4.3 China's Response to US Pivot to Asia
1 March 2017
Xi’s approach to the mammoth task of preparing China for the impending ‘duel of the century’ is multi-prong.
Strengthening the Rule of CCP
He began first by psychologically preparing his people, incessantly reminding them of China’s humiliating history of semi-colonization by foreign powers and of the atrocities committed by the Japanese.
Next, Xi embarked on an unprecedented anti-corruption drive to enhance the legitimacy of the Chinese Communist Party as the ruling party; consolidate his powerbase by appointing his people to replace corrupt officials in key positions including those in the military; uproot deeply entrenched vested interests in SOEs to facilitate the downsizing of the state sector and the restructuring of the slowing economy; and most importantly, gain the confidence of the Chinese people in his leadership.
Politically, to strengthen his grip over the party, Xi also accumulated several titles within a short span of time and became the most powerful Chinese leader since Mao. In 2016, Xi further assumed the unprecedented appointment as the commander-in-chief of the Joint Battle Command (JBC). In addition to the authority he already has as the chairman of the Central Military Commission (CMC) to manage and restructure the armed forces, the new appointment now gives him on the ground operational command over the regional military commanders. The appointment puts Xi in a better position to pre-empt any internal revolt that may threaten the stability of the regime while also establishes a clear chain of command in times of conflict.
Modernization of its Armed Forces & Militarization of SCS
Militarily, Xi wasted no time in adding a new impetus to the ongoing modernization of its armed forces. The 2016 US annual congressional report on China’s Military and Security Development, for example, outlines Chinese efforts in building islands in SCS and equipping them with radar stations, airfields, harbours, and missile systems; expanding its navy by refurbishing an acquired old aircraft carrier and constructing new ones while also expanding its submarine fleets; upgrading its air force; and developing its capabilities to engage in space warfare. Beside outlining the abovementioned hardware enhancements, the report also delineates the sweeping organizational reforms China implemented to overhaul its entire military structure in order to strengthen the CCP’s command and control, to upgrade its ability to conduct joint operations, and to improve its ability to fight short-duration, high-intensity regional conflicts at greater distance. (See Part 4: Modernization of China's Military)
China’s claim of the entire 3.5 million square kilometres of the SCS as its territory is by itself a critical component of its national defence strategy. During the 19th century, the battleships of Western powers were able to encroach unimpeded and to attack the then defenceless Chinese littoral cities. Today, there are also talks by the American military establishments of attacking Chinese military assets outside of its 12-mile zone thus imposing what amounts to a naval blockade of China’s major ports. SCS, and for that matter the East China Sea as well, therefore constitutes a serious security concern for China, just as Soviet Union wanted East Europe as a buffer zone or US invoking Monroe Doctrine to declare Western hemisphere or even the Atlantic Ocean (for the German submarines during WWII) out of bound. The claim of SCS as a whole based on the so-called nine-dash line, therefore, allows the Chinese to push out their defensive lines so that foreign forces can be dealt with far beyond its shores and that any military conflict, regardless of the outcome, will have minimal disruptions to economic activities and limited damages to properties on the mainland, in particular its economically vibrant coastal regions. In effect, the move isolates and defines China’s choice of battleground for any conflict coming by the sea.
Still, until the provocative actions of the US and its Asian allies, the Chinese had little excuse to openly project its military power into the SCS. US’ pivot to Asia provided the motivation, if not justification, for China to not only modernize its military capabilities but also begin sending its forces into SCS and beyond. Besides occupying and fortifying existing islands in SCS, they also began building new ones in 2013. According to Wall Street Journal, China had constructed artificial islands from 2,900 acres of reclaimed land in both the Spratly and Paracel chains by mid-2015. Some of these islands reportedly now have airstrips and are equipped with military assets including radars that are networked to detect and track stealth aircrafts. In effect, the islands serve as unsinkable aircraft carriers to enable China to project its forces and defend SCS more effectively.
US’ Modus Operandi in Dealing with ‘Rogue’ States
China’s preparations for facing off US go well beyond modernizing its military forces and capabilities. Based on US’ modus operandi of dealing with what it considers rogue states, effective containment requires not only threats of military actions but also of trade embargo as well as economic and financial sanctions. The goal of such punitive actions is to create economic hardship that could in time foment social unrest eventually leading to a regime change in a rogue state.
Iraq, for example, was slapped with a decade of US-UK imposed regime of sanctions which not only left its economy in tatters but also resulted in the collapse of the healthcare system and the deterioration of water supplies, which together pose “one of the gravest threats to the health and well-being of the civilian population." The appalling state of healthcare and the shortage of clean water caused child death rate to treble, among other human calamities attributable to the sanctions.
Iran was also banned from exporting its oil in 2012. Moreover, its banks were disconnected from the Belgium-based Society for Worldwide Interbank Financial Telecommunication (SWIFT) whose governance is dominated by US and European central banks. The financial sanction made it difficult for Iran to transfer funds and conduct trade. Within the first ten months of 2012, Iranian rial, already battered by the country’s policymakers’ economic mismanagement predating the sanctions to begin with, lost more than 80% of its exchange value.
Similar punitive strategies are still being used on Russia and North Korea. Chinese leaders are thus keenly aware of the harms US can inflict through these measures short of war. China’s preparations therefore go well beyond just strengthening its military capabilities.
Diversifying Risks of its Currency and Financial System
Efforts to internationalize RMB began even before the onset of the 2008 Global Financial Crisis with the setting up of the first offshore RMB clearing centre in Hong Kong in 2003 followed by the start of personal RMB banking business there in 2004. This was followed by the creation in 2007 of the Hong Kong dim sum bond market where RMB-denominated bonds could be issued. In 2008, China launched the Cross-Border Trade RMB Settlement Pilot Project to allow the use of RMB for import and export between Yunnan province and countries in the Greater Mekong Subregion including ASEAN countries as well as between Guangdong province and Hong Kong and Macau.
After 2009, in the aftermath of the Global Financial Crisis, efforts to internationalize RMB began to accelerate with the setting up of a worldwide network of authorized RMB clearing centres. This involves the Chinese central bank People’s Bank of China (PBOC) authorizing a bank (typically a big four Chinese bank) in the chosen country to act as a conduit between the onshore and offshore markets and clear RMB transactions locally. The creation of such centres is the Chinese government’s way of internationalising the currency without liberalizing its capital account thus limiting the exposure its domestic financial system has to the rest of the world. This gives the Chinese government time to gradually reform and liberalize the domestic capital markets in stages. As of 2017, a global network of 23 RMB hubs covering most of the global and regional financial centres has been set up.
Since 2008, China has also signed currency swap agreements with about 30 countries. The swaps are denominated in RMB and the local currencies of the counterparty countries, without involving the US dollar. Like the setting up of RMB clearing centres, Beijing has embraced these swap agreements as long term means to expand the use of its currency without opening up its capital account.
The original purpose of currency swap agreements is to provide countries with liquidity in times of crisis. For example, in the aftermath of the 1997 Asian financial crisis, Asian countries, including China, entered into swap agreements under the framework of the Chiang Mai Initiative. Similarly, in the 2008 Global Financial Crisis, the US conducted currency swaps with several countries mainly to provide US dollar liquidity for those countries.
In the case of the Chinese swap agreements, the intention of the PBOC was not only to “stabilize the international financial market,” but also to “facilitate bilateral trade and investment.” There is thus a strong correlation between the volume of the bilateral trade and the size of the swap agreement. A major trading partner such as South Korea may have a large swap agreement to ensure that there is enough RMB liquidity for Korean importers to make payments to Chinese exporters.
In 2015, China also launched its own cross-border renminbi payments system China International Payments System (CIPS). At the time of launch, China’s CIPS counted 19 domestic and foreign banks as direct participating banks along with 289 institutions in 69 countries as indirect participants. As of December 2016, participation in the system had grown to 28 direct participants and 544 indirect participants.
Before the launch of CIPS, there were three global payment systems handling money flows: the US has its Fedwire and CHIPS systems, while the Belgium-based SWIFT has supremacy in Europe and the rest of the world. When a dollar payment is made anywhere in the world to a recipient in the US, it is routed to New York and cleared almost instantaneously by the American CHIPS system. In contrast, the use of RMB for settlement of transactions was a lot more complex than using the US dollar because of the absence of a direct link between financial institutions in the payment country and China to process the clearing. The process thus takes longer and results in high transaction costs. CIPS resolved this issue by fully integrating itself into the domestic clearing system – the Chinese National Advanced Payment System (CNAPS) – thus allowing cross-border clearing from both onshore and offshore participants to be processed promptly and efficiently. Payments made from London, for example, will therefore directly go to China’s central bank PBoC through CIPS, just as dollar payments go to CHIPS in New York.
In effect, CIPS and the extensive global network clearing banks form the distribution channel for what could be China’s most important export in the coming decades: the RMB, just as the dollar is US’ most valuable export today. In addition to bringing China a step closer towards its objective of RMB internationalization, the establishment of CIPS also protects China from unrestricted access to the SWIFT system by US agencies (i.e. spying) for information on Chinese transactions. Moreover, it allows China as well as countries and organizations that have been shut out of dollar access, for running afoul of US interests, to reduce its reliance on SWIFT, thus making it more difficult for the US to impose financial sanctions against them.
Finally, China is also putting together a financial structure comprising of the BRICS New Development Bank (NDB) and Beijing’s Asian Infrastructure Investment Bank (AIIB) to challenge the monopoly of the Bretton Woods system formed by the International Monetary Fund and the World Bank. The Chinese were quick to state that the new financial structure is not to replace but to reinforce the existing financial order. To demonstrate the point, the first round of loans made by AIIB in early 2016 was syndicated with the World Bank, the Asian Development Bank and the European Bank for Reconstruction and Development.
Hence, amid the progressive delegitimation of the US-led international monetary system in the aftermath of the Global Financial Crisis, China’s moves indicate its intention not to remain just as a subservient rule-taker that accepts the status quo of the current US-centric international monetary order. As a rising power, it has begun exhibiting behaviours as both a rule-maker, promoting global reforms, and a rule-breaker, creating its own arrangements.
Rising demand for RMB spells bad news for the US dollar. The tussle between RMB and US dollar is very much a zero-sum game. The gain of RMB is therefore US dollar’s loss. Countries hold US dollar and dollar-denominated debts as reserves to pay for imports and as safe assets. As they switch to using more RMB to pay for imports, demand for US dollar as a transactional currency declines. This in turn induces them to keep less US dollar as foreign exchange reserves. The lower demand will eventually translate into declining value of US dollar and rising interest rates. Looking ahead, unless the trend of rising RMB can be reversed, the US government will likely find it increasingly difficult to count on issuing unlimited amount of low cost dollar-denominated debts to finance its welfare spending and infrastructure upgrading but also the wars it needs to fight on multiple fronts to preserve its global hegemony.
Economically Integrating Eurasia Through One Belt One Road
Next, on the trade and investment front, Xi launched the “One Belt, One Road” (OBOR) initiative in 2013 as a response to US-led Trans-Pacific Partnership (TPP). Its land-based component, the New Silk Road (NSR), is an extension of China’s “Go West” policy, which started in 2000. The NSR now seeks to go beyond China’s western region to link China up with Central and South Asia, Europe, and Middle East by helping to put in place hard infrastructure needed for trade and industrial development. As of mid-2016, 39 railway lines between China and Europe were operational. One 7,000 mile rail, for example, connects China with Germany as well as Kazakhstan, Russia, Belarus and Poland along the way. Another ambitious 5,900 mile trans-Central Asian railway links China with Kazakhstan and Turkmenistan before ending at Iran. With an improved transportation infrastructure and a couple of huge customs unions, land transport of goods between China and these countries can not only be two to three times faster than sea but also at a fraction the cost of air.
As a contiguous continent linked together by the NSR, Eurasia covers 70% of the world’s population, 75% of energy resources, and 70% of GDP. Notably, many of the Central Asian and Eastern European countries connected by the NSR are where the US has relatively little influence because their markets have been traditionally neglected by the US companies because of poor accessibility. China’s game-changing NSR initiative thus brings many long term benefits.
To begin with, the land-based NSR greatly enhances China’s national security. It not only serves as alternative routes for cross-border trade especially between China and Europe in the event if sea routes are rendered inaccessible by conflict or by naval blockade. More importantly, it also gives China access to alternative sources of energy from oil-rich Central Asia, with new pipelines transporting oil and gas from the Caspian Sea region into China, thanks to agreements with Turkmenistan, Kazakhstan, Uzbekistan and Tajikstan. At the same time, oil and gas resources from the Middle East can now be transported to the Bay of Bengal by sea and delivered on land to the southern Chinese city of Kunming through Myanmar thus bypassing the chokepoint at Straits of Malacca.
Next, the Eurasian continent constitutes a massive market for the excess supply of low cost Chinese industrial and consumer goods. In addition to reducing the pressure China faces to rebalance its predominantly investment-driven Chinese economy, the new markets will provide growth impetus particularly to China’s less developed western regions which are in a better position to exploit opportunities in the Eurasian heartland because of proximity. This will help to achieve long-standing goal to correct the domestic developmental imbalance between its western and eastern regions.
More importantly, the NSR Initiative is a vision of greater economic integration between mutually complementary economies. Industrial policies are usually nationally oriented. NSR, in contrast, is China’s attempt to implement a transnational industrial policy. Over the past three decades, China was the hub of an East Asian distributed production network put in place by western MNCs to take advantage of the low-cost Chinese labour. As China moves up the value chain, however, policymakers have become keenly aware that some of its industries have to move abroad as costs escalate and pollution worsens. As part of Chinese government’s ‘Go-Out’ strategy, therefore, Chinese companies are fast becoming MNCs. Many have started looking east to put in place their own distributed regional production network. So far, 46 cooperative industrialization zones have been built by Chinese companies in countries along the various NSR routes.
Over the longer term, NSR will thus drive growth in otherwise torpid inland countries in Eurasia and integrate their economic fortune with that of China through orderly flow of economic factors, efficient allocation of resources and deep integration of markets. Industrial Revolution started in Britain in the 18th century but really took off in Europe only in the 19th century because of the advent of railway which helped to integrate disparate continental economic regions into congruous markets and to link production sites with distant raw materials. Now, the railway network put in by the Chinese will be the spark to bring on the industrialization revolution of the Eurasian heartland.
To ensure the success of NSR, China has vowed not to export its ideological beliefs and values and evaluate projects based on purely economic and business considerations. By keeping geopolitics out of NSR, China is deliberately seeking to differentiate itself from the US practice of bundling aid with the export of western liberal values.
The potential economic benefits of a tightly-integrated Eurasian markets have already attracted a lot of attention and interests. However, its success is not a foregone conclusion. Rising ambivalence towards Chinese direct investments as well as populist sentiments in more developed Europe against more free trade stand in the way of deeper connectivity with China. Domestic instability as well as longstanding conflicts that exist between neighbouring countries across the landscape may also hamper China’s gargantuan efforts to integrate the Eurasian continent.
In the Caucasus region (a mountainous region of SE Europe lying between the Black Sea and the Caspian Sea), for example, the Azerbaijan-Armenia conflict is blocking the broader regional integration process and inhibiting its ability to become a true land bridge between Asia and Europe. Middle East is also rife with civil wars while remaining a hotbed of terrorism associated with Islamic fundamentalism. Meanwhile, long-standing acerbic relationship between Europe and Russia has deteriorated over the Ukraine crisis. Further down in South Asia, China’s infrastructure-building and political partnerships with Pakistan, Bangladesh, and Sri Lanka are seen as a threat by India and border conflicts between the two countries have recently made a comeback.
But if NSR pans out as conceived, it will not only greatly enhanced China’s national security and economic sustainability in the coming decades. More importantly, against the background of Trump’s exclusive inward-looking economic policies to “Make America Great Again”, the inclusive outwardly-oriented NSR (OBOR) initiative will also progressively enhance China’s soft power and potentially alter geopolitical and economic balance in China’s favour.
Employing Measures Short of War
In the current faceoff, both US and China have adopted the common practices of using measures short of war which are actions targeted to further their respective interests while eroding the influence of the other, without crossing the threshold into high-order war.
US, for example, routinely falls back on its military superiority and economic power as well as its hold on global institutions and international monetary system to impose punitive actions including naval blockade, trade embargos and economics and financial sanctions on what it considers ‘rogue’ nations.
Although new to the game, China is fast becoming an avid practitioner in using diplomacy, economic incentives and pressure, and limited yet aggressive military demonstrations to expand its influence. The incrementalist tactics of island building, the internationalization of RMB, the creation of CIPS, AIIB and NDB as well as the launching of OBOR initiative, are all excellent examples of measures short of war employed by China to advance its long-term interests at the expense of the US.
In a 2016 report entitled “Stretching and Exploiting Thresholds for High-Order War” published by RAND, it was pointed out that beside China, Iran and Russia have also been consistently resorting to such short-of-war measures to exploit a soft spot in US policy and willpower in Middle East and Eastern Europe while carefully managing the risk of US response. More pertinently, the report opines that US responses to such efforts to encroach on US interests have been halting and ineffective so far. Obama, for example, chose inaction to avoid unnecessary friction with China when the latter began constructing man-made island in the disputed waters, prompting Duterte to later tick off the US for not deploying an armada of its 7th Fleet based in Japan to stop China in the track right from the start.
Deepening Integration, Rising Confidence, & Increasing Assertiveness
To be sure, even without imminent threats from the US, the Chinese initiatives by themselves constitute good strategies to diversify risks and would have been introduced as part of rising economic rivalry between the two superpowers.
Mao adopted autarkist policies when faced with the threat of ‘Western imperialism’, which led to China falling behind economically and technologically. Contrary to Mao’s insular approach, the current Chinese leadership has not only sought to expand external engagements extensively but also to do so progressively based on Chinese’ rules and terms and supported by China-led institutions. In effect, China is putting in place elements of a new international order in which it has more power in setting rules.
As a red princeling of a Long March veteran who fought alongside Mao, Xi is well indoctrinated with Mao's deep-rooted fear of US imperialism. Hence, it would not be far-fetched to say that this is a conflict that the Chinese anticipate coming all along and have been preparing since the days of Mao. This can be seen from how, within a short span of merely a few years, China has managed to successfully launch and execute the various initiatives.
Each of these initiatives requires careful strategizing and years of planning and laying the ground work by various agencies in a coordinated manner. The speed with which China got their acts together is not only a reflection of Xi’s effectiveness as the commander-in-chief compared to his American counterpart, be it Obama or Trump or even Hillary Clinton, whose roles in Middle East were openly questioned even by the military commanders. It is also a demonstration of the efficacy of the centrally-controlled Chinese political apparatchik compared to the US system of acrimonious bipartisanship incapacitated by narrowly-focused vested interests on both sides of the political aisle. CCP stronghold of political power means that China is able to exercise a consistent long term geopolitical strategy while the US flip-flops with every change of its leader.
More importantly, Xi has the undivided support of the Chinese people. Even though there is unhappiness with regards to some policy issues, the majority of the Chinese, are not unhappy with the CCP or with what Xi has done for China. They, including even some of the liberals who yearn for more political freedom, do not see the American model of bipartisan democracy, which has run itself aground, as a workable alternative for China. More importantly, the pain and humiliation of China’s past history of semi-colonization are deeply etched in the heart of all Han Chinese. Regardless of the costs arising from the impending conflicts with the US, no Chinese will blame the government for going to war to defend China’s sovereignty. On the contrary, any fighting is likely to only strengthen, not weaken, CCP’s rule, regardless of the outcome.
China is no more the weakling it once was at the end of WWII. Likewise, the US is no more the economic powerhouse and the geopolitical hegemony it once was. Analysts have compared the military strength of the US and China and concluded that US is likely to win in a conflict. There is little doubt that the US has technological superiority in terms of military hardware. Despite so, China has demonstrated that it can take out satellites and its submarines have managed to outsmart US aircraft carriers. Moreover, the technological gap is fast closing.
Simple comparison of raw numbers of military assets can also lead to wrong conclusion. It is relatively a lot more expensive for the US to project and sustain its full firepower in a conflict happening halfway round the globe than for China to commit all its military assets in battle fights taking place in its front yard. Compared to the deindustrialized US economy, China also has the industrial capacity to churn out more military assets very quickly when conflict starts. At the end of the day, superior hardware wins battles but may not be enough to win a protracted war. China has the unwavering support of all Chinese to fight as long as it is needed but the same cannot be said about the domestically bitterly divided US.
A more interesting question to ask is what US hopes to achieve from its pivot to Asia? Even if China loses in an all-out conflict, a highly unlikely outcome to begin with, it will be just a matter of time the Chinese reorganize and seek to reclaim what they see is rightfully theirs. As a civilization with a history dating back 5000 years, China has time on its side.
Updated 10 December 2016
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 Notably, the rapid depreciation could also be attributed not to the sanctions but more to hyperinflation and increase in the amount of money in circulation which more than quadrupled between 2001 and 2011 before the sanction was imposed.
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 ??? “Why the Chinese are laughing at the United States” Nov 7, 2016. Newsweek.
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 ???? “One Big Reason America isn’t Ready for World War III.” April 21. 2016. The National Interest.