You are now living through Cold War 2
A late push for re-engagement is not going to work.
The early days of the original Cold War included the launch of Sputnik in 1957 and the shooting down of a U-2 spy plane in 1960. Perhaps people will remember the Spy Balloon of 2023 as a similar moment in the early days of Cold War 2.
For those who weren’t watching the news over the last couple of days, China sent a spy balloon over the U.S. The Chinese government tried to claim that it was a weather balloon blown off course, but this obvious fiction fooled no one. The spooky white orb was first noticed in Montana, and made its way over the heartland and off the coast of South Carolina, where the U.S. finally shot it down over the water. Here’s a video of the balloon’s final moments:
The spy balloon incident is exacerbating tensions between the two countries — U.S. Secretary of State Anthony Blinken already cancelled a planned trip to China. But I think this is mostly just a sign of the times. A collision between a U.S. spy plane and a Chinese fighter jet in 2001 was a much more serious incident, but it didn’t start a cold war. And the U.S. and China fly spy satellites over each other’s territory every day. The massive popular uproar produced by the Spy Balloon of 2023 won’t cause Cold War 2 — it’s a sign that Cold War 2 is already here.
The would-be restorers of 2015
Over the last few months, there has been a sort of last-ditch push to avert Cold War 2 and bring back the world of U.S.-China “engagement” that prevailed from the 1980s through the early 2010s. In a speech at the World Economic Forum meeting in Davos in January, China’s vice-premier Liu He declared that “we have to abandon the cold war mentality”. China has toned down the bellicose “wolf warrior diplomacy” of 2020-2022, and reassigned its most aggressive diplomat to a less prominent role. Recent messaging from Chinese state media has echoed the pro-globalization rhetoric of earlier times:
Meanwhile, on the U.S. side, a few voices have started to call for at least a partial return to the engagement strategy. In a recent article for Foreign Affairs, political scientist Jessica Chen Weiss argued that U.S. policy toward China is needlessly confrontational, that we’re sleepwalking toward catastrophic conflict, and that instead we should “negotiate the terms of China’s growing influence.” And in a 2022 book, economist C. Fred Bergsten argues that China will inevitably become the world’s biggest economic power, and that the U.S. should return to a strategy of engagement as a way of reconciling itself to that fact. He recommends that the U.S. try to cooperate with China in an informal “G-2” where they quietly cooperate to steer the globe.
But the most important call for re-engagement on the U.S. side is coming from people who argue that China is still just too good an investment opportunity to pass up. Henry Paulson, the former Treasury Secretary and head of Goldman Sachs, recently argued that confrontation with China would put the U.S. economy in danger:
China and the United States are in a headlong descent from a competitive but sometimes cooperative relationship to one that is confrontational in nearly every respect. As a result, the United States faces the prospect of putting its companies at a disadvantage relative to its allies, limiting its ability to commercialize innovations. It could lose market share in third countries. For those who fear the United States is losing the competitive race with China, U.S. actions threaten to ensure that fear is realized…In the case of high technologies, some targeted decoupling will be absolutely necessary. But wholesale decoupling makes no sense. Americans benefit from access to the world, and China will remain a huge market that Americans can either partake in or abandon to competitors. China is the world’s second-largest economy, its largest manufacturer, and its largest trader. It will be a big part of the global financial picture for decades to come.
Reading Paulson’s article, my instinct is that the strongest calls for a conciliatory U.S. approach toward China will come from the finance industry — especially banks and asset managers.
Why do I think this? Because of the changing nature of the investment opportunities available to American capital in China. Foreign direct investment in manufacturing defined the Chimerica era, but it’s becoming less important now. Companies like Apple are slowly starting to disinvest from Chinese factories and move supply chains elsewhere — a decision that is probably due to rising Chinese costs and local political risk as much as to geostrategic concerns or U.S. government pressure. Overall, FDI into China shrank in the 2010s, both in absolute terms and (especially) as a percent of GDP.
European companies will probably be slower to disinvest from China, given the strict regulation that limits their opportunities at home, but even there you can see the general trend. Multinationals won’t want an abrupt decoupling, but I doubt they’ll push hard to reverse the trend.
So if FDI in China isn’t a great opportunity for Westerners anymore, what is? Portfolio investment. U.S. banks and asset managers, hungry to find high returns wherever they can, will be eager to pour capital into China, especially now that Zero Covid is over and the real estate crackdown is being partially reversed. Some of this will go into Chinese stocks, but much of it will probably be handed off to Chinese asset managers, from where it will eventually, inevitably, flow into real estate-related investments —developers, local government financing vehicles, contractors, shadow banks, etc.
(As a side note, my uneducated guess is that this will not be a great investment play, and that despite the government’s efforts to reflate the property sector, Chinese real estate will be anemic for years to come. U.S. finance companies, I predict, will end up being the “dumb money” that swoops in to give some Chinese investors a timely bailout from their mistakes in the 2010s. In a future post, I’ll try to assess what kind of investment opportunities really exist in China. But I digress.)
Anyway, I think that calls for a return to the engagement strategy vis-a-vis China will increasingly use the lure of portfolio investment, rather than the vague threat of war or the need for cooperation on climate change, as their main hook. You’ll probably hear phrases like “China is investable” and “China is a safe place to put your money”, etc. It will be interesting to see how that argument plays in D.C., where the finance industry has traditionally been close to the levers of power.
But basically, I don’t think either halfhearted Chinese charm offensives or economic arguments for engagement will do much to turn back Cold War 2. It’s already too late for that.
The events of 2019-22 won’t be swept under the rug
The primary reason I don’t think engagement can be restored is that no one is just going to forget the events of the previous four years. Those events started not with the coming of Covid in 2020, but with China’s human rights crackdowns in the late 2010s.
If you look at Pew survey data, you can see that opinion of China in the U.S., Europe, and the Anglosphere turned sharply negative in 2019 (among most of China’s neighbors, opinion was already pretty negative before that). What happened in 2019? The Hong Kong protests. China’s leaders may not understand this, but Hong Kong was a beloved international city — a top travel destination with a globally influential pop culture. When the entire city poured into the streets in 2019 to protest for democracy, China responded with a draconian security law and massive crackdown that essentially crushed the city’s uniqueness under a totalitarian bootheel. That’s not the kind of thing you can just sweep under the rug and forget about; Hong Kong is still there, still being repressed every day. 2019 and 2020 were also when information about China’s repression of the Uyghurs in Xinjiang became widespread; that will linger in people’s minds too, due to efforts to stop sourcing products built with Uyghur slave labor.
Furthermore, the bellicosity of China’s “wolf warrior” era will not soon be forgotten, as it punctured the previously dominant trope of the country’s “peaceful rise”. Basically, you can’t go around bellowing like the Kaiser for three years and then suddenly go back to being all about peace and globalization and expect everyone to just forget. It’s all the same people in charge as a year ago — Xi Jinping, and cronies of Xi Jinping. People like that don’t just decide that a world-historic transfer of hegemony is in process and then scrap that idea just because they lost some money on real estate and they couldn’t contain an epidemic.
And even more importantly, the new overtures haven’t been matched by more peaceful actions on the ground. China has stepped up its military intrusions into Taiwanese airspace and waters, and continues to build up forces and clash with India along their disputed border. U.S. intelligence officials allege that China’s leaders are preparing for action against Taiwan later in the decade.
Credulous writers and investors in the West may take China’s recent overtures at face value, but China’s neighbors clearly do not. India is sending in more troops, Taiwan is stepping up its defensive efforts, Japan is boosting military spending and capabilities, and Southeast Asian countries, fed up with China’s divide-and-conquer strategy in the South China Sea, are starting to form balancing coalitions. And all of these countries are seeking increased military cooperation with the U.S. as a hedge against Chinese aggression in the years to come.
And then, of course, there’s the Spy Balloon of 2023. It’s probably not militarily significant, but it looks like a clear provocation. It’s not the kind of thing you do if you’re trying to ratchet down increasing tensions. Of course, China’s policymaking apparatus isn’t a monolith, and it’s possible that doves are trying to reach out even as hawks are pressing for more confrontation. But if even half of China’s leaders are committed to Cold War 2, the U.S. will have little choice but to accept the challenge. Fred Bergsten’s notion of a “G-2” is obvious fantasy, while Jessica Chen Weiss’ warnings of imminent conflict mean little as long as China’s leaders don’t heed them — which of course they don’t.
So Cold War 2 is a reality, and we’re all living in it right now. If history is any guide, expect at least the next three decades to be defined by mutual U.S.-China distrust and tensions rather than re-engagement or cooperation against shared challenges. China’s leaders may wish they could take a mulligan and reset things to the trajectory of 2015 or 2017, but eventually they will realize that they can’t, and their tone will likely turn frosty again. Meanwhile, Americans will likely continue to see events like the Spy Balloon in a more negative, threatening light than they would have in earlier decades.
That doesn’t mean, of course, that events will follow the script of the first Cold War — China is not the USSR, the world economy is far more globalized than in the 1950s, and technology has evolved by leaps and bounds. Economic decoupling will happen in some industries, but not complete decoupling — the trend may be directionally away from Chimerica, but there will still be plenty of trade between the two countries unless and until a major war breaks out. Hopefully the protagonists of Cold War 2 will also avoid some of the mistakes the superpowers made in Cold War 1 — the nuclear arms race, the bloody proxy wars and proxy genocides, and so on. By some estimates, over 10 million people died in the first Cold War; that was considered a success only in comparison with the nuclear holocaust that we narrowly avoided. It would be far too much to expect the world to be a rational place in the 21st century, but at least we can hope to be a little more rational than last time.
Excellent analysis, thank you. Yes, we’ve been in a heated cold war since Putin and Xi announced their best-friend status and Putin turned around and started a hot war at NATO’s border. Since we are at war, it’s time we Americans remembered how we won the last war and begin to act accordingly. Hank Paulson can continue to invest in China, but our politicians should not help him. Friendshoring and other forms of decoupling will gain even more momentum.
But the people who will soon start to feel the cold breezes are school administrators. As soon as the Supreme Court bans affirmative action there will be calls in Washington to ban Chinese student visas. For how can it be that seats previously going to Blacks and Latinos will now go to the children of the CCP...? No, that will not work in a democracy. Rubio is probably already working on the draft.
This does seem like the direction we're headed. It will be good to decouple what is too tightly coupled now both to on-shoring and friend-shoring so we can't be held hostage to not being able to manufacture. Also learning curves happen in manufacturing.
We should not let finance screw the world again like they did by forcing the off-shoring and gutting of US Manufacturing. Great line " I predict, will end up being the “dumb money” that swoops in to give some Chinese investors a timely bailout from their mistakes in the 2010s" its ok if its their money but unfortunately its really our money from retirement funds, etc.
There should be no "finance industry" its just accounting that has been hijacked to grift the world.