AIQ - The Now Normal

Empire states of mind

Is the age of US exceptionalism at an end?

As the world starts to emerge from the COVID-19 pandemic, the US’s position as global hegemon will be under mortal threat from a resurgent China that looks to have escaped the virus relatively unscathed.

The roots of the term American exceptionalism can be traced back to an 1840 book entitled Democracy in America by Alexis de Tocqueville. In it, the French political scientist and historian described the country as “quite exceptional”, having studied the township governments of New England, which had no parallel on his native continent.

It wasn’t until a century later that the trope started to be widely used, by now in reference to the dominant position the US found itself in at the end of the Second World War. By then, it had 80 per cent of the world’s gold, accounted for half of global economic output and had a monopoly on nuclear weapons. That enabled it, in conjunction with its victorious allies, to establish a framework of liberal political and economic rules, overseen by a variety of newly created international institutions.

Before long, the US regarded itself as the global standard bearer of liberal democracy and free-market economics and was looking to export its values around the globe. With the country by now embroiled in a Cold War with the Soviet Union, those efforts often went hand in hand with offers of military support, as it looked to guarantee the security of friendly nations.

Friend or foe

By the early 1990s, with the Cold War ending and the Soviet Union on the verge of collapse, the US’s position as global hegemon appeared assured. So much so, the country began turning its attention to China. President George H. Bush became a vocal advocate for increased trade with China, a country with which the US had no diplomatic ties until President Richard Nixon’s historic visit in 1972.

In the spring of 2000, the US effectively endorsed China’s entry to the World Trade Organization (WTO), which had succeeded one of those global rule-setting bodies it helped found. The hope was that this would encourage Beijing to accelerate economic liberalisation and eventually lead to political reform.

While China has undergone a remarkable economic transformation, political reform has failed to materialise

Things haven’t worked out as planned. While China has undergone a remarkable economic transformation – the country’s economy grew 4,000 per cent in US dollar terms between 1989 and 2019 – political reform has failed to materialise. Far from embracing democracy, in November 2012 China selected Xi Jinping, its most powerful leader since Mao Zedong.

Worse still from a US perspective, Xi has made it abundantly clear he believes China is in a long-term struggle for the crown of global hegemon. In one of his first speeches as leader, he talked of “building a socialism that is superior to capitalism”, whose economic and technological prowess will give it “the dominant position” in world affairs.1

US Secretary of State Mike Pompeo in July said 50 years of engagement with China had failed. “If we want to have a free 21st century, and not the Chinese century of which Xi Jinping dreams, the old paradigm of blind engagement with China simply won’t get it done.”2

China’s economic strength means America now has a far more formidable adversary on its hands than it ever had in the Soviet Union. On current trends, its economy is set to overtake the US’s to become the world’s biggest in less than a decade.3 With a population four times larger than the US, it is even possible to imagine the day China usurps the US militarily. According to the US Department of Defense, China already boasts a bigger navy, while it also has 50 per cent more regular military personnel.4

The COVID effect

The demise of American exceptionalism may be hastened by COVID-19. After all, the US has been one of the worst-affected countries, thanks in part to its chaotic handling of the pandemic as the federal government regularly clashed with state governments over how best to balance safeguarding public health and the economy.

The US has been one of the worst-affected countries

As of December 12, it had recorded 16.4 million infections, or 49,103 cases per million inhabitants, and 299,000 deaths. Ironically, given its origins, the pandemic has wreaked far less damage on China, which has recorded 86,741 infections and 4,634 deaths.5

Although the US economy has held up better than many others, it is still set to contract by around three per cent in 2020, whereas China’s grew by 2.3 per cent. That was well down on its normal level but, driven by a strong second half recovery, still meant that China was the only major economy to be in positive territory for the year. Moreover, the US recovery could be enfeebled once the country emerges from the pandemic. The US fiscal deficit is expected to soar by around $3 trillion in 2020 after Washington was forced to rack up a record amount of debt to support the economy.

A fragmented world

Sir Dominic Asquith of Macro Advisory Partners says the pandemic will lead to an ever more fragmented world, by weakening the US and at the same time stoking fresh nationalist and populist urges.

The reality facing any US administration is the global landscape is going to be realigned

“The next decade is going to see a continuing diminution of US influence and authority. The reality facing any US administration is the global landscape is going to be realigned,” says Asquith, formerly Britain’s top diplomat in India, Libya, Egypt and Iraq.

According to Henry Kissinger, one of Pompeo’s predecessors, the US and China are “in the foothills” of a new cold war.6 Initially, that manifested itself as a trade war, as Donald Trump looked to make good on a campaign pledge to shrink the US’s record bilateral trade deficit with China by slapping tariffs on imports and pressuring US companies to rip China out of global supply chains. Amid signs his policy was backfiring by hurting the US economy, corporations and the stock market, while doing nothing to curb the bilateral deficit, Trump in January 2020 signed a partial trade accord.

However, many commentators always believed the trade war was no more than a sideshow, camouflaging a battle for technological superiority. No sooner had the trade truce been agreed, the US intensified its attack on Chinese technology companies such as Huawei, the TikTok app owned by Chinese internet company ByteDance and Tencent Holdings’ WeChat.

Charles Parton, senior associate fellow at the Royal United Services Institute, a defence and security think tank, says rapid technological advances, together with the fact the distinction between civilian technologies and those used for military purposes is getting ever more blurred, is driving the US and China further apart.

Technological warfare

The US is trying to restrict the flow of technology to China, restructure global supply chains, and invest in emerging technologies at home. For its part, China is racing to develop semiconductors and other core technologies to reduce its reliance on US suppliers.

“It’s clearer than ever that having technological superiority, whether it’s from semiconductors, quantum computing, artificial intelligence or Big Data, translates into geopolitical strength,” says Deutsche Bank’s global head of technology investment strategy, Apjit Walia.

The US and China have long accused each other of using technology to carry out espionage and cyberattacks. Now technology is being blamed for political interference. The head of national counterintelligence for the US government, William Evanina, in August said China was among a number of countries trying to increase discord, undermine the American people’s confidence in the democratic process and sway the outcome of the 2020 election.7

The world’s reliance on technology-enabled connectivity was thrown into stark relief by the pandemic

The world’s reliance on technology-enabled connectivity was thrown into stark relief by the pandemic as employees were forced to work, children to learn, and consumers to shop, online. With technology widely expected to go on playing an ever-bigger part in people’s daily lives and given the growing menace of state-sponsored cybercrime, Walia expects the technology cold war to intensify.

Mikhail Zverev, Aviva Investors’ head of global equities, agrees. He says while Huawei, a privately owned company, has to date been the biggest casualty of this cold war, others are certain to follow. However, investors also need to be on the lookout for other opportunities. Nokia, Ericsson and Samsung Electronics could be beneficiaries of Huawei’s demise, along with US telecoms equipment group Ciena.

“Western telecoms companies are under pressure to strip Huawei out of the core of their 5G networks. Leading players such as Ciena could take a disproportionate share of Huawei’s business,” Zverev says.

“We’re going to build a wall”

While some reckon the ultimate outcome will be two digital ecosystems that to a large extent are incompatible with one another, Deutsche Bank’s Walia believes neither side will be in a hurry to build what he calls a “tech wall”. He estimates that could cost the technology sector as much as $3.5 trillion over the next five years.

“The feedback we’ve had from policymakers and investors is that such a divorce would simply be too painful,” he says. Instead, he predicts a “lukewarm” war as calmer heads prevail, with the US and China taking tit-for-tat measures to block each other’s access to key technologies, at the same time as pressuring other countries to align technologies, such as 5G telecoms networks and the internet, with their own.

Investors are already starting to distinguish between those that are heavily dependent on international suppliers

Aviva Investors’ head of emerging market equities, Alistair Way, says a broader range of Chinese technology companies could be targeted by the US. As a result, investors are already starting to distinguish between those that are heavily dependent on international suppliers and customers that could find themselves in the firing line, and others, such as Alibaba and Tencent, that are more focused on their domestic market.

Echoing Walia’s remarks, he believes a technology war would be far from straightforward for either side to win given many policies are likely to have unforeseen and often adverse consequences. For example, US efforts to damage Huawei have aided Taiwanese semiconductor group MediaTek at the expense of Qualcomm, a US rival.

“Chinese companies are suddenly getting a whole lot more nervous about buying from US chip makers like Qualcomm. Even if Huawei goes out of business, MediaTek and not Qualcomm could hoover up a lot of market share from the Chinese companies that replace it,” he says.

Zverev highlights the prospects for Taiwanese chipmakers such as Win Semiconductor for similar reasons. While it has been hurt as a result of the US banning it from doing business with Huawei, he believes there will be plenty of other Chinese companies knocking on its door.

Battle for control

It is increasingly apparent that a struggle for control of the international rule-making bodies erected after the Second World War lies at the heart of US and China tensions. Many commentators believe China’s ultimate goal is to shape those bodies more to its own liking. Witness its recent appointment to the United Nations Human Rights Council, despite what most in the West consider to be a poor record on human rights.

“It’s using economic leverage and implied threats with smaller nations to get their support. We need like-minded democracies to defend these bodies,” says Parton, a former diplomat who spent 22 years working in or on China, Hong Kong and Taiwan, and advises UK lawmakers.

A struggle for control of international rule-making bodies lies at the heart of US and China tension

Pompeo admitted as much in his July speech. “If we don’t act now, ultimately the Chinese Communist Party will erode our freedoms and subvert the rules-based order that our societies have worked so hard to build… The free world must triumph over this new tyranny,” he said.

He added the US “can’t face this challenge alone” and called for a new alliance of like-minded democracies.

Parton says his remarks make it all the harder to fathom why Washington has spent so much of the past four years “putting off” its natural allies and doing its best to undermine institutions such as the WTO, World Health Organisation (WHO) and NATO, which set the rules-based order Pompeo refers to.

“The US desperately needs to start repairing alliances around the world if it is to have a chance of winning this war over values,” he says.

Return to the fold

US President Joe Biden has signalled his intent to reset four years of isolationist US foreign policy under a new tagline, ‘Restoring American leadership’. He has already begun to reverse Trump’s signature foreign policy decisions by re-entering the Paris climate accord and halting the country’s exit from the WHO.

US hegemony is being challenged in multiple ways as the country struggles to maintain its influence

However, Asquith believes Biden faces an uphill struggle. He sees US hegemony being challenged in multiple ways as the country struggles to maintain its influence. Iran, for instance, is likely to strengthen alliances with Russia, China and others; Russia and Turkey will be ever more confident of flexing their muscles as they look to extend their influence; while an increasingly assertive and ambitious Chinese regime will look to become “much more hegemonic” by operating according to its own rules and standards, not those established by the US.

He says there has been a feeling for some time in countries such as India, Japan and Brazil that leading multilateral institutions needed “de-Atlanticising”. He expects China to tap into this sentiment, sending a message to the US it has “the capability and the will to generate alternative groupings” if it blocks reform.

Asquith says China will simultaneously look to apply economic leverage to encourage others to adopt its rules and standards. Although Russian President Vladimir Putin is wary of giving too much away in his dealings with China, there is every chance Russia will adopt China’s 5G technology. That would be “massively important”.

Great-power overreach

Stephen King, senior economic advisor at HSBC, former specialist advisor to the House of Commons Treasury Committee, and author of the 2017 book Grave New World: The End of Globalization, the Return of History, also believes the days of American exceptionalism are drawing to a close.

Just as China is expanding its influence via programmes such as the Belt and Road Initiative, the US probably knows it cannot maintain its clout in lots of different parts of the world indefinitely, he says.

“If you look at the rise and fall of great powers, it strikes me the US has got to the point of what you might call great-power overreach. It is now left to wonder how far it can go before it is forced into some kind of retreat and has to find space for China to operate,” says King.

The US has not spent a single day at peace, making it the most warlike nation in the history of the world

In April 2019, former US President Jimmy Carter said much of China’s success was down to its peaceful foreign policy. He noted China had not once gone to war since 1980, whereas the US, with troops deployed in 150 countries, had not spent a single day at peace, making it “the most warlike nation in the history of the world”.8

“It [US war spending] is more than you can imagine… China has not wasted a single penny on war, and that’s why they’re ahead of us. In almost every way,” Carter said.

According to a November 2018 study by Brown University’s Watson Institute of International and Public Affairs, the US has spent $5.9 trillion on military operations in Iraq, Syria, Afghanistan, Pakistan and other nations since 2001.9 China, meanwhile, poured more cement in just three years than America did in the entire 20th century.10

If the US’s position as the world’s undisputed hegemon is ending, predicting what comes next is less straightforward. A survey of global investors by UBS in January 2020 found 57 per cent expected China to replace the US as the world’s biggest superpower by 2030.11

However, others believe it is premature to reach that conclusion. Even if China’s GDP does surpass the US’s in the next decade or so, Parton says the headline GDP numbers mask some worrying trends, notably worsening water shortages in the north of the country; deteriorating demographics; poor educational attainment across large swathes of the population; low productivity; and rising debt. According to the Institute of International Finance, China’s debt was on course to hit 335 per cent of GDP at the end of June, putting it on a par with the US.12

Besides, China has a long way to go before it could be considered a wealthier nation. As of 2019, average GDP per capita was just over $10,000, compared with $65,000 in the US. Most important of all, its authoritarian system means it would find it difficult to pick up the mantle as the world’s leader if it wanted to. There is no indication it wants to, however.

A bi-polar world

Instead, many believe it is more likely the world divides into two blocks that over time become ever more distinct, with China and the US vying to seduce other nations into their sphere of influence. For instance, Parton and King believe that in the wake of the pandemic, China may accelerate efforts to pick off cash-strapped nations with its Belt and Road Initiative, as it did last year with Italy and Greece.

It is more likely the world divides into two blocks that over time become ever more distinct

Asquith says this will present a dilemma to many countries, especially in Europe and Asia, which will be reluctant to pick sides. He cites India as a “classic” example.

“It already feels surrounded by China and is desperate to ensure there is no Russia-China clinch. Despite having a live border dispute with China, India will certainly resist being formally aligned to the US,” he says.

While many other countries will be happy to continue relying on the US for security, they will be loath to give up their economic ties with China in a hurry. According to IMF data, 138 out of 202 nations already trade more with China than the US, while China provides a bigger export market for 84.13 For some countries, the answer may be to strengthen regional alliances or form closer collaboration with other like-minded nations further afield as a means of growing their clout.

Given the level of mistrust between the US and China, some scholars have warned the two nations could be heading for military conflict. American political scientist Graham Allison of Harvard University says China’s ascent is reminiscent of Germany’s a century earlier, which ultimately led to World War One.

However, Parton and Asquith say while China’s relations with neighbouring countries, in particular Taiwan, are an ever-present source of concern, all-out conflict between two nuclear powers is unlikely. After all, with their economies so heavily intertwined, the US and China have even more reason to avoid war than the US and the USSR did during the original Cold War.14

Market implications

The end of American exceptionalism is likely to have sizeable ramifications for financial markets. For a start, the current abundant demand for dollar assets depends heavily on the vast trade and financial system built up by the US following World War Two. If that begins to be dismantled, it raises questions over the ability of US companies and the US government to borrow as easily from foreigners as they have been accustomed to.

Whether this eventually leads to the US dollar losing its status as the world’s reserve currency is another matter. “While that is plausible, it looks to be a long way off. If you really believe the dollar’s in trouble, then it’s chaos you should expect, not the sudden arrival of a new shiny currency,” King says.

COVID has reduced to tatters the illusion of American exceptionalism

In an August 2020 op-ed for Rolling Stone magazine, Wade Davis, a Canadian-US anthropologist who works at the University of British Columbia, wrote: “COVID has reduced to tatters the illusion of American exceptionalism.” He was referring to the damage done to the US’s reputation and international standing by its chaotic handling of the crisis.15

However, the pandemic looks to have weakened the country in an equally important way, by causing a massive increase in inequality. While millions of Americans were losing their jobs and turning to the government for help, the richest were seeing their wealth soar. According to Bloomberg, the 50 richest people in America have seen their wealth grow $339 billion since the start of 2020 and are now worth almost $2 trillion, as much as the poorest 165 million.16

Such unprecedented levels of inequality have led to deep schisms emerging in recent years in American politics. By making the country increasingly hard to govern, they are undermining its ability to lead on the world stage. Billionaire investor Ray Dalio in November 2019 called on US politicians to declare the growing wealth gap a national emergency and take urgent steps to address it or face the prospect of a violent revolution where “we are all going to try to kill each other”.17

In his 1840 book, de Tocqueville marvelled at the ability of American people to govern themselves responsibly and prudently, and above all to preserve their own liberty. The chaos surrounding the recent presidential election adds to the feeling the era of American exceptionalism is in its final death throes, irrespective of the president in office. There is a lot riding on what comes next.

Investing in the age of rising us-china tensions

With US-Sino relations growing ever more fractious as the two nations vie for global dominance, it is increasingly likely the world’s two leading economies will start to decouple.

What started out as a trade war has already morphed into a battle for technological supremacy with the US attempting to thwart Chinese efforts to overtake it in several areas, most notably semiconductors.

As China extends its sphere of influence and challenges the global economic order established by the US after the Second World War, other nations may have to choose sides. That could have major implications for their economies and companies.

Sunil Krishnan, Aviva Investors’ head of multi-asset funds, says a growing number of countries are falling within China’s economic sphere. He sees that trend continuing as the US, with few clear and bipartisan strategic ambitions for foreign policy, finds it increasingly difficult to project its power overseas.

“With diplomatic pressures being brought to bear on them, third-party countries are treading a tightrope, and investors need to be on the lookout for nations occasionally struggling to keep their balance, as we have seen between Australia and China,” he says.

Michael Grady, Aviva Investors’ head of investment strategy and chief economist, agrees. “What we saw between China and Australia was in some ways no different to the breakdown in relations between China and the US, but the reality is China can inflict a lot more pain on Australia,” he says.

Although few countries will want to have to pick sides between the US and China, Grady argues the issue would be especially acute in Europe.

“If Europe had to choose sides, it’s hard to know which way it would go. From an economic growth perspective, the export growth markets for Europe are in China and southeast Asia, not the US,” he says.

As part of its efforts to retain technological superiority, the US has looked to weaken several Chinese technology companies such as Huawei. Grady says China’s “fairly restrained” response to date reflects its ability to play a long game. He believes it has been weighing up its options as it awaits the direction charted by a new US administration.

However, he believes it is unlikely to be so restrained indefinitely. Beijing has already threatened to block the export of rare earths, a vital component in the manufacture of multiple high-tech products, while its ultimate weapon would be to prevent US multinationals from operating in what has become a key market for many.

“China’s now a very big market for a lot of US companies. If relations continue to worsen and the two economies separate, some US multinationals could start to see themselves unable to do business in China,” Grady says.

The decoupling of the US and Chinese economies is already beginning to make life difficult for some firms. Credit portfolio manager Chris Higham says British banks HSBC, and to a lesser extent Standard Chartered, are two companies being caught in the crosshairs of the conflict.

“HSBC’s in a difficult position. It may need to either pick Europe and the US or China and Asia, which after all is where all the growth is. At the moment, it’s got three legs, but if it’s forced to split up and you’re only left with one or two legs, it’s unlikely to be as good a credit,” he says.

Krishnan says investors ultimately need to be on their guard against the risk that the souring of relations between the two superpowers spills over into military conflict. While that seems unlikely at present, the mere threat of it would be enough to unsettle markets.

Aviva Investors’ head of emerging market equities, Alistair Way, sees a risk that, as China begins to flex its muscles by taking a more hawkish tone on Taiwan, it could start to damage Taiwanese companies.

“Taiwanese firms such as TSMC, its flagship semiconductor company, could be in an awkward position. It really doesn’t want to have to choose sides, but it might have to. It has had fantastic results, but it feels like investors may want to start factoring in the risk of increased pressure from China,” he says.

Giles Parkinson, global equity portfolio manager, agrees. “Some people may say this is the new Intel for the next 20 years, but its assets are pretty much all in Taiwan. I don’t pretend to know what happens between Taiwan and China, but I do know if those two countries ever enter armed conflict, that share price could go down an awful lot.”

References

  1. Tanner Greer, ‘Xi Jinping in translation: China’s guiding ideology’, Palladium Magazine, May 31, 2019
  2. Mike Pompeo, ‘Communist China and the free world’s future’, U.S. Department of State, July 23, 2020
  3. ‘Military and security developments involving the People’s Republic of China 2020: Annual report to congress’, US Department of Defense, 2020
  4. ‘COVID-19 coronavirus pandemic’, Worldometer, 2020
  5. ‘Kissinger says US and China in 'foothills of a Cold War'’, Bloomberg, November 20, 2019
  6. ‘Statement by NCSC Director William Evanina: Election threat update for the American public’, Office of the Director of National Intelligence, August 7, 2020
  7. Brett Wilkins, ‘Jimmy Carter: US 'Most warlike nation in history of the world'’, Common Dreams, April 18, 2019
  8. ‘$5.9 trillion spent and obligated on post-9/11 wars’, The Watson Institute for International and Public Affairs at Brown University, November 16, 2018
  9. Niall McCarthy, ‘China used more concrete in 3 years than the US used in the entire 20th century’, Forbes, December 5, 2014
  10. ‘China will replace the US as the world’s biggest superpower by 2030: UBS survey’, Wall Street Reporter, January 24, 2020
  11. ‘Global Debt Monitor: Sharp spike in debt ratios’, Institute of International Finance, July 16, 2020
  12. ‘GDP per capita (current US$)’, World Bank, 2020
  13. ‘Direction of Trade Statistics (DOTS)’, International Monetary Fund, 2020
  14. Graham Allison, ‘The thucydides trap: Are the U.S. and China headed for war?’, The Atlantic, September 24, 2015
  15. Wade Davis, ‘The unraveling of America’, Rolling Stone, August 6, 2020
  16. ‘The 50 richest Americans are worth as much as the poorest 165 million’, The Mercury News, October 8, 2020
  17. ‘Ray Dalio: tackle inequality or face a violent revolution’, Financial Times, November 5, 2019

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