The return and intensification of geopolitical competition is happening in an era of unprecedented interdependence. For almost a quarter century, the major powers have made economic, financial, and technological integration an end in itself. Now they are waking up to the fact that interdependence means they may have leverage over, and be vulnerable to, their geopolitical rivals. Some of these consequences are inherent to integration: authoritarian states like China and Russia, for example, are being exposed to information flows through the Internet that may prove inconvenient or even threaten the stability of their regimes. Part of this shift is also due to the broader array of active measures that globalization has made possible. Interdependence provides means of coercion—such as sanctions and cyberwarfare—that are far more attractive than the use of military force because they entail a lower risk of escalation, cause fewer casualties, and are less controversial. Such new threats will encourage rivals to carve out spheres of independence for themselves to hedge against the downside risks of being reliant on others. Countries will try to wall themselves off from their rivals, even if only in a limited way. Globalization will continue, but not as we’ve known it.
Using interdependence for strategic advantage is not new. The past century is replete with examples of great powers using any advantage they might have in the international economy as a weapon in war or in a struggle for supremacy. Britain sought to use German reliance on its financial system as a weapon against it in World War I, only be to be persuaded otherwise by the United States.1 After World War I, France and Britain sought to suppress German power through punishing reparations, only to see their strategy backfire when the Nazis came to power. The Nazis used Germany’s economic weight to bully and co-opt its neighbors in Central Europe in the 1930s. In 1940–1941, the United States sought to choke the Japanese economy to punish it for its aggression in Asia, only for the Japanese leadership to decide that it should attack Pearl Harbor. In 1956, President Eisenhower threatened a selloff of the British pound to force Great Britain to remove its forces from Egypt during the Suez Crisis. During the Cold War, the United States created the Coordinating Committee for Multilateral Export Controls (CoCom), which was designed to organize the Western world in withholding crucial technologies from the Soviet Union. Since the Cold War, the United States has employed sanctions against many states and private actors, including Russia, Iraq, Iran, North Korea, Cuba, and Serbia, as well as al-Qaeda and other terrorist networks.
The historical record is very clear: it is impossible to separate the economic from the geopolitical. Dependency on rivals will be ruthlessly exploited in a time of crisis. But doesn’t international relations teach us that interdependence should decrease tensions between states? Why would it become a tool of warfare?2
The key to understanding the strategic effects of interdependence on a bilateral relationship is to see that it is not a monolithic force. Some types of interdependence will encourage cooperation and decrease tensions. Others will have the opposite effect, increasing tensions and friction. How can we tell the difference between the two? The positive type of interdependence is one where the benefits are shared and it is difficult for either side to turn it into leverage that can be used to inflict disproportionate damage on the other. The negative type of interdependence is one where one side gains disproportionate leverage over the other and has the ability to use this leverage as an economic weapon at a time of crisis. In addition, if one side has an asymmetric vulnerability that the other side tries to exploit, it might retaliate in another area where it holds an asymmetric superiority. This increases the risk of miscalculation and of a crisis that can spiral out of control.
The economist Albert O. Hirschman described this dynamic in 1945 in a seminal book called National Power and the Structure of Foreign Trade.3 Hirschman was born in Germany to Jewish parents who subsequently converted to Presbyterianism. As a young man, he became active in the struggle against the Nazis and fascism, fighting with the Republicans in the Spanish civil war. During World War II, he was active in anti-fascist efforts in France and in 1941 he fled to the United States.4 As a scholar at UC Berkeley, Hirschman sought to explain how Nazi Germany was able to use international trade as part of its strategy of aggressive revisionism in Europe. It was an unprecedented study that cut across academic fields (and, as a consequence, was overlooked for decades). Hirschman showed how in the years before World War II aggressive countries, like Nazi Germany and Fascist Italy, traded internationally with a “bully commercial strategy” rather than abiding by a fair, rules-based system.
Hirschman found that countries are vulnerable if they are too dependent on a single country that is not equally dependent on them. Hirschman focused on trading relations between a large country and a small country under certain conditions, but his insight can be applied to other types of interdependence between countries of approximately equal size. If China is heavily dependent on the United States for energy or the United States is heavily dependent on China for finance, each will be especially vulnerable to unilateral actions by the other.
During the Cold War, the United States and the Soviet Union had very little to do with each other economically. Trade was miniscule; there was no investment between the two; each had its own economic bloc. After the Cold War, countries across the globe integrated with each other to unprecedented degrees. World trade grew from 38 percent of world GDP in 1991 to 59 percent in 2013, a sixfold increase in absolute dollars.5 Global Foreign Direct Investment (FDI) stocks were worth $23 trillion in 2012 compared with $1.7 trillion in 1992, a fourteenfold increase.6 Financial systems have also become tightly integrated. Little or no thought was given to the risks of interdependence because great-power rivalry was presumed to be a thing of the past. Now, as geopolitical rivalry returns, the world remains interdependent. Thus we are entering a world characterized by “interdependent competition.” Countries are competing with each other but they are also closely linked; consequently, they are gradually exploring how to use these linkages to their own advantage. As Mark Leonard of the European Council on Foreign Relations put it, the major powers of the early twenty-first century are engaged in “connectivity wars.”7 Russia brandishes energy as a weapon. China uses its enormous size as an export market to influence its neighbors. But thus far, one country has stood out from all others in its use of interdependencies for its own advantage—the United States.
THE ROLE OF AMERICAN FINANCIAL POWER
In terms of GDP and financially, the world may be becoming more economically multipolar.8 But the United States has a major advantage when it comes to controlling the commanding heights of the global economy and the capability to convert that influence into geopolitical power.
America’s greatest asset may be the role of the dollar as the world’s reserve currency. Possessing the world’s reserve currency bestows “an exorbitant privilege” that allows a great power to operate under far looser fiscal and monetary constraints than all other countries.9 It is widely believed that the United States can run huge deficits to finance high levels of defense spending because its debt is denominated in its own currency. The owner of the reserve currency is also able to make momentous decisions that affect all countries on the basis of its own narrow interests.10 The United States and its key allies, particularly the United Kingdom, provide the financial centers of gravity for the global economy. There is not a global bank or financial institution that can survive and prosper if it defies U.S. or European law. As a report by the Eurasia Group put it, “Access to the US marketplace and US banks, and Washington’s ability and willingness to use them, are becoming more important as instruments of foreign and security policy.”11 The dependency of other countries and financial institutions on the United States means that Washington can use targeted sanctions to cut off others from capital markets and the financial system. The Eurasia Group called this the weaponization of finance.
The United States has worked closely with the European Union to consolidate its control over the international financial system and to convert that influence into geopolitical power. Over the past two decades, it has refined and deployed economic weapons against Iran, North Korea, terrorist networks, and now Russia. The United States has, in other words, become very adept at the use of financial warfare, which former senior U.S. Treasury official Juan Zarate describes as “the use of financial tools, pressure, and market forces to leverage the banking sector, private sector interests, and foreign partners in order to isolate rogue actors from the international financial and commercial systems and eliminate their funding sources.”12 These states and rogue groups have recognized this power as strategically valuable. Jack Lew, Treasury secretary in the Obama administration, said that economic sanctions are “a new battlefield for the United States, one that enables us to go after those who would wish us harm without putting our troops in harm’s way.”13
Thus far, the U.S. and European use of financial weapons has been carefully calibrated. In the conclusion to his book endorsing their use, Zarate argued that it was very important not to expand the use of sanctions to include diplomatic goals instead of focusing on rogue state conduct. He writes, “Illegal or suspect conduct must remain the primary driver for attention and isolation. Though financial suasion may appear to be a tantalizing and powerful tool to achieve political or diplomatic motives, its efficacy will be drastically diminished if diplomatic goals take precedence over conduct based drivers.”14
As Walter Russell Mead put it, “the more powerful the sanctions weapon becomes, and the more we try to use it, the greater the incentive we create for other people to challenge it.”15 U.S. policymakers are cognizant of the risk and have been extremely cautious about using the core infrastructure of the international financial order—such as the SWIFT payments system for the world’s banks—for strategic ends. But they have not hesitated to use modest financial sanctions to retaliate against U.S. rivals.
THE CASE OF CRIMEA
As we saw in Chapter 2, Russia’s annexation of Crimea—the first unilateral territorial expansion in Europe since 1945—and its subsequent support for separatists in eastern Ukraine were widely viewed in the United States and European Union as revisionist acts and significant challenges to the post–World War II international order. But it was also clear from the outset that the United States (to Europe’s relief) chose to take a military response off the table. NATO would not undertake any action, including lethal assistance to the Ukrainian military or boots on the ground, that could lead to armed conflict between the West and Russia. But there had to be a response. And sanctions appeared to fit the bill.
Sanctions on Russia
Sanctions were a very appealing option. They were already at the top of policymakers’ minds because the United States had threatened sanctions and imposed visa bans on the Yanukovych government for the crackdown on the Euromaidan protests. Russia was the world’s eighth largest economy in 2013, just before the annexation of Crimea, but it is heavily reliant on energy exports and is not a major player in international finance.16 Overall, Russia is much more dependent on Western markets than vice versa. Thus sanctions offered the prospect of imposing costs on Russia while limiting the costs incurred by the United States and Europe. The United States was able to implement the first of several rounds of sanctions unilaterally and press Europe to do more, which it did in a progressive way as Russian aggression continued.17 A tipping point was reached with the downing of Malaysia Airlines flight MH17 by Russian-backed forces on July 17, 2014, killing 298 people: after this attack, the European Union introduced a new round of sanctions targeting the Russian financial system and Russian companies.
The U.S. and EU sanctions included asset freezes and travel bans against individuals close to Putin as well as sanctions against sectors in the defense and energy industries believed to be engaged in aggression against Ukraine. Several Russian banks—including Gazprombank, Vnesheconombank, and Rosselkhozbank—were prevented from raising debt or equity with a maturity longer than ninety days.18 U.S. energy companies were restricted from cooperating with their Russian counterparts. Licensing systems were used to prevent trade in dual-use technologies as well as in energy exploration equipment.19 EU sanctions were more consequential and controversial domestically than U.S. sanctions, since the European Union is Russia’s largest trading partner and Russia is the European Union’s third largest after the United States and China.20 The United States engages in far less trade with Russia.21
At a meeting in late July 2014 to toughen sanctions, the European Union warned Moscow in an official statement that “destabilizing Ukraine, or any other eastern European neighboring state, will bring heavy costs to its economy.”22 The same day, President Obama declared: “The sanctions that we’ve already imposed have made a weak Russian economy even weaker. Foreign investors already are increasingly staying away. Even before our actions today, nearly $100 billion in capital was expected to flee Russia. Russia’s energy, financial, and defense sectors are feeling the pain. Projections for Russian economic growth are down to near zero.” The new sanctions will “ratchet up the pressure on Russia, including the cronies and companies that are supporting Russia’s illegal actions in Ukraine.”23
Although the sanctions were limited in scope, their effect was compounded by the fall in the price of oil. Together, these events had a devastating effect on the ruble, which collapsed in value, falling from 34 rubles to the dollar on July 1, 2014, to 69 to one on January 30, 2015.24 Russian GDP contracted by 4.6 percent from July of 2014 to July of 2015—its greatest drop since 2009.25 Capital flight for the first half of 2014 was estimated at $75 billion.26 Russian companies were advised not to list on the London Stock Exchange.27 Inflation rose to 11.4 percent in 2014 and was at a 15.8 percent annual rate by August 2015.28 Living standards plummeted for the first time since the 1990s—international air travel fell by 20 percent, car sales fell by 36 percent, and shops stopped stocking many Western food products.29
As bad as this was, Russians experienced much worse in the not too distant past. They adjusted, as they have done many times before. The United States and the European Union stopped short of imposing sanctions that would truly hurt the Russian economy; instead they held such sanctions in reserve as a means of deterring further aggression.
The Russian Response
Putin has long been suspicious of Russian integration into the global economy. He believed that Russia was too reliant on international sources of finance in the 1990s, which in his view made it a captive of the West and the politically motivated conditionality imposed by the IMF and the World Bank. He also saw a Russia ravaged by resource crises, including a food shortage in St. Petersburg while he was a city official there. He concluded that Russia would only succeed and maintain its sovereignty if it was more self-reliant. In their biography of Putin, Fiona Hill and Clifford Gaddy show how the idea of strategic reserve is central to his philosophy of governing. In the 1990s Putin learned, Hill and Gaddy wrote, that “Russia’s ultimate guarantee of survival—and of the country’s wealth and development—is its natural resources. They should therefore be kept in strategic reserve.” This was also an important theme of Putin’s dissertation for a graduate degree in economics, which he received in the mid-1990s. In this dissertation, according to Hill and Gaddy, he argued that “Russia must not allow itself to be dependent on any foreign country or countries for the infrastructure crucial to ensuring the export and import of key commodities and goods.”30
Putin implemented this philosophy as president. When he became president for the first time in 2000, Russia’s foreign-currency reserves were only $8.5 billion while its external debt was $133 billion. Eight years later, Russia’s debt was down to $37 billion while its foreign currency reserves had skyrocketed to $600 billion. A fourteenfold increase in the price of oil, from $10 per barrel in 1998 to $140 per barrel in 2008, helped Putin, but he also displayed skill and resolve in ensuring that the benefits went to the state and not just the oil companies. At the height of the financial crisis in October 2008, Putin told a group of foreign investors that while they were unprepared for the turbulence, “we did not allow ourselves to be caught by surprise. When we formulated our long-term economic and financial policy, we took into account potential risks and threats … We were sometimes even criticized for being too conservative. Well, I think that conservatism proved justified.”31
After the annexation of Crimea, Putin turned once again to self-reliance—but this time using China as an interim bridge. Reports surfaced in the Russian media, originating from the Russian government, that Russian aerospace and military-industrial companies were planning to purchase electronic components worth several billion dollars from China until they could adjust their manufacturing industry to produce these parts at home. Andrei Ionin, chief analyst at GLONASS Union, an association of Russian firms working on navigation systems to rival GPS, said that “establishing large-scale cooperation with Chinese manufacturers could become the first step toward forming a technology alliance involving BRICS member states.”32 In July 2014, Putin warned that the “very notion of state sovereignty is being washed out. Undesirable regimes, countries that conduct an independent policy or that simply stand in the way of somebody’s interests get destabilized.” He promised “additional steps to decrease the dependence of the national economy and financial system on negative external factors,” including “political risks.”33 Putin has tried to follow through on this promise. His goal is to provide a safety net for Russia, and potentially other countries disenchanted with Western economic dominance, as a way of reducing the West’s ability to expel its rivals from the global economy and as part of a comprehensive response to Western sanctions.
Pure self-reliance in an age of globalization will come at a cost, which Russia is already experiencing. But Russia was willing to pay this cost and has succeeded in its objective of thwarting the West’s strategy to bring Ukraine into the orbit of the European Union. Few nations will voluntarily follow in Russia’s footsteps, but the experience of all the players in the Ukraine drama has taught other nations and companies that involvement in the global economy can be turned against them in a time of crisis. Governments may not be able to be wholly self-reliant, but they can take steps to reduce their exposure, particularly in areas of strategic importance such as finance, information networks, and military power. In other words, Putin’s diagnosis of the problem—integration means that you are strategically exposed—will resonate even if the radicalism of his response, full self-reliance regardless of the cost, is rejected.
WHY CHINA IS ALSO WORRIED
The failure of the U.S. model of globalization and the return of economic warfare in Europe will have far-reaching implications for the U.S.-China relationship. Prior to 2008, China bought into the idea that interdependence would be a stabilizing force in world politics, even though there were large imbalances and reasons for concern. In many ways, this belief has continued. But the crisis also proved to many Chinese that the U.S. economy and the U.S. financial model were a force for instability rather than sustainable prosperity. As Cornell University professor Jonathan Kirshner has argued, the crisis created the space for a “new heterogeneity of thinking about money and finance,” whereas before there was only one approach to which all serious people and economies adhered. “The loss of faith in the American model,” Kirshner wrote, “has transformed China’s international economic strategy” because it began to seek ways to hedge against the volatility inherent in the U.S. system.34
The perceived failure of the U.S. model of globalization is not the only element of the interdependent order that worries China. The Chinese Communist Party is concerned that the open flow of information may undermine its regime. What makes this concern particularly dangerous is that the flow of information is intrinsic to interdependence and not the result of a deliberate decision made in Washington. For instance, in 2012 the New York Times conducted a major investigation of public records in China and exposed the seemingly illicit wealth held by the families of Chinese government officials.35 Beijing put severe pressure on the New York Times and other media outlets, to the point that Bloomberg promised to curb stories critical of the regime so as to continue operating in China.36 Beijing has also spared little effort to limit the freedom of the Internet. In addition, the Chinese government, concerned that travel abroad by Chinese scholars and experts could result in the spread of Western ideas, has cracked down on nongovernmental organizations and imposed restrictions on scholarly travel.
While the inherent nature of an open and interdependent order is a concern, Western sanctions on Russia have also raised the possibility that such measures could be used against China in retaliation for aggression abroad or for human rights abuses at home. This may seem far-fetched but it is hardly less likely than the prospect of a full-scale war between the United States and China, which is, after all, a contingency both countries plan for. There is also recent history. The United States imposed sanctions on China after the Tiananmen Square massacre in 1989. If the United States could hit Russia with sanctions after its annexation of Crimea, it seems at least conceivable that smart sanctions would be on the table if the Chinese government put down a revolution or felt compelled to make a move against Taiwan. U.S. officials have done little to assuage these fears. During the Ukraine crisis, U.S. Assistant Secretary of State for East Asia Daniel Russel explicitly drew a link between the U.S. response to Russia’s annexation of Crimea and how the United States would react to aggression by China. Russel said the retaliatory sanctions on Russia should have a “chilling effect on anyone in China who might contemplate the Crimea annexation as a model,” especially given the extent of China’s economic interdependence with the United States and its Asian neighbors.37
These two concerns—a loss of faith in the U.S. model and fear of sanctions—are mutually reinforcing and they point in one direction. China wants more influence in the global order, particularly in the economic, financial, and information realms, to ensure that the global order can never be turned against it. It is not that China wants to replace the U.S.-led economic order for all countries; it just does not want to be fully dependent on it. China is in a position quite different from that of Russia. It is the world’s second largest economy. It is not heavily dependent on energy as a source of income. In fact, it is an energy consumer, not an energy provider. China’s economy is much more diversified than Russia’s. China occupies a crucial position in global supply and manufacturing chains. It is the dominant trading partner for much of East Asia, especially Southeast Asia. It is inextricably bound up with the U.S. economy, especially with the U.S. financial system. It is the European Union’s second largest trading partner and has massively increased its investment in Europe since the financial crisis.38
China is also in a stronger position in terms of developing its own tools of interdependent warfare. Russia had few economic means of retaliating in kind against the West. Western economic warfare had a limited economic cost for Europe and the United States, and it was one they were willing and able to pay as the price of ratcheting up pressure on Moscow. China, conversely, has means and the cost would be immense. To put it bluntly, over the next decade, and if it puts its mind to it, China poses as much of a potential economic threat to the United States as the United States does to China. One could be forgiven for thinking that the relative equality of the United States and China means that economic warfare will be taken off the table. It will not be. Both countries are preparing military options to use against each other in the event of a major crisis, such as over Taiwan or Japan. Given that war would be more costly than sanctions, it follows that as long as traditional conflict is thinkable, so too is economic coercion. In fact, in the event of a major crisis, policymakers are likely to turn first to the economic tools because they are perceived as less likely to escalate than military force. The incredibly dense linkages between the American and Chinese economies will be subjected to deep study by military planners as they seek to identify vulnerabilities to exploit and defend against.
BLUNTING THE AMERICAN ADVANTAGE
So globalization is here to stay, but China, with Russia’s support, has a strategic incentive to reduce the risks of interdependence with the West. Moscow and Beijing are going about this task in a number of ways.
Changing the Incentive Structure inside the West
Interdependence is by its very nature mutually beneficial to the two countries involved. If Russia trades with Germany, both economies will benefit, although perhaps to varying degrees. If it were not mutually beneficial, trade would quickly come to an end. Mutual benefit means that both sides will pay a price if sanctions are introduced. Analysts tend to look at the way in which the threat of sanctions can increase pressure on a country like Russia to cease acts of aggression, but the flip side of the coin is that interdependence constrains the West’s response to such acts. Thus it came as no surprise that the European Union, which has substantial economic ties to Russia, was much more skeptical of economic sanctions than was the United States. As Stuart Gottlieb and Eric Lorber wrote: “Greater interdependence might, in fact, reduce the likelihood of conflict between nations or groups of nations. After all, it increases the cost of conflict for all of them. However, as the EU-Russian case shows, the logic can also work in reverse. It is incredibly difficult to punish economic partners for international aggression. The rational fear of economic backlash creates high tolerance for international wrongdoing.”39
Some Western companies are paying a significant price. ExxonMobil found oil in the Russian Arctic but could not develop the field because its partner was Rosneft, the major energy company subject to sanctions.40 Shares in Adidas dropped by 15 percent after it was forced to close stores in Russia. Joe Kaeser, chief executive of Siemens, warned that broader geopolitical tensions posed “serious risks” for Europe’s economy. The Erste Group, Eastern Europe’s third largest lender, warned that the economic fallout in the region could include banking failures. The U.S. credit card companies Visa and MasterCard have also been affected, not just in Russia but also more widely, due to market concerns about hedging against the future risk of sanctions elsewhere. Royal Bank of Scotland, Citigroup, and Bank of America all reduced their investments in Russia prior to the toughening of EU sanctions in July 2014.41 And then there is France, which canceled its sale of a second Mistral naval vessel to Russia.
This economic dynamic quickly melds into the political world. The writer Anne Applebaum has noted: “As they began to do business in Europe in the 1990s, the Russians learned very quickly about the importance of politically connected companies. As a result, they have begun to acquire shares in more of them.”42 This includes Rosneft’s purchase of 13 percent of Pirelli, the Italian tire giant, and Rosatom’s expansion of Hungary’s only nuclear power plant. Several of Europe’s most politically important companies have deep ties to Russia, including E.ON Ruhrgas (a German gas company), Eni (the Italian state gas company), and Royal Dutch Shell. Or take Nord Stream, a Baltic Sea pipeline controlled by Russian giant Gazprom, which has former German chancellor Gerhard Schroeder as its chairman. When Schroeder celebrated his seventieth birthday in 2014, at the height of the Crimea crisis, Putin was one of the attendees at a bash put on by Gazprom. In Germany, analysts speak of the Russia verstehers (understanders) who sympathize with the Kremlin’s position, often because they are economically engaged with it.
These costs have not prevented Europe from adopting sanctions on Russia, but they do demonstrate the difficult headwinds that any such strategy faces. Interdependence does not just constrain aggressor states; it also constrains the response to their aggression. It suggests as well that new fault lines have been created within democracies, weaknesses that they will have to work around as they cope with the rise of revisionist states.
Diversifying the Economic Infrastructure
China is seeking to build a parallel infrastructure in the global economy to reduce its dependence on Western-dominated institutions. The goal is not to replace the existing order but diversification. Toward that end, China has created a series of regional economic institutions designed to inaugurate a Sino-centric Asian economic order. The Asian Infrastructure Investment Bank came into being in 2015 over the objections of the United States and Japan but with the support and membership of many U.S. allies, including the United Kingdom, France, Germany, South Korea, and Australia. China also rolled out the New Silk Road, which seeks to link East and Central Asia through two initiatives.43 The Silk Road Economic Belt promotes overland investment in Central Asia by means of a network of railways, energy pipelines, investment, and the greater use of the renminbi.44 The Maritime Silk Road seeks to expand maritime trade through investment in ports in the Indian Ocean and the Persian Gulf.
China is also undertaking other initiatives, often with the other BRICS. In 2015, the BRICS launched the New Development Bank (NDB), also known as the BRICS Bank. Based in Shanghai, with five members that have an equal voting share and $100 billion in capital, the NDB will compete in the same space as the World Bank.45 China and Russia are also exploring a way of depriving the United States of its “nuclear economic weapon.” Andrey Kostin, chief executive of VTB, Russia’s second largest bank, told the 2015 Davos meeting: “We have already created a domestic alternative to the SWIFT system … and we need to create alternatives internationally.”46 Russia has been pressing the rest of the BRICS to help it create an international alternative but thus far the talks have been only informal.47
China is also looking to reduce its reliance on the dollar and to increase use of the renminbi. Di Dongsheng, an associate professor at the Renmin University of China, has written about a debate in Beijing about the internationalization of the renminbi. One constituency worries that internationalization will increase volatility in the Chinese economy, while another believes that it will help advance economic and social reforms. There is also a third group. As Di describes it, “Foreign policy experts with close ties to the People’s Liberation Army also hope to accelerate the pace of renminbi internationalization” because they “tend to believe in the great currency–great power nexus, which would require more assertive diplomacy and power-projection capabilities.”48
Di argues that the debate has shifted decisively toward those favoring internationalization. Internationalization is part of a more general rebalancing of China’s economy under which it will import more, thus giving it potential leverage over some of its trading partners. Internationalization will also increase Beijing’s incentive to abandon its principle of noninterference in the sovereign affairs of other countries because it will seek to protect its interests overseas.
The dollar will remain the world’s premier reserve currency. But a successful Chinese effort to increase the role of the renminbi in East Asia will have two major strategic consequences. The first is that China, and perhaps others, will be able to protect itself from a U.S. strategy of using the dollar for strategic purposes. If the world has two currencies in widespread use, the impact of any Western sanctions will be lessened. The second is that China will be able to use the renminbi for its own strategic ends in its own neighborhood if the renminbi becomes the dominant currency in East Asia. That is, the renminbi does not need to replace the dollar worldwide to have a strategic impact.
CHINA AND RUSSIA LOOK TO THE OFFENSIVE
China and Russia are developing their own tools of economic statecraft and warfare. They would like to have the means of deterring U.S. financial and economic power—either to dissuade Washington from using sanctions or to retaliate if it does.
In 2008, at the height of the financial crisis and less than two months after Russia’s invasion of Georgia, which put relations between Moscow and Washington into deep freeze, Russian officials approached the Chinese government and proposed a coordinated dumping of Fannie Mae and Freddie Mac bonds in an effort to force another massive bailout and badly damage the U.S. economy. Chinese officials declined the offer and promptly informed U.S. Treasury Secretary Hank Paulson, who subsequently told the tale in his memoir. Russia’s attempt to destabilize the U.S. economy shows the risks of requiring the cooperation of a state that may have a geopolitical interest in your failure even if they would also suffer from the economic shock.49 Thankfully, Russia’s economic weight was very limited in 2008, but imagine how difficult and complicated it would be to tackle a new Asian financial crisis if China and Japan were at each other’s throats in the East China Sea.
At the end of June 2015, foreign investors held $6.175 trillion in U.S. debt.50 Of that, China holds approximately 20.5 percent, the largest of any foreign holder. (Japan is the second largest, with approximately 19.3 percent.)51 While U.S. officials maintain that China’s holdings exercise no influence over U.S. policy, some Chinese officials and analysts have hinted that they would consider such a strategy if China’s sovereignty was threatened.52 Most analysts believe that China cannot use its holdings of debt as a weapon because China’s economic interests would be badly damaged if it began to dump U.S. debt.53 This is true most, but not all, of the time.
If the United States and China were on the brink of conflict over Taiwan or disputed islands in the East or South China Sea, China may calculate that unloading U.S. debt would hurt the U.S. economy more than the Chinese economy, either in absolute terms or in the relative pain that each country could endure during the crisis (if the Chinese felt more strongly about Taiwan than did the American people, for example, this balance would be in their favor). Even if China did not execute this strategy, giving the impression that it would be willing to do so could be effective, especially if Chinese policymakers were simply trying to deter the United States from taking an action (such as entering a conflict on the side of an ally) rather than compelling it to do something.
The risks of China’s vast holdings of U.S. debt should not be exaggerated, but neither should they be dismissed. China is refining its ability to use sanctions and the tools of economic coercion against countries that are smaller, and thus easier to intimidate, than the United States. China has imposed sanctions on bananas and tourism in a dispute with the Philippines over the Scarborough Shoal, on rare-earth metals in a dispute with Japan over the arrest of a Chinese fisherman in 2010, and on salmon exports from Norway after the awarding of the Nobel Peace Prize to Chinese dissident Liu Xiaobo. It has also encouraged informal boycotts of Japan in response to Japan’s purchase of the Diaoyu/Senkaku Islands in September 2012.54 This is part of a strategy to use China’s economic importance, especially in the region, to raise the costs of opposing Beijing.
LEVELING THE PLAYING FIELD WITH CYBERWARFARE
Interdependence reaches well beyond economics and finance, of course, and the playing field begins to level out for China and Russia in these other arenas, especially technology and cyber security. Yes, the United States enjoys considerable structural advantages in cyberwarfare. The National Security Agency is immensely capable. The world’s largest technology companies are American. And the United States has been at the cutting edge of developing offensive cyber weapons. Most notably, in 2012, word leaked of a U.S. covert operation called “Olympic Games” that was designed to sabotage the Iranian nuclear program by planting a virus known as Stuxnet, one of the most advanced and sophisticated viruses ever developed.
Yet the United States is also incredibly vulnerable given the technological nature of the U.S. economy and the country’s reliance on information networks in all fields, including in the military. This vulnerability is one that China and Russia have been all too willing to exploit to gain a strategic edge over the United States in the emerging geopolitical competition. China has been repeatedly identified by U.S. agencies and the U.S. Congress as the number one cyber threat to the United States.55 China’s cyberwarfare operations are the responsibility of the PLA’s General Staff Department’s Third Department, which has over 130,000 people attached to it.56 The Chinese military believes that the U.S. military’s reliance on information networks offers China an opportunity to occupy “the new strategic high ground.”57
By their very nature, cyberwar operations are shrouded in secrecy. It is widely believed that China has engaged in massive state-sponsored espionage of Western corporations to steal vast quantities of highly valuable intellectual property. The U.S. government has complained repeatedly about this, pointing out that it crosses the boundary of what is commonly regarded as acceptable espionage. But perhaps even more notable is what China has being doing that is regarded as legitimate by the United States. In 2015, it was revealed that China is building a vast database of Americans, particularly those in sensitive government positions, by hacking government departments, health-care companies, and other organizations. Perhaps the most high-profile hack was of the U.S. Office of Personnel Management (OPM), which compromised the records of over 21 million people. OPM holds personnel files on millions of American government workers, including in the Pentagon, State Department, and White House. The files include the security clearance form filled out by all government employees, which contains details on every foreign national the employee knows, old addresses, financial information, and personal weaknesses. The files for background investigations into each employee, which could involve romantic entanglements and other potentially embarrassing and compromising information, were also reportedly compromised.
As Director of National Intelligence James Clapper put it, the OPM breach was “a gold mine for a foreign intelligence service.”58 One U.S. government official told the Washington Post, “This is part of their strategic goal—to increase their intelligence collection via big-data theft and big-data aggregation. It’s part of a strategic plan.”59 This is not an illegitimate or shocking action. It is what countries do in a strategic competition. Current and former senior U.S. intelligence officers said as much. Clapper said, “You have to kind of salute the Chinese for what they did … If we had the opportunity to do that, I don’t think we’d hesitate for a minute.”60 Michael Hayden, a former head of the National Security Agency and the Central Intelligence Agency, struck a similar note. OPM, he said, was a “legitimate foreign intelligence target. To grab the equivalent in the Chinese system, I would not have thought twice. I would not have asked permission … This is not ‘shame on China.’ This is ‘shame on us’ for not protecting that kind of information.”61
What made the OPM hack special was that China used interdependence—in this case information networks—to turn an American strength into a strategic liability. It was a victory that would have been inconceivable before the age of the Internet. We are likely to see similarly ambitious operations, on all sides, in the years to come.
Russia’s cyberwarfare operations are even more secret than China’s. Russian hackers are regarded as among the best in the world and the Russian government is suspected of being closely involved in major cyber attacks on U.S. interests. One of the most spectacular occurred in 2016 when Russia was named by U.S. intelligence as the likely source of cyber attacks on the Democratic National Committee (DNC). These attacks accessed thousands of internal documents, which ended up in the possession of WikiLeaks, which in turn released them to maximize political pain on Democratic nominee Hillary Clinton. There were other leaks of the personal emails of leading political figures—including Colin Powell and John Podesta—in the fall of 2016, while Russia was also believed to be behind fake news, whereby false stories were planted in social media. The interference was widely perceived as Putin’s revenge on Clinton and the Obama administration for what he saw as U.S. meddling in the Russian elections in 2012 and in Ukraine in 2013 and 2014. Putin may also have seen Donald Trump as more aligned with Russian interests in Europe and the Middle East.
Russia’s gambit was successful—Clinton’s candidacy was hurt by the drip-drip effects of the leaks, Trump was elected, and the credibility of American democracy was damaged by its vulnerability to outside pressures.
As the United States and Russia compete with each other, one can expect active measures to distort and influence the domestic politics of each. Putin has responded to the threat he perceives from the West by cracking down on non-governmental organizations, targeting opposition figures, and consolidating his power. But the United States is an open system and much more vulnerable to external interference. It has never had to deal with this type of threat before—one where a rival power could interfere with its domestic democratic process on such a large scale. Dirty tricks surely happened in the past, but their dangers have become magnified in the era of big data and cyberwarfare. This raises difficult questions about how to respond and deter Russia from such actions in the future.
THE FUTURE OF GLOBALIZATION
Fears of cyberwar and the weaponization of interdependence are taking a toll on investment.62 The United States is concerned that China is using market openness to preemptively penetrate U.S. companies and technologies in ways that Beijing could strategically exploit at a time of crisis. In a 2013 interview, former director of the CIA and the NSA Michael Hayden explained, “If you’ve got a foreign company supply[ing] you with essential communications infrastructure and/or helping build your network, the detailed knowledge that company obtains can be a powerful intelligence tool for foreign security services to leverage off to map out and target your telecommunications network for espionage and other malicious purposes.”63
Later in the interview, Hayden singled out Chinese technology giant Huawei, saying that it represents an “unambiguous national security threat” to the United States and Australia. In 2012, a House Intelligence Committee Report into the activities of Huawei and ZTE, another Chinese telecommunications company, recommended that both be viewed with suspicion and be banned from mergers, acquisitions, and takeovers in the United States or from supplying vital components to the U.S. telecommunications infrastructure.64
Huawei and ZTE are meeting with stiff resistance in the United States, but they have had a more mixed experience elsewhere. Taiwan, Germany, India, and Australia blocked Huawei and/or ZTE from major contracts.65 But Huawei enjoyed the support of former UK prime minister David Cameron in making a £1.3 billion investment in the United Kingdom (despite considerable concerns from Parliament), and the European Union as a whole continues to do business with it.66
Concerns have spread from the technology sector to other infrastructure areas. Cameron backed Chinese investment in an £18 billion project to build a nuclear power plant at Hinkley Point despite security concerns, such as that China could threaten to turn off the plant if it was engaged in a dispute with the United Kingdom. After Cameron’s resignation, the new British prime minister, Theresa May, paused the project and subjected it to further review due to those same concerns, before finally approving it.67 In Australia, the Turnbull government blocked a deal that would have seen Chinese investors take a majority stake in the country’s largest electricity company, Ausgrid, again citing national security concerns.68
Unconditional interdependence would allow Chinese companies and investors to fully avail themselves of all the opportunities that globalization offers—but there is widespread recognition that technology infrastructure is a special case where “Trojan horse” concerns are real. Further integration is unlikely to ease tensions; it will only exacerbate them.
As tensions rise between the world’s major powers, they will use whatever leverage they have to advance their strategic goals. The use of force is too high-risk, except as a last resort, and reassuring allies or pre-positioning forces is insufficient as a coercive tool. Consequently, countries will prepare for limited economic warfare, more in the financial arena than in trade, and they will make widespread use of cyberwarfare. They will also seek out other means of using a rival’s reliance on and participation in the global system to their own advantage. This development will have enormous repercussions. Globalization will continue but not as we have known it. Countries will delink from each other where they perceive a strategic vulnerability. They will maximize their leverage where they can. They will develop means of retaliation. And they will continue to test each other.