At some point soon, Beijing will be unable to fulfill commitments and therefore make itself vulnerable

by Gordon G. Chang

IN INTRODUCING its new National Security Strategy, President Trump’s White House identified China as a “revisionist” power, a “rival” and “competitor.” Throughout its sixty-eight pages, the document catalogues Beijing’s hostile behavior and suggests that Chinese influence in America and elsewhere is “malign.” It is right to do so.

Fortunately for America and contrary to Washington conventional wisdom, the mighty-looking Chinese state is, in reality, particularly vulnerable at this moment. For one thing, its slowing economy is on the verge of a debt crisis. At the same time, Beijing, largely because of the expansive vision of its ruler, Xi Jinping, is overstretched. China’s provocative acts are alienating other states, strengthening a growing coalition against Beijing. Xi’s relentless pursuit of absolute control at home has weakened Chinese institutions. The Chinese people are restless.

The popular narrative about China today resembles that of the Soviet Union in the early 1970s. Then, Americans believed they had to accommodate Moscow. Within two decades, however, the Soviet empire imploded. Trump is by no means Ronald Reagan, but the current president, like his illustrious predecessor, is willful and disposed to breaking convention. More than at any other time in this decade, the United States is in a position to demand that Beijing adhere to established rules and norms.

AT FIRST glance, the extraordinary four-decade rise of China gives Beijing a definitive edge over Washington. And most observers believe that advantage will only widen over time. China’s economy will overtake America’s by 2032, according to a report released in December by the Centre for Economics and Business Research, in London.

Some think the 2032 prediction is far too conservative. The Chinese economy will be the world’s largest by 2027, the Goldman Sachs analyst Jim O’Neill contended in 2011. In 2016, one observer, using Conference Board data, predicted the crossover year would in fact be 2018.

Big economies push smaller ones around, but don’t expect Chinese general secretaries to be bossing American presidents anytime soon. As an initial matter, it is extremely unlikely that China’s economy will surpass America’s by 2032, much less 2018 or 2027.

China is on the edge of a systemic debt crisis. The country avoided a downturn in 2008 only by embarking on one of history’s largest and longest spending campaigns, a two-part effort. First, there was a formal stimulus plan, a $586 billion, two-year initiative. Second, Beijing forced state banks to extend credit, primarily to state entities, in an unparalleled spree. All parts of the state were mobilized in this zealous program. Lin Zuoming, then the general manager of the Aviation Industry Corporation of China, publicly complained in early 2009 that officials made his state enterprise borrow the equivalent of $49.2 billion from twelve Chinese banks, declaring that he was concerned about what to do with all that cash.

In the five years after 2009, Chinese banks extended an amount of credit that was roughly equal to that in the entire U.S. banking system, even though at the end of 2008 the Chinese economy was less than one-third the size of America’s. And the lend-a-thon/spend-a-thon has continued since the end of that half decade.

Beijing technocrats had long dictated outcomes, so that is what they did in 2008. As they overpowered market forces in China, they prevented the correction that swept market economies late last decade. Yet because Chinese officials were determined to avoid a downturn at home, the underlying imbalances in China’s economy became larger.

The most important imbalance is the country’s indebtedness. In 2008, China’s debt-to-GDP ratio, a standard metric for debt sustainability, was 130 percent. Today, there is no agreement on the number, but many put it north of 300 percent, and some believe the figure, once so-called “hidden” liabilities are counted, has crossed the 400 percent threshold into stratospheric territory.

Now, Chinese leaders are continuing to pile on the debt in order to keep up growth rates. Their country, however, is not growing at the 6.7 percent pace announced by the official National Bureau of Statistics for 2016. In the middle of 2017, the World Bank issued a chart that revealed the Chinese economy in the previous year had grown 1.2 percent. That figure, shockingly low to some, is consistent with the most reliable indicator of Chinese economic activity: total primary energy consumption. In 2016, that metric was up 1.4 percent.

Even at 6.7 percent growth—or the 6.9 percent announced for 2017—China is incurring debt about three times faster than it is producing economic output. Beijing can, at least for some time, continue debt accumulation at this frantic pace, because it controls the large lenders, the large borrowers, the markets and the courts.

“It would appear that China thinks it can grow its way out of its current debt problems in the same way it did in the ’00s,” Fraser Howie, the coauthor of Red Capitalism: The Fragile Financial Foundation of China’s Extraordinary Rise, told the National Interest. “But the world economy is now very different, China then rode a wave of global growth and World Trade Organization entry, which is no longer available to it.”

Nonetheless, as Howie puts it, Beijing remains “drunk on credit.” Chinese technocrats continually talk about “deleveraging” and actually try to slow credit growth from time to time, but they do not sustain their efforts because a continual reduction in debt would result in a severe downturn. Beijing’s newest initiatives show desperation: packaging dubious loans for sale to consumers and restricting sales of apartments to prevent values from cascading down.

Peking University’s Michael Pettis told Fortune at the end of last year that since World War II there have been “at least two dozen decade-long investment growth miracles” similar to China’s. All suffered a “terrible adjustment,” he noted, and in none of these historical precedents were “imbalances at such deep levels and debt at such high levels” as China’s are now.

At some point, China’s economy will have to “adjust,” because Chinese leaders, despite all their powers, have yet to rewrite the laws of economics. And because they have prevented market corrections for so long (Beijing claims 1976 was the last year in which Chinese GDP declined) the inevitable downturn must be severe.

That severe downturn can take the form of a crash—perhaps the world’s sharpest—or decades of recession or recession-like stagnation. No matter how the economy adjusts, China is unlikely to catch up with the now-resurgent, and larger, American economy anytime this half century.

And China’s adjustment could be coming soon. At the Communist Party’s Nineteenth National Congress, held in October, Zhou Xiaochuan, the governor of the People’s Bank of China, publicly mused about China suffering a Minsky Moment—the point where asset values collapse, foreshadowing a market crash.

The extraordinary comments of the head of the central bank mirror concerns among the Chinese, elites and commoners alike. That concern is evident in the flow of cash leaving the country. In 2015, net capital outflow from China amounted to $1 trillion, according to Bloomberg. In 2016, it appears outflow was somewhere in the vicinity of $1.1 trillion. In 2017, outflow declined sharply, but only because Chinese technocrats imposed draconian capital controls, many of them not formally announced.

NOT ONLY is money fleeing China; so are the Chinese themselves. Survey after survey—some conducted by Chinese state entities—shows that almost half the country’s wealthy plan to emigrate in a half-decade time frame.

The new wave of emigration, evident in the increase of Chinese faces in the world’s major cities, is a reflection of more than just anxiety about an impending failure of the economy. Xi Jinping is taking China in particularly troubling directions. His relentless pursuit of control has roiled the Communist Party, reversing decades-long moves to institutionalize Chinese politics. There have been, throughout the tenure of his rule, rumors of attempted coups, with one surfacing as recently as December.

At the same time, Xi’s ambition—should we call it hubris?—has led to China overextending itself abroad, from border areas to far-flung locations. An increasingly provocative foreign policy, marked by irredentism, is pushing other states into coalition to protect themselves from Beijing’s expansionism.

The most significant such grouping is the “Quad,” consisting of the United States, Japan, Australia and India. Last decade, Beijing was able to derail close cooperation among the four democratic states, but after years of Chinese provocation, these friends are now working closely. And they are drawing in others, most notably Vietnam.

Beijing may be able to irritate Hanoi without lasting consequence, but it can’t expect the same with New Delhi. Once, Indian policymakers could see no farther east than the Strait of Malacca. But now they state that both the South China Sea and East China Sea are integral to Indian security. That change, which means India is developing links with East Asia, is in direct response to Chinese provocation in the waters surrounding India’s shores.

America and its friends form a powerful combination. “Together, the United States and our allies and partners represent well over half of the global GDP,” Trump’s National Security Strategy states. “None of our adversaries have comparable coalitions.” China, for example, has one formal ally: the Democratic People’s Republic of Korea. It has only one large friend—Russia—but the Russians are also weak, and in some ways another drain on Beijing’s overextended resources. At a time when China needs friends, its paramount leader appears determined to pick up weak partners and alienate strong states.

Finally, Chinese society for some time has been restless, unsettled, volatile and angry. Xi has aggravated the situation by encouraging what Arthur Waldron, the University of Pennsylvania historian, calls a “feral anti-Western reflex.” That xenophobia underpins Xi’s goal of creating “confidence in our culture,” an element of his “Four Confidences” initiative.

As part of that effort, the Chinese media has been cheering the destruction of symbols considered foreign—such as, most recently, Santa Claus. “We all know that race hatred and xenophobia are pure poison, never to be touched, but there are times when such reasonable sentiments frustrate a militaristic government,” Waldron told the National Interest, referring to Xi’s China. He continued:

“Then it will reach deep into its medicine chest, pull out the small bottle of race hatred labeled with the sinister skull and cross bones, thinking ‘a few drops of this will do the trick’ as they seek to whip a calm population into a mob consumed by primitive hatred and destructiveness.”

That is, in broad outline, what Mao Zedong did, except that where Mao used “rightist forces,” Xi targets those who are not Chinese. Xi’s veneration of the first leader of the People’s Republic, evident from the start of his rule in late 2012, shows he thinks the country should look back to one of the darkest times in its history for inspiration.

In sum, China has passed an inflection point. “The really extraordinary thing about 2017 is how abruptly the China story has reversed,” wrote Douglas Bulloch for Forbes. When that year began, the country appeared to own the century. Now, many are worried that China is regressing into a dangerous era.

No wonder many Chinese these days are living—or are preparing to live—anywhere but China.

SO WHAT is Washington capable of? It can, should it so choose, trigger economic and financial crises in China. The Trump administration can accomplish that by doing nothing more than enforcing American law. Chinese banks have been laundering North Korean money through New York for decades. At the end of June, Treasury Secretary Steven Mnuchin designated Bank of Dandong a “primary money laundering concern” pursuant to Section 311 of the Patriot Act, thereby imposing what is essentially a death sentence on the small Chinese bank. That bank can no longer clear transactions in dollars, the world’s dominant currency.

The Trump administration obviously intended the designation to be a signal to the Chinese to stop cleaning up cash for the Kim regime. Beijing seemed to get the message when, in September, the Chinese central bank ordered commercial banks to sever some ties with North Koreans, but there are clear indications that the order has been ignored.

“Chinese customers are still violating U.N. sanctions by buying coal from North Korea,” sanctions expert Joshua Stanton told the Hill in December. “They’re almost certainly paying North Korea through our financial system, using a Chinese bank. Justice Department documents have implicated large Chinese banks in coal purchases from North Korea.” And evidence suggests that Chinese entities since October have been transferring oil to Pyongyang, again requiring the assistance of China’s banks.

“If the Obama administration was willing to impose heavy fines on Europe’s biggest banks for violating Iran sanctions, the Trump administration must be willing to hold Chinese banks accountable for breaking our laws and U.N. sanctions, too,” says Stanton, who runs the One Free Korea site.

China’s largest banks, from all indications, would be principal targets of new Section 311 designations. Bank of China, one of China’s Big Four banks, was named in a 2016 UN report for operating a laundering scheme in Singapore for the regime of Kim Jong-un. From all appearances, the bank has been engaging in this criminality in other locations, especially Chinese cities bordering the North.

Moreover, Bank of China, which does business in the United States, is probably not the biggest Chinese bank participating in cash cleaning for Pyongyang. That honor may go to China’s largest bank—and the world’s largest bank as measured by assets—the Industrial and Commercial Bank of China.

The effect of a Patriot Act designation on a large Chinese institution would rock the Chinese banking system, destabilize Chinese markets and perhaps trigger the final loss of confidence in the Chinese economy.

THAT ECONOMY is also subject to other American pressure. In August, Robert Lighthizer, the U.S. trade representative, initiated, pursuant to Section 301 of the Trade Act of 1974, an investigation of China’s persistent theft of American intellectual property. These investigations permit the imposition of extraordinary remedies, such as across-the-board tariffs. There is also an investigation pursuant to Section 232 of the Trade Expansion Act of 1962 into Chinese steel and aluminum imports. In November, the Commerce Department initiated antidumping and countervailing-duty investigations pursuant to the Tariff Act of 1930.

China is particularly vulnerable to American action. In 2016, the U.S. merchandise trade deficit with China amounted to $347.0 billion, which constituted a staggering 68.0 percent of China’s merchandise trade surplus. And from all accounts, China’s dependence on the United States widened in 2017 as its surplus against America surged to a record while its overall surplus declined.

China’s dependence on the United States undercuts the oft-heard narrative that Beijing could hurt the U.S. economy through retaliation. Yes, the two countries are, as the official China Daily tells us, “increasingly interwoven,” but that does not mean America should be afraid of using its power. For one thing, trade-deficit countries have relatively little to lose from trade wars. Therefore trade-surplus countries, like China, are usually hesitant in sustaining trade friction.

Moreover, there are other reasons for Beijing to shrink from a fight with Washington. The United States does not have an economy geared toward selling to China. China, however, does have an economy geared toward selling things to America.

Finally, the American economy in 2016 produced $18.62 trillion of gross domestic product. China claimed its 2016 GDP was $10.83 trillion. Bigger combatants have decisive edges in trade wars, especially when the gaps are this large.

Beijing, of course, has cards of its own to play. It could, for instance, use the American debt it holds—about $1.19 trillion of it—to influence Washington. Chinese state media has, since mid-2007, talked about employing the “nuclear option”: selling American debt to punish Washington. In January, Chinese officials evidently whispered to Bloomberg that they might stop purchasing American debt.

Beijing’s foreign exchange regulator refuted the report, and China has never employed the nuclear option, for good reason. For one thing, China’s central bank has already been selling Treasury obligations since 2014 to defend its currency, the renminbi, as a tactic to reduce capital outflow. Since then, China’s foreign currency reserves have fallen by almost $900 billion according to official reports, and more according to unofficial tallies. So Beijing has, for its own reasons, already been unloading dollars during the period, while America has remained unaffected.

Moreover, selling debt is not much of a weapon. Sales of dollar debt—all of America’s sovereign obligations are denominated in its own currency—would net China greenbacks. If Beijing were selling debt to target Washington, it would have to convert its dollar proceeds into assets denominated in other currencies. That means those currencies would, due to the pressure generated by China’s purchases, soar in value. And that means the central banks of those countries would have to buy dollars to bring their money back to the levels that prevailed before Beijing’s purchases. In short, China’s actions would have little long-term effect on the dollar’s value. Sustained Chinese sales would mean, however, that American debt would be held by Washington’s friends, rather than by the Chinese.

Beijing does have considerable leverage over American companies doing business in China—these businesses have always been akin to hostages—but Chinese power is less significant than first appears. Beijing has, during Xi Jinping’s rule, attacked foreign businesses in especially predatory ways, so they have already suffered much. Beijing could do more to injure them, but it will, in all probability, do more anyway as Xi seeks to close off market opportunities to foreign competitors.

IN ANY event, the Trump administration is not helpless. It can always retaliate against Chinese businesses operating in the United States and, in the case of a formal expropriation by China, freeze Beijing’s hoard of U.S. obligations. Chinese leaders can always huff and puff—and they will—but they are not holding the aces in the deck.

China’s leaders have one important advantage, but it is one that Americans, on their own, have conferred on Beijing. And it is an advantage Americans can take back anytime they choose.

China holds a special place in the imagination of Washington policymakers, and that gives Beijing, as a practical matter, power. Since Nixon, Americans have believed the integration of China into the international system—the liberal world order—was one of their most important goals. Over time, they also came to believe the United States had a stake in the maintenance of Communist Party rule.

That perception is changing fast. Now, virtually no one believes in what Washington-based journalist James Mann aptly termed “The China Fantasy.” Beijing by now has disappointed those who had accepted—and who had based American policy on—the notion that sustained economic development would ultimately lead to a democratic China, or at least a China playing the role of a “responsible stakeholder,” as Robert Zoellick famously termed it in 2005.

It is in this context that Trump’s National Security Strategy poses a threat to an increasingly turbulent and unstable China. The president perceives the world to be in a state of “continuous competition” instead of cooperation. The approach of the National Security Strategy is bad news for a China that still relies on an America that maintains generous, decades-old policies.

As more in Washington come to that realization, China will lose crucial American support. “A geopolitical competition between free and repressive visions of world order is taking place in the Indo-Pacific region,” the National Security Strategy states. The document also makes this not-so-veiled threat: “We are under no obligation to offer the benefits of our free and prosperous community to repressive regimes and human rights abusers.”

As views on China change, Americans’ perceptions of their own country will change as well. “The decline and decay of America is an old standby, not only in the foreign or hostile press, but the American press as well,” Waldron observes. “Bernard Baruch always said, ‘Never sell short the United States of America.’ As I survey the horizon I see no American decline. It is a recurrent delusion among foreign policy intellectuals.”

ONE FINAL point. The commonly accepted view that Trump is withdrawing from the world is at odds with his National Security Strategy. Yet even if America were abandoning global leadership, the notion that the United States is losing the ability to influence China is wrong. Paradoxically, American withdrawal would probably enhance its leverage.

The United States is in a period of renewal, something evident from its resurgent economy. At the same time, Beijing, eager for global influence, is rushing to fill what it perceives to be a vacuum. “As the U.S. retreats globally, China shows up,” said Maj. Gen. Jin Yinan of China’s National Defense University, as reported by Evan Osnos in the New Yorker. China, as we can see from General Jin’s gleeful comment, is stretching itself thin.

The Chinese think they can move to center stage, as Xi Jinping boldly announced in his three-hour, twenty-three-minute Work Report, delivered at the opening session of the Communist Party’s Nineteenth Congress in October. Center stage? At some point soon, Beijing will be unable to fulfill commitments and therefore make itself vulnerable. Yale’s Paul Kennedy called that “imperial overstretch,” and Beijing now has a bad case of it.

Gordon G Chang is the author of The Coming Collapse of China