ‘decoupling.’ Xi Jinping is already busy doing that—his way.

A China hand and former Treasury Department colleague told me before the 2016 election that officials in Beijing preferred Donald Trump to Hillary Clinton because they thought Mr. Trump would be an easier negotiator.

Yet Mr. Trump has proved to be anything but—and in ways that ill serve U.S. interests. Through a series of vacillating threats and entreaties that often seem to be decided on a whim, he has shown President Xi Jinping that he is an unreliable negotiator. Mr. Trump’s public bullying makes it hard for Mr. Xi to accept any deal while saving face, which is very important to the Chinese. Thus Mr. Xi is no longer earnestly negotiating, merely going through the motions.

The Costs of China’s Crackdown on Hong Kong

The new buzzword in Washington discussions of Sino-U.S. negotiations is “decoupling.” From the Trump administration’s perspective, they are threatening Beijing with the prospect of disentangling the U.S. and China entirely and creating two distinct economic systems, similar to the bipolar world of the Cold War. Many in Mr. Trump’s orbit believe that blocking China’s access to U.S. technology would thwart China’s attempts to surpass the U.S. on the world stage.

This approach is naive and probably counterproductive. It is accelerating rather than slowing the Made in 2025 program. Mr. Xi has jettisoned Deng Xiaoping ’s established strategy: “Hide your strength, bide your time, never take the lead.” From his perspective, decoupling is not only an American threat—it’s the new Chinese strategy.

Nowhere is this more evident than Huawei’s case. The Trump administration has temporarily cut off most transactions between U.S. companies and Huawei, and China hawks are pushing the president to make this decoupling permanent. Meanwhile, Mr. Trump dangles access to American-made components as leverage to get Mr. Xi to buy American soybeans. But Mr. Xi does not appear interested in tactical détente as he was last year, when he asked Mr. Trump to save ZTE, the other prominent Chinese telecommunications firm. Instead of giving in to Mr. Trump’s demands, Huawei recently introduced its own operating system, Harmony, an alternative to Android that will reduce Huawei’s reliance on U.S. technology.

I do not contend that China is benign or even that Mr. Trump has misdiagnosed the problem. Rather, my concern is that the president’s erratic approach has aggravated the situation by encouraging Mr. Xi to embrace decoupling on his own terms. After more than two decades of globalization, severing the integrated supply lines of the world’s two largest economies will necessarily be messy. For the U.S., Mr. Trump’s approach makes it even messier.

National-Security Concerns Threaten Undersea Data Link Backed by Google, Facebook

U.S. firms and Chinese partner have sunk hundreds of millions of dollars into Los Angeles-Hong Kong cable project

U.S. officials are seeking to block an undersea cable backed by Google, Facebook Inc. and a Chinese partner, in a national-security review that could rewrite the rules of internet connectivity between the U.S. and China, according to people involved in the discussions.

The Justice Department, which leads a multiagency panel that reviews telecommunications matters, has signaled staunch opposition to the project because of concerns over its Chinese investor, Beijing-based Dr. Peng Telecom & Media Group Co., and the direct link to Hong Kong the cable would provide, the people said.

Ships have already draped most of the 8,000-mile Pacific Light Cable Network across the seafloor between the Chinese territory and Los Angeles, promising faster connections for its investors on both sides of the Pacific. The work so far has been conducted under a temporary permit expiring in September. But people familiar with the review say it is in danger of failing to win the necessary license to conduct business because of the objections coming from the panel, known as Team Telecom.

Team Telecom has consistently approved past cable projects, including ones directly linking the U.S. to mainland China or involving state-owned Chinese telecom operators, once they were satisfied the company responsible for its U.S. beachhead had taken steps to prevent foreign governments from blocking or tapping traffic.

If the U.S. rejects Pacific Light’s application, it would be the first time it has ever denied an undersea cable license based on national-security grounds, and it could signal regulators are adopting a new, tougher stance on China projects.

The threat of a failed approval process reflects growing distrust of Chinese ambitions and comes amid escalating tensions between China and the U.S., part of a broad rivalry between the world’s two largest economic powers. A prolonged trade conflict has each side affixing tariffs on hundreds of billions of dollars in goods flowing between the two countries, while Washington has sought to blunt Beijing’s ambitions to expand military and economic influence in Southeast Asia, the Pacific, Africa and elsewhere.

A number of U.S. officials—as well as some from allied countries—also have been waging a high-profile campaign to exclude China’s Huawei Technologies Co. from next-generation mobile networks, and to limit its role in the undersea cable networks that ferry nearly all of the world’s internet data.

The Pacific Light project cost at least $300 million to build based on its route, according to consultants who advise companies on subsea cable construction. Companies like Google and Facebook have spent the past decade funding similar cables to handle ever-growing network traffic between the U.S. and Asia. The new link to Hong Kong would give them greater bandwidth to a major regional internet hub with links to growing markets in the Philippines, Malaysia and Indonesia as well as mainland China.

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Latest U.S. Concern Over Huawei Lies Deep Under The Sea

Latest U.S. Concern Over Huawei Lies Deep Under The Sea
While U.S. security officials have openly targeted Huawei’s operations in the airwaves, they have been less vocal about another potential security threat: its undersea cables. Experts say in theory these cables could enable China to spy. Photo: George Downs/The Wall Street Journal

Team Telecom’s concerns over Pacific Light include Dr. Peng’s Chinese-government ties and the declining autonomy of Hong Kong, where pro-democracy protesters have been holding massive demonstrations for months against Beijing’s efforts to integrate the territory more closely. Dr. Peng is China’s fourth-biggest telecom operator. Listed in Shanghai, the private firm serves millions of domestic broadband customers. In the past, a cable link to Hong Kong would have been viewed as more secure than one to mainland China, but the distinction is becoming less relevant, these people say.

Proponents of the project say its approval would give the U.S. better oversight over the data that flows through the cable because Team Telecom could advise the FCC to force the companies to agree to certain conditions to protect security. Even if the U.S. thwarts this particular cable, the need for greater data capacity will still exist, and that data will just find its way through other cables that aren’t necessarily within the U.S.’s jurisdiction, they say.

Roughly 380 active submarine cables carry almost all the world’s intercontinental internet traffic via about 1,000 landing stations.

Armoured

cable

Network

management

system

Terminal

equipment

Cable with

bundle of

fiber-optic

lines

Cable landing

station

Sources: U.K. Cable Protection Committee; Alcatel Submarine Networks

Team Telecom last year reversed its long-held stance on Chinese applications to provide telecom services through U.S. networks, and recommended for the first time the denial of an application based on national-security and law-enforcement concerns. In May, the Federal Communications Commission adopted the recommendation that came after years of deliberation, voting unanimously to deny an application from China Mobile Ltd. ’s U.S. arm even though it had previously approved applications from fellow state-owned operators China Telecom and China Unicom .

Though the FCC makes the final decision on whether to grant a license for the Pacific Light project, it has historically deferred to recommendations from Team Telecom after its members coalesce around a unified view. The ad hoc group has no resolution mechanism in the event of a dispute. It isn’t known how strongly other members of the team, including the Defense and Homeland Security Departments, feel about the issue.

Should the Justice Department hold firm in its opposition and win support from other Team Telecom members, the group’s negative view would likely kill the project. If other team members decide to fight the Justice Department on the issue—and it refuses to back down—any approval could be delayed indefinitely, leaving the project in limbo. It is possible regulators might extend the temporary permit in the interim. Team Telecom, meanwhile, could still recommend the FCC approve the project if the Justice Department changes its position.

Pacific Light Data Communication Co., the Hong Kong company managing the cable project, said it has already installed more than 6,800 miles of the cable system, which will be ready for service by December or January. Senior Vice President Winston Qiu said he hadn’t heard of any U.S. regulatory problems. “We didn’t hear any opposition,” he said.

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Dr. Peng didn’t respond to emailed and faxed requests for comment. Repeated calls to its offices and those of its subsidiaries and biggest shareholder went unanswered.

A Google spokeswoman said the company has “been working through established channels for many years in order to obtain U.S. cable landing licenses for various undersea cables. We are currently engaged in active and productive conversations with U.S. government agencies about satisfying their requirements specifically for the PLCN cable.” A Facebook spokeswoman declined to comment.

A Justice Department spokesman declined to comment on the project and said its reviews and recommendations are “tailored to address the national-security and law-enforcement risks that are unique to each applicant or license holder.” The Pentagon referred questions to the Justice Department as the team’s lead agency. Spokesmen for the Department of Homeland Security and the FCC declined to comment.

The Pacific Light project has taken an atypical path. Google ownerAlphabet Inc. teamed up with Facebook in 2016 to provide its U.S. financing, adding to the tech companies’ growing inventory of internet infrastructure. Google took responsibility for its U.S. landing site. The Hong Kong end fell to a company controlled by a mainland Chinese real-estate magnate that had only recently entered the telecom sector.

The Chinese partner later sold its majority stake in the project to Dr. Peng, a company with interests in telecom, media and surveillance technology. In 2014, Dr. Peng signed a strategic cooperation agreement with Huawei to jointly research cloud computing, artificial intelligence and 5G mobile technology, according to an exchange filing. Dr. Peng’s website lists Huawei as a partner.

Dr. Peng’s chairman, Yang Xueping, is a former Shenzhen government official, according to the company’s website, and its subsidiaries have worked on several projects with government entities, including building a fiber-optic surveillance network for Beijing police, its website and filings show. Last year, Dr. Peng said in an exchange filing that two wholly owned subsidiaries had been fined 2 million yuan ($279,000) after some of their executives were convicted of bribing Chinese officials in connection with Beijing police projects.

Trump’s stunning decision to escalate trade wars with China and Mexico signals a turning point for U.S. policy

President Trump’s plan to slap new tariffs on Mexican imports, weeks after escalating his trade war with China, leaves the United States fighting a multi-front campaign that threatens more instability for manufacturers, consumers and the global economy.

The president’s bombshell announcement that he would impose 5 percent tariffs on Mexican imports, with the possibility of raising them to 25 percent if Mexico doesn’t stop migrants from crossing into the United States, left some economists fearing there were few limits to Trump’s appetite for trade conflict.

“In our view, if the U.S. is willing to impose tariff and non-tariff barriers on China and Mexico, then the bar for tariffs on other important U.S. trading partners, including Europe, may be lower than we previously thought,” Barclays economists said in a research note. “We think trade tensions could escalate further before they de-escalate,” Barclays added.

Adam Posen, president of the Peterson Institute for International Economics, called Trump’s move against Mexico a turning point for financial markets and the U.S. economy.

In global markets Friday, investors spooked by new tariff threats sought safety in German government bonds and the Euro rather than their customary dollar-denominated havens. This “seems to me an indicator that the concerns about the U.S. are rising,” Posen said.

The president’s latest move rocked business leaders who were already scrambling to reshape supply chains to avoid fallout from the U.S. confrontation with China. The added uncertainty may paralyze executives who can’t be sure their next supply chain location will be any safer than their last.

“A lot of companies feeling pressure to get out of China are looking at Mexico if they want to serve the US market, Vietnam if they’re more focused on Asia,” said William Reinsch, a former Commerce Department trade official. “Trump’s action yesterday scrambles all those plans.”

In one example of a company caught in the crossfire, GoPro of San Mateo, Calif., last month announced it would move manufacturing of some of its cameras from China to Mexico, so that it could stop paying tariffs to import them to the United States — tariffs resulting from the U.S. trade war with China. Weeks later, GoPro now faces new tariffs to import those goods from Mexico. The company declined to comment Friday.

As U.S. companies race to find new tariff-free places to manufacture, so far few have reported returning production to the United States, despite the president’s stated aim of using trade policy to help bring jobs back home. Many are still seeking alternative locations overseas, where labor is cheaper.

Trump said he would impose the new tariffs because the Mexican government wasn’t doing enough to stem the flow of migrants, many of whom travel through Mexico from Central America. Some White House officials who support Trump’s approach believe the threat of tariffs is the only way to get the attention of Mexican leaders.

The Mexican government tried to defuse the tension Friday, saying the two sides would meet in Washington on Wednesday for high-level talks.

If no solution is found, Mexico is certain to impose retaliatory tariffs on U.S. goods, with likely targets including U.S. pork, beef, wheat and dairy products, said Former Mexican diplomat Jorge Guajardo.

Some prominent Republicans, including Senate Finance Chairman Charles E. Grassley, raised concerns that the new tariffs could threaten a trade agreement the Trump administration clinched only months ago with Mexico and Canada, to replace the 1994 North American Free Trade Agreement.

Others said the about-face treatment of Mexico would damage Trump’s ability to negotiate trade deals it is pursuing with other partners, including China and Europe.

“You can’t negotiate a trade agreement with someone and then turn around and whack them,” said Douglas Holtz-Eakin, a Republican economist and former Congressional Budget Office director.

In late March, Trump threatened to shut the entire southern border to curb illegal immigration, but backed down a week later after an outcry. That has left some wondering how seriously they should take the latest tariff threat.

If Trump follows through with new tariffs on Mexico, it would hurt U.S. economic growth and increase the possibility of the Federal Reserve reversing course and cutting interest rates this year, economists said.

The drag to the US economy could be meaningful, especially if the tariffs reach 25%,” the upper limit that Trump has set, Bank of America Merrill Lynch economists wrote Friday. Even if the tariff remains at 5 percent, the effective cost could be higher because many parts cross the border several times as products are assembled, and the tariff must be paid upon each crossing into the United States.

U.S. automakers will be among the principal casualties. Last year, the United States imported roughly $350 billion in merchandise from Mexico, including about $85 billion in vehicles and parts, according to the International Trade Administration.

A full 25 percent tax “would cripple the industry and cause major uncertainty,” according to Deutsche Bank Securities.

“The auto sector – and the 10 million jobs it supports – relies upon the North American supply chain and cross border commerce to remain globally competitive,” said Dave Schwietert, interim president of the Auto Alliance, an industry group. “This is especially true with auto parts which can cross the U.S. border multiple times before final assembly.”

“Widely applied tariffs on goods from Mexico will raise the price of motor vehicle parts, cars, trucks, and commercial vehicles – and consumer goods in general — for American consumers,” the industry group said. “The potential ripple effects of the proposed Mexican tariffs on the U.S. North American and global trade efforts could be devastating.”

Consumers could pay up to $1,300 more per vehicle if the tariffs are implemented, according to Torsten Slok, chief economist for Deutsche Bank Securities.

Retailers, technology companies and textile manufacturers also will be hurt. U.S. mills now ship yarn and fabric to Mexico, where it is turned into apparel and exported back to American retailers. Last year, the U.S. textile industry exported $4.7 billion in yarn and fabrics to Mexico, its largest single market.

“Adding tariffs to Mexican apparel imports, which largely contain U.S. textile inputs, would significantly disrupt this industry and jeopardize jobs on both sides of the border,” said Kim Glas, president of the National Council of Textile Organizations.

The new dispute with Mexico came as the U.S.-China trade conflict continued to deepen.

China on Friday announced it would establish a blacklist of “unreliable” foreign companies and organizations, effectively forcing companies around the world to choose whether they would side with Beijing or Washington.

The new “unreliable entities list” would punish organizations and individuals that harm the interests of Chinese companies, Chinese state media reported, without detailing which companies will be named in the list or what the punishment will entail.

Chinese reports suggested the Commerce Ministry will target foreign companies and groups that abandoned Chinese telecom giant Huawei after the Trump administration added Huawei to a trade blacklist this month, which prohibited the sale of U.S. technology to the Chinese company.

At a time when Western corporations have cut back executive travel to China after authorities detained two Canadians on national security grounds in December, the new blacklist sent another shock wave through the business community.

“I think foreign and especially U.S. firms now have to worry that China is creating a new ‘legal pretext’ to at least impose exit bans on foreign individuals who make this new list, if not worse,” said Bill Bishop, the editor of the Sinocism newsletter, referring to the Chinese practice of not allowing designated foreigners to leave China.

Aside from the new blacklist, China in recently days also escalated threats to stop selling the U.S. so-called rare earths — 17 elements with exotic names like cerium, yttrium and lanthanum that are found in magnets, alloys and fuel cells and are used to make advanced missiles, smartphones and jet engines.

Analysts said it could take years for the United States to ramp up rare-earths production, after its domestic industry practically disappeared in the 1990s. Roughly 80 percent of U.S. imports of the material come from China, according to the United States Geological Survey.

The People’s Daily, the Communist Party’s official mouthpiece, carried a stark warning for the United States this week in an editorial about rare earths: “Don’t say we didn’t warn you.”

That commentary surprised China experts because the People’s Daily, which often signals official positions with subtly codified language, uses that phrase sparingly: It famously appeared before China launched border attacks against India in 1962 and Vietnam in 1979.

To China, All’s Fair in Love and Trade Wars

The standard line from President Donald Trump and those who support his get-tough approach toward Beijing is that because China sells more to the U.S. than the other way around, Washington has the upper hand in its game of tariffs. “China buys MUCH less from us than we buy from them,” Trump recently tweeted, “so we are in a fantastic position.”

The intrusive Chinese state has all sorts of levers to control the economy and society, and in an environment that lacks rule of law, officials can pull them at their pleasure. They also have far more targets to aim at than the trade data suggest. Many American companies have substantial operations within China that are tremendously important to their bottom lines. General Motors and its partners, for instance, sold more than 3.6 million vehicles in China last year, almost all of them manufactured locally. Starbucks operates more coffee shops in China than in any other market aside from the United States. These businesses are vulnerable to government-inspired nefariousness, from product boycotts and state-press smear campaigns to regulatory investigations

The Chinese have employed such tactics in the past. In 2017, for instance, China’s government waged an undeclared war against South Korean business over a dispute regarding an American missile-defense system. When Seoul rebuffed Beijing’s demands that it cease deployment of the system—which the Chinese considered a threat to their security—China tried to compel the South Koreans by pressuring their companies and economic interests.

A primary target was Lotte, a Korean conglomerate with interests in candy, hotels, retail, and other businesses. Lotte committed the crime of providing land for the missile system. The Chinese government whipped up nationalist ire against the company through the state-controlled media. One op-ed in the Global Times, a newspaper run by the Communist Party, entitled “Lotte’s Development in China Should Come to an End,” thundered that “showing Lotte the door will be an effective warning to all the other foreign forces that jeopardize China’s national interests.” Protests erupted in front of supermarkets owned by the Korean group, while inspectors ordered outlets closed after supposed violations. Sales plummeted, and Lotte eventually exited from the business. That wasn’t all. Chinese shoppers also shied away from Korean-branded cars and cosmetics. Korean pop stars were denied entry visas; group tours to Seoul for big-spending Chinese travelers were canceled.

Canada is enduring such treatment right now. Angered that Canadian authorities (at the behest of Washington) arrested the chief financial officer of the Chinese telecom giant Huawei Technologies, Beijing blocked Canada’s exports of pork and canola, pinching the country’s agricultural sector. China has taken this step even though it isn’t in its own economic interest, since its domestic pork industry has been ravaged by swine flu. Similarly, in 2012, Chinese quarantine officers began impounding Philippine bananas amid a flare-up over contested claims in the South China Sea.