Russia and China’s challenge to US hegemony

Recent economic and geopolitical events should be seen through a longer-term strategic lens. During the Cold War, we lived in a bipolar world dominated by the US and its Allies on one side and the Soviets and their vassal states on the other. Ever since the Soviet Union and the east bloc collapsed, there has been a lot of talk about the United States as a geopolitical and economic hegemon. And the Russian default in 1998 marked a low for post-Soviet Russian economic power. But the global landscape is changing. And two of the BRIC nations, China and Russia, are vying for greater geopolitical and economic status.

I have a unique position to view the recent developments from. As a former US diplomat and investment banker in Europe now producing an Economics-themed show for a Russian Television broadcaster in the US, I have seen and am seeing a lot of differing strategic viewpoints expressed over the past few weeks. What I see are an interlocking and sometimes contradictory tapestry of countries and economic areas vying for naked self-interest while trying to maintain some level of moral authority doing so. I am not under any illusion that much of what we are witnessing is a geopolitical game with Ukrainians as the pawns.

Now, on the one hand, we have the Ukrainian situation with the EU-NATO-US triumvirate seeking to extend power eastward into the former east bloc versus a rejuvenated Russia that is using its energy reserves to regain global status. At the same time, in the east, we see a resurgent China trying to give their currency international appeal while making the transition from export dependence to consumer-led advanced economy. These are tectonic shifts in the economic and geopolitical world that the US is resisting as best it can.

My view here is that the US was at its peak relative to the rest of the world at the end of World War 2 due to Europe’s disarray and indebtedness following the war. The US used this geopolitical, military and economic dominance to cement all of Western Europe into the US fold, a rivalrous allegiance dominated by the US but extended via the EU and Anglo-American economic connections. Russia tried as it could to compete with the entire east bloc but the economic system was a failure and the Soviet empire crumbled.

Nevertheless, the relative military, economic and geopolitical importance of the US has diminished. And as the Soviet Union disappeared, three trends emerged to highlight this. The first was the economic development and integration into the global economy of a number of emerging countries in Asia and Latin America. The second was the re-emergence of China as an economic power. And the third was the cohesion of the EU into a counterweight to the US within the advanced economic alliance. Only the decline of Japan as an economic power was favourable to the US as the Soviet empire collapsed.

And so, as the 21st century began, the US was in a less advantageous position geopolitically. The US, therefore, concentrated on using the EU and NATO alliances to push further eastward into Europe because, with Russia weakened, this was the best opportunity available to gain geopolitical points. And eventually almost the entire east bloc left the Russian orbit and moved into the EU orbit.

Unfortunately for the US, the boom in natural resource prices buoyed Russia’s economic fortunes just as this process was beginning. And eventually the Russians re-emerged as a counterweight to the US. What we see developing in Ukraine now is a culmination of that re-emergence and the US’s attempt to isolate Russia in order to forestall this development.

It won’t work, however, unless the US can reduce Russia’s importance through lowering oil and natural gas prices or by helping to lessen Western Europe’s dependence on Russia for natural gas. These are moves that will take years to develop fully. And so Russia will remain a geopolitical contender in Europe for some time to come.

Meanwhile in the east, China has grown at a 10% annualized rate for something close to 25 years. Economically, the country is very much a contender for global power. The missing element for China is the economic system which is more of a command-style economy with capital controls and limited currency convertibility. The Third Plenum in November showed China’s earnest desire to move aggressively to change this.

I think the Chinese are serious about rebalancing. This will involve two or three major interlocking features. First, the Chinese need to shift emphasis economically from export to consumption. The benefit here is that doing so not only makes the Chinese less dependent on demand from now indebted advanced economy private sectors but also makes China less prone to overinvestment in infrastructure that inevitably leads to writedowns and loss socialization.

Second, the Chinese will need to make their currency more attractive internationally by increasing convertibility and flexibility. The recent move to widen the trading band to 2% from 1% is a big move in that direction. It shows that the depreciation in the Yuan is more about currency flexibility and economic strength than it is about rebalancing and economic weakness.

But, there is a weakness here. The Chinese will have to make the financial system more flexible and consumer-friendly in the sense that emphasis will shift from state-owned enterprises (SOEs) to consumers. Doing this necessarily means writedowns, loss socialization, bankruptcies, and slower credit and economic growth.

It is this slower credit growth that is creating a major headache throughout the emerging markets as the demand for industrial commodities weakens.

I highly recommend the Barry Eichengreen-co-authored post at Vox that asks “is there room for more than one international currency?” as a framework for understanding the geopolitical and economic events. There is room for more than one international currency. And what we are seeing, therefore, is a realization that this is true – that the US dollar’s dominance can and will be challenged. The US is trying as best it can to thwart this change so as to maintain its “exorbitant privilege” but I think the die is cast and we are going to see a more multi-polar world geopolitically and economically.

In the short-term, what this means is volatility – especially over Ukraine – because politicians face a multiplicity of economic and strategic interests that are both short- and long-term. And in Europe, the potential for policy error is enormous because the stakes are high. I believe the US has overplayed its hand in Ukraine and that sanctions will boomerang onto the world economy in a negative way. When the conflict in Crimea began, I thought the Europeans, who stood to lose more economically, understood how integrated the Russians were into the global economy. But Europe seems ready to press ahead with sanctions – perhaps because the moral imperative to do so is high. We will have to wait and see what these sanctions are and how the various political leaders defend their implementation. My worry is that we are seeing crisis escalation and that this crisis will continue to escalate for some time.