TINOS, Greece, Feb 14 (Reuters Breakingviews) – The prospect of mutually assured destruction (MAD) helped avert nuclear conflict during the Cold War. Hopefully, fear of the economic equivalent will do a similar trick when it comes to a showdown with China. Still, the shooting down of a suspected Chinese spy balloon, which has led to a breakdown in diplomatic relations, is a reminder that errors can happen.
To see whether MAD will be enough to prevent war between America and China, look at just how disastrous such a conflict – which could be triggered by a Chinese invasion of Taiwan – would be.
Even before America shot down the balloon, the United States and its allies had been preparing for a possible confrontation. They became increasingly concerned after China and Russia pledged a “no-limits” friendship just before President Vladimir Putin invaded Ukraine.
America is already trying to degrade Chinese military capacity while making itself less dependent on imports from the country. Similarly, the People’s Republic is trying to avoid overdependence on the United States.
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So far, America has embraced three main initiatives. It has imposed export controls to stop China getting access to high-end semiconductors. It is subsidising its own high-technology and green industries. Finally, it is pushing “friendshoring” to build supply chains of critical raw materials such as rare earths and equipment such as solar panels in friendly countries. President Joe Biden has had some success in persuading European and Asian allies to go along with these policies.
Further steps along similar lines seem inevitable. America is poised to introduce new restrictions on U.S. companies funding the development of advanced computing technologies in China, according to the New York Times. Some members of Congress want to extend export controls to other sectors such as biotechnology. In both cases, the United States will want its key allies on side; otherwise sanctions will be too easy to evade.
Paul Tucker, author of “Global Discord” and a former deputy governor of the Bank of England, adds that the West should seriously consider ring-fencing the subsidiaries of Western banks in China to minimise financial contagion if the shutters come down.
A Chinese invasion of Taiwan would lead to economic repercussions of a totally different order. But their exact nature depends on how the military conflict evolves. Tucker says it’s useful to think of three scenarios.
First, assume that China wins easily or faces no resistance. America would then be worried that its other allies in the region, such as Japan and South Korea, would come under pressure to switch their allegiance to the People’s Republic. The United States might respond with crushing sanctions on China. But this would only be worth doing if its allies thought America really would stand by them – and, in this scenario, its credibility would be low as it wouldn’t have managed to protect Taiwan.
Second, America could also go all-in with economic sanctions if China’s invasion gets stuck. It might do this because it thought that damaging China economically would cause the People’s Republic to backtrack. Although the military scenario would be very different from the previous one, the economic response would be similar.
Third, imagine China is unable to complete a rapid takeover of Taiwan but this time the economic response is targeted. This is more or less what happened following Russia’s invasion of Ukraine. America and its allies have imposed financial sanctions and export controls while trying to cut the price Russia can get for its hydrocarbons. But they haven’t entirely frozen economic relations. America might choose this option because it wanted to limit the damage to its own economy – or because it was unable to persuade key allies, whose economies are even more intertwined with China’s, to go along.
DIFFERENT CIRCLES OF HELL
In Dante’s inferno, the poet visits the different circles of hell, each one worse than the other. A Chinese invasion of Taiwan would be hellish, but some scenarios would be especially ghastly from an economic perspective.
The first circle might involve sanctions over trade in strategic goods. America and its allies would stop any remaining exports of militarily useful equipment. China could retaliate by stopping exports of rare earths, pharmaceutical ingredients and green technology.
The second circle might be a freeze on China’s $3.2 trillion in international reserves. The People’s Republic could retaliate by confiscating $1.9 trillion of Chinese assets and $1.2 trillion of portfolio investments held by foreigners, while instructing Chinese companies to stop servicing $2.7 trillion in external debt, according to a report by Hung Tran, a senior fellow at the Atlantic Council.
The third circle could be to cut off even nonstrategic trade between America’s allies and China, with the exception of basic necessities such as food and oil. This would cause a deep global recession. Despite widespread talk of economic “decoupling”, trade in goods between the United States and China last year reached a record $691 billion.
The fourth circle would include the U.S. Navy blockading Chinese imports of seaborne oil. This would be hugely risky. “A hydrocarbon blockade might tip into an all-out war, not excluding a nuclear war”, says Tran.
Quantifying the hit of any of these scenarios is a fool’s game. But it is worth remembering that the Chinese economy is 10 times larger than Russia’s, and that the invasion of Ukraine has delivered an economic shock to the globe even though Moscow hasn’t faced the full slate of possible sanctions.
Despite all these concerns, America might run the risk of economic war. After all, China is more vulnerable to sanctions, says David Dollar, a senior fellow at the Brookings Institution. On the other hand, the pain threshold of America and its allies might be lower than China’s – and once the rivals entered the first circle of hell, they could be sucked deeper in a vicious spiral.
This prospect should be sufficiently terrifying for both sides to pull back from confrontation. But it’s not a guarantee and wise diplomacy will also be needed.
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Editing by Peter Thal Larsen and Streisand Neto
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