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Peak China may pose peak danger

“When bad folks have problems, they do bad things.” So said Joe Biden in August when speaking about how China was a “ticking time bomb” because of its economic troubles. Experts are downgrading the country’s full-year growth target below an official 5% goal.

But last month when in Vietnam, the U.S. president changed his tune. He said he thought China would not invade Taiwan precisely because the world’s second-largest economy was slowing down: “Matter of fact, the opposite — it probably doesn’t have the same capacity that it had before.” He added that Chinese President Xi Jinping “has his hands full right now”.

It is not surprising that Biden is giving contradictory messages about how dangerous China is to its neighbours, with which the United States has been constructing a network of increasingly close security alliances. A glance through recent history suggests great powers are a threat whether they are rising, peaking or falling, says Victor Sebestyen, a historian.

He points out that Germany, France, the British Empire, the Ottoman Empire and the Austro-Hungarian Empire all fought wars before and after they peaked. Russia’s current war in Ukraine is a case of a declining power which has invaded its neighbour.

That said, China may be especially dangerous if its power is in fact peaking. This is because Xi could enter a “now or never” mindset – believing that, if the People’s Republic waits too long to press its claims to Taiwan or large chunks of the South China Sea, the chances of mounting a successful military invasion will drop. Beijing is certainly riling its neighbours. For example, last week it installed a floating barrier by a rocky outcrop in the South China Sea claimed by the Philippines – which Manila promptly removed.

Some economists argue it is too early to say that China has peaked. They say the $19 trillion economy can resume its upward march once it has managed its way through its vast overhang of debt – which has doubled to over 300% of GDP since the 2008 global financial crisis.

Reuters Graphics
Reuters Graphics

But the problems of debt, over-investment, a technology Cold War with the United States and increasing state intervention in the private sector are deep-seated. What’s more, Xi seems reluctant to embrace deep reforms required to establish a firmer growth trajectory. Even if he did, once the medicine had worked, a declining population would sooner rather than later hold the country back.

A war between the United States and China still seems unlikely – because both sides know that the economic and human costs of a clash could be catastrophic. But the fact that Europe’s economies were closely entwined in the early 20th century didn’t stop World War One.

Peak Danger

Many of China’s neighbours – from India to Vietnam and the Philippines – are scared that it will grab some of their territory. They were angry when the People’s Republic in August published a new “standard map” of China which incorporated one of India’s states as well as Taiwan and 90% of the South China Sea.

The United States and its Western allies are also worried that China could browbeat Japan and South Korea, two nations economically important to them. This is why America is strengthening its alliances with its Indo-Pacific allies – and why they are ramping up their defence spending.

Japan, for example, is planning to double defence spending to 2% of GDP by 2027. Washington is even negotiating a big arms deal with its old enemy Hanoi.

Meanwhile, the United States and other allies are imposing controls on the export of technology such as advanced chips to the People’s Republic. They are also seeking to cut their dependence on key Chinese goods such as critical minerals and solar panels.

Unsurprisingly Beijing sees America’s efforts as an attempt to encircle it. The combination of that and weak economic prospects makes China especially threatening in coming years, says Michael Beckley, a political science professor at Tufts University.

The near-term risks have probably risen since Beckley reached that conclusion in “Danger Zone”, a book he authored last year with fellow academic Hal Brands. This is partly because China’s economy is now in deeper trouble than most observers thought and partly because America has beefed up its alliances rapidly.

Even European countries, which were reasonably relaxed about the People’s Republic, are increasingly wary partly because of Xi’s friendship with his Russian peer Vladimir Putin.

But the same developments also mean that the period of peak danger may be relatively short. Once the U.S. alliance has reinforced its defensive posture, the costs of military action by Beijing will rise – and China will be less able to ramp up its own armed forces overseas if it faces financial instability at home.

Fat-tail Risk

The Biden administration is trying to reduce tension. A series of senior U.S. officials have met Chinese counterparts in recent months – and Washington hopes Xi will visit San Francisco for the Asia-Pacific Economic Cooperation summit in November. But it’s hard to run a policy that involves reassuring and containing China simultaneously.

What’s more, the United States is finding it hard to maintain an emollient message. For example, Biden called Xi a “dictator” in June, something Beijing called a “provocation”. If Donald Trump wins next year’s presidential elections, he could take a more hawkish line given that many Republican politicians are especially hostile towards China.

Despite the diplomacy, tension between the two countries has been rising. Goldman Sachs’ Cross-Strait Risk Index, based on monitoring press mentions of tension in the Taiwan Strait, has shot up to 72 from single digits in early 2020. Tufts’ Beckley said there may be a 10% chance of war over the next decade.

It is, of course, hard to put any number on geopolitical risk. But a low probability of a catastrophic event is certainly something to worry about more the longer China’s economic problems persist. If companies and investors haven’t increased the weighting they assign to such a scenario, they would be wise to do so.

Hugo Dixon for Reuters

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