US-China decoupling will have a devastating impact on the global economy

The global economy is not just splitting into two as a result of cynical political manoeuvring; it is in danger of falling apart
Financial markets need to grapple with the impact of the geopolitical climate, rather than seeing it as something that concerns politicians only

Anthony Rowley

Published: 3:30am, 16 Apr 2023

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It’s time to end the fiction that the world can be divided into ideological blocs without massive damage to the global economy, and that politics is somehow separate from economics. This is understood by some economists but not by many politicians who control the levers of global power.

The global economy is not just splitting into two as a result of cynical political manoeuvring; it is in danger of falling apart. How could it be otherwise when great power rivalry is eroding global trade and financial links, and ratcheting up strategic tensions almost daily?

Volatility in stock and bond markets, exchange rate fluctuations, swinging inflation expectations and falling business confidence are all symptomatic of this sad situation. So, too, are declining business investment and financial system scares, plus a general sense of economic malaise.

US president Joe Biden and his predecessor Donald Trump must take much of the blame for this. They have provoked East-West schisms by pouring opprobrium on China for challenging the global dominion which the US feels it has sole right to exercise, and by fostering a “with us or against us” attitude.

The Ukraine war, whose origins are also linked to external geopolitical manoeuvring, has meanwhile aggravated schismatic tendencies by dividing Europe against itself. Yet, national leaders generally hesitate to take sides against powerful nations.

That is no reason, however, why so many others are as mealy mouthed as they have been about criticising the irresponsibility of those leaders who divide the world in pursuit of narrow nationalistic ends. Reluctance to speak out has only deepened the dangerous global divides we are witnessing.

Setting aside the more extreme views of those wedded to a pro-US versus pro-China line – or a pro-Ukraine versus pro-Russia one, for that matter – too many economists have spoken of these schismatic and destructive impulses only as though they were accidental phenomena, regrettable but unavoidable.

02:45

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There have, however, been a few exceptions to this egregious conspiracy of silence. One is an International Monetary Fund blog article titled “Geopolitics and fragmentation emerge as serious financial stability threats”, which was released on April 5 just before the annual meetings of the IMF and World Bank in Washington.

The article notes that “concerns about global economic and financial fragmentation have intensified amid rising geopolitical tensions, strained ties between the US and China, and Russia’s invasion of Ukraine”. Mention of geopolitical tensions as a negative for the global economy is long overdue.

Financial measures of the kind employed by Washington to sanction Russia especially, (but also China) not only have economic implications but also affect financial stability, as the IMF noted. They have an impact on cross-border investment, international payments and asset prices.

The IMF explained that geopolitical tensions also have a major effect on cross-border investment portfolios and bank lending. An increase in tensions between investing and recipient countries, such as the United States and China since 2016, reduces cross-border investment and bank lending significantly.

Geopolitical tensions are also transmitted to banks through the real economy. The effect of disruptions to supply chains and commodity markets on domestic growth and inflation can, meanwhile, exacerbate banks’ market and credit losses, further reducing their profitability and capitalisation.

All this has been happening even as the world has been struggling to cope with, and then recover from, the massive economic and social impact of the Covid-19 pandemic. It has been a strategy of wanton destruction on the part of those countries ratcheting up tensions.

So let us stop the pretence that all is going to be well economically if we all agree to march under the (US-led) flag of rule of law, human rights and common values. There is cynical opportunism as well as idealism in such exhortations, but life isn’t quite so simple.

French President Emmanuel Macron has shown courage and realism in this regard by suggesting in an interview with French newspaper Les Echos and news website Politico Europe on April 9 that Europe should not automatically follow either the US or China’s position on issues such as Taiwan. He said the “great risk” Europe currently faces is getting “caught up in crises that are not ours”, preventing it from building what he calls “strategic autonomy”.

02:54

French and EU leaders visit China to discuss trade and the Russia-Ukraine war

Just so. Not only Europe, but just about every country on the planet is caught up in the ideological conflict primarily between Washington and Beijing – although reluctant “allies” are often dragged in – which purports to be largely about values, but in reality is about geostrategic power.

Michael Spence, a Nobel laureate in economics and former dean of the Graduate School of Business at Stanford University, put it bluntly in an opinion piece he wrote for Project Syndicate: “Make no mistake, the economic consequences of this lurch toward confrontation will be severe.”

Financial markets need to get a handle on how the geopolitical climate affects them rather than seeing the situation as something that concerns politicians only. As the IMF says, financial fragmentation stemming from geopolitical tensions could “roil capital flows and key economic and financial market indicators”.

A better understanding and monitoring of the interactions between geopolitical risks and more traditional ones related to credit, interest rates, markets, liquidity and operations could help prevent potentially destabilising fallout from geopolitical events. The time for action is now.

Anthony Rowley is a veteran journalist specialising in Asian economic and financial affairs