Wait, you’re saying that investing in the other side in the early phase of Cold War II might have been a bad idea? You’re telling me that “long totalitarianism” was not a smart trade? The big losers from Xi’s tyranny and the Cold War that he is waging will be those Western investors who foolishly believed that Chimerica could survive not only a global financial crisis made in America, but also a global health crisis made in China.
BY NIALL FERGUSON FOR NIALLFERGUSON.COM
For the past three years, I have been trying to persuade anyone who would listen that “Chimerica” — the symbiotic economic relationship between the People’s Republic of China and the United States of America, which I first wrote about in 2007 — is dead. The experience has taught me how hard it can be for an author to kill one of his own ideas and replace it with a new one. The facts change, but people’s minds — not so much.
Chimerica was the dominant feature of the global economic landscape from China’s accession to the World Trade Organization in 2001 to the global financial crisis that began in 2008. (I never expected the relationship to last, which was why I and my co-author Moritz Schularick came up with the word: Chimerica was a pun on “chimera.”) At some point after that, as I have argued in Bloomberg Opinion previously, Cold War II began.
Unlike with a “hot” war, it is hard to say exactly when a cold war breaks out. But I think Cold War II was already underway — at least as far as the Chinese leader Xi Jinping was concerned — even before former President Donald Trump started imposing tariffs on Chinese imports in 2018. By the end of that year, the U.S. and China were butting heads over so many issues that cold war began to look like a relatively good outcome, if the most likely alternative was hot war.
Ideological division? Check, as Xi Jinping explicitly prohibited Western ideas in Chinese education and reasserted the relevance of Marxism-Leninism. Economic competition? Check, as China’s high growth rate continued to narrow the gap between Chinese and U.S. gross domestic product. A technological race? Check, as China systematically purloined intellectual property to challenge the U.S. in strategic areas such as artificial intelligence. Geopolitical rivalry? Check, as China brazenly built airbases and other military infrastructure in the South China Sea. Rewriting history? Check, as the new Chinese Academy of History ensures that the party’s official narrative appears everywhere from textbooks to museums to social media. Espionage? Check. Propaganda? Check. Arms race? Check.
A classic expression of the cold war atmosphere was provided on July 1 by Xi’s speech to mark the centenary of the Chinese Communist Party: The Chinese people “will never allow any foreign force to bully, oppress, or enslave us,” he told a large crowd in Beijing’s Tiananmen Square. “Anyone who tries to do so shall be battered and bloodied from colliding with a great wall of steel forged by more than 1.4 billion Chinese people using flesh and blood.” This is language the like of which we haven’t heard from a Chinese leader since Mao Zedong.
Most Americans could see this — public sentiment turned sharply negative, with three quarters of people expressing an unfavorable view of China in recent surveys. Many politicians saw it — containing China became just about the only bipartisan issue in Washington, with candidate Joe Biden seeking to present himself to voters as tougher on China than Trump. Yet somehow the very obvious trend toward cold war was ignored in the place that had most to lose from myopia. I am talking about Wall Street. Even as China was ground zero for a global pandemic, crushed political freedom in Hong Kong and incarcerated hundreds of thousands of its own citizens in Xinjiang, the money kept flowing from New York to Beijing, Hangzhou, Shanghai and Shenzhen.
According to the Rhodium Group, China’s gross flows of foreign domestic investment to the U.S. in 2019 totaled $4.8 billion. But gross U.S. FDI flows to China were $13.3 billion. The pandemic did not stop the influx of American money into China. Last November, JPMorgan Chase & Co. spent $1 billion buying full ownership of its Chinese joint venture. Goldman Sachs Group Inc. and Morgan Stanley became controlling owners of their Chinese securities ventures. Just about every major name in American finance did some kind of China deal last year.
And it wasn’t only Wall Street. PepsiCo Inc. spent $705 million on a Chinese snack brand. Tesla Inc. ramped up its Chinese production. There were also massive flows of U.S. capital into Chinese onshore bonds. Chinese equities, too, found American buyers. “From an AI chip designer whose founders worked at the Chinese Academy of Sciences, to Jack Ma’s fast-growing and highly lucrative fintech unicorn Ant Group and cash cow mineral-water bottler Nongfu Spring Co., President Xi Jinping’s China has plenty to offer global investors,” my Bloomberg opinion colleague Shuli Ren wrote last September.
Recent months have brought a painful reality check. On July 2, Chinese regulators announced an investigation into data security concerns at DiDi Global Inc., a ride-hailing group, just two days after its initial public offering. DiDi had raised $4.4 billion in the biggest Chinese IPO in the U.S. since Alibaba Group Holding Ltd.’s in 2014. No sooner had investors snapped up the stock than the Chinese internet regulator, the Cyberspace Administration of China, said the company was suspected of “serious violations of laws and regulations in collecting and using personal information.”
The cyberspace agency then revealed that it was also investigating two other U.S.-listed Chinese companies: hiring app BossZhipin, which listed in New York as Kanzhun Ltd. on June 11, and Yunmanman and Huochebang, two logistics and truck-booking apps run by Full Truck Alliance Co., which listed on June 22. Inevitably, this nasty news triggered a selloff in Chinese tech stocks. It also led several other Chinese tech companies abruptly to abandon their plans for U.S. IPOs, including fitness app Keep, China’s biggest podcasting platform, Ximalaya, and the medical data company LinkDoc Technology Ltd.
To add to the maelstrom, on Thursday Senators Bill Hagerty, a Tennessee Republican, and Chris Van Hollen, Democrat of Maryland, called on the Securities and Exchange Commission to investigate whether DiDi had misled U.S. investors ahead of its IPO. Also last week, U.S. tech companies such as Facebook, Twitter and Google came under increased pressure from Hong Kong and mainland officials over doxxing, the practice of publishing private or identifying information about an individual online.
For several years, I have been told by numerous supposed experts on U.S.-China relations a) that a cold war is impossible when two economies are as intertwined as China’s and America’s and b) that decoupling is not going to happen because it is in nobody’s interest. But strategic decoupling has been China’s official policy for some time now. Last year’s crackdown on financial technology firms, which led to the sudden shelving of the Ant Group Co. IPO, was just one of many harbingers of last week’s carnage.
The proximate consequences are clear. U.S.-listed Chinese firms will face growing regulatory pressure from Beijing’s new rules on variable interest entities as well as from U.S. delisting rules.
The VIE structure has long been used by almost all China’s major tech companies to bypass China’s foreign investment restrictions. However, on Feb. 7, the State Council’s Anti-Monopoly Committee issued new guidelines covering variable interest entities for the first time. Recognizing them as legal entities subject to domestic anti-monopoly laws has allowed regulators to impose anticompetition penalties on major VIEs, including Alibaba, Tencent Holdings Ltd. and Meituan. This new framework substantially increases risks to foreign investors holding American deposit receipts in the tech companies’ wholly foreign-owned enterprises. For example, Beijing could conceivably force VIEs to breach their contracts with their foreign-owned entities. In one scenario, subsidiaries of a Chinese variable interest entity that are deemed by Beijing to be involved in processing and storing critical data could be spun out from the VIE — just as Alibaba was reportedly forced to spin out payments subsidiary Alipay in 2010.
The stakes are high. There are currently 244 U.S.-listed Chinese firms with a total market capitalization of around $1.8 trillion, equivalent to almost 4% of the capitalization of the U.S. stock market.
Major Chinese companies have seen their U.S.-listed stocks crater this year (Baseline=100)
And the pressure on them is coming from the American regulators, too. The Holding Foreign Companies Accountable Act passed last December empowers the SEC to require foreign companies to disclose shareholder information and auditing records to the Public Company Accounting Oversight Board. Three consecutive years of noncompliance will force a delisting. The SEC’s new regulations went into effect in April, so the earliest delisting could be in 2024. But the requirements extend to revealing information about companies’ boards of directors and their affiliations with the Chinese Communist Party, as well as about the extent to which Chinese companies are owned or controlled by “a government entity.”
This is in direct conflict with Article 177 of the revised China Securities Law, which “prohibits foreign regulators from directly conducting investigations and collecting evidence” in China, and restricts Chinese firms from releasing documents related to their securities outside of China without approval from the China Securities Regulatory Commission. The combination of new regulatory pressure from both Beijing and Washington seems likely to force a significant number of Chinese companies to delist from U.S. exchanges over the next decade. Indeed, Washington has already delisted China’s three big telecommunications companies, China Telecom Corp., China Unicom and China Mobile Ltd., on the ground that they have Chinese military ties.
The fight over U.S.-listed Chinese firms has coincided with another sign of impending decoupling. Tesla’s love affair with China appears to heading for a rocky end. There has been a marked increase in criticism of the U.S. electric vehicle company, both in mainland newspapers and on social media, focusing on concerns about Tesla’s safety standards. In February, Chinese agencies, including the State Administration for Market Regulation, China’s most important market watchdog, summoned Tesla executives to discuss what they said were quality and safety issues in their vehicles. In March, the government was reported to have banned employees of state-owned enterprises and military personnel from using Tesla vehicles.
There has also been speculation in Chinese media that Teslas may be prohibited from entering certain “sensitive” areas. And last month, the Chinese government ordered a recall of almost all the cars Tesla has sold in China — more than 285,000 in all — to address an alleged software flaw. According to the China Automotive Technology and Research Center, Tesla’s share of the Chinese market for battery electric vehicles fell from 23% in the first quarter of 2020 to 11% in the second quarter of 2021.
To Wall Street’s way of thinking, China’s behavior makes no sense, especially in the context of a potential check to China’s economic recovery. Expansion in manufacturing slowed in June, as export demand weakened and supply bottlenecks held back production, according to official statistics released last week. China’s services sector, which has lagged behind manufacturing since the pandemic began, also showed signs of renewed weakness, partly because of recent outbreaks of Covid-19 in Guangdong and elsewhere.
Moreover, these short-run wobbles are trivial compared with the much bigger economic problems that American China-watchers detect. In a new piece for Foreign Affairs, the Rhodium Group’s Daniel H. Rosen paints a dark picture:
Since Xi took control, total debt has risen from 225 percent of GDP to at least 276 percent. In 2012, it took six yuan of new credit to generate one yuan of growth; in 2020, it took almost ten. GDP growth slowed from around 9.6 percent in the pre-Xi years to below six percent in the months before the pandemic began. Wage growth and household income growth have also slowed. And whereas productivity growth … accounted for as much as half of China’s economic expansion in the 1990s and one-third in the following decade, today it is estimated to contribute just one percent of China’s six percent growth, or, by some calculations, nothing at all.
The standard view, to which I also subscribe, is that the combination of accumulating private-sector debt and demographic decline — a trend made significantly worse by the pandemic — condemns China to significantly lower growth in the coming years. So why, burnt investors ask, jeopardize China’s access to Western capital, not to mention the access to Western technology that comes with large-scale U.S. foreign investment in China?
The answer has to do with the political calculations of the Chinese Communist Party, a way of thinking that could hardly be more foreign to the wolves of Wall Street.
As one hugely successful Chinese tech investor put it to me on a visit to Beijing in September 2018, there are three Chinas: the “New New China” of the dynamic technology sector; the “New Old China” of the most profitable state-owned enterprises, such as banks and telecoms; and the “Old Old China” of the heavy industrial, rust belt state-owned enterprises.
“We are New New China,” he told me. “We have U.S. passports, we cross the Pacific often, we are in California a third or half of the year.” In short, the Chimericans. But “New Old China” is the Communist Party elite — the “princelings” descended from the senior party figures who survived the madness of Mao, and their children, whose wealth comes from the state-owned cash cows. “Old Old China” is everyone else, whether in the miserable rust belts or the impoverished countryside.
Three years ago, my friend correctly predicted growing pressure on New New China from the Communist Party, which had begun to regard the big tech companies as so large and powerful as to pose a political threat. Jack Ma’s decline and fall — from an Elon Musk level of stardom in China to near invisibility — has proved that prediction right. It was Ma’s blunt and public criticism of the Chinese financial regulators last year that led to the cancellation of the Ant Group IPO and his eclipse as a public figure.
If you thought the CCP’s top priority was global economic dominance, cancelling Ant’s IPO made no sense. Ant had the potential to become the most powerful financial services platform in the world, its artificial intelligence technology honed on the vast trove of Chinese data harvested by the Alipay app, its game plan simple but brilliant, as its chief executive Eric Jing once explained to me over dinner in Hangzhou: to make Ant the default online market for all financial products throughout the world’s emerging markets.
So why did Beijing decide to abort this potentially world-beating mission? The answer is that the Communist Party’s top priority is domestic: specifically, the preservation of its own power.
The CCP did not plan for China to become home to the only tech companies in the world big enough to compete with Silicon Valley’s. It just happened because there was enough freedom from regulation for Ma to create, with breathtaking speed, “Amazon with Chinese characteristics.” Such are the consequences of allowing a free-market system to flourish even as you retain control of state-owned enterprises that you assumed would always be the economy’s commanding heights. Already in 2018, however, it was becoming clear to Xi and his fellow princelings that Jack Ma and his arriviste counterparts at the other big tech companies were getting too big for their boots. And the crux of the matter was their ownership of all that data generated by their Chinese users.
Significantly, China’s new data-security law, which was completed in June, gives the government greater power to get private-sector firms to share data collected from social media, e-commerce, lending and other businesses by classifying such data as a national asset. That ended the ambiguity that had led some big tech representatives to suggest that users’ data might not be available on demand to the government.
A similar logic explains Beijing’s sudden iciness toward Tesla. According to Article 36 of the Data Security Law, data stored in China cannot be transferred to foreign law-enforcement authorities or judicial bodies without prior Chinese government approval. “Provisions on the Management of Automobile Data Security,” released in May, specifically targeted automobile data storage and processing. The new rules state that geographic and mapping data collected by smart cars could constitute critical infrastructure information — again a matter of national security.
A cynic would say that Tesla is merely receiving the treatment previously meted out to many other Western companies. It has been welcomed into China just long enough for homegrown companies to copy its technology; now the future will belong to the likes of BYD Auto Co. Yet this is to understate how seriously the government takes the data issue. If you are intent on building a new kind of surveillance state, applying the power of artificial intelligence to all the data you can harvest from your citizen-helots, it makes perfect sense to ensure that the Communist Party has complete control over the data. And if you believe you are in the early phase of Cold War II, it makes perfect sense to ensure that companies based in the other superpower are cut off from the data.
Like the Soviet Union in Cold War I, China believes that the U.S. will behave the same way it does. Maybe it’s true —maybe Tesla would make data gathered by its Chinese vehicles available to the U.S. National Security Agency. But you can be absolutely certain BYD would make U.S. data available to the NSA’s equivalent in Beijing if they had sold a lot of Chinese electric vehicles to Americans.
Xu Zhangrun, who was a professor of jurisprudence and constitutional law at Tsinghua University until he was fired last year, believes that Xi has restored tyranny in China, by removing the constraints on his power — such as informal term-limits — that his predecessors had imposed after Mao’s death. “Tyranny ultimately corrupts the structure of governance as a whole,” Xu has written, “and it is undermining a technocratic system that has taken decades to build.” That may well prove to be true.
In the short run, however, the big losers from Xi’s tyranny and the Cold War that he is waging will be those Western investors who foolishly believed that Chimerica could survive not only a global financial crisis made in America, but also a global health crisis made in China.