"Humans who acquire the Bomb never lose the ability to make them and they only get cheaper with technology."
- Eric Weinstein, PhD - Managing Director of Thiel Capital
Last year, I wrote a newsletter supportive of America's use of tariffs against China that surprised a lot of people, especially given my strong belief in free trade. With the volatility of the markets recently, I’ve received a lot of calls asking if I still hold that view.
The reasons for my position include issues of commerce, but they go far beyond it. What follows is a 4-point examination of why I believe China is a danger to the liberal world order.
For the sake of the free world, I encourage you to read it.
Point #1 - China's Surveillance State
James Madison was America's fourth president and he is commonly acknowledged as the primary writer of the Constitution of the United States. It is an amazing document and our constitution is taught in Europe as a masterpiece on two levels: government structure as a function of distant power vs local power; and government structure as a function of human kindness vs. human corruption. For this discussion however, I want to lean in the direction of human nature.
James Madison's insight into human nature is one of the traits that made him such a fascinating man. He once said, "If men were angels, no government would be necessary. If angels were to govern men, neither external nor internal controls on government would be necessary. In framing a government which is to be administered by men over men, the great difficulty lies in this: you must first enable the government to control the governed; and the next place, oblige it to control itself."
It is because of that view of human nature that America has the separation of powers between the different branches of government. Yes, that structure creates gridlock, but it also prevents the concentration of power. America's founders - given their experience with King George III of England and their study of history back to the Roman Empire - were very motivated to not allow government power to be concentrated in one person.
And that brings me to China.
China fundamentally holds the view that the American form of government is contemptible. "Should government power be held in check?" thinks China. "No." is the answer. China is an authoritarian state. Much to my worry, a change was made to China's constitution last year such that President Xi was voted to be China’s president for life.
Out of 2,964 votes by members of China’s parliament, only two people voted against Xi’s lifetime term. That is a 99.93% majority.
I have mentioned in other newsletters that Peter Thiel, a founder of PayPal, is one of my favorite American intellectuals. While not speaking of China at the time, he has intriguingly observed that slight majority wins of 51% are normal in many settings. Majority votes might be as high as 70% on occasion. When you see a near 100% consensus on an issue however, something is usual wrong. There is corruption.
President Xi Jinping of China now has political power not seen since Chairman Mao. If you don’t remember the history of China during the 20th century, Mao was the man that starved to death between 50 and 100 million Chinese citizens in his quest to implement his top-down, government directed, socialist policies.
There are some that suggest we are in a new age and that President Xi is a "benign tyrant" of the like that philosophers of times past have said is the best kind of leader. That is possible. It is also possible that Mars could be made of fairy dust.
Concentrations of power are dangerous.
President Xi may be doing the things he believes are needed for his country, but what he is doing are things Americans would not accept. To understand what I mean, consider the following questions: Why has China has passed new legal rulings in Hong Kong that prevent pro-democracy legislators for running for office? Why are books that speak of "press freedom" and "civil society" banned in China? Why did the Chinese government, just two months ago, block every language version of Wikipedia in China? Why did China require LinkedIn to prevent Chinese users from seeing content prohibited by the government AND block users in other countries from seeing banned content that originated in China? Why is the Chinese government developing a "citizen score"?
That last one is terrifying. China is attempting to implement a system of algorithmic surveillance, using artificial intelligence, data mining, and storage, to construct detailed profiles of every one of its citizens. Today, there are 176 million cameras in China. By 2020, that number is expected to be 450 million. Today, Beijing’s Public Safety Bureau proudly states that 100% of the city is covered by surveillance cameras. Frustratingly, the government has "gamerized" a government created cell phone app used to collect data on its citizens to make the experience of sharing data with the government "fun!" Today, Chinese citizens are bragging about their "citizen scores" on social media. I posit that if one were to criticize the Chinese government, one’s score would go down. Probably by a lot. With the social pressure to conform being such an important part of Chinese culture, you can imagine what a powerful tool this is.
George Orwell's book "1984" comes to mind. We should be aware and beware.
I want to make it clear that my concern is with the Chinese government and not the Chinese people. My wife is a teacher of intellectually gifted children and many of her students are from China. We love those kids and are friends with their parents. I am honored that they chose to immigrate to America.
Point #2 - China's Military
Authoritarian regimes are not good, but many governments around the world are authoritarian. Afghanistan, Iran, Sudan, Yemen, Saudi Arabia, and North Korea have authoritarian governments. While we worry about some of those countries more than others, we don't worry a lot. Why? It is because the U.S. military can, if necessary, crush their militaries.
While we don't like to think about it, brute power is important.
China is in a completely different category. China is a country of 1.4 billion people and thus, it is a nation with roughly four times America’s population. It should come as no surprise that China has 2,035,000 soldiers in uniform and an additional 510,000 in reserve. By comparison, the United States has 1,359,000 soldiers in uniform and 800,000 in reserve. While there is no doubt the training received by the men and women serving in the active and reserve units of the United States military makes them far better warriors than their Chinese counterparts, the sheer number of Chinese soldiers should cause us all to sit up and take notice.
With China's growing wealth, China has made massive improvements in its navy. Since 2014, China has launched more submarines, warships, principal amphibious vessels and auxiliaries than the number of ships currently serving in the COMBINED navies of Germany, India, Spain, Taiwan, and the United Kingdom. That is extraordinary. The country doesn’t have an aircraft carrier worth a darn, but I’m not sure they are that valuable in our modern age. Nevertheless, China has had 32 new ships commissioned in the last two years compared to the 13 new ships commissioned by the United States. By 2020, it is expected to have between 69 and 78 submarines. The United States has 70 submarines.
It is important to not forget about China’s coast guard either, because China now has the largest coast guard on the planet. It has 130 ships, approximately 70 of them built since 2010. Those newer ships are substantially bigger than the older ones and they are equipped with helicopter facilities, water cannons, and 30MM to 76MM guns.
This tremendous advancement in China’s seafaring capabilities was made possible because China is now a world class ship builder. Associated with its ship building expertise is the fact that these ships' gas turbines, diesel engines, and almost all of its shipboard weapons and electronic systems are produced in China.
China has the second largest military budget in the world behind the United States. China spent ~$250 billion in 2018 on its military as compared to America's ~$650 billion. Given that the US spends 2.6 times the amount of money, you would think the America would be much, much further ahead. We are ahead and I’m confident that American could win a war with China if it came to that, but I am concerned that America is too confident in the safety a 2.6 spending differential implies.
Think about economic parity and the fact that some places are less expensive than others. China has a much lower wage base than the United States and a lot of its military equipment is built in China. Per an article from 2015 regarding the salaries of China’s soldiers, it appears that their wages are a fraction of US soldiers’ wages. For example, a 30-year colonel in the United States military earns ~ $10,000 per month. A person holding the same rank in the Chinese military earns ~$1,300 per month. The difference is extraordinary. While I am confident that there is an awful lot of error in what I am about to write, I am also confident that – because of the cost differences between the United States and China – China is EFFECTIVELY spending nearly as much on its military as we are spending on the United States military.
The difference in capability between China's military and the United States military has narrowed considerably in the last ten years. Given the growth of China's economy and the growth of its military budget, there is no reason - emphasize no reason - to be believe that China's military capability will not equal America's capability in the next decade or so.
Increased Military Aggression
Territory has always been part of national identity and China is certainly asserting theirs. The country claims it has sovereignty over a major part of the South China Sea. Yes, China is claiming a good part of an ocean and that claim, if honored, would effectively double the size of the country. The area they are claiming is known as the "Nine-Dash Line," based on a map that was published by the then Republic of China in 1947. In 2016, the United Nations ruled that China has no legal basis to claim "historic rights" to this area. Not surprisingly, China rejected this ruling.
Important sidebar - There is an interesting aspect of international law that says that a nation’s borders extend from its shores outward for 200 miles.
During the 2nd term of President Obama’s administration, United States satellites provided evidence that China was building islands – yes, you read that correctly…"islands" – in the South China Sea. When asked about it at the White House in 2015, President Xi lied like a dog and said that China didn’t "intend to pursue militarization" of the islands. Flash forward to 2018 and we now have evidence that the islands contain radar installations, bomber-sized bunkers, anti-ship and surface-to-air missiles. One of those islands is 500 km from the Philippines. Others are near Vietnam, Borneo, or in the middle of the ocean. All of them are in contested areas by various governments, but it appears that China is seeking to assert its claim of ownership the "possession is 9/10ths of the law" way.
The thing is, if we look at those islands China is now claiming to own and apply the 200-mile border from them, China effectively "owns" the South China Sea. This is dangerous.
I believe it is fair to say that China believes that securing the South China Sea is in its strategic interest because of the importance of oil. Geologist believe that there may be 11 billion barrels of oil there, making it equivalent to the Persian Gulf. Additionally, nearly 80% of China’s oil imports and 13% of its natural gas imports come from ships using the South China Sea.
From the US’s perspective, China’s military build-up and unchallenged territorial grabs could allow it to strangle the South China Sea and reduce transit through that part of the world. Approximately 1/3 of all global trade goes through the South China Sea. That 1/3 of global trade represents ~$5 trillion, of which $1.2 trillion relates to US trade, transported by American ships – including war ships. If China was to put a chokehold on the South China Sea, it could greatly pressure Japan, Taiwan, or South Korea by cutting off the oil that goes to those countries.
Oh, I forgot to mention that China is also claiming the airspace above the "Nine-Dash-Line." Can you imagine America, or any other nation besides China, not being able to fly over the South China Sea?
Point #3 - China's Version of "Fair Trade"
China is a massive country with enormous natural resources. Its people are willing to work for very low wages because, to them, those wages provide a much improved standard of living relative to their other options. Like so many things in life, relativity matters.
With those advantages however, China is absolutely gaming the free trade regime established by the World Trade Organization.
Which of the following practices should count as "fair" in global trade: US companies technology transfer is facilitated by "junk patents" that are used to retaliate against foreign companies’ intellectual property lawsuits? US companies desiring to sell their products in China are forced to go thru very lengthy certification processes that effectively stop US companies from competing in China? Strong ties exist between the Chinese government and Chinese companies that export their products to the United States and compete with US companies? China-supported credit lines to industrial developers that, while theoretically neutral among sectors, in practice favor only export-heavy industries, thus making their products more competitive than American-made products? The Chinese government's refusal to allow Chinese companies to be sued in U.S. courts because those are Chinese-owned companies and thus deserve protection from prosecution like that of a diplomat?
The above are examples of how the Chinese government’s industrial planning simply does not fit into the categories currently given to trade enforcement by the World Trade Organization. The WTO is a flyswatter trying to stop the damage of an elephant. It simply doesn’t have the tools to do the job.
I am angry at politicians - on both the Right and the Left - that act as if "free trade" of that sort should be allowed and that retaliation is not in order.
Yes, the cost to retaliate for trade violations is expensive, but so is the cost to have a judicial system in the United States that prosecutes people for theft. Nevertheless, it is necessary to incur the cost and be willing to inflict punishment so that people obey the rules! James Madison again.
Point #4 - Addressing the Problem
I believe I have made a persuasive case that China needs to be contained. Doing that is going to require a Churchill-like force of will. Unfortunately, many political leaders, academics, and pundits – from nations around the world – appear to be making Chamberlain-like arguments.
Appeasement, appeasement, appeasement.
They are wrong.
American can take action in a way that may create some painful muscle ache today because our out-of-shape selves must go to the gym, but our actions benefit us by increasing our life expectancy to 85. Of course, we could choose to enjoy the taste of a hot-fudge-sunday today, but at the cost of us dying at 55.
By analogy, that is the choice before us.
Competing interests make the choice difficult because of the trade-offs between short term desires and long term impacts. For instance, while technology companies want the theft of their technology stopped, other multinational corporations want the sanctions against China to end so they don’t miss quarterly earnings targets. American workers want jobs, but low-wage competition abroad, technological innovation, and demands for a "living wage" in the United States - even though the products that "living wage" workers create are sold abroad to lower wage markets - make that difficult. The politicians are in a "damned if you do, damn if you don’t" situation. If they support policies that go hard after China, the short-term economic pain of sanctions may so rile their local constituencies that they are voted out of office. If they go the easy route and let China continue to do what it is doing, they cede the future of America - and I believe the liberty of the free world - to an authoritarian nation. A very powerful authoritarian nation... with values antithetical to ours.
President Trump is a frustrating and polarizing figure. On the one hand, he is the only politician in a few decades to call out the abuses done by China. For that, he deserves credit. On the other hand, his bull in a "china shop" style alienates people at home and abroad. For that, he deserves criticism. To my knowledge, he has never given an articulate argument to the American people, nor to other world leaders, on why reining-in China is so important.
Still, I don't deny this is a chaotic mess.
That should not stop us from acting. Remember, we are not asking China to do anything that we don’t expect from other nations. Don’t steal our technology. Don’t subsidize your industries. Don’t stop American firms from competing in your markets. Don’t manipulate your currency. Don’t bully your neighbors and do not do things that cause us to worry that you are planning to "control" the South China Sea.
Economically, I believe the United States is well positioned to inflict great pain on China in an effort to encourage it to behave more appropriately. I say that because of simple math. America exports $178 billion worth of goods to China. China exports $558 billion in goods to the United States. Because China exports more to us than we do to them, they are hurt more by our tariffs on its goods than we are hurt by its tariffs on our goods. In 2018, Trump implemented tariffs on $300 billion worth of Chinese goods. He is threatening to place tariffs on an additional $250 billion worth of Chinese goods. If he does, he is effectively taxing 100% of the goods that China exports to the United States.
China’s total exports to the world are ~$2.5 trillion dollars. That means that the United States represents 20% of China’s export market and that is a big deal. American can really hurt the Chinese economy. If the European Union and Japan were to get onboard, our combined actions would represent 50%+ of China's export market.
And while President Xi is extremely powerful, he has to be sensitive to the economic pain his citizens feel.
China is currently responding to America's tariffs with tariffs on American goods and a bit of currency manipulation. The goal with the yuan's devaluation is to make the yuan to dollar price of Chinese goods so low that, when the currency conversion calculations are done, American businesses and consumers won't even realize that there is a tariff. The problem with this tactic is that a lot of Chinese real estate developers in China have huge, huge, huge loans that are denominated in American currency. That means that as the Chinese government is devaluing its yuan as a reaction to the American tariffs, the Chinese government is creating a domestic constituency in China – one that is very wealthy and powerful – that is screaming in pain as it converts devalued yuan into American dollar when making mortgage payments. I believe we have them by the short-hairs, as a result.
National egos are involved in this and that means this is going to take time. The longer it takes, the more it will hurt. Some people in various segments of America's economy will be hurt badly by this trade war. As a nation, we need to find a way to share that pain and stay the course.
Looking back on my childhood, I can remember being in elementary school when the alarm would unexpectedly start ringing in class. That alarm was a warning that told all of us to dive underneath our desks. Why? It was to teach us how to protect ourselves from the damage caused by an atomic bomb.
Of course, now we are talking nuclear weapons. And there is no real protection.
In researching China for this newsletter, I watched a wonderful 2015 IQ Squared debate on whether there is an inevitable conflict coming between the United States and China. One of the participants, a University of Chicago professor, said that America doesn’t want a war and neither does China. Unfortunately, America is full of human beings that are imperfect. China is full of human beings that are imperfect. Imperfect people do stupid things. He asked the audience to consider America’s 2nd Iraq War as one example. I ask that you look at China’s decades long embrace of communism as another.
In my view, to keep our imperfections in check, we must hold each other to the letter and spirit of the international order on the little things. Like trade. If we do, I believe we make life better for everyone in the long term. If we don't, the stakes become much higher.
My political views are generally on the political right, but Eric Weinstein is a man on the political left who regularly impresses me. He says, "Maybe we need to have an above ground nuclear test every once in a while, just to remind people what is at stake."
Something to consider.
I hope you found this topic interesting. Give me some feedback when you can. If I can be of help, let me know.
Entrepreneur, financial guy, husband and father of two great kids.