US trade war raises the specter of new Cold War

The Year of the Golden Pig is around the corner, but no Eldorado is in sight for Xi Jinping’s China. According to Chinese astrology, the upcoming Lunar New Year, starting on February 5, traditionally brings wealth and economic prowess.

A sudden birth rate surge is usually observed during that rare zodiacal alignment in the world’s most populous nation, with parents eager to take advantage of this good omen, which promises a golden future for their newborn babies.

Yet this time Chinese middle classes are fretting with anxiety ahead of 2019, amid growing economic uncertainty due to a slowing GDP growth, and an unprecedented trade war with the United States.

In 2018, US President Donald Trump took Beijing’s leadership by surprise, slapping massive tariffs on the world’s second-largest economy, which sent shockwaves through the Politburo.

Impact on the ground has been limited so far, but the psychological damage is done, with markets, investors and consumers questioning China’s ability to weather the storm.

Next year will raise the stakes for President Xi as the world’s two leading powers will be engaged in tense trade talks and the daunting task of bridging their widening difference during a short window of less than three months.

The year to come might herald the official start of a long Sino-US cold war with global ramifications, even if an elusive trade breakthrough can be achieved.

After decades of economic growth and a “peaceful rise,” a new chapter of open strategic competition between Washington and Beijing has begun. This new environment will hang over all the key issues China’s leadership will face in 2019, from domestic politics to economic strategy, or diplomacy, making the next 12 months a potential watershed.

Assertive nationalism

The scene is already set.

“No one is in a position to dictate to the Chinese people what should or should not be done,” Xi said this month when he set the tone by defying Trump without naming him.

His comments came in a speech on December 18 to celebrate the 40th anniversary of the “opening up” of the country by late paramount leader Deng Xiaoping.

Assertive nationalism and an iron fist will continue to be Xi’s trademark despite mounting international and economic headwinds.

China’s most powerful leader since Mao Zedong gave his own interpretation of four decades of opening up, dashing hopes that he would reverse his state-centric policies, which he has rolled out since taking office in 2013.

“The leadership of the Communist Party of China is the most essential feature of socialism with Chinese characteristics,” he said in a clear message to pro-market supporters, calling for a new round of reforms, or liberals hoping for breathing space.

In 2019, we can expect the ongoing crackdown on any political dissent to continue ahead of the 30th anniversary of the Tiananmen Square repression on June 4, 1989. Severe online censorship, coupled with forceful arrests, will ensure the date will remain taboo and possibly forgotten by younger generations.

As for the economy, Xi faces a strategic dilemma when it comes to trade. He also has to deal with slowing growth at home.

Amid increased anxiety among investors, he needs to prevent any hard landing that could compromise social stability. Yet the champion of China’s renaissance cannot afford to look weak by caving in publicly to Washington’s demands.

His assertive nationalist agenda sets the country on a collision course with his largest trading partner, the US, putting in jeopardy the Asian giant’s ascent, pro-market forces within the CPC argue.

Taking advantage of US requests for further market access, some economists and senior officials are pushing for a new round of domestic reforms, with the aim of reducing the key role of state-owned enterprises. This would breath new life into the private sector.

Pinning their hopes on Xi’s close economic confidant, Vice-Premier Liu He, they are pushing for a grand bargain with Washington that would both de-escalate trade tensions and foster a new round of economic modernization at home.

This strategic debate might linger until March, or the end of the negotiation window agreed by Trump, and maybe beyond as the deadline could be extended as many experts expect.

But Xi’s recent speeches have dampened hopes for a radical overhaul of the Chinese economy, putting the emphasis instead on “self-reliance,” a slogan from the Mao era.

Beijing is already easing credit to support its slowing growth, which is expected to dip below 6.5% in 2019, according to the Chinese Academy of Social Sciences, a government-funded think-tank.

Investors are hoping Beijing will unleash an ambitious stimulus package next year to prop up markets, following a challenging 2018, which saw stock exchanges nosedive in Shanghai and Shenzhen.

Walking a tightrope

Reassuring investors will be a key priority as manufacturers are already looking at alternative manufacturing bases and markets, especially in Southeast Asia, to reduce their China exposure.

Meanwhile, the People’s Bank of China will walk a tightrope when it comes to managing the yuan, which faces market downward pressure. While a lower currency would support China’s exports, the government is keen to support the currency to assert the country’s alleged economic strength on the world stage.

Finally, we come to strategy and diplomacy. The trade war has raised the stakes in the Asia-Pacific region with the risk of it spilling over to security and diplomatic issues.

Both Washington and Beijing could be tempted to flex their muscles in areas like the South China Sea, Taiwan or even North Korea in order to increase their leverage at the negotiating table.

While US Vice-President Mike Pence’s recent speeches have signaled a tougher line against China’s rise, Beijing has responded with stern determination. This was illustrated by the arrest of three Canadian citizens in apparent retaliation for the arrest of the daughter of the founder of tech giant Huawei and the group’s chief financial officer Meng Wanzhou in Vancouver.

In such a volatile environment, an incident at sea during a US Navy “freedom of navigation” exercise off one of the contested artificial islands built by China in the Spratly or Paracels could escalate a fraught situation.

Xi’s assertive foreign policy will not allow him to back down publicly on those sensitive issues, especially if he offers trade concession to the Trump administration.

Yet for all his nationalist rhetoric, the general secretary of China’s Communist Party has no interest in triggering a major conflict that could backfire on the economy. Rather, Beijing would prefer to reap the benefits of the Year of the Golden Pig.