Condivergence: Investing in the contest of the century: The US and China rivalry

This article first appeared in Forum, The Edge Malaysia Weekly, on January 18, 2021 - January 24, 2021.
Condivergence: Investing in the contest of the century: The US and China rivalry
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January 2021 could be one of the most stunning months as one decade ends and a new one begins. Just as we thought that with the approval of new vaccines, the pandemic would be finally brought under control, the occupation of the US Capitol by President Donald Trump’s supporters signalled a turning point in US politics.

The US presidential election had told us already that the US was deeply divided, but the violent assault on the temple of American democracy on Jan 6 suggested that American politics has entered a period that the Chinese recognise as a cultural revolution. Every country goes through a period when well-held beliefs in stability and order are swept away by a new generation who believe in change by different means, including the use of violence.

The US and China rivalry is the contest of the century. With 400,000 deaths from the pandemic and a decline in US GDP in 2020, while China has controlled its pandemic outbreak and recorded positive growth of just under 2% in 2020, the gap between the two largest economies in the world has narrowed.

The renminbi had appreciated against the US dollar by 5.3% in 2020, so in market exchange rate terms, the Chinese economy has emerged stronger, whereas the Biden administration will have its hands full trying to heal the political divide, tackle the pandemic and restore US economic vibrancy. 

In his book Has China Won, Singapore diplomat and academician Kishore Mahbubani argues that the US has consistently underestimated China.

Why is this so?

Success always breeds complacency and then hubris. Under president Richard Nixon in the 1970s, the US befriended China as a counterweight to the threat of Soviet power. By 2000, there was already concern within the US that China was rising far too fast, but the US was distracted by 9/11, which heralded the rise of Middle East terrorism. The consequent Gulf War and then the invasion of Iraq caused the US to focus on the war against terrorism, while China powered ahead with market reforms. By the 2008 global financial crisis, when the US financial system stumbled, both Wall Street and Deep State hawks realised that China had become a strategic rival to be feared.

How will this rivalry play out? Harvard political scientist Graham Allison claims that there is a Thucydides Trap, in which both sides will end up with war, a point that Chicago historian John Mearsheimer, in his book The Tragedy of Great Power Politics, agrees with, because “the bottom line here is that the US does not tolerate peer competitors”.

However, history plays out not because one party does not tolerate another, but because mistakes are made that can be solved diplomatically or through war. In many cases, war broke out not necessarily because of evil intentions by either party, but because of a series of accidents, misjudgements or even strategic blunders.

The sociologist Michael Mann sees society as interlocking power networks, which derive power from four sources: control over ideological, economic, military, and political resources (IEMP). To this, I would add “technological resources” that would include today artificial intelligence, science and social technology, creating five dimensions of power. Competition between the US and China exists along all five dimensions and must be examined in depth because national security considerations play a far larger role in investor decisions than previously understood.

Historians remind us that we can never take anything for granted. Investors living in a US-dollar dominated financial world assume that New York will continue to be the global financial centre, just as under the British empire, the pound sterling was the hegemonic reserve currency. As the bankers Rothschilds used to say, “Buy with the bells and sell with the cannons.” The drums of war are beating, and investors cannot ignore them.

The Cold War did not break out into nuclear Armageddon because both sides feared nuclear extinction,  what is called MAD (mutually assured destruction). The Soviet Union possessed huge military strength, but its economy was badly managed and the system collapsed in 1991. This suggests that rivalry will play out from a combination of very different factors. It was the rise of Brexit and Trumpism that caused Armenian President Armen Sarkissian, a physicist by training, to call for the need for “quantum politics” to tackle today’s challenges.

In his view, “the pandemic is accelerating the transformation of the classical world of the 20th century and before — where organised forms of connectivity mattered — into a quantum world where change is faster and more unpredictable, and can be more random. To fight pandemics, manage financial crises and other risks, we need to change not only our lifestyle but our perspective. If we start thinking about this world as a quantum world, we will find the logic behind events and be able to predict them with some degree of probability”. 

Quantum thinking does not mean that there is no logic or pattern to what appears to be chaos. The linear, mechanical and monist classical view in economics that has dominated Western thinking is deductive, static and wrong in a world where abrupt change and uncertainty are dynamic and non-linear.

Ideologically, the US thinkers look for the silver bullet — the “first best solution” to all problems — as shown in Trump’s reliance on the vaccine to solve the pandemic. The political consensus within the country is broken because both sides demonise each other, just as they are united in demonising China, socialism or any ideology or religion that they disagree with. Monism believes in perfection of the “One”, the best, brightest, pure, supreme power that will not tolerate challenges from diversity. 

The linear view is that the dollar will weaken, interest rates will remain low, and inflation will not return, but those who understand reflexive markets know that the market works through cycles of boom and bust, fear and greed, panic and stability. Thus, what is happening in the markets is that central banks are engineering liquidity to ensure that financial markets do not collapse, whereas technology is changing lifestyles so quickly that no one knows how to value technology stocks. The biggest bubble in the world is currently Bitcoin, which challenges even the role of central bank fiat money as a means of payment and store of value.

As John Maynard Keynes correctly surmised, investing is like a beauty contest in which it is not who you think is the prettiest contestant, but what the market considers is the winner. The consensus assumption is that the reserve currency central bankers will continue to print money to keep markets up. But what if that assumption is wrong?

Clearly, world views are shaped by ideology, which itself rests on assumption and beliefs that may not align with the facts. Science and logic do not work in an era when emotion and conspiracy theories have currency with nearly half the population. This is why value investing is competing with momentum investing, and no one knows how and when the tide will turn.

World Bank chief economist Carmen Reinhart thinks that the pandemic is morphing into a “quiet financial crisis”. Globally, financial institutions’ balance sheets are damaged, and only patched up with regulatory forbearance and central bank liquidity. If the real economy continues to worsen from periodic lockdowns, then financial crises cannot be avoided, at least at the local or national level. Financial crises are never quiet, because in inter-locked and inter-dependent financial markets, contagion will be virulent.

The contest of the century does matter, because if financial crises or conflicts break out, who is left standing matters.

We shall soon see whether the Year of the Bull will turn out to be a Bear.

Tan Sri Andrew Sheng is a former central banker and financial regulator. The views expressed here are his own.

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