The Coming War With China

Somehow, like it or not, the world turns. Today’s hegemon becomes tomorrow’salso-ran. Today’s reserve currency becomestomorrow’s toilet paper. Today’s cock o’ the walk becomes tomorrow’s dinner.

Hey, we didn’t create this system. We don’t even especially like it. But that’s just the way it is.

Whether you already have made a fortune, or are trying to build one, you need to be very careful about what currency… or currencies… your wealth is denominated in.

The End of History?

Governments were set up to take control. Ruling elites – by force of arms – established laws, protocols and armies to try to prevent anyone from taking their place.

Their wealth, power and status were to be preserved at all costs. But in the 18th and 19th centuries, firearms started to become ubiquitous. It was harder for elites to maintain their authority over the masses.

Every farmer on the American frontier had a rifle. A ragtag band of insurgents in the American colonies (with the help of the French Navy) could defeat the best army in the world. An out-of-work actor could buy a handgun and pop off a president.

Unable to stay in control by force alone, governments had to resort to fraud. Ordinary citizens were allowed to vote on who would rule over them. They were also promised the fruits of others’ labors, if they voted the right way.

For a time, it looked as though this new model – social democracies run by flaming politicians and professional functionaries – had defeated all rivals.

The Soviet Union – which relied on more old-fashioned blunt force to run its slave-driven economy – fell in about 1991.

Maoist China had thrown in the towel, more or less, 10 years earlier when the country’s “paramount leader,” Deng Xiaoping, announced, “To get rich is glorious.” (Historians now claim he never uttered those words. But they accurately captured his vision for China.)

And Francis Fukuyama – hallucinating – wondered if the “end of history” was at hand.

If the end of history were at hand, the dollar, the Fed and federal finances would have nothing to worry about. But between history and the greenback, if we were taking bets, we’d put our money on history.

Most likely, history will trundle forward. And the dollar will be knocked off its perch as the world’s leading currency sometime before the 21st century comes to a close.

But how exactly will that happen?

No one knows. But few imperial elites give up the No. 1 position without a fight. As they see their power, their status and their wealth challenged, they typically find a casus belli, hoping to stomp the newcomer before it is too late.

The End of History?

The phenomenon is known to historians as the “Thucydides Trap.” Political scientist Graham Allison explains:

When a rapidly rising power rivals an established ruling power, trouble ensues. In 11 of 15 cases in which this has occurred in the past 500 years, the result was war.

The great Greek historian Thucydides identified these structural stresses as the primary cause of the war between Athens and Sparta in ancient Greece.

In his oft-quoted insight, “It was the rise of Athens and the fear that this inspired in Sparta that made war inevitable.”

Note that Thucydides identified two factors: a rising rival and fear of that rise. China is rising. The US power elite fears its rise.

And for good reason: Having the world’s reserve currency is an “exorbitant privilege,” as former French president Charles de Gaulle described it.

It allows Americans to buy things from overseas without ever really paying for them. Instead, we send over pieces of paper that we create ex nihilo. That paper is then sent back to the US to buy Treasury bonds and other dollar-denominated assets.

From an economic point of view, the system (established by Richard Nixon in 1971) is loopy.

The Chinese pretend they have good customers. Americans pretend they have good credit. And everyone pretends to get richer… based on promises to settle up sometime in the future.

In practice, nobody wants the day of reckoning to come. Because they all know that there are vastly more claims on tomorrow’s output than tomorrow can satisfy.

Between 1971 and today, roughly $10 trillion more has been received by Americans in goods from overseas than has been shipped to foreigners. That money is an outstanding claim on US existing wealth and future output.

There is also (with some overlap) about $17 trillion worth of US government debt – also a claim on future American output. And this is just part of the total credit market debt of $55 trillion.

And that’s not to mention Washington’s unfunded liabilities…

Editor’s note: Boston University professor Laurence Kotlikoff recently told Bonner & Partners Investor Network subscribers that America’s “fiscal gap” – the difference between Washington’s projected financial obligations and the present value of all its projected future tax income – is a mind-boggling $210 trillion. That’s about 211% of US GDP. (You can find out more about this shocking situation here.)

To honor these claims, the US would have to run a budget surplus. (When? How?) But instead of running a surplus, we run deficit after deficit.

Edging Toward a Reckoning

Instead of edging toward a reckoning, all major governments seem to want to make the situation worse.

The US stimulates its people to buy more Chinese-made goods. And China stimulates its manufacturers to make more stuff for people who can’t really afford it. Both are heading for trouble.

Americans are hooked on spending. They consume their wealth… and more.

China is hooked on producing. As it adds productive know-how and capacity, it becomes more and more competitive. Not only can it produce more consumer gadgets at lower prices, but also it can produce the latest in military hardware.

It’s a matter of time before that fighting gear comes out. At least, that’s what history suggests.

If there is a military conflict, how will it turn out?

The US spends three times more than China on “defense.” Advantage: Pentagon. But as the Persians discovered in their wars with the Greeks, having the biggest, best-funded army does not necessarily give you an edge. Instead, it can invite sluggishness, complacency and overreaching.

The US military is the fattest, most zombie-infested bureaucracy in the world. It suffers from an overabundance of resources. It supports troops (at a cost of $1 million per soldier per year) all over the globe.

It builds weapons systems that are often obsolete before they are put into service. It coddles armies of lobbyists, contractors, consultants, retirees, hangers-on and malingerers.

Like all bureaucracies, it looks out first and foremost for itself. Looking out for the security of the nation is a distant second.

America’s 10 huge aircraft carriers, for example, may be marvelous ways to generate contracts, fees and expenses. They may also be great ways to throw US military muscle into two-bit conflicts around the world.

But put them up against a modern, electronically sophisticated enemy… Then what?

We will probably find out…

Reprinted with permission from Bonner & Partners.