The Art of The New Cold War Newsletter
#6
Welcome to the The Art of the New Cold War Newsletter.
In this edition, we explore the AUKUS pact and Investing in China.
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And as always, for more, please check out my book: The Art of The New Cold War
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Topic 1: AUKUS causes a Ruckus
Last week, the United States announced a new military partnership with the United Kingdom, and Australia – dubbed the AUKUS pact.
While the AUKUS pact includes coordination and increased collaboration in strategic areas such as artificial intelligence, quantum technologies and cyber capabilities, perhaps the most significant part of the pact, undoubtedly the one receiving the most headlines, is that America will also be arming Australia with a new fleet of state of the art nuclear-powered submarines. A historically significant move representing a departure from decades of strict US military policies against sharing this kind of advanced technology.
Though not explicitly stated, the AUKUS pact is clearly aimed at combating the rise and expansion of China. And indeed from a strategic standpoint, AUKUS hits China right where it hurts. As the Wall Street Journal points out, it threatens one of China’s relative military weaknesses: the ability to locate and defeat submarines, particularly nuclear-powered vessels. The AUKUS pact also signals a hardening of the U.S. position toward China, and a significant raising of the strategic stakes. As Sam Roggeveen of the Lowy Institute notes, that while previously there was reason to question whether America really desired a new “Cold War” with China, “this announcement is significant evidence that it is indeed prepared to take such a momentous step.”
This fact was not at all lost on China and they immediately expressed their deepest displeasure, with China’s Foreign Ministry calling the AUKUS pact a reflection of “outdated Cold War zero-sum mentality and narrow-minded geopolitical perception” and claiming that it would bring about a regional arms race.
China, though, was not alone in expressing displeasure with the new pact. France too was especially incensed.
Indeed, to France AUKUS meant FUKUS (pardon the French). For as a result of the pact, France lost a 60 billion dollar submarine deal, as Australia chose the US made nuclear submarines over French diesel powered submarines and canceled the order for which they had previously contracted. The perceived slight was made worse as apparently the French were not informed about the new pact, and resulting loss of their deal, until right before it was announced. In response, the French called the pact a stab in the back, and promptly recalled their Ambassadors from both the U.S. and Australia. They have since been restored.
Despite France’s protestations, however, as Washington Post columnist Josh Rogin tweeted wryly, France has made very clear their wish for “strategic autonomy” as it relates to China, and now seem rather perturbed that they are getting it:
It should also be recalled that right before President Biden took office, the EU, pushed hard by France and Germany, moved forward with a Comprehensive Agreement on Investment (CAI) with China, despite Biden’s pleas to hold off and allow his new administration the opportunity to engage with them on China policy. From that point onward, it has been clear, in both word and deed, that despite the almost century long Transatlantic Alliance with America, which saw the defeat of Nazi Germany and the Soviet Union, that France does not wish to stand with its long standing ally in the New Cold War with China. Instead, they seek neutrality, if not to profit by playing one off of the other. Thus, France, and the EU generally, should not be wholly surprised when they find themselves set aside for more erstwhile allies.
But while France and China were angered by the AUKUS pact, others were quite pleased by the development, including, notably, Japan and India, who are already aligned with both America and Australia in the QUAD alliance, aimed at combating China in the Indo Pacific. And indeed, Japan’s foreign minister, Toshimitsu Motegi, quickly welcomed AUKUS, while the Times of India noted the overlapping membership of the Quad and AUKUS and even suggested that “in future, the two could merge.” No doubt this will be a topic of discussion when the leaders of the QUAD meet in Washington on Sept. 24th.
Not to be completely outdone, however, a day after Biden announced the new AUKUS pact, China announced it had applied to join the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP). The CPTPP is the successor agreement to the Trans-Pacific Partnership (TPP) initially negotiated by the Obama administration before President Donald Trump withdrew the U.S. from the agreement shortly after taking office. Among others, the CPTPP, which is now the world’s largest trading group, includes Australia, Canada, Chile, Japan and New Zealand.
China certainly relishes the delicious irony of joining a trade agreement begun, and then abandoned, by the US, and which was originally explicitly designed to exclude China. And though there are serious questions as to whether China will be ultimately able to make the necessary economic reforms to successfully enter the CPTPP, or whether member nations like Japan, Australia and Canada will accept them, it is at the very least a useful juxtaposition for China to make in relation to America, showing countries in the Indo Pacific that they are committed to the region’s economic prosperity, while America in turn is far more concerned with military hostilities. This plays to what China sees as its main advantage over the U.S.: economics. And perpetuates an emerging thematic of the New Cold War: US military might vs. China economic might.
For America, security based pacts like AUKUS and the QUAD are strategically smart and effective in many ways in combating China and limiting its military expansion. But they must also be complemented with economic based alliances in order to blunt China’s greatest strength: the size of the Chinese market and the resulting economic influence it provides. And so just as it is not in China’s strategic interest for America to form security alliances like the QUAD and the AUKUS in China’s own backyard, it is not in America’s strategic interest to neglect and allow China to dominate the economic aspects of the New Cold War either, especially in the all important Indo Pacific region. As I write in my book:
“America must be a major driver of economic development in the region to counter and compete with China. To do so, America must not only prioritize the region economically but also reallocate resources currently being employed in places like the Middle East and others of lesser strategic importance and deploy them to the Indo-Pacific. America should also join with allies and other stakeholders in the region such as Japan and Australia to coordinate, drive, and amplify economic development opportunities in the region to compete with those offered by China.
Indo-Pacific nations will be watching closely to see U.S. commitment to the region. Any perceived erosion of U.S. credibility in supporting allies or inability to provide a viable alternative to the economic opportunities offered by China will force nations to reconsider their relationship with the U.S. and move closer to China. America must therefore continually demonstrate commitment to the region. A good step in this regard would be for America to re-enter the Trans-Pacific Partnership (TPP). By renouncing TPP, America forfeited a leadership role in establishing multilateral rules and institutions for regulating trade in the region, and which also accounts for one-third of all world trade. Something China—understanding the strategic bullet it dodged—called a grand gift. It also laid significant doubts concerning U.S. commitment. Returning to the TPP will lay some of those doubts to rest.”
Topic 2: Xi’s new economy. Return of the Mao.
There is a lot happening in China economically these days, as the government continues its ever growing crackdown on various sectors of the economy, which we have documented extensively in previous editions of the Newsletter. But it is becoming clearer by the day that this not simply a rectification of a few wayward sectors, or a comeuppance for some brash Chinese billionaires who flew too close to the sun and angered their political masters in Beijing. But a complete reorientation and overhaul of China’s entire economic system.
Former prime minister of Australia and the global president of the Asia Society Kevin Rudd sees the crackdown in China, as part of an entirely new development paradigm playing out, which is being driven by a return of Communist Party ideology, severe demographic issues, and economic, and cultural, decoupling from the West. Rudd writes in the Wall Street Journal:
“The forces of ideology, demographics and decoupling have come together in what Mr. Xi now calls his “New Development Concept”—the economic mantra combining an emphasis on greater equality through common prosperity, reduced vulnerability to the outside world and greater state intervention in the economy. A “dual circulation economy” seeks to reduce dependency on exports by making Chinese domestic consumer demand the main driver of growth, while leveraging the powerful gravitational pull of China’s domestic market to maintain international influence. Underpinning this logic is the recent resuscitation of an older Maoist notion of national self-reliance. It reflects Mr. Xi’s determination for Beijing to develop firm domestic control over the technologies that are key to future economic and military power, all supported by independent and controllable supply chains.
Much of the party’s recent crackdown against the Chinese private sector can be understood through this wider lens of Mr. Xi’s “new development concept.” When regulators cracked down on private tutoring it was because many Chinese feel the current economic burden of having even one child is simply too high. When regulators scrutinized data practices, or suspended initial public offerings abroad, it was out of concern about China’s susceptibility to outside pressure. And when cultural regulators banned “effeminate sissies” from television, told Chinese boys to start manning up instead of playing videogames, and issued new school textbooks snappily titled “Happiness Only Comes Through Struggle,” it was all in service of Mr. Xi’s desire to win a generational contest against cultural dependency on the West.”
Jude Blanchette of the Center for Strategic and International Studies echoes Mr. Rudd’s sentiment: “This is not a sector-by-sector rectification; this is an entire economic, industry and structural rectification.” Barry Naughton, a China economy expert at the University of California, San Diego, goes further still: “Xi does think he’s moving to a new kind of system that doesn’t exist anywhere in the world. I call it a government-steered economy.” And a recent Wall Street Journal examination shows Xi is trying forcefully to get China back to the vision of Mao Zedong, who saw capitalism as a transitory phase on the road to socialism: “He is trying to roll back China’s decades long evolution toward Western-style capitalism and put the country on a different path entirely, a close examination of Mr. Xi’s writings and his discussions with party officials, and interviews with people involved in policy making, show.”
So, what then does this all mean for those looking to invest in China? This has sparked quite the debate between some of Wall Street’s biggest titans, including notably, legendary hedge fund manager George Soros and Blackrock’s Larry Fink.
BlackRock, the world’s largest asset manager, recently began a major initiative in China, launching a set of mutual funds and other investment products for Chinese consumers. This came just weeks after BlackRock recommended that investors triple their allocations in Chinese assets. “The Chinese market represents a significant opportunity to help meet the long-term goals of investors in China and internationally,” BlackRock Chairman Larry Fink wrote in a letter to shareholders.
In response, legendary investor, turned political influencer George Soros wrote an essay in the Wall Street Journal, entitled “Blackrock’s China Blunder”, in which Soros bluntly stated that pouring billions of dollars into China would likely lose money for Blackrock’s clients and damage the national-security interests of the U.S. and other democracies. Soros wrote: “The BlackRock initiative imperils the national security interests of the U.S. and other democracies because the money invested in China will help prop up President Xi’s regime, which is repressive at home and aggressive abroad. Congress should pass legislation empowering the Securities and Exchange Commission to limit the flow of funds to China. The effort ought to enjoy bipartisan support.”
As the Wall Street Journal points out, the BlackRock-Soros feud is a microcosm of Wall Street’s China dilemma. On the one hand, companies like Blackrock see a massive market of 1.4 billion potential customers. But on the other hand, there are incredible risks related to the brewing tensions between America and China, and the heavy and fickle hand of the Chinese Communist State.
Putting aside Soros’s national security related arguments about investing in China, however, which I largely agree with by the way, the continuing and growing crackdown of major sectors and industries of China’s economy, along with the looming collapse of China’s largest property developer, Evergrande, which has roiled markets this week and portends a major rectification of the whole Chinese property sector representing nearly 30% of the entire Chinese economy, seems to support Soros’s thesis that foreign investors are increasingly playing with fire in China, and should significantly limit their exposure accordingly. And indeed, other major investors echoed Soros’s sentiment this week, including Cathy Wood of Ark Invest, who announced she is largely divesting from China, while other high profile investors, like Jim Chanos, and Mohammed Al Erian questioned whether China is even currently, as El Erian put it, “an investable market.”
To exemplify the point, private equity giant Blackstone recently got burned in China, with a large real estate deal abruptly falling apart due to “political reasons.”
Some have speculated that President Xi is merely making necessary reforms to China’s economy that are long overdue, including an out of control and severely over indebted real estate sector. And that Xi is attempting to steer China’s economy to be more productive and innovative, less fragile, and more equitably distributed, or what Xi calls “Common Prosperity”. It also comes at a time when Xi is looking to be crowned President for life in 2022 at the next Party Congress, and the economic crackdowns are way to further solidify his support with the Chinese people.
While this may all indeed all be true, and there may in fact be valid reasons for some of the actions Xi is taking, can and should US investors take the risk, with not only their own money but those of ordinary Americans as well, by investing in China with the current incredible uncertainty? Let alone for the fact that by doing so they are helping America’s great rival. I think not. Shrewd and patriotic US investors alike would be wise to stay far away from China these days.
And for any who wants to read an insider’s account of how things really work in China, may I suggest the fascinating new book Red Roulette.
![Red Roulette: An Insider's Story of Wealth, Power, Corruption, and Vengeance in Today's China by [Desmond Shum]](https://substackcdn.com/image/fetch/f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fbucketeer-e05bbc84-baa3-437e-9518-adb32be77984.s3.amazonaws.com%2Fpublic%2Fimages%2F58e725ee-162a-46af-821a-e0f8ad4f4dd6_331x500.jpeg "Red Roulette: An Insider's Story of Wealth, Power, Corruption, and Vengeance in Today's China by [Desmond Shum]")