No matter where you live, a kinetic confrontation between the top two global military powers would impact you. For example, I live in Europe and although there would probably be no direct impact, the indirect consequences would be groundbreaking. The United States would be forced to reevaluate their commitments around the world, changing the security landscape overnight. Not to mention the economic impact on supply chains, global demand, and consumer sentiment.
The mood has changed
You could have spotted the changing Chinese attitude towards the West even if you do not follow geopolitics closely. All you had to do was watch Chinese movies, especially those depicting historical events. Foreigners were nearly always portrayed as intrusive elements bringing chaos into the harmonic Chinese society. Nevertheless, older films did not cast them as outright evil, and the main actor (the hero) was often able to come to terms with the foreigners or persuade them to stay out of the way.
But this narrative began to shift at the beginning of the second decade of the 21st century. Especially in new films, not only are Americans/Brits often the villains, but we can also witness spectacular punishments of Western armies or nations that dared to challenge China.
That’s something we’re not used to in American movies. Sure, the Chinese or Russians are usually the bad guys. But not the Chinese or Russian states. In all the James Bond / Mission Impossible / whatever movies, China or Russia are always tricked into confrontation with the US/Europe by some treacherous villain. And once the hero saves the day, all sides are relieved that world peace was saved again.
You may shake your head, but I personally consider these narratives as valuable insights into the society. It also clearly shows the difference and ultimate misunderstanding of each side. Peace has always been the goal in modern Western movies (plus not offending China to allow the film’s release in their cinemas). However, peace was never the ultimate achievement in Chinese movies. In the older films, it was internal unity (not surprising given Chinese history). The conciliatory tone even towards the US or Britain was in line with the Party’s propaganda stressing the peaceful rise of China.
But then came Xi Jinping, and things started to change. A few examples:
- the Nine-Dash line
- wolf warrior diplomacy
- de facto abolishment of “One country, two systems”
- frequency and severity of incursions into the Taiwanese ADIZ
And so, the core message in Chinese movies has evolved from unity to an unavoidable clash with outside powers (mainly the USA) that want to choke the inevitable rise of China. While Western analysts focus on the messaging coming from the Chinese leadership, not many pay enough attention to the changing mood within the general society and the rising willingness to solve diplomatic conflicts with force. People in the West have long forgotten the Unequal Treaties from the 19th century. The Chinese have not.
The environment for a hot war between the US and China is in place. But what are the actual odds of it happening? I’ve always preferred a quantitative approach not just in markets, but in life in general.
Here are three pieces of data I monitor:
- Chinese fiscal spending
- Relative performance of Chinese aerospace and defense stocks
- Copper and iron ore prices
Let’s go through them one by one.
Chinese fiscal spending
This is not simply the budget deficit, but also monetary measures like bank reserve ratios. The idea is quite simple. If China plans to go to war, they will ramp up fiscal spending to facilitate not just the buildup of armed forces, but stimulate the economy in general. Once the war starts, they will get cut off from funding on Western markets anyway and their Dollar reserves (Treasuries) frozen like we saw with Russia at the onset of the Ukraine war. Or, if you want a more historical parallel, think about the German economy before WW2.
Reality: There is no apparent fiscal spending spree. The Chinese economy has been slowing down due to COVID lockdowns and then imploding real estate debt. Despite this headwind, the central government has been rather moderate in addressing these problems. All the fiscal and monetary measures have been limited and aimed to slow the economic decline, rather than turn the non-productive parts of the economy around with a fiscal bazooka.
Relative performance of Chinese aerospace and defense stocks
I’m looking for remarkable outperformance beyond what is considered normal market price action. By the way, I generally consider market-based indicators to be much more reliable than official macroeconomic data. That’s especially true in the case of China due to its well-known practice of manipulating nearly all macro data.
Reality: While Chinese defense stocks have been outperforming between summer 2020 and autumn 2022, it was nothing extraordinary. Some of this can also be attributed to the overall trend in global defense stocks outperformance during the period. And since October 2022, Chinese defense stocks have been underperforming the broad index.
Copper and iron ore prices
Steel is absolutely critical for any war effort. Think about shipbuilding or armored vehicles. Copper is an indispensable metal for all modern electronics, including smart weapons. Considering that China gets the majority of its iron ore and copper from imports, it would be not just prudent, but outright necessary to massively ramp up these imports prior to any confrontation with the US. The price impact on these metals would be obvious.
Reality: While both copper and iron ore have recovered since their lows in 2022, the overall price action can be described as sideways consolidation. We’re still far from the previous highs.
Conclusion
The conclusion is pretty clear. The data does not show any transition to a war economy that would be typical prior to a major conflict. This does not rule out a sudden confrontation due to an incident or miscalculation. But I simply do not observe any methodical preparation for a prolonged major war.
Some Western analysts have made claims of incompetence and paralyzed decision-making of the Chinese leadership due to numerous purges by Xi Jinping. While it may be true in some areas, China seems to act as a rational player when it comes to strategic military posture.
This rationality is also visible in the Chinese armed forces, which has its priorities set correctly. To state one example among many, consider the two most impressive weapons of the PLA.
The second most impressive weapon is the DF-27, the new intercontinental ballistic missile. It has an estimated range of 5000 to 8000 km and has both land-attack and anti-ship capability. Its payload is allegedly a hypersonic glide vehicle that can reach speeds beyond Mach 8 and penetrate all existing US air defense systems. While terminal guidance to a moving carrier strike group might prove tricky, the DF-27 would certainly obliterate the vast US military installations in Guam.
While the DF-27 is truly impressive, it looks like a child’s toy compared to THE most impressive weapon in the PLA’s arsenal, which is… TikTok.