War on Terror now passe - China the Real Threat

This is a free email Stratfor (NB: NOT StrategyPage) send me for advertising purposes. Presumably they won't mind me posyting it here where potential customers might be found:

U.S. Perceptions of a Chinese Threat
By George Friedman

The U.S. Department of Defense released its annual report on China's military last week. The Pentagon reported that China is moving forward rapidly with an offensive capability in the Pacific. The capability would not, according to the report, rely on the construction of a massive fleet to counter U.S. naval power, but rather on development and deployment of anti-ship missiles and maritime strike aircraft, some obtained from Russia. According to the Pentagon report, the Chinese are rapidly developing the ability to strike far into the Pacific -- as far as the Marianas and Guam, which houses a major U.S. naval base.

Whether the Chinese actually are constructing this force is less important than that the United States believes the Chinese are doing this. This analysis is not confined to the Defense Department but has been the view of much of the U.S. intelligence community. There is, therefore, a consensus in Washington that the Chinese are moving far beyond defensive capabilities or deterrence: They are moving toward a strike capability against the U.S. Seventh Fleet.

If this analysis is correct, then the reason for U.S. concern is obvious. Ever since World War II, the United States has dominated all of the world's oceans. Following that war, the Japanese and German navies were gone. The British and French did not have the economic ability or political will to maintain a global naval force. The Soviets had a relatively small navy, concerned primarily with coastal defense. The only power with a global navy was the United States -- and the U.S. Navy's power was so overwhelming that no combination of navies could challenge its maritime hegemony.

In an odd way, this extraordinary geopolitical reality has been taken for granted by many. No naval force in history has been as powerful as the U.S. Navy. The U.S. Navy does not have the ability to be everywhere at all times -- but it does have the ability to be in multiple places at the same time, and to move about without concerns of being challenged. This means, quite simply, that the United States can invade other countries, anywhere in the world, but other countries cannot invade the United States. Whatever the outcome of the invasion once ashore, the United States has conducted the Iraq, Kosovo, Somali, Gulf and Vietnamese wars without ever having to fight to protect lines of supply and communications. It has been able to impose naval blockades at will, without having to fight sea battles to achieve them. It is this single fact that, more than any other, has shaped global history since 1945.

Following the Soviet Strategy?

The Soviets fully understood the implications of U.S. naval power. They recognized that, in the event of a war in Europe, the United States would have to convoy massive reinforcements across the Atlantic. If the Soviets could cut that line of supply, Europe would be isolated. The Soviets had ambitious goals for naval construction, designed to challenge the United States in the Atlantic. But naval construction is fiendishly expensive. The Soviets simply couldn't afford the cost of building a fleet to challenge the U.S. Navy, while also building a ground force to protect their vast periphery from NATO and China.

Instead of trying to challenge the United States in surface warfare, using aircraft carriers, the Soviets settled for a strategy that relied on attack submarines and maritime bombers, like the Backfire. The Soviet view was that they did not have to take control of the Atlantic themselves; rather, if they could deny the United States access to the Atlantic, they would have achieved their goal. The plan was to attack the convoys and their escorts, using attack submarines and missiles launched from Backfire bombers that would come down into the Atlantic through the Greenland-Iceland-United Kingdom (GIUK) gap. The American counter was a strong anti-submarine warfare capability, coupled with the Aegis anti-missile system. Who would have won the confrontation is an interesting question to argue. The war everyone planned for never happened.

Today, it appears to be the Pentagon's view that China is following the Soviet model. The Chinese will not be able to float a significant surface challenge to the U.S. Seventh Fleet for at least a generation -- if then. It is not just a question of money or even technology; it also is a question of training an entirely new navy in extraordinarily complex doctrines. The United States has been operating carrier battle groups since before World War II. The Chinese have never waged carrier warfare or even had a significant surface navy, for that matter -- certainly not since being defeated by Japan in 1895.

The Americans think that the Chinese counter to U.S. capabilities, like the Soviet counter, will not be to force a naval battle. Rather, China would use submarines and, particularly, anti-ship missiles to engage the U.S. Navy. In other words, the Chinese are not interested in seizing control of the Pacific from the Americans. What they want to do is force the U.S. fleet out of the Western Pacific by threatening it with ground- and air-launched missiles that are sufficiently fast and agile to defeat U.S. fleet defenses.

Such a strategy presents a huge problem for the United States. The cost of threatening a fleet is lower than the cost of protecting one. The acquisition of high-speed, maneuverable missiles would cost less than purchasing defense systems. The cost of a carrier battle group makes its loss devastating. Therefore, the United States cannot afford to readily expose the fleet to danger. Thus, given the central role that control of the seas plays in U.S. grand strategy, the United States inevitably must interpret the rapid acquisition of anti-ship technologies as a serious threat to American geopolitical interests.

Planning for the Worst

The question to begin with, then, is why China is pursuing this strategy. The usual answer has to do with Taiwan, but China has far more important issues to deal with than Taiwan. Since 1975, China has become a major trading country. It imports massive amounts of raw materials and exports huge amounts of manufactured goods, particularly to the United States. China certainly wants to continue this trade; in fact, it urgently needs to. At the same time, China is acutely aware that its economy depends on maritime trade -- and that its maritime trade must pass through waters controlled entirely by the U.S. Navy.

China, like all countries, has a nightmare scenario that it guards against. If the United States' dread is being denied access to the Western Pacific and all that implies, the Chinese nightmare is an American blockade. The bulk of China's exports go out through major ports like Hong Kong and Shanghai. From the Chinese point of view, the Americans are nothing if not predictable. The first American response to a serious political problem is usually economic sanctions, and these frequently are enforced by naval interdiction. Given the imbalance of naval power in the South China Sea (and the East China Sea as well), the United States could impose a blockade on China at will.

Now, the Chinese cannot believe that the United States currently is planning such a blockade. At the same time, the consequences of such a blockade would be so devastating that China must plan out the counter to it, under the doctrine of hoping for the best and planning for the worst. Chinese military planners cannot assume that the United States will always pursue accommodating policies toward Beijing. Therefore, China must have some means of deterring an American move in this direction. The U.S. Navy must not be allowed to approach China's shores. Therefore, Chinese war gamers obviously have decided that engagement at great distance will provide forces with sufficient space and time to engage an approaching American fleet.

Simply building this capability does not mean that Taiwan is threatened with invasion. For an invasion to take place, the Chinese would need more than a sea-lane denial strategy. They would need an amphibious capability that could itself cross the Taiwan Strait, withstanding Taiwanese anti-ship systems. The Chinese are far from having that system. They could bombard Taiwan with missiles, nuclear and otherwise. They could attack shipping to and from Taiwan, thereby isolating her. But China does not appear to be building an amphibious force capable of landing and supporting the multiple divisions that would be needed to deal with Taiwan.

In our view, the Chinese are constructing the force that the Pentagon report describes. But we are in a classic situation: The steps that China is taking for what it sees as a defensive contingency must -- again, under the worst-case doctrine -- be seen by the United States as a threat to a fundamental national interest, control of the sea. The steps the United States already has taken in maintaining its control must, under the same doctrine, be viewed by China as holding Chinese maritime movements hostage. This is not a matter of the need for closer understanding. Both sides understand the situation perfectly: Regardless of current intent, intentions change. It is the capability, not the intention, that must be focused on in the long run.

Therefore, China's actions and America's interpretation of those actions must be taken extremely seriously over the long run. The United States is capable of threatening fundamental Chinese interests, and China is developing the capability to threaten fundamental American interests. Whatever the subjective intention of either side at this moment is immaterial. The intentions ten years from now are unpredictable.

As the Pentagon report also notes, China is turning to the Russians for technology. The Russian military might have decayed, but its weapons systems remain top-notch. The Chinese are acquiring Russian missile and aircraft technology, and they want more. The Russians, looking for every opportunity to challenge the United States, are supplying it. Now, the Chinese do not want to take this arrangement to the point that China's trade relations with the United States would be threatened, but at the same time, trade is trade and national security is national security. China is walking a fine line in challenging the United States, but it feels it will be able to pull it off -- and so far it has been right.

U.S. Defense Policy: Full Circle

The United States is now back to where it was before the 9/11 attacks. Defense Secretary Donald Rumsfeld came into office with two views. The first was that China was the major challenge to the United States. The second was that the development of high-tech weaponry was essential to the United States. With this report, the opening views of the administration are turning into the closing views. China is again emerging as the primary challenge; the only solution to the Chinese challenge is in technology.

It should be added that the key to this competition will be space. For the Chinese, the challenge will not be solely in hitting targets at long range, but in seeing them. For that, space-based systems are essential. For the United States, the ability to see Chinese launch facilities is essential to suppressing fire, and space-based systems provide that ability. The control of the sea will involve agile missiles and space-based systems. China's moves into space follow logically from their strategic position. The protection of space-based systems from attack will be essential to both sides.

It is interesting to note that all of this renders the U.S.-jihadist dynamic moot. If the Pentagon believes what it has written, then the question of Afghanistan, Iraq and the rest is now passé. Al Qaeda has failed to topple any Muslim regimes, and there is no threat of the caliphate being reborn. The only interesting question in the region is whether Iran will move into an alignment with Russia, China or both.

There is an old saw that generals prepare for the last war. The old saw is frequently true. There is a belief that the future of war is asymmetric warfare, terrorism and counterinsurgency. These will always be there, but it is hard to see, from its report on China, that the Pentagon believes this is the future of war. The Chinese challenge in the Pacific dwarfs the remote odds that an Islamic, land-based empire could pose a threat to U.S. interests. China cannot be dealt with through asymmetric warfare. The Pentagon is saying that the emerging threat is from a peer -- a nuclear power challenging U.S. command of the sea.

Each side is defensive at the moment. Each side sees a long-term possibility of a threat. Each side is moving to deflect that threat. This is the moment at which conflicts are incubated.
Send questions or comments on this article to analysis@stratfor.com.
Perhaps it will turn in the Cold War MK2, imagine it being stationed in Japan.... the BFG of the modern day perhaps could be BFJ?
dan_man said:
Perhaps it will turn in the Cold War MK2, imagine it being stationed in Japan.... the BFG of the modern day perhaps could be BFJ?

As a small island off Europe with strictly limited power projection capabilities, the UK would be well advised to stand well clear of any future US/China confrontation. There's practically nothing we could do to influence the outcome but trying to do so may precipitate an extra hot portion of stir-fry courtesy of Beijing, if you catch my drift...
I heard somewhere (can't remember where) that the chinesse think that if Europe gets it's act together Europe could be a super power...


Book Reviewer
This is the latest pitch by the US military for lots more conventional high tech toys. Counter insurgency is too messy and there isnlt anything much for the airforce and navy to do.

The chinese would be stark starting bonkers to take on the US in a conventional or nuclear war.

However they OWN the US. If they stop buying US debt at their current rate then the US economy goes down the toilet.
Listy said:
I heard somewhere (can't remember where) that the chinesse think that if Europe gets it's act together Europe could be a super power...

Europe can't even decide what shape banana's should be, never mind organising a potent military force.

I've worked alongside the Frogs, Eye-ties, Krauts and Spanish.

Only the Krauts impressed me.
Pteranadon said:
This is the latest pitch by the US military for lots more conventional high tech toys. Counter insurgency is too messy and there isnlt anything much for the airforce and navy to do.

The chinese would be stark starting bonkers to take on the US in a conventional or nuclear war.

However they OWN the US. If they stop buying US debt at their current rate then the US economy goes down the toilet.

If the US economy goes down the toilet then the Chinese economy goes down very soon after it.
the_matelot said:
Europe can't even decide what shape banana's should be, never mind organising a potent military force.

I've worked alongside the Frogs, Eye-ties, Krauts and Spanish.

Only the Krauts impressed me.

Thats why As I said If we can get their act together....
F**k that! I'd have to get an Indian takeaway instead of a Chinese on a friday night! :D


The only thing I can see preventing the dominance of China is the current reliance of the Chinese economy on supplying the rest of the world and, in particular, the west.
Though i'm undecided on how Battlestar Giraqicta changes things...

I fear we are heading for a major war...
I also fear we are not going to win this one.
ytomk said:
The only thing I can see preventing the dominance of China is the current reliance of the Chinese economy on supplying the rest of the world and, in particular, the west.
Though i'm undecided on how Battlestar Giraqicta changes things...

I fear we are heading for a major war...
I also fear we are not going to win this one.

If you having little or nothing to do with someone, you're not likelyto fall out with them. If you have a lot to do with them, for example being in business together, there are ample opportunities for major disagreements.

In 1913-14 and 1939 Germany traded heavily with UK, France and the US. In 1940-1 Japan traded a lot with the US.

USSR never traded much with USA, and there was no major war between them.

China trades massively with the US.
Right on cue, another email from Stratfor:

An Inflection Point In China's Banking Problem
By George Friedman

The month of May witnessed an interesting phenomenon: a spate of reports on China's nonperforming-loan problem. What is most intriguing is that these reports did not come from organizations like Stratfor -- minor outfits that have been talking about this for a couple of years. It came from real, solid, serious mainstream organizations that were, and continue to be in some cases, quite positive about China on the whole. What is important here is not that China has a serious problem with bad loans in its banking system. That's old news. What is important is that mainstream analysts in the West now are taking official notice of it. The wide divergence between the Western perception of Chinese economic health and the realities of China's economy is beginning to close. There will be consequences to that.

The first report came from Ernst & Young, which released a study saying that China had a substantial problem with nonperforming loans (NPLs). We have to confess to not having seen that report, because the accounting firm withdrew it a few days later. The Chinese government blasted the report, using words like "ridiculous" and "distorted." Ernst & Young, which has a substantial practice in China, denied having retracted the report because of pressure from the government. Whatever their reasons for doing so, we wish we had been faster in asking for a copy.

No matter, because May also brought studies on the same subject from PricewaterhouseCoopers (PWC), McKinsey Global Institute, and Fitch. Each said the same basic thing: that Chinese banks have enormous NPL numbers on their books. The PWC report was issued by a group within the company that specializes in making markets in NPLs. Their news was that the water in China was fine and everyone should come in. McKinsey focused on inefficiencies in the Chinese banking system that should be cleared up, so that NPLs could decline and the Chinese gross domestic product could surge. Fitch was the harshest of the three, but that firm also argued that the Chinese had the tools in place to handle the problem. The bottom line was that all three acknowledged that NPLs were a big issue for China, but they took different approaches in trying to put the problem in perspective. In other words, they gave a warning without yelling "Fire!" Some of the reports were criticized by the Chinese, but none were blasted. Meanwhile, Moody's Investors Service has told us that they will be releasing a report in a couple of weeks. It will be interesting to see what their take is.

Let's begin this analysis by looking at a couple of quotes from these reports. McKinsey, for example, writes:

"Underlying these reforms, however, is capital misallocation by the system. Nonperforming loans are the most conspicuous outcome of this misallocation, but our research shows that the much larger volume of loans to underperforming ventures that don't go bad but yield only negligible returns are potentially more costly to China's economy."

Fitch's report states:

"Summing all of these figures, we come up with total official nonperforming loans of US$206 bn and other estimated problem loans of over US$270 bn in the banking system. We would reiterate, however, that a large portion of this latter figure is comprised of estimated Special Mention loans or loans that currently are not classified as nonperforming [emphasis Fitch's]. At the same time, there is an additional US$197 bn in NPL carveouts still remaining on the balance sheets of China's asset management companies, which no longer represent direct losses for banks but are a future liability for the government."

Fitch also states:

"Beyond this, estimating a rate of flow of new nonperforming loans is not an easy exercise given Chinese banks' extremely weak historical data and ongoing deficiencies in accounting and disclosure. Few banks report data on NPL flows, and those that do show recent flow rates in the extremely low single digits. We believe these numbers understate the likely level of ultimate credit losses, given what we know to be the slow evolution of a strong credit culture and risk management practices and our suspicion that China's over-reliance on investment-led growth comes at a cost to bank credit quality."

Fitch is estimating China's bad-loan situation (our term, lumping all these categories together) at $673 billion, but it warns that -- given Chinese accounting and reporting, and the fact that what reporting exists is not credible -- $673 billion is a low number. That's important. If $673 billion was the final number, then measures that are put in place could limit the ultimate losses to a level below that figure. If, however, the total number of bad loans is substantially higher than $673 billion -- which is our view of the situation -- then the system would be lucky to have to write off only this amount.

There are numerous ways to measure the magnitude of the problem, but one of the simplest is this. China is said to hold nearly $819 billion in foreign reserves. Fitch's conservative estimate of the bad loan situation comes close to matching that number, and a more liberal calculation would swallow those reserves up and then some. Put very simply, the Chinese banking system is in deep trouble -- and with it, so is the Chinese economy.

It has become an article of faith that China's economy is booming. The economy certainly is growing rapidly. But growth and size alone don't tell you how healthy an economic entity is. During the Great Depression, the U.S. economy was enormous, but it was crippled. Japan's economy was growing at a phenomenal rate in the 1980s, all the while heading for its disaster. Size and growth are but two measures of an economy -- or of a business. They do not tell you how well it is doing.

The basic problem of the Chinese economy, as in many Asian nations, is that the banks have not made loans with business considerations in mind. They made loans for political reasons and to maintain social stability. In many cases, loans were seen as being more like grants. As a result, they were invested in enterprises that did not make enough money to repay (or even attempt to repay) the loans. Frequently, rather than bankrupting the business or writing off the loan, the banks lent more money to the business -- so that it could repay old debts, and there was an appearance that the loans were viable. Loans went into land speculation or to investments in areas that were already overbuilt. (And this does not attempt to take into account ancillary problems, such as corruption and embezzlement, which also have been significant issues for the Chinese government.)

In the first part of 2006, there has been a huge surge in lending in China. With the economy already growing at rates of more than 9 percent, it would seem structurally impossible to grow it any faster. Shortages in skilled workers, management, buildings -- all these limit the rate of growth. The truth is that a substantial portion of the loans that went out were issued to keep bad loans floating, like using one credit card to pay the monthly payment on another. You can do that for a while, but you can't do it forever.

What keeps the Chinese system alive is not domestic consumption, which is not rising in tandem with overall growth. What keeps China afloat is exports -- exports in ever greater numbers, and with ever-smaller profit margins. Surging exports are critical to China, as they were to Japan before it. They generate the cash that allows the financial system to continue operating.

This is also the Achilles' heel of the Chinese economy, as Fitch points out:

"Given the weaknesses already discussed, we believe Chinese banks remain acutely vulnerable to an economic slowdown, although the analysis above recognizes that much work has been done to tackle these weaknesses and at a minimum suggests that Chinese banks and the government are more equipped today than in the past to deal with problems that may arise."

Here is the problem. The official policy of the Chinese government is to cool off the economy. In fact, the Chinese are attempting to cool growth only in certain sectors, where they perceive particularly dangerous bubbles starting to form. For the most part, however, they are doing everything they can to keep the economy hot, in order to try to manage the financial problem. Now, Fitch argues in its report that the Chinese banks are better equipped than in the past to deal with their problems. We agree with that assessment; they were completely unprepared in the past and now are abysmally prepared. You cannot prepare to deal with a loan situation as bad as that in China. You simply keep cycling as fast as possible and hope that something turns up.

In our view, this spate of reports on China's financial situation marks a turning point.

One of the things that has kept the Chinese economy booming was cheap exports. But another was the perception in the West that, underneath it all, China was sound. This perception induced foreign banks to invest in Chinese banks. There have, of course, been studies detailing the Chinese debt problem for some time: Standard & Poor's, for example, estimated the bad debt in 2002 at $600 million. That part isn't new.

However, when "irrational exuberance" (to quote Alan Greenspan) is at its peak, it is hard to break through the noise. Markets continue to rise, even as bad news comes out. Last week, for example, we saw the Bank of China make its initial public offering and shares soar, just as these financial reports were emerging. That doesn't mean these reports are wrong or that the Chinese have things under control. It simply means the market is ignoring news and rising on its own giddiness.

Nevertheless, a turning point has been reached that will be difficult to ignore. Reports from Stratfor are, of course, one thing. Reports from a single credit agency are another. But when a series of reports from highly respected, mainstream analysts all come out within a few days of each other -- with each, in their own way, telling the same basic story, it becomes hard for the system to dismiss that. Western companies moving into China have CEOs and CFOs who must exercise due diligence. There are now too many reports out there to be simply ignored. All of them are caveated. None of them write China off. But a critical mass is forming that will cut through the froth in due course.

Obviously, this does not mean that China will implode, disappear or anything like that. It will remain an enormous economy and an important one. But this does mean that the dynamics of the Chinese economy are shifting. The debt issue represents a deep structural problem that China will either deal with -- as South Korea did -- or not, as Japan did not. (Japan reaped more than a decade of economic stagnation as a consequence. It is significant that China lacks the degree of insulation that Japan built up; the economy has more external exposures and would not weather a similar crisis as well.) The point is that, ultimately, the books have to balance everywhere. That means that the huge structural imbalance of China, which these debts represent, must be rectified. And that process, as in all such matters, will be painful.

It is not clear how much pain Chinese society can withstand before it fractures. This is clearly a concern for Beijing as it tries, simultaneously, to reform the economy and to crack down on dissent. The Chinese, like anyone in this fix, try to put the best possible face on the situation. Which is why they exploded at Ernst & Young. But even the government in Beijing couldn't shout down the ensuing tidal wave of financial reports; instead, they grumbled and pointed to the passages that said it could all be managed.

Perhaps it can. But if it can, it won't be easy -- and we doubt that it is possible. We have been writing about this problem for several years now, and people keep asking when the crisis will come. Our answer is simple: If this isn't a crisis, what would a crisis look like? The Chinese financial system is sinking under nonperforming and underperforming loans. Mainstream Western analysts are all writing about the problem and calling for reforms that the Chinese cannot possibly implement in time to make a difference. At some point, the weight of evidence will shift the behavior of the Western financial community, and that will be that.

In the meantime, let the exports flow -- for they surely will, and in breathtaking quantities.
Send questions or comments on this article to analysis@stratfor.com.
Talk about War, more money for King George's supporters/finaciers.
Japan worries me more than China.
China is prepareing a defensive stratagy, offence being the best defence if needed.
I can't see China being able to deal with the US Submarine threat, that is the hunter killers who can close any port anywhere.
Euro as a Superpower, not in my life time.


War Hero
I attended a London conference with my company last year where 99% of the delgates were the UK's top engineering and building services consultants, the brief being that of World Energy. One of the speakers was a young Chinese chap who, as part of his final Masters degree, had been researching and working on the subject a big British association. His briefing was enlightening, if scary. The sedatining effects of the pre-conference drinkes and prior dull speakers were soon forgotten whilst we watched with increasing horrified fascination the detailed facts and figures this articulate chap delivered on China's industries, their prowess, their rapid expansion and their projected impact on the rest of the World. Politics was obviously off-limits but the accompanying general statistics, demographics, GDP statistics etc. were truly astounding. Inevitably the main discourse over lunch was these revelations and the fact that quite honestly few had realised the true might of China and the stealth behind their development.

Undoubtedly an unknown quantity that we should perhaps be seeking to conciliate with.... :(
Chinese Gov finacial figures can never be trusted. Deng demanded 8% growth one year and for years after all departments grew by 8%.
Compulsory bank loans are fact, and Non Performing Loans, ie loans that where never intended to be repayed are Asian life, they all do it, make the US / Uk finacial markets look like saints.

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