The cost of dominance

Original Content: AXA IM

Key points

• The high level meeting between US and Chinese officials last week was acrimonious. The real issue is dominance. Old cold war concepts are en vogue again. There are crucial limits to those historical precedents, but the macroeconomic ramifications of a superpower clash are significant.

Beyond the immediate challenge of the pandemic, the US-China relationship is the main source of global instability. On this front, the newsflow is not encouraging. The meeting in Anchorage between the US Secretary of State and National Security Advisor with their Chinese counterparts did not start well. Antony Blinken raised the human rights issues in Hong Kong, Tibet and Xinjiang, as well as Beijing attitude to Taiwan. The Chinese side accused the US of condescension, questioned Washington’s own record on human rights, but the key statement by Yang Jiechi was that the US does not have the qualification to say that it wants to speak to China from a position of strength. The real issue is dominance.

Comparisons with the cold war between the US and the USSR are made more frequently in the US. We note some nostalgia for the Reagan era, when the US managed to exhaust their strategic competitor in a ruinous spending spree on military capability. We think the comparison is misleading. The Soviet economy was stagnating well before the competition with the US intensified in the 1980s, and the asymmetry in economic power was massive by then, while China continues to catch up quickly with the US. Beijing is drawing on the dividends on strong economic growth to upgrade its military power without sacrificing its other priorities.

Joe Biden’s National Security Advisor Jake Sullivan quipped that the US should focus less on slowing China down and more about the US running faster themselves. This is where Biden’s foreign policy meets his domestic agenda. His big investment plan is designed to preserve the US technological leadership. This may work and deal with secular stagnation. After all, the competition with the USSR underpinned the space programme which produced some key innovations and contributed to the development of the High-tech sector in the US.

Still, securing geopolitical dominance comes with a macroeconomic cost. The rise in US military spending under Reagan fuelled a persistent fiscal deficit and dependence on foreign investors which prolonged the phase of high real interest rates ushered in by Paul Volker’s monetary tightening. Joe Biden is helped by an accommodative Fed, but he also found a very deteriorated twin deficit position to start with. The ongoing rise in market interest rates is a warning shot. Beijing may consider that the US will not have the wherewithal to walk the talk, but a lesson from the old cold war is that overconfidence on either side is dangerous.