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Unrestricted, All Domain Warfare

China has been executing an unrestricted, all domain war against the United States for decades. We review select methods and effects.

By Chris Recker  ▪  August 29, 2019
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"There cannot be two suns in the sky, nor two emperors on the earth."

Confucius

"tao guang, yang hui" => "bide time, build your capabilities"

Proper translation: overturn the tyrant's hegemony, exact revenge

Warring State Proverb cited by China's hawks and explained by Michael Pillsbury

Below we briefly summarize why China looms so large. We rely heavily on Michael Pillsbury's "The Hundred-Year Marathon" and "Unrestricted Warfare" by People's Liberation Army (PLA) Colonels Qiao Lang and Wang Xiangsui. Though they are a fraction of the material we have reviewed with respect to the situation, they are rich sources of material. We recommend you read them.

When investing globally or considering the impact of trade wars, we believe accounting for the broader picture is essential to informing decisions. Many U.S. companies are targeting growth in China as critical to their long term prospects. For consumer companies like Nike, Starbuck's or luxury goods brands whose products are terrific and less strategically important to national security, these may be effective approaches to growth. Critical technology, industrial and healthcare companies who are advanced manufacturers are facing different calculations entirely. For index investors, dynamics in China may have material effects on large multinational corporate earnings growth. Since Europe exports so much to China, any slowdown there could rollback onto the Continent.

Why is the U.S. market so important for China's economy? By our back-of-the-envelope calculations, as much as 20% of the Chinese economy could be tied to its trade surplus with the United States. China is a net energy and food importer along with other critical material inputs so it needs U.S. dollars to keep its economy humming. What happens when the United States determines that China is a threat to its existence and targets trade and dollar funding? If nearly 40% of China's oil imports come from the Persian Gulf and the Strait of Hormuz shuts down, what does that imply for the Chinese economy? And, Europe? We believe it is important to take a step back and understand why this conflict between the U.S. and China is so serious and whether either side can even come to an agreement.

China Intentions: They (have) (continue) will hit the West

When the West reaches consensus that China's game is to rule the world, China plans to attack American weaknesses and subdue it. At some points in history, national security trumps economics. No pun intended. After allowing China to build tremendous global manufacturing imbalances, technology acquisition and military expansion, the West and its allies are at one of those critical points in history. Do or die.

In our view, capabilities breed intentions. In China's case, the Chinese Communist Party and the PLA in their words and actions have made their intentions clear: Tianxia. A Chinese empire with 'all-under-heaven' dominated by a Chinese tyranny. (When China calls out U.S. hegemony the proper translation and their meaning is U.S. tyranny.) China's rulers see their manifest destiny as rulers of the world with all barbarian non-Chinese under their submission.

This fact could have tremendous implications for profits, economic growth, interest rates and survival. Let's start.

China Military Parity

A team at the Rand Corporation has built a scorecard depicted below that plausibly maps Chinese capabilities and their evolution toward parity with the United States. When our commander in the Indo-Pacific names China as the No. 1 adversary to the U.S., he is serious, deadly serious.

But analysts have reported that China only values its military power at about 10% of their comprehensive national power estimate. Economic and technological power matter more.

https://www.rand.org/paf/projects/us-china-scorecard.html

Techonomic Warfare

Encirclement or wei qi (the game of "Go") using deception has been at the heart of all Chinese actions toward the United States and its allies. "Peaceful rise", "takings its rightful place", "we are a poor country" are all lies and deceptions meant to lull corporate executives, politicians and military leaders into the false belief that Chinese intentions are benign.

Lies are talk, money walks.

The money is in the Chinese mercantilist macro game using the subsidies of currency and cheap credit. The micro game utilizes slave labor and environmental regulatory arbitrage plus low cost infrastructure. In addition to industrial espionage, the government ties forced technology transfers for access to the Chinese market. As a result, U.S. corporations have amassed industrial capacity with $200 billion to $400 billion of sales to the U.S. in China proper. Furthermore, U.S. subsidiaries in China have more than $200 billion in sales. This has purchased a China lobby in boardrooms and executive suites in U.S. multinationals and mega-banks--you can see them complaining about tariffs on financial TV.

China's intelligence approach is death by a million cuts. Chinese cut-outs are being educated at our top universities and employed in Silicon Valley and other tech centers likely stealing trade secrets and technology in the areas of military know-how, artificial intelligence, supercomputing, biotech and other cutting edge research. They use private equity and venture capital firms as fronts to acquire critical tech and relocate it to China. Cybertheft is another effort entirely. This has resulted in a massive increase in Chinese tech prowess.

Manufacturing Game: Deceive, Co-Opt, Subvert

In the 1990's China's first open shot in the economic war occurred when it devalued the yuan massively. Co-opted, one of the largest U.S. retailers then demanded that U.S. suppliers meet the Asian price. This sounded the death knell for U.S. factory production and a boon for China. When China joined the WTO in 2001, factory closings in the U.S. accelerated. Some estimate that since the mid-1990's between 50,000 and 70,000 American factories have closed losing 5 million manufacturing jobs and potentially another 10 million in related support jobs.

Partially financed by U.S. corporations China gained tens of millions of jobs, trade secrets and production capacity. By playing off of short term thinking and greed, the Chinese Communist Party fooled the Americans into building up an enemy.

Subsidies flow through state owned banks who provide cheap credit fueling investment in infrastructure and manufacturing capacity below the cost of Western competitors. As part of the CCP/PLA strategy state-owned enterprises could obtain below market loans and/or operate at losses to strategically drive out Western competitors in critical industries providing material and components to defense, technology, resources and pharmaceutical industries.

The goods trade deficit is a proxy for the hollowing out of U.S. manufacturing. Since the Global Financial Crisis, the U.S. has mitigated this deficit by becoming the largest oil and gas producer in the world nearly eliminating the need to import oil and gas on a net basis.

Now that the CCP has taken over key U.S. industries, it is going after the most advanced areas of U.S. advantage. China 2025 is a coup de grace that targets what remains of U.S. and European advanced manufacturing. This appears to be a key point in current trade negotiations. We doubt China ever cedes the point in anything but writing.

Capabilities Lead to Expansion: Building Land and Naval Power Projection

The Chinese Belt and Road Initiative is a plan to build global access. One might term it "Build Routes for Invasion". On the surface, this effort is meant to radically reduce shipping times from East Asia to Western Europe. This will flood the West with cheap, subsidized goods and is aimed at the heart of manufacturing in Germany, Italy and France while cutting out North America entirely. It has the added benefit of quickly moving armies and material over vast expanses. In other words, it is China's map for global power projection as a land power.

Was this the Genghis Khan's campaign map?

Source: Mercator Institute for China Studies
https://www.merics.org/en/bri-tracker/mapping-the-belt-and-road-initiative

China's encirclement initiatives conveniently align with global maritime choke points. Note their involvement in Venezuela located near the Panama Canal and Exxon's recent oil finds off Guyana that Venezuela claims. The United States blocked Chinese efforts to build multiple airports on Denmark controlled Greenland.

Global Energy Transportation Choke Points
Source: Energy Information Administration

China expands in the South China Sea and is building a global footprint of military bases beginning in the artificial reefs of the South China Sea to Cambodia to the Horn of Africa. Chinese territorial claims far outpace internationally recognized norms.

Source: CIA

To enforce these claims and move to control out to the second island chain, China is building a multitude of missile capabilities and military launch points throughout the South China Sea, while challenging Japan, South Korea, Vietnam and the Philippines in their respective waters and territories.

Racist Ideology

Most (over 90%) Chinese are Han. Thus when one mentions a Han racist ideology held by the CCP/PLA leadership, it is almost synonymous with a Chinese purist view of the world. This fits into tiangxi's heaven's mandate and is consistent with oppression of Tibetans and Uighurs (pictured in a re-education camp below). This intolerance extends to all barbarians or non-Chinese.

Source: Al Jazeera
https://www.aljazeera.com/indepth/features/escape-xinjiang-muslim-uighurs-speak-china-persecution-180907125030717.html

The Assassin's Mace and Profits

Clearly, the symbiotic relationship between U.S. corporations and the Chinese model has resulted in higher profits as margins are up significantly since China engaged in this economic war. Breaking with China while maintaining profitability is a key concern for many executives and creditors. Hundreds of billions of profits could be at risk for U.S. corporations. This wall of money is influencing the U.S. response to Chinese actions and buying time for the People's Liberation Army.

In addition to a military buildup, technology advances and geographic expansion, the Chinese are increasing asymmetric capabilities that can eliminate U.S. strengths in space, power projection and nuclear triad. Thus, we end with the "Assassin's Mace" in Chinese mythology. Think David and Goliath. Michael Pillsbury describes it as "the trump card that ensures victory over a powerful opponent."

Have the Chinese acquired their Assassin's Mace, yet? For example, sometime in the future Russia's nuclear powered submarine drones could use advanced sensors and AI to autonomously track our submarine force and destroy it by detonating megaton weapons in each boat's vicinity. Concurrently, a swarm of hypersonic missiles and carrier killers could hit our strategic bombers, land based ICBM silos and carrier strike groups. This would allow a nuclear strike on the United States without the threat of significant retaliation. In a decade or less, China could roll into the North American landmass and possess the best territory on the planet. Who would or could challenge them, then? How much will anyone care about S&P 500 profits?

Have we developed countermeasures to stop the CCP/PLA endgame? Are we our own worst enemies?

Markets will have to begin pricing the odds of more significant confrontation between these competing forces. Bond markets have already embarked on this path...equities not so much.

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Chris Recker
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