China Threatens More Than Just the U.S. Economy

China and the interest rates are scaring investors. The U.S. economy has already started to feel the early cautionary tremors of a potentially heavy fall.

The warnings are mostly for the hyper-valued (we passed the overvaluation point long ago) technology stocks, which led the 830-point-plus Dow Jones avalanche on October 11 as the Nasdaq lost four percent.

iStock.com/Dilok Klaisataporn

The End of the U.S. Economy’s Dominance Has Begun

A new and more hostile chapter about U.S.-China relations and the cost of money (interest rates evidently) is about to be written. Investors understand that a much harsher period approaches and it won’t be easy for the U.S. economy to adapt.

Yet, adaptation will be as certain as it will be traumatic.

Americans have been spoiled by almost a decade of near-zero, or ultra-accommodative, interest rates. Their increase is merely the first salvo fired in the direction of the U.S. economy.

The European Union will soon follow suit as the European Central Bank (ECB) prepares to gradually stop buying bonds, ending the era of cheap euros and quantitative easing (QE).

Expect the financial system to suffer global shocks as the path to more “normal” rates intensifies.

As this already complex process intensifies, leaving more questions than answers as to how the hyper-financialized U.S. economy will cope, China and the United States have intensified what is shaping up to be a full-on trade war.

The Transformation of China as America’s Biggest Foe

To grasp the implications of China’s transition from friend to foe (or at least to a bigger foe) and understand the gravity of the “Chinese question,” consider what Vice President of the United States Mike Pence said at the Hudson Institute in Washington.

Pence signaled the most serious deterioration in relations between the two superpowers since 1972, when President Nixon held his famous summit with Chairman Mao, opening relations between the United States and the People’s Republic of China (PRC).

The present risk is nothing short of ceasing more than 45 years of cooperation between the U.S. and the PRC. (Source: “Vice President Mike Pence’s Remarks on the Administration’s Policy Towards China,” Hudson Institute, Inc., October 4, 2018.)

Is it all Trump’s fault, as experts of Washington’s games will present it? No, and that’s what makes it scarier. The shift in U.S.-China relations is more structural and inevitable than a temporary blip, given the vagaries of an eccentric president like Trump.

The Thucydides Trap and the U.S. Economy

In many ways, Trump has merely sped up the high-noon showdown between the first and second economic superpowers. And it was all but certain that China would eventually complement its commercial strength with political and military might.

Consider the risk of a U.S.- China conflict in terms of the Peloponnesian War and the Thucydides trap. (Source: “The Thucydides Trap,” Foreign Policy, June 9, 2017.)

Thucydides was the Greek historian who analyzed the Peloponnesian War (431–404 BC). He explained that a rising power and a declining power will always collide, believing war as inevitable in some form to “resolve” the tensions.

Chinese President Xi Jinping is apparently a fan of Thucydides as he likes to quote the Peloponnesian War metaphor about ancient Greece.

He may simply be sending salvos, warning Washington of the effects of the intensifying standoff—in which Trump has increased the stakes with tariffs on hundreds of billions of dollars’ worth of goods.

But China was not an idle bystander in the years preceding Trump’s tariffs. China has expanded militarily for the past few decades, raising concerns from those on the receiving end of its might such as South Korea, Vietnam, the Philippines, and Japan.

In the latter case, Beijing and Tokyo continue to dispute the sovereignty of an uninhabited archipelago, which the Japanese call Senkaku and the Chinese call Diaoyu.

Nevertheless, Trump’s trade war has caused China to suffer a (first) real pain, which could take a large bite out of its economy. In fact, the International Monetary Fund (IMF) has already projected a slowdown for the Chinese economy. But it has not spared issuing a similar warning for the U.S. economy. (Source: “Trump’s trade war with China and Europe will hit global growth – IMF,” The Guardian, October 10, 2018.)

The Trade War Is Only the Prelude to a Deeper U.S.-China Confrontation

Washington will try to contain the emergence of China as the 21st-century superpower. Doing so will involve a long standoff that could up bankrupting the U.S. economy, whereas ascendant China has been preparing for the coming “high noon” for decades. As in the case of all empires, America will struggle to retain dominance until it bankrupts its economy completely.

The United States Has a Point About Fearing China

China’s economic rise since 1979 already altered the global balance of power. But China has acquired the taste for power, which soon turns into an appetite for dominance.

The Chinese Communist Party has left Marx and Lenin behind. It has traded the chief ideologues of 20th-century communism for a new nationalism to renew the Great China of the past.

Xi Jinping is much less Mao Zedong than he is Emperor Taizu of Song, who led China in the 10th century, pushing territorial expansion, stability, and prosperity.

The Cold War with China Could Heat Up

Trump did not start to antagonize China as much as China, through its steady economic and geopolitical rise, threatens the U.S. economy and the military might it affords.

China has made no secret of the fact it demands to be treated as a superpower. It has all the military, diplomatic, economic and political attributes to make the claim.

China has invested billions in modern weapons and artificial intelligence, all the while investing in “green” technology to change its image from polluter to clean energy champion. It also plans missions to the moon and a space program that could easily outclass the U.S. and Russia.

And then there are China’s efforts to replace the U.S. dollar with the yuan, and the petro-yuan in particular.

China holds billions in U.S. Treasury bonds, which it could unload at any moment (though probably not just yet), eroding the power of the dollar and the U.S. ability to print as many dollars as it needs to keep its trillion-dollar military complex in place.

China 2025

Beijing has challenged the U.S. with the “Made in China 2025” plan. It has identified 10 key industrial sectors, which threaten no less than the big Silicon Valley players, which dominate the U.S. economy and Wall Street. (Source: “‘Made in China 2025’: is Beijing’s plan for hi-tech dominance as big a threat as the West thinks it is?,” South China Morning Post, September 25, 2018.)

Investors who haven’t already done so should investigate the defense sector for long-term security in this climate.

China’s growing military threat will keep U.S. defense contractors busy for years to come. Interestingly, one of those companies, Boeing Co (NYSE:BA) also supplies China’s growing airlines. There are few alternatives to Boeing.

Airbus SE (OTCMKTS: EADSF, EPA: AIR) is a direct competitor, but it doesn’t have as big a footprint in China as Boeing. And Boeing, of course, also happens to be one of the largest defense companies.

While looking into defense, investors should keep tech stocks under close watch, for they stand to lose the most from a rising China.

China’s effort and determination to become the leading power of the 21st century won’t go unnoticed in Washington.

Bilateral U.S.-Chinese relations are destined to worsen.

U.S. presidents, Republican or Democrat, will have little choice—given the current U.S. role—than to confront and resist. It’s a dangerous and expensive game that will hurt the U.S. economy rather than halt China’s inevitable rise along the path to dominance.