The Cutting Room Files, Part 6: The Future of China

Read the other installments in this series:
The CRF Files, Introduction
CRF Files, Part I: The Future of Korea
The Cutting Room Files, Part 2: The Future of Mexico
The Cutting Room Files, Part 3: The Future of Canada
The Cutting Room Files, Part 4: The Future of Japan
The Cutting Room Files, Part 5: The Future of the United Kingdom
The Cutting Room Files, Part 7: Europe
The Cutting Room Files, Part 8: American Politics

by Melissa Taylor and Peter Zeihan

This piece is part of the Cutting Room Files, portions of the upcoming Disunited Nations text that were cut for length and adapted for the newsletter. Disunited Nations is available for pre-Order now on IndieBoundApple BooksHudson BooksellersBarnes & NobleAmazonGoogle Play, or Kobo

December 16 and 17 all the international news that was fit to print showcased announcements in both China and the United States that after some 18 months of talks, tariffs and recriminations, a Phase1 trade deal had been reached.
So we’re out of the woods? Right? The threat to the global trading system is now addressed?
Um, no.
Trade deals can come in all shapes and sizes but roughly put there are those that restructure industries, those that restructure countries, and those that restructure the world. When it comes to China, Trump is going for the latter. The problem is that you don’t restructure the world without restructuring the Chinese economy and you can’t restructure the Chinese economy without restructuring the political system all the way up to the very tippy top. The people at the tippy top have some say in how that all goes down… the question is how much.  
To figure out just how much say they have, let’s revisit what the Trump administration is demanding:

  • An end to industrial subsidies including the end to the Chinese practice of flooding its market with cheap capital. Favored companies today can expect those loans to be rolled over indefinitely. Given that kind of leeway, these companies went after market share rather than profits. In other words: China brims with overcapacity, a factoid which drives product prices down, commodity prices up, forces the Chinese to dump their products into other markets, and drives competitors in other countries out of business.
  • An end to all state-run cybertheft and an end to the systematic practice of joint ventures which require technology transfer. The Americans claim, reasonably, that this harms American companies that go through the effort of research and development. It adds to the cost of securing information and just generally sucks.
  • The immediate opening of nearly all sectors of the Chinese economy to fully-foreign owned firms. In other words: competition from the outside in all sectors. Since Chinese firms are for the most part competitive due to price, and that price competitiveness is due to heavy subsidies, remove those subsidies and allow more efficient foreigners to enter China’s home market and mass bankruptcies are the logical outcome.

From the American perspective, this sounds like a decidedly easy problem to fix.
Step one, simply stop massively subsidizing industries and infrastructure that the economy can’t meaningfully absorb. Step two, stop taking intellectual property that isn’t yours. Step three, become a true capitalist society with competition from the outside… ok, that last one sounds like a lot no matter how you say it.
But the point is: sure, maybe that means a recession, but such adjustments are part and parcel of being a modern economy. Cultures as diverse as France and Turkey and Korea and Thailand and South Africa and Brazil have mostly managed such transitions ok. Certainly the “mighty” and “eternal” Chinese can pull it off.
Yet from the Chinese perspective – that is, from Chinese President Xi Jingping’s and the Chinese Communist Party’s perspectives – this is utterly unfathomable. Giving in to any of these demands wouldn’t simply be perceived in China as an unforgivable loss of face, but each and every one would shatter the Chinese economic model, the Chinese political system, and China as a country. Easy money is, after all, the only way the Party can keep up its end of the bargain with its citizenry: a better life than your recent ancestors in exchange for trust in and power to the Party. It does this by offering widescale employment and keeping the doors open at inefficient companies. For the wealthiest, the tradeoff is even more straightforward. Anytime you have a fire hydrant of money blasting, you can expect interests to become entrenched, corruption to spread. Even dictatorial, statist regimes need a political base.

The Party knows this is an unsustainable system and has been racing against the clock, trying to steer an un-steerable, careening behemoth. It aims to transition the Chinese economy from the wobbly foundations of a heavily subsidized economy that relies on other economies buying their goods to something rarified, something more like what the Americans have: a stable, self-sustaining market where goods are produced and consumed domestically. To do so, it needs to cut back overcapacity in a controlled fashion and boost consumption by the Chinese consumer. Until that goal is achieved, the Chinese remain dependent upon imported technology, energy and raw materials, and upon exported goods to more stable markets. China’s real problem is that this entire sequence requires a global system that is open and safe as guaranteed by the Americans.
So far the Party has failed in transitioning the country onto more stable macroeconomic footing, fearing at each step that it will lose one or more of its most important constituencies. Put another way, the Party finds itself unable to transform its economy away from dependence on the Americans. It finds itself at the end of its economy’s ability to take on debt.
Which brings us back to the Phase1 deal:
The trade talks have followed an almost disturbingly predictable pattern: The Americans make demands the Chinese cannot possibly meet. The Chinese promise to comply. A few weeks later Chinese actions make it clear they have no intention of complying. The Americans levy more trade restrictions. Repeat.
All the Phase1 deal is is a bribe to the Trump administration: a promise to purchase a few tens of billions of dollars of American agricultural products and to start implementing protections for intellectual property (some of which were agreed to twenty years ago), in exchange for a slight rollback of the tariffs already in place and a promise to delay a new planned batch for the time being.
The next step in the drama is obvious: sometime in late January or February, the Americans will again say the Chinese are not complying, and that new batch of pre-prepared tariffs will slam into place. And incidentally, geopolitics aside, I can’t think of a better international backdrop for a populist president than to run against China in an election year.
So it’s time to call it. There isn’t going to be a meaningful trade deal with the United States because agreeing to the Americans’ demands would be the end of the Party. The Americans can afford, if they must, to cut China out. It isn’t “easy,” but it’s more akin to a cold than leukemia. In fact, a combination of cheaper resources like natural gas, advanced technology, highly educated labor, and geopolitical disruption all make relocation to North America easier at the same time that East Asia’s costs – from labor to risk – are going up. Some companies and industries have already moved into the NAFTA marketplace and we’re still in the early stages of all these trends. If the world’s largest, most important consumer market, and the physical guarantor of all Chinese supply chains simply walks away, the Chinese are simply out of options.
More likely, it will be (far) worse than that for the Chinese. If the Americans, instead of merely cutting out the Chinese instead get aggressive, things could quickly cascade. Even with a naval deployment policy that’s one-quarter of what it is currently, the Americans could easily – almost lazily – interrupt any trade flow on the planet. In comparison, the Chinese cannot even guarantee their maritime safety within a thousand miles of their own coast, and most of their oil comes from five times that distance along a path littered with threats and rivals. And the size of those oil inflows? Edging up to 12 million barrels a day – greater than what American total imports were at the height of American energy dependency in the early mid-2000s.
China’s crash will be much like its rise. Big, bold, brash, loud, all-consuming, and, in hindsight, completely inevitable.
For more on what the future holds for China, and the entirety of the East Asian rim, take a look at my new project, Disunited Nations: The Struggle for Power in an Ungoverned Worldnow available for pre-order.

The Cutting Room Files, Part 5: The Future of the United Kingdom

Read the other installments in this series:
The CRF Files, Introduction
CRF Files, Part I: The Future of Korea
The Cutting Room Files, Part 2: The Future of Mexico
The Cutting Room Files, Part 3: The Future of Canada
The Cutting Room Files, Part 4: The Future of Japan
The Cutting Room Files, Part 6: The Future of China
The Cutting Room Files, Part 7: Europe
The Cutting Room Files, Part 8: American Politics

This piece is part of the Cutting Room Files, portions of the upcoming Disunited Nations text that were cut for length. Disunited Nations is available for pre-Order now on IndieBoundApple BooksHudson BooksellersBarnes & NobleAmazonGoogle Play, or Kobo

I’m not going to more than obliquely address the UK elections coming this Thursday (December 12). Polls at this time point to a strong Conservative showing, largely because British Labour leader Jeremy Corbyn is a sexist, anti-Semitic, anti-Western, authoritarian, unrepentant Stalinesque bigot whose main message to lifelong Labor members is “vote for me because I’m not a Conservative.” Not exactly a winning program, and that’s before you take a look at his economic proposals. Corbyn is also personally for Brexit even if his party is semi-officially opposed.

I’m far more concerned with what will happen in the United Kingdom in the weeks and months to follow. Barring some truly impressive political gymnastics, the UK’s divorce from the European Union has been baked in for some time. And while it has been dizzily entertaining to watch British politics contort in its attempt to alternatively operationalize or deny that basic fact, this particular chapter is almost over and Brexit is about to happen.

As seems to be the case with me these days, looking forward first requires a look back.

Only a century ago, the British Royal Navy was the greatest the world had yet seen. The Brits used that incredible navy and their capable (if small) contingent of land forces to maintain an empire where the sun never set. That isn’t a metaphor, but instead quite literal.

But the ravages of the World Wars shattered the world’s navies and shattered right along with them the British Empire. The British were so desperate at times for war materiel that they signed away to the Americans the rights to many of the bases that made their empire.

What did they get in exchange? Fifty destroyers that were far shy of substandard when they had been built a quarter-century previous, along with a fistful of loans on terms that could best be described as usurious. This was Lend-Lease, the policy discussed in American history textbooks as a gesture of “goodwill.” The near-eradication of British power from the Western Hemisphere and the welding of British fortunes to American strategic desires was the first step in the creation of the American-led international system. Britain didn’t claw its way out from under the debts until the 2000s, and it still hasn’t gotten most of its bases back.

The issue with London from the American perspective is harsh in its simplicity. Only three countries have ever threatened the U.S. mainland directly. The Soviet Union aimed nukes at the United States, and so Washington will typically take steps overt and covert to whittle away at Russian power. Mexico and the United States fought a land war, that ended with the Americans taking half of Mexico’s territory.

The third country to threaten the American mainland is the Americans’ former colonial master, the United Kingdom, and Washington will always – at a minimum – keep an eye open for opportunities to ensure that the balance of power in the bilateral relationship never again tips against the United States. Are the two countries allies and family? Certainly. But as we all know, family drama trumps pretty much everything else. 

Which brings us to the current day: Brexit is providing Americans with the biggest opportunity to lock the Brits into strategic enslavement since Lend-Lease.

The first aspect of the opportunity is institutional:

Big decisions in the European Union require unanimity, and there is no version of a British divorce from the EU that would have satisfied the Irish on border issues and France on nationalist issues and Spain on Gibraltar and the Netherlands on EU rules and Germany on market access and Luxembourg on financial issues and still be able to make it through the British Parliament.

There was never going to be a divorce deal, and in prolonging the Brexit talks from a few weeks to now over three years the Brits have had to sacrifice nearly every bit of financial, political, economic and strategic leverage they could have used to chart an independent path. Strategically and economically, the British are now weak and vulnerable, and their eventual post-EU membership trading partner will be able to pick them clean.

The second aspect of the opportunity is about economic centers of gravity:

Half the UK’s trade portfolio today is with the EU. In perfect conditions it takes the EU over a decade to negotiate a trade deal with countries they like (think Canada). Add in some Brexit-related bad-blood, the never-far-below-the-surface geopolitical competition with the French, the Dutch insistence that anyone who gains access to EU markets also follow EU rules in full, an Irish penchant for knife-twisting, Germany’s iron-clad demand that the UK pay Europe in cash for EU market access, and Spain’s never-ending bitching about Gibraltar, and ten years will barely be enough time to decide the shape of the negotiating table. That flat-out rules out meaningful re-integration with the Continent on the sort of time frame the EU likely has left (which in and of itself will be a topic for later in this series of newsletters).

Turkey is often mooted in the British press as a replacement, but its current imports from the UK are less than 1/30th the amount they would need to be to replace the UK’s exports to the EU. In fact, to replace EU trade, Turkey would have to import from the UK exclusivelyAnd the country has dropped into narcissistic nationalism. So let’s just stop pretending anyone is interested in that deal, shall we?

China is simply too far away to be the Brits dominant trading partner, even if you buy into the “rising China” propaganda. (Incidentally, much China-UK trade today is gateway trade to the EU. Post-Brexit that’ll go pbbbbbt.) The combined Commonwealth is both too scattered and insufficiently wealthy. Even worse, the most significant piece of the Commonwealth – India – is notoriously opposed to free trade deals on principle. Canada is willing, but just isn’t big enough. Nor does Canada boast enough young people to serve as a meaningful sink for British goods.

The only market with the proximity, size, institutional capacity, and complementary needs and capabilities to be a meaningful trade partner is the United States itself.

The third aspect is political:

Like the United States, the UK is experiencing one of its once-a-generation political reshufflings with both the Conservatives and Labour shattering along economic and populist fault lines. Neither Boris Johnson nor Jeremy Corbyn are the sorts of blokes you would introduce to your mom, and the pair are now deliberately, hilariously, tragically mis-running Parliament. Makes it difficult to have a meaningful conversation about the future, much less build consensus, much less get anything done. Post-EU domestic economic regeneration was always a near-impossibility, but with this sort of political chaos the post-Brexit Brits will be desperate for any sort of lifeline. Only an American lifeline will be on offer, but that comes with conditions. Many conditions.

The fourth aspect of the opportunity is strategic:

Post-Order America won’t be in the business of supporting allies that cannot support themselves. To that end Britain has location and hardware arguing for it. Great Britain’s position just off the European mainland has made London the European arbiter for the bulk of the past four centuries. Britain’s geography couldn’t be better designed to drive the French mad. It acts as both effective barrier to large-scale attack while also giving the English a redoubt from which to interfere on the mainland. Close enough to participate in Eurovision, separate enough that armies marching across Europe isn’t reason enough to leave tea early. That’s useful to America.

Just as important, the Brits are in the process of floating two of the four biggest aircraft carriers in history that are not U.S. flagged. That’s useful to America. But in the post-Cold War era the British tried to do three things simultaneously: downsize their military while also building those supercarriers while also increasing the size of their ground forces to assist the Americans in places like Afghanistan and Iraq. As such the British navy was forced to decommission a huge swathe of their ships. As venturing out with a supercarrier that doesn’t have an escort ring is a great way to lose a supercarrier, the only way the British navy can now function is hand-in-hand with the American Navy. Moreover, carriers are crap for defending trade. That takes a lot of smaller ships – smaller ships the Brits currently do not float…but the Americans do.

The Americans are certainly willing to de facto merge navies for Britain’s strategic and economic benefit, but only in exchange for considerations on other things. Lots of other things. Most notably in the bilateral trade deal the Brits so desperately need.

Which brings us to the nitty gritty.

Within British politics there has always been a small but vocal group – most notably but hardly exclusively within Labour – who is annoyed that the United States plays such a loud role in internal British…everything. Of late most of the British political spectrum has come to the conclusion that if there is a future for the UK in the wider world, it will involve a trade deal with Washington. Which means we’re starting to see some linkage between some latent anti-Americanism and some raw-nerve British political issues. This was unavoidable, but that doesn’t mean it is pleasant, much less focused on the right things.

The item that’s getting the most press at present are Jeremy Corbyn’s recent comments on the National Health Service. Most in Europe and Anglo-America look at the NHS as…a bit of a disaster. Middling-quality, high-cost health care permeates the British system, but the Brits adore the NHS and really that’s all that matters. Corbyn has postulated that a trade deal with the Americans will force American-style prices for prescription drugs onto the NHS (apparently the American inclination for pill-popping is something else we got from our cultural parents).

Honestly, it is a perfectly reasonable concern, but it is also almost comically small fry. If one wants to be afraid of getting in bed with the American elephant, one needs to think bigger than drug prices.

Much bigger.

First, agriculture.

It probably comes as no surprise that British food isn’t…good. A big piece of the explanation is geographic. The UK is a short-summer, cool-temperature, low-sun country with mediocre soil quality. Those aren’t the sorts of conditions that generate a wild diversity of high-quality foodstuffs. What improvements to British agriculture and rural prosperity that have occurred during the past four decades are largely due to EU exposure.

On the production side, the few things the Brits do well – certain types of meat, dairy and especially fish – are exported to the EU market, a market that soon will be largely closed. On the financial side, the EU’s agricultural subsidy program is among the world’s most lavish. It has slowed technological uptake and consolidation that has defined global agriculture since the 1970s. With Brexit those subsidies will vanish in a day.

Like it or not, low-cost, high-quality American agriculture is about to swamp the British market, and American trade negotiators will blast away whatever protectionist measures the Brits will want to erect to protect their own farmers. Phytosanitary requirements, hormones, tariffs, quotas, you name it. It will all vanish and 66 million UK consumers will soon be American fed.

Second, manufacturing.

Even after seven decades of integration, most European countries take great pains to protect their manufacturing networks from foreign involvement. The UK included. For the Americans, who have already integrated with Canada and (to a greater extent) Mexico, that won’t fly. The Brits will have to join the American manufacturing supply chain system based on the NAFTA model.

If the Brits thought that tussling with the French over aerospace or the Germans over automotive was a frustrating experience, its nothing compared to dealing with the colossal, tangled networks of North America where mammoth economies of scale can drown the Brits out. What will likely hurt the most is sudden exposure to Mexican manufacturers. US and Canadian manufacturers have had decades to adjust to the ever-more-skilled but always-less-expensive Mexican work force. UK manufacturers will have to do so nearly overnight.

Third, finance.

London has been the world’s second-most important financial center for decades, a position it solidified with its membership in the EU. Put simply, the Brits penchant for low taxes and lower regulations has long encouraged many Europeans to handle their finances in London rather than at home. This is doubly true for any pass-through monies that sought to escape the bloc for greener pastures.

The agony of endless Brextensions has taken the shine off that system. With the specifics of the UK’s future in doubt, the UK is no longer the holder of value it once was, and pass-through money is more likely to skip London altogether. The wildly gyrating pound only underlines both weakenings. U.S. trade talks will end both roles altogether. The Americans will demand the relocation of the bulk of the London financial district to New York City.

(Don’t think for a moment that the Europeans will get more than one-quarter of London. Every time the Continental Europeans float the idea that all euro-clearing must be handled in the eurozone, the Americans remind them that should that occur the U.S. will require that all dollar-clearing would then need to be handled in the United States. As the USD is more important to European trade than the euro, such reminders tend to convince the Europeans to pipe down for a bit.)

Most of the pro-Brexit crowd voted the way they did because they don’t like faceless European bureaucrats deciding issues for Britain. The reality is that Britain’s only way forward post-Brexit is to assign even greater levels of authority to American bureaucrats.

The Brits could always say no. They could try to fly solo against a more insular and prickly America, an unleashed France, a rapidly rearming Germany, a resurgent Turkey, and a desperate Russia in an environment of wildly higher energy prices and food prices. (Spoiler alert: There’s a full chapter in Disunited Nations on each of these countries’ pasts and futures.) The Brits could choose to slip into permanent military irrelevance and strategic vulnerability. They could choose to suffer an economic disconnect as bad as the Great Depression that would include dramatic reductions in standards of living and employment and energy availability and health care. Some countries, when faced with the choice between pride in poverty vs relative wealth and security, go with the former.

But I doubt it. The Brits tend to be pretty pragmatic. Stiff upper lip and all that.

Early in the Order era, the Brits attempted to restart their empire by seizing the Suez Canal from the Egyptians. The Americans gave them a hard f**k-no, started to cut the British economy out of global finance, and made some not-very-veiled threats that they’d eject British troops from Egypt by force of arms. The Brits – shocked and chagrined – made the conscious decision to never again be on the Americans’ bad side. In the 2020s that means strategic subjugation, by doing a deal on America’s terms.

While this forecast may seem as cheery as a London winter morning, it could be a lot worse.

In a post-Order world, these British economic sectors are going crash anyway. At least a deal with the United States holds out the hope for something better down the line. Even more importantly, the Brits have something few others could hope for: the Americans have saved them a seat at the table.

The Americans spent the last seven decades paying the world to be on their side. Those days are over. The only countries that will be able to enjoy U.S. market access and strategic cover are those who either pay the U.S. a lot of money, or bring something exceedingly shiny to trade. Supercarriers, being the gold standard of strategic assets, count. Islands off major continents, being the gold standard of strategic positions, count.

Simply put, the United Kingdom has an in so long as it cow-tows appropriately. Japan is in a strikingly similar position for similar reasons. Mexico gets an invitation because it is an entangled neighbor with a dynamic economy. Canada (barely) squeaks over the threshold largely out of habit. South Korea (so far) is paying its way.

And that’s…everyone.

Those five countries are the only five major countries likely to make the final cut before the end of 2020. They collectively account for nearly half of the American trade portfolio, and they will comprise nearly the entire American Friends & Family plan. With the exception of the UK, everyone else’s deals are already in the can. Whoever wins the election on Thursday will need to seal a deal with the Americans before the Americans lose interest in…everything. Beyond these five countries, everyone else will have to defend their own territory and trade, and there are less than a handful of states that have the strategic and economic capacity to even attempt such a feat.

Dark? Dreary? Even depressing? Sure. But in a world of full American disengagement, having any relationship with the Americans at all is about as good as it gets.

Pre-order Disunited Nations: The Scramble for Power in an Ungoverned World