A World Restored to Geopolitical Instability
Realism about the risks posed by modern revolutionary powers present in the international state system
For around thirty-five years financial markets have not had to worry about superpower rivalry and state-on-state war. The end of the tensions in the cold war that accompanied the emergence of Michel Gorbachev as leader of the USSR, the subsequent collapse of the Warsaw Pact and implosion of the Soviet Union transformed the geopolitical landscape. The US was left as a sort of hyper power with unique influence and as the world’s only remaining superpower. The days when there would be a flight to quality assets in financial markets, raising the value of the dollar and US treasury bonds, simply on the rumour that the General Secretary of the Communist Party had died overnight (as happened on several occasions in the early 1980s when then the USSR was led by ailing leaders such as Leonid Brezhnev and Konstantin Chernenko) were long over.
The Cold War end with America becoming a hyperpower in a monopolar world
Conventional state-on-state war appeared highly unlikely if not redundant. Instead, the expectation was that there may be complex policing operations by international coalitions led by the USA to remove rogue governments, prevent and punish genocide and to apply liberal internationally agreed norms of behaviour. These were the sort of operations that would be carried principally by rapid deployment brigades, amphibious forces, air and special forces, rather than heavy artillery and tank formations.
The era of state-on-state war was replaced by a decade epoch of peace dividends
The only major conventional wars were the US led responses to the Iraq invasion of Kuwait in 1991 and the Iraq war in 2003. The international operation against the Taliban in Afghanistan after 9/11 in 2001 and the operations that followed it were more in the character of the policing counter insurgency. In a context where state-on-state war was not expected after 1990, NATO countries began to consume their peace dividend progressively lowering spending on defence.
The Russian invasions of Ukraine in 2014 and 2022 transformed this perception that kinetic warfare between states was over. The realisation that conventional state on state wars between major powers is a possibility came at a time when people slowly began to get to grips with a longer standing gradual and in many respects more profound change. This is the emergence of the People's Republic of China as a strategic competitor that is close to being the equal of the USA, if it is not already able to more than match the US. When Mrs Clinton was US Secretary of State the Chinese Foreign Minister bluntly, if crudely explained why the US had to take account of Chinese views because China is a bigger country than America. The USA no longer appears as a unique hyper power with a complete technological advantage over all comers.
Both China and the Russian Federation have developed hypersonic military technology that the US does not possess. Russia, North Korea, and China have a military industrial complex that appears to be able to produce conventional kinetic war materiel such as heavy artillery, artillery shells and rocketry on a scale that the west cannot presently match with comparable ease. With a lag western defence industries have started to increase their production of armaments and the production of ammunition is three quarters greater than in 2022. In short, in geostrategic terms the world is becoming a multipolar place with several large military establishments capable of challenging the US and its NATO and other allies in an uncomfortable manner.
The Russian Federation has transformed perceptions of European Security
The framework of European security has been transformed by President Putin’s invasion of Ukraine in two significant ways. The first is that the Russian Government has explained how its operation in the Ukraine could have been avoided. President Putin laid this out in November 2021. The gist of it was that there would be no need for a Russian intervention in Ukraine if there were a general agreement on European security that involved the withdrawal of non-local troops from the new countries that joined NATO after 1997 having once been part of the Warsaw Pact. Had this proposal been accepted it would have radically undermined the political coherence of NATO, because NATO would have withdrawn external support from its eastern allies at the request of the Russian Federation.
The territories of Ukraine, Moldova, Poland, and the Baltic states are, from the perspective of the Russian Federation’s present government, contingent and open to modification at the discretion of the Russian Government. This has radically destabilised the security of the contemporary European state system. On their eastern flank there is an unsatisfied revolutionary power that wants borders to be changed and is prepared to use military force to accomplish change. Part of this desire for change is a reprise of 18th century Russian imperial design for expansion and partly a genuinely held concern about Russia’s security and the extent that it is surrounded by an armed alliance formed to contain it in 1949. Modern Russia should be categorised as a revolutionary power that wants to change the present geopolitical structure of Europe and is prepared to fight to do so.
Russian action in Ukraine has provoked a realistic military response within NATO
The second way the Russian intervention or ‘special operation’ in Ukraine has changed the perception of European security post 1989 is that Russia has crystalised or clarified an understanding of latent or historically normal Russian statecraft that many people thought was possible yet chose to pretend was remote or unlikely. In turn this has provoked an international reaction to Russia in Europe. Europe has turned again to US leadership within NATO to give it protection against Russia. This has made the NATO alliance much more cohesive. President Macron for example refrains from his clinically framed rhetoric suggesting that NATO is ‘brain dead’. German appears to have pivoted away from its accommodating Ostpolitik, the hallmark of German policy since the early 1970s. The German Chancellor has employed vivid rhetoric in doing so and provided important financial assistance to Ukraine. Yet Germany still appears to be bypassing the international sanctions regime by selling goods through Kyrgyzstan. Moreover, there is little evidence, despite the Chancellor’s rhetoric, of the Germany army being significantly rebuilt.
As important has been the consequences of the Russian provocation in Ukraine that has resulted in Finland and Sweden applying to join NATO. Until now the NATO security guarantee to the Baltic states and potentially to Poland looked like an undertaking that would be impossible to make good on if Russia chose to challenge the USA and NATO on it. It appears NATO has acquired a new vulnerable commitment comparable to that of its commitment to West Berlin until 1989 that it would not be able to deliver. For example, one British Secretary of State for Defence surprised the chiefs of his General Staff, by saying that of course Britain and NATO would not take the risk of defending the present Polish frontier from Russian invasion.
It was to overcome this suspicion that America and NATO were not fully committed to defending its recently acquired commitments on its eastern flank and certainly not in the way that it did before 1989 that NATO agreed forward deployment of armed forces including American service personnel in the Baltic states.
Scandinavian powers have abandoned neutrality and strengthened NATO’s eastern flank
Finland’s membership and Sweden’s application for membership have transformed NATO’s purchase on the eastern Baltic. The combination of the acquisition of the strategically important island of Gotland and Finland’s border with Russian and heavily equipped armed forces significantly improves NATO’s position. Moreover, the effective thwarting of Russia by the Ukrainian armed services and full domestic mobilisation was an immense setback for the Russian Federation and the prestige of its armed service in 2022. However, as the war has progressed in its second year Russia’s armed services have performed better and that improved performance has been noted by realistic observers. Sanctions have not moreover broken the capacity of the Russian military-industrial complex to produce war materiel or thwarted Russia’s ability to wage war. Russia has announced that defence spending will rise by 70 per cent and revenue from oil and coal continues much as it did before the sanctions were imposed. European states are now more realistic in assessing the long-term risks posed by their Russian neighbour and this has resulted in a material improvement in NATO’s capacity to meet it through expansion in Scandinavia.
The historical revival of China potentially changes all previous calculations about US security
The emergence of China’s economy is something that the world has been familiar with for a couple of decades. Global business and political elites were not just aware of it but embraced it and adapted themselves to the sensibilities of the Chinese Government. The former US Treasury Secretary and former Chairman of Goldman Sachs is a good example of the sort of accommodation international business and political elites have exhibited. David Cameron’s Conservative-Liberal Coalition Government announced a new golden age in Anglo-Chinese relations, the Chancellor of the Exchequer George Osborne turned to China for financing of important nuclear utility investment and the British Government ignored the Obama administration’s request not to participate in the new Chinese led international development bank set up in Beijing in competition with the World Bank, the Asian Infrastructure Investment Bank (AIIB). Indeed, Danny Alexander the Liberal Democrat former Chief Secretary to the Treasury in David Cameron’s Coalition Government went on to become vice president for policy and strategy at the AIIB.
What was less noticed was the emergence of China’s hard military power. Inevitably China has acquired military capabilities that have in many ways matched China’s increased economic role in the world economy. It is not just the size and scale of equipment available to the People's Liberation Army, it is the sophistication of the science and technological base that appears to be increasingly available to China. This is reflected in the scale and increasing quality of Chinese academic science publishing and the acquisition of patents. Along with long standing institutional structures that link the Communist Party, the Chinese armed services and China’s industrial and economic base, that enable China to mobilise economic, scientific, and technical progress for political objectives. China’s political leadership is well placed to mobilise economic assets for military and defence purposes. It is presently probably better placed to do so than either the principal European economies or the USA
The rapprochement between China and Russia that started in the 1990s has also had a profound effect on China’s military capability and changed its sensibility as a political and military power radically. Good relations with Russia over the last thirty years have meant that China has not had to worry about the Sino-Russia land border. As a result, China has been able to apply the new resources made available by its economic transformation to create a navy with supporting airpower. China over the last two decades has constructed the world’s largest navy. China is now a significant maritime power in the eastern Pacific.
China has emerged as a maritime power as well as a land power
In international relations analysis there is a long-standing categorisation of powers into continental or land power and maritime powers. It is a taxonomy originally framed by Sir Halford Mackinder, Reader in Geography at Oxford University and Director of the London School of Economics in a lecture ‘The geographical pivot of history’ at the Royal Geographical Society in 1904. Classic examples of land or continental powers are Germany and Russia. In contrast Britain and France are maritime powers. The USA offers an example of how an essentially land continental power can be transformed into a maritime power as its circumstances change. In the early years of the American republic such as the Federalist period it was a land power struggling to consolidate its power over its land border. By 1900 it was a transcontinental power that had huge maritime interests in both the Atlantic and Pacific, perhaps best reflected in its acquisition of Hawaii and long-standing relationship with the Philippines. In the same way that the US changed from being an essentially land power into a maritime power with interests and alliances that reflected that development. In the same way China has effectively become a maritime power. China is a massive continental power that is now equipping itself with a naval arsenal to extend its reach beyond the Pacific. China has yet to acquire a full blue water naval fleet capable of projecting power across the world in the manner that the US Navy and the Royal Navy can. Yet a dimension of the de facto growing Chinese naval power was demonstrated recently in the Persian Gulf. After the hurried withdrawal of American naval assets to protect US interests closer to Israel, the result was that China had the most significant naval presence there in mid-October.
Military capacity is one thing, the desire to use it to modify the international state system is something else. In many respects modern China conforms to the classic contours of a revolutionary power that does not accept present borders and the present state system. China has an acute perception of historic injustices that continue to rancour its leaders. President Xi wants to be seen as reversing these Chinese slights, injustices and humiliations imposed on Imperial China’s Qing Dynasty at the hands of the British, French and Americans in the 19th century.
This anti-imperialist rancour is combined with another historic source of Chinese dissatisfaction and continuing anger. These are the historic folk memories of Japanese war, occupation, and atrocities between 1931 and 1945.
This China has scores to be settled. These scores are further amplified by the issue of Formosa or Taiwan. China wants Taiwan to be returned to its sovereignty. China’s political leadership is determined to get Taiwan returned to its effective control. This makes China a revolutionary power in the way that France was after the revolution at the end of the 18th century, as Germany was in the 1930s and the USSR was throughout most of its existence.
The concept of a revolutionary power
Henry Kissinger in his seminal book on the Congress of Vienna in 1815 A World Restored formulated the proposition of the revolutionary power that does not accept the prevailing status quo. China conforms to Kissinger’s notion of a revolutionary power. Likewise, until 2017 the response of the principal powers to China’s rise was to assume that its clear agenda of aggressive assertion expressed by its wolf-warrior diplomats and in the behaviour of China in international air space and on the high seas and in its international transactions could be overlooked.
China’s history makes it a revolutionary power – the Nationalist perspective
To what extent would a change in the leadership of China offer the possibility of a fundamental change in the behaviour of China and its perception of historical rancour? This is an interesting question and one way of approaching it is to ask how China would have behaved if the Kuomintang under the leadership of Chang Kai Shek had prevailed in 1949. The Republic of China in the first half of the 20th century wanted to reverse the decline and international humiliation of China during the Quing Dynasty. The perceived failure of the Imperial Government was central to the revolution in 1912 and Dr Sun Yat Sen’s vision of Chinese modernisation. In the 1920s the politics of the Republic of China were coloured by the disappointment that German concession territories were not returned to China but confirmed as possessions of Japan in the Versailles Treaty, with the result that the Chinese delegation boycotted the signing ceremony. Chang Kai Shek’s Foreign Ministry had in 1938 published what it called a ‘Map of national Shame’ that recorded Mongolia, parts of Siberia, and Indochina as ‘lost territories’. If the Nationalists under the leadership of Generalissimo Chiang Kai Shek had prevailed in the long-term, the Kuomintang would have pursued an agenda of assertion that would have addressed China’s deeply felt grievances. It was not an accident that as part of the price for the Republic of China’s role supporting the American and British allies in the Second World War was cancellation of the 19th century extraterritoriality provisions of the treaties.
In the context of the post-war years the Republic of China would initially have probably looked to America as a source of protection against both Soviet expansion and Communist revolutionary insurgency. The need for that support would have initially tempered China’s assertiveness. Under the Kuomintang China would have avoided the mistakes of a fully socialised and planned economy. Both the damage of the Great Leap Forward and the Cultural Revolution would not have taken place. Under Chiang Kai Shek the Republic of China would have been authoritarian and in terms of a proper understanding of the rule of law a lot would have been unsatisfactory. Yet a modern market economy would have evolved albeit probably a corporatist and somewhat state directed market. It probably would not have conformed to the axioms of Paretian economic welfare, but a large dynamic functioning economy would have emerged by the end of the 1970s not so different from perhaps Korea. That functioning market economy would have given China the economic assets to assert itself earlier than has happened with the Communist leadership of the Peoples Republic of China. Moreover, the great culture and heritage of Chinese civilisation would not have been brutalised and would have exerted a magnetic pulling power over the occidental imagination. The soft power of a Republic of China even with the blemishes of the Kuomintang’s authoritarian administration would have been great.
The geopolitical significance of Taiwan
If the Kuomintang had prevailed in 1949 the Republic of China would have had the possession of Formosa. Formosa was seized by Japan in 1895 and returned to China in 1945. It is where Chang Kai Shek retreated with the remnants of the Nationalist army of the Republic of China in 1949. This, with American help, denied mainland China control of what is now Taiwan. It has removed a hugely strategically important island from the control of China. Taiwan is a large island about the size of Wales with perhaps the West Midlands and Merseyside added in. Historically it has been central to trade between China, Japan, the Philippines, Indonesia, the Malay states, and the wider reach of Asian commercial transactions over the last thousand years. Any visitor to the Asian Civilisations Museum or the National Museum of Singapore in Singapore will notice the pivotal role Formosa has played in trade explored and presented by Asian archaeologists. The Taiwanese museums in Anping, a treaty port forced open by the Treaty of Tientsin 1858, illustrate these long-standing trade and maritime connections between Formosa and the wider world. Taiwan is geographically very close to the Philippines. Any power that controls its landmass, airspace and international waters is well placed to dominate the South China Sea and beyond. The artificial islands that China has energetically tried to create in recent years would be nothing in comparison to the strategic reach that control of historic Formosa would offer a Chinese government that combined it with the mainland.
In 1949 if the Kuomintang had prevailed it would have controlled both. If a provocative or hostile power had effective control of Taiwan it would pose awkward strategic problems for Japan. It is not an accident that after the Meiji restoration when Japan modernised and opened itself to the world, one of its first acts of geopolitical expansion was to force Imperial China to cede Formosa to it. Formosa was a possession of the Qing Dynasty for around 235 years. The People's Republic of China wants effective control and sovereignty over Taiwan. The big question is whether it is prepared to use military force to achieve its political goal or whether it considers such action too risky and uncertain.
China’s mens rea?
Assessing China’s state of mind, its intentions or what in criminal proceedings would be called China’s mens rea remains challenging given the care and ambiguity of its leaders over many years. Yet over the last decade there has been a combination of behaviour and rhetoric that offers some guidance about Chinese determination to assert itself. President Xi and China’s wolf-warrior diplomats have expressed their intentions and impatience with powers that have yet to accommodate themselves to China’s rise. This impatience is reflected in the behaviour of China’s consular officials, air force and navy. In Manchester Chinese consular staff emerged from its consulate to assault people protesting against the Chinese Government. In international waters and in the international airspace Chinese aircraft and ships have gone to an egregious effort to provoke and endanger the aircraft of foreign powers.
What does this mean for financial markets?
The first thing is the need for investors and financial market practitioners to come to terms with the radical instability present in the contemporary state system. There are two major revolutionary powers China and Russia that want to change the present state system. Russia wants to rearrange the territories and frontiers of the states that once formed the USSR and the former socialist states that formed the Warsaw Pact. China wants its historic grievances addressed and wants to reframe the principal international institutions that have governed the world since 1945. At the heart of these ambitions is a vision to construct a parallel set of institutions to the Bretton Woods’ structure based around the IMF and the World Bank. China and Russia would like to construct an international payments system that is not based on the dollar and ensure that the dollar is no longer used as the world’s principal reserve currency. In addition, China has a strategic agenda in Southeast Asia to replace the US as the principal maritime power in that part of the pacific as well as an ambition to establish effective control over Taiwan. China moreover appears to have sufficient military capacity in relation to the US for any cautious observer to be unclear about the certainty of the US prevailing against China in a kinetic exchange over Taiwan in the western Pacific.
China and Russia as revolutionary powers- a world restored to dangerous instability
The consequences of the clear emergence of modern China and Russia as revolutionary powers that want to disrupt the present international order are not going to go away. For all practical purposes we are back to the position of fundamental instability that prevailed before the end of the Cold War when there were two revolutionary powers. The Soviet Union met Henry Kissinger’s criteria for being one and the USA also probably did so as well.
Superficially the US sought to maintain the broad shape of the post 1945 system and the international institutions that emerged under its leadership rather than to over-turn things. Yet the US exhibited acute anxiety about its own security in facing an ideological foe that had the charisma to attract various Marxist imitators attracted to replicating variants of Soviet and Chinese communism. This anxiety was expressed in a democratic society where paranoia about Soviet progress in space technology, the missile gap, revolutionary insurgency in Asia and Latin America resulted in perceived military weakness being used as a partisan weapon in electoral politics. This resulted in the US behaving in a manner that had the potential to destabilise the superpower politics of the Cold War. Contemporary orthodox historical opinion judges the Cold War nuclear armed international system, with hindsight, as being more stable than it was. President Kennedy made much partisan use of anxiety about the missile gap in the late 1950s. His conduct in the White House as president in relation to Cuba involved destabilising risks and provocation. A decade later the Committee on the Present Danger formed in 1976 was critical of détente and the Strategic Arms Limitation Treaty (SALT I) agreed by President Nixon in 1972. It greatly contributed to the framing of the US foreign policy debate in partisan terms and in practical policy terms was taken up by the Reagan administration with great success albeit risk. After the end of the Cold War in many respects the agenda of liberal internationalism and neoconservative regime change placed US policy within the criterion that amounted to the sobriquet revolutionary power. Today disappointment with that agenda has made the US much more cautious about foreign intervention and ‘forever’ wars, culminating in the US withdrawal from Afghanistan. There is, moreover, a sober appreciation of the limits of US power and its effective relative decline in relation to China, as well as the challenge of managing provocation from countries such as North Korea that is definitely nuclear armed and Iran that probably has nuclear weapons.
The difference between the Cold War period and now is that the instability in international relations is not centred around a bi-polar rivalry between the US and USSR but a multipolar world where superpowers testing tolerance of other powers is more awkward given that there are three major players involved as well several other significant revolutionary powers, such as North Korea and Iran that are also interested in testing present relationships and engaging in determined exercises of provocation.
In economic and financial terms what does this analysis imply?
The first is the scope for sudden and pleasant geopolitical surprises and flare ups. The second is a return to much higher defence spending in what Simon Sebag Montefiore has evocatively called the rich comfortable democracies in Europe and North America. The third is periodic bouts of inflation that arises from interruptions of supply in goods, energy and commodity markets driving up specific relative prices. In principle the central banks should be able to contain such price shocks by maintaining non-accommodating monetary conditions that prevent such spikes in relative prices from spilling over into a wider and sustained general inflation. Although the performance of the principal central banks – the Federal Reserve, the ECB, and the Bank of England - over the last three years when presented with similar relative price shocks is not reassuring. The combination of higher defence spending, periodic adverse economic shocks raising the price level for households and firms requiring a political response to mitigate them along with ageing societies and the costs that accompany an old demography suggests higher borrowing by governments. On a collective international flow of funds basis, a higher supply of sovereign debt implies higher interest rates and greater periodic inflation risks also implies an increase in inflation risk premiums. This may well result in a more realistic long-term real yield curve for government bonds and a better equilibrium between savers seeking returns and the range of instruments available in international markets. All economic agents in their decisions will have to take account of the likelihood of increased future constraints, risks, and costs. Travelling and transporting freight around the world will be exposed to greater danger and cost. Many things and conveniences that the citizens of the rich comfortable democracies have taken for granted over the last forty years may be periodically interrupted or curtailed.
Warwick Lightfoot
29 November 2023
Warwick Lightfoot is an economist and was Special Adviser to the Chancellor of the Exchequer between 1989 and 1992.