Few articles have riled me up as much as this one, which exemplifies the misguided conventional thinking regarding China. It is a microcosm of the wishful thinking that permeates the global community at the moment. Here are a few reasons why Paul Kane is wrong.

Geo-political
Taiwan is an old, old ally of the United States, with strong political and cultural ties. Taiwan sends a significant portion of its youth to be educated in the United States. To “ditch” them, as Kane suggests so casually, would severely damage U.S. credibility in Asia. Our other allies—Thailand, Japan, Korea—could not help but wonder that if they would be next. The U.S. is already witnessing a careful realignment of Asia as China flexes its muscles and other countries seek to balance China’s power. To ditch Taiwan would be to irrevocably damage U.S. standing internationally. We would be giving a sovereign, democratically elected government up to an autocratic totalitarian state. Does this sound familiar to anyone?

Kane makes the completely unsubstantiated claim that writing off Taiwan “could pressure Beijing to end its political and economic support for pariah states” like Iran or North Korea. China’s firmly stated position is that domestic affairs are domestic affairs, and that no country has the right to interfere in another country’s internal affairs. As far as China is concerned, Taiwan is rogue province, not a country. That means that Taiwan is an internal affair, and not subject to international pressure. To them, the U.S. selling arms to Taiwan is like China giving missiles to Texas.

Ditching Taiwan would merely be an affirmation of China’s position that the international community has no right to interfere in other countries’ affairs. That would give them even more cover to deny, obfuscate, and stonewall on aid to Iran and North Korea. This is a position that they have held since the joint communique that opened China, and one that they have firmly held to since in vetoing intervention in Sudan, Syria, and other countries.

Economic
Let’s start with a few basic numbers. The U.S. debt is approximately 15 trillion dollars. Kane points out that China holds 1.14 trillion of U.S. debt. Guess who holds more than that? We do. As in, the Federal Reserve. According to the Federal Reserve Bank of St. Louis, Federal Reserve Banks hold about 1.6 trillion dollars of U.S. debt. In essence, the government is paying itself to loan itself money. Sound screwy? Absolutely. While the normally fringe Ron Paul is crazy about a lot of things, one of the best ideas I’ve heard from him is to have the U.S. government forgive itself its own loans. So, in essence, we could reduce the deficit by more than that without having to throw anyone to the lions.

In addition, Europe holds more in U.S. treasuries, and Japan almost as much.

What’s more, if you adjust for inflation, the yield for 5- and 7-year treasures is negative. In essence, people are paying the U.S. to hold their money for them. If you want to talk about balance sheets, think about that. By having China purchase more U.S. debt, they would essentially be transferring their wealth to our balance sheets.

Thirdly, while much has been made about the supposed “power” that China yields over the United States due to its large holdings of U.S. bonds, that power is shaky at best. While some make comments about how disastrous it could be if China suddenly dumped all their treasuries on the market at once, that fails to account for how much damage that would cause to China’s balance sheet as well. Already, due to a sinking dollar and rising RMB, the real value of China’s dollar holdings have been dropping. So why does China continue to buy treasuries? Because there is nowhere else even remotely safe to park that much money.

Fourthly, Kane describes Taiwan’s growing economic ties with China and states that “the island’s absorption into mainland China is inevitable.” If economic ties meant that absorption was inevitable, Canada would be the 51st state. Taiwan is socially, politically, and economically distinct from mainland China. While integration is possible, it is in no way “inevitable.”

Military
Kane makes a point of talking about the power of the hard-line militarists, and argues that removing Taiwan as a wedge issue would reduce their power and influence. While he is indeed correct in estimating the influence of Taiwan, he misses the larger picture. Taiwan is a proxy issue where China sees its military interests most directly opposed with the U.S. However, the Chinese military sees all of Asia and the Pacific as its rightful sphere of influence. A withdrawal from Taiwan would merely shift the conflict centers to Korea, Japan, and Thailand in the east, and Pakistan and India in the west. There is absolutely no evidence to support the assumption that a concession on Taiwan would reduce Chinese military spending.

China is building a stealth fighter and an aircraft carrier. Taiwan is less than 100 miles away from China at the narrowest point. You do not need an aircraft carrier to militarily dominate Taiwan from the mainland. Nor do you need the world’s largest submarine fleet with ICMBs capable of reaching the West Coast. These projects would proceed unabated even if the U.S. were to abrogate its defense treaty with Taiwan because the goal is not Taiwan—it is to match U.S. capabilities.

Kane calls the U.S. Navy “China’s greatest military asset” because it helps keep the sea lane safe for shipping, a description that is hardly in keeping with the military expenditures I’ve pointed out above. Rather, China recognizes that the U.S. Navy is one of America’s greatest assets, and they want to be able to match it. Hence the enormous submarine fleet.

For me, the clincher to Kane’s ignorance on China is his statement that Taiwan is China’s “unspoken” top priority. For any veteran China watcher, that claim is absurd. China’s emphasis on Taiwan is broadly proclaimed and widely disseminated.

America’s national debt is a long-term problem, not a short-term problem. But betraying Taiwan will do little to help the national debt, and will only destabilize America’s position in the years to come.

Everyone is familiar with the concept of China’s politics as being experimental rather than ideological. “Socialism with Chinese Characteristics” says it all by saying nothing—the ultimate disclaimer. “Chinese characteristics” are as indefinable as “Chinese thinking,” “Chinese fashion” or “Chinese culture.” To a novelist in a crumbling hutong, they may be one thing. To Hu Jintao, they are quite another. What has not been examined quite coolly enough is the project called the Chinese economy. China is and isn’t a part of the world market. It is and isn’t comparable to all other major economies. It is and isn’t a plutocracy. While Ben Bernanke might disagree, the Chinese leadership are not just robotic, money-grubbing ubercapitalists. They are scientists conducting the world’s most costly, long-running, and risky experiment. Their lab is the length and breadth of China, with each region and municipality a workshop for low-level tinkering. This makes over a billion ordinary Han Chinese, Tibetans, Uygur, Miao, Bai, Hui, and, yes, foreigners, laboratory mice. We are the “consumers” that the government purports to assist through their economic policies, the people who will, eventually, benefit from the Solomon-like wealth the Chinese government has successfully appropriated from, well, us in the past three decades. But when does any right-minded entity pass the savings on to the customer? Yes, we can sometimes benefit indirectly from a favorable exchange rate or a temporary policy introduced before an Expo or Asian Games. But we can also suffer. Food prices are still on the rise; I pay as much for shoes here as I would in London, and a sleeper train ticket from Guangzhou to Chengdu over the Chinese New Year will set you back more than a night in the Peninsula.

These aberrations are the result of miscalculations in planning. While they hurt the laboratory mice, the boffins don’t care too much—there are always new rodents to prod, poke, inject, and immolate. What they are interested in is reconfiguring their formulae, tweaking, calibrating, and recording the results. Sometimes it goes wrong. Leasing a Beijing apartment with no elevator or thermostat from the State for a maximum of 70 years will cost you more than most downtown Manhattan condos which you will own for life, but that’s what happens when the scientists running the lab turn the “real estate” sector over to their inexperienced children. Base government performance evaluation entirely on short-term GDP growth, and of course you open the floodgates to reckless investment, mindless construction, the printing of money to cover costs and, finally, rampant inflation. But sometimes it goes right—forcing foreigners who want to transfer their earnings from Chinese companies back to their countries of origin to first convert yuan into U.S. dollars means the banks (i.e. the State) can cream a nice chunk off the top. Forcing returning Chinese tourists to pay tax on all luxury goods bought outside the country costs nothing and makes a tidy sum. Land transfer fees, arbitrary sales taxes, hospitals charging through the nose for essential vaccinations—it all adds up.

Of course, people the world over are subject to taxation as well as the whims of math aces who wasted their otherwise valuable skills to dick around on the stock market.  In America, that very dicking around caused the Great Recession. The difference is that in the West, money controls government. In China the two are interchangeable: money is government and government is money. All the big corporate hitters, bar none, are state-owned enterprises. The State has cunningly created entities like the Agricultural Bank of China, Sinopec, and China Unicom to disguise the fact that you’re only ever buying from the State. Your money, like it or not, goes straight into central coffers. You might as well just pay 100% of your income as tax. Such is planned economics.

Private enterprise is kept small through the judicious use of monopoly, coercion, and red tape. If you want to set up a business bigger than a noodle stand and succeed, you’ll need state backing just to get past the planning stage. Big private enterprises were by and large sweet sixteen gifts from Party officials to their offspring—a chunk of state monopoly with state backing that keeps a steady flow of income back into, you guessed it, the State. It’s an open secret that most of the major real estate developers in China are owned by the children of the Politburo or top National Party Congress members. Same goes for oil, coal, steel, weapons and power. Folks cry “nepotism,” and the government can holler back “Chinese characteristics.” Such is the wondrous middle ground of being able to employ the free market or a planned economy wherever and whenever it suits, and yet, unlike the United States, being forced to pay lip service to neither. As the entire Chinese economy is an isolated, locked-down laboratory experiment, rather than a sacred cow, the government is freed of responsibility when things go wrong, because they can blame economics and justify tightening their stranglehold on the market. If government policy causes a catastrophe—well, we’re experimenting here, things go wrong sometimes. Without those pesky elections to worry about, lean years can be weathered and fat years indulged, because the higher-ups know they’ll remain in power no matter what happens. People will still bank with us, buy their gas from us, and pay us for the food they produce. They have no choice, unless they bury their cash in the backyard, strike oil, or grow their own corn. And even if they did all that, the State could, with minimal fuss, repossess their backyard, oil well, or cornfields, because the land belongs to the State anyway. Thus China is ever more adept at accessing the benefits of market economics (immense corporate tax revenues, bullish growth, limitless influx of luxury commodities) and few of the drawbacks (corporate accountability, private sector tax evasion, the fickle tide of consumer trends).

I don’t believe China is, as is often claimed, moving toward a more liberal economy. I don’t believe any regime run by human beings seeks to relinquish money for a morality. I believe that it is, step-by-step, ensuring that the State becomes so interchangeable with corporate China that they ultimately fuse as one. China’s “sinomists” aim to create a watertight oligarchy that Woodrow Wilson could have only dreamed of. Democracy is the final barrier to a similar state of affairs in the West—the vote remains the one free and open choice the average citizen has. China never had this stumbling block to contend with in the first place, and thus holds its people captive without even having to think about hearts and minds. One economy, one government, one China, fused together in one giant, inescapable test tube. Perhaps those in the labcoats are just opportunistic profiteers, or perhaps they are truly in search of the holy grail that is a perfectly balanced economy. One thing’s for sure, they’ll have to go through a lot more mice before we hear a “Eureka!”

The United States Treasury Department issues bonds as a form of debt financing. Government bonds are considered free of credit risk because of the government’s ability to raise taxes to service these bonds at maturity. The undeclared “bearer bonds” included 249 certificates worth $500 million apiece and 10 "Kennedy bonds" of $1 billion each.

There are few news reports these days that inspire confidence in the U.S. economy. Unemployment levels rose to a 26-year high of 9.5% in June and word of a second stimulus package (vehemently opposed by Obama) has investors balking at earnings projections and questioning whether we are in fact on the road to recovery. Amidst the worst recession since the Great Depression, a mind-boggling news story has emerged which poses questions pulled right from the pages of a Tom Clancy novel.

In early June, Italian authorities seized two Japanese men attempting to cross the border at Chiasso, 50 kilometers north of Milan, into Switzerland. Hidden within a false bottom inside their briefcase were $134 billion in undeclared U.S. bonds. The lack of explanations, as well as U.S. media coverage, about this inexplicable event has lead many to question whether there is more to this story than the powers that be would want us to believe.

As William Pesek of Bloomberg recounts, “These two guys were carrying the gross domestic product of New Zealand or enough for three Beijing Olympics. If economies were for sale, the men could buy Slovakia and Croatia and have plenty left over for Mongolia or Cambodia. Yes, they could have built vacation homes amidst Genghis Khan’s Gobi Desert or the famed Temples of Angkor.”

So the question emerges, who were these men? The bonds in their briefcases could classify them as one of America’s largest creditors, just ahead of the UK. One report claims that these were Japanese nationals working for the Finance Ministry. If this is true, it implies that Japan may have been attempting to dump their U.S. bonds somewhere else using Swiss financial institutions. Japan’s confidence in the U.S. dollar hinges on their belief that the U.S. government can repay such bonds. A news story such as this does not exactly promote belief in America’s economic stability.

Top Foreign Holders of U.S. Treasuries (March 2009)
Holder                        Total
China                         $767.9 Billion
Japan                         $686.7 Billion
Caribbean                     $213.6 Billion
OPEC                          $192.0 Billion
Russia                        $138.4 Billion
United Kingdom                $128.2 Billion

“They are clearly fakes,” said Stephen Meyerhardt, a spokesman for the U.S. Bureau of the Public Debt in Washington. “That’s beyond the fact that the face value is far beyond what’s out there,” he said. “No such ‘Kennedy bonds’ exist.” The total of Treasury paper “bearer” bonds outstanding is only $105 million. The Treasury has been issuing bonds solely in electronic form since 1986.

Clearly fakes, but then what purpose would two men such as these have for counterfeiting and transporting such a massive amount of U.S. debt? Another discrepancy is the fact that original and recent bank documents were seized as proof of their authenticity. Were banking institutions duped in this counterfeit ring as well? How much “counterfeit” U.S. debt exists in the international market? And why did it take nearly two weeks for this statement to be released if authenticity could be verified simply by looking at a photograph?

Italy’s Guardia di Finanz, a financial police agency, also expressed doubts about the bonds’ authenticity, especially the “Kennedy bonds,” but noted the others were so well made that it was hard to tell them apart from real ones.

Had the bonds been authentic it would have been a boon for Italy. The perpetrators could be fined 40% of the total value for attempting to smuggle them out of the country.

The Japanese nationals were subsequently released because they had committed no crime. Their whereabouts are unknown (read: missing) according to a reporter sent to Como by the Mainichi Shimbun to investigate the matter. Would the Italian financial police really release such sophisticated “counterfeiters” without tracking their whereabouts?

Market guru Karl Denninger thinks a more deceptive plot may be at hand:

You’re not going to walk into a bank with $130 billion in bearer bonds and cash them. Nor are you going to sell a bond with a $500 million face value to someone without them authenticating it. They will be authenticated before you get one dime out of them—no matter who you think you’re going to “give” them to.

So if they’re fakes and you’re “just screwing around,” there is no reason to hide them. Nor is there any particular reason to have authentic and recent original bank documents in your luggage with them, as has been reported.

…

Ok, who has $130 billion in bearer bonds? Remember, bearer instruments haven’t been issued by the Treasury since 1982, when they became illegal to issue, at least to U.S. institutions and residents (there was an exception carved out for Treasury instruments issued to non-U.S. residents in 1985—a time of high deficits). The answer to that question: it is rather unlikely that there remains $130 billion of legitimate U.S. Bearer issuance outstanding anywhere—to anyone.

The many unanswered questions have conspiracy theorists chomping at the bit, speculating as to the hows and whys of transporting such massive amounts of U.S. currency.

Could the U.S. have issued clandestine bonds to Japan in order to finance budget deficits in the past decades which went unreported? Was Japan trying to hand off the bonds due to concerns that the U.S. government would be unable to service the debt? Were the smugglers victims of a Nigerian counterfeit scam? Is foreign confidence in the American dollar in jeopardy? Where are the bond smugglers and the bonds?

And what about this German article that claims the bonds are legitimate?

Readers can draw their own conclusions from the facts of this fascinating story but the notion that something like this could have happened with barely any U.S. media coverage speaks volumes in itself.

Many countries are currently grappling with their own crises, and dealing with growing urges towards protectionism. And, even as the concept of “Buy American” becomes increasingly meaningless when a company headquartered in Japan sells cars in the US that are made in Mexico, nevertheless, countries around the world are looking for ways to salvage the debris left from reliance on exports. Countries like Germany, Japan, or China have seen their economies go in the toilet thanks to an abrupt cessation of importing by countries like the United States. Many pundits in Asia are hoping that the notoriously thrifty Chinese will suddenly engage in a rush of buying—enough to dig the Chinese economy out of its current hole. But of course, in order to dig out their own economy, the Chinese will have to “Buy Chinese.”

This is not to say that large multinational firms who design in one country, produce in another, and sell in a third will disappear. Far from it, in search of cheaper sources of labor and new markets, this trend will only accelerate. However, simply put, countries will increasingly look towards ideas of supply chain stability. Stability that is, perhaps, easiest (if not best) to be found by keeping things close to home.

The Political and Economic Background
In the midst of an economic boom in December 2007, Chinese President Hu Jintao unveiled his “Three Supremes” policy during a speech to the Party’s central Political-Legal Committee. In it he asserted that “in their work, the grand judges and procurators shall always regard as supreme the party’s cause, the people’s interest and the constitution and laws” in descending order of importance. This policy comes in the wake of several years in which the Party focused on bolstering the professional competence of all those involved with the legal system. As preeminent Chinese legal scholar Jerome Cohen noted, this change in policy has “demoralized many professionally oriented members of this rising legal class [and they have been] subject to intensive political indoctrination in the theory of three supremes.”

This sense of demoralization may derive in part from the fact that the two most important “Supremes”—the party’s cause and the people’s interest—can be understood in economic terms. The Party and many outside experts believe that China needs to maintain an 8% economic growth rate in order to provide jobs for all of the new entrants into the labor force. Without an 8% growth rate, the Party fears that it will be faced with massive levels of unrest that may challenge its monopoly over political power.

Mr. Zhou Tianyong, a scholar at the Central Party School where the next generation of top cadres is trained, has warned that the economic growth rate may drop to 7.5% in 2009. Signs of this slowdown are already apparent: the officially announced growth rate for the fourth quarter of 2008 was 6.8% and approximately 20 million of the country’s 130 million migrant workers have been unable to find work and have therefore returned to the countryside. Mr. Zhou warned that in such an economic environment “[t]he redistribution of wealth through theft and robbery could dramatically increase and menaces to social stability will grow.” He continued, “this is extremely likely to create a reactive situation of mass-scale social turmoil.” Given that the country experienced 87,000 “mass incidents” (protests) in 2005, when the economic growth rate was 10%, the potential for widespread destabilizing “mass incidents” in lean economic times is high.

Guangdong Province
The case of Guangdong Province provides insight into the practical implications that of the “Three Supremes” policy has had on the government. During his speech at the 2009 Davos World Economic Forum, Chinese Premier Wen Jiabao noted that, “The current crisis has inflicted a rather big impact on China’s economy. We are facing severe challenges, including notable shrinking external demand, overcapacity in some sectors, difficult business conditions for enterprises, rising unemployment in urban areas and greater downward pressure on economic growth.” Although Guangdong posted a record high export total of $39.1 billion in September 2008 that accounted for 28.7% of the country’s total exports, more than 15,500 businesses in Guangdong were shuttered during the first 10 months of 2008. Nearly half of these closings occurred in October. In response to these bleak numbers, Guangdong Communist Party Chief Wang Yang repeatedly applauded the closing of such “backward enterprises” in late 2008 because they would allow Guangdong to “empty the bird cage for new birds to settle down.” Yet this official optimism quickly soured and a new, more aggressive policy aimed at maintaining economic productivity was announced shortly thereafter.

On January 6, 2009, the Guangdong Province High People’s Procuratorate, which is mandated to issue arrest warrants, issued an Opinion that instructed its officials on how to proceed with their work. The key section of the Opinion, the “Six Nos“, reads as follows: “not to arbitrarily freeze bank accounts of an enterprise; not to arbitrarily seal accounting books of an enterprise; not to cut communication channels of an enterprise; not to arbitrarily release any report that would hurt an enterprise’s reputation; not to arbitrarily detain any key technicians of an enterprise; and not to affect an enterprise’s negotiations on a major project or its production by law enforcement.” This Opinion can be read as a concrete manifestation of the “Three Supremes” policy insofar as it forces the procurator to refrain from upholding its duty to prosecute those who break the law when doing so may have a negative impact on the economy.

Conclusion
In his speech at Davos Premier Wen asked rhetorically, “Will China’s economy continue to grow fast and steady?” His response: “Yes, it will.” Whether or not the Premier’s optimistic economic forecast will be judged prescient remains to be seen. What is clear, however, is that through the announcement of the “Three Supremes” policy and delineation of the Opinion in Guangdong, the Chinese leadership has bet that subverting the rule of law—and not strengthening it—is the most effective way to overcome the international financial crisis.

Yet the “Three Supremes” policy must also be understood within the context of domestic Chinese politics. Throughout the past decade, Chinese economic growth has hovered around 10%. Moreover, the economy has continued to grow at a dizzying speed since Deng Xiaoping began the “reform and opening” process 30 years ago. Indeed, almost all Chinese entrepreneurs have not experienced an economic downturn, or even a slow growth rate—they only know explosive growth. I believe that one of the implications of this growth is that the expectation of breakneck economic growth has been built into the national subconscious of all of the Chinese people, businessmen and proletariat alike. This national subconscious is much different than that in the West, where no country has experienced sustained 10% growth in generations and political frustrations are relieved through elections.

In short, these heightened expectations pressure the government into an almost monomaniacal quest to maintain growth—law and environment be damned. Yet by essentially prohibiting the prosecution and detention of suspected white collar criminals in Guangdong, the provincial government may be weakening the very legal institutions and practitioners that are most well equipped to spur economic growth by requiring transparency and ensuring an equal playing field for management and workers alike.

The rate of economic growth in Chinese since 1979 has been dizzying. 400 million people lifted out of poverty. Double-digit year-on-year growth since the early 1990s. Such unfettered growth has caused many scholars and bureaucrats to look to China as the new model for growth and development. The Chinese government, rightfully pleased with its superb economic stewardship, has begun asserting itself and wagging a disapproving finger at the U.S. The Chinese criticisms of the U.S. economy in this article were justified, but insightful criticism of a system does not mean that an alternative system is better. Although the Chinese economy may look good now, it is teetering on a broken foundation.

The fatal flaw with the Chinese system is a lack of rule of law. When the central government “opened the door” in 1979, it also decentralized the enforcement of the law and ceded power to local elites. Centrally-promulgated law is now up to international standards, but it is locally and often times arbitrarily enforced, rendering much of it DOA. Indeed, many deals are completed with a handshake instead of a contract. The reason for this is that guanxi, or relationships, are the key factor in determining who gets what, when, why and how. Because of the incestuous relations between local Party elites and business leaders, the state cannot serve its function as a third party enforcer. Rather, the state is part of the system that undermines the importance of the law.

The problem facing China is that it cannot continue to develop as it has, but it does not have a system in place to reign in the pollution and endemic corruption. China is running out of fresh water and its environment is being devastated by polluting factories and industries, which continue to churn out cheap goods for American consumption. Because competition is so fierce and oversight so poor, many factory bosses see cutting corners and polluting as the only way to stay solvent. Thus the economic competition that has created the Chinese economic juggernaut is sowing the seeds of its demise.

As long as local Party elites have a monetary and professional interest in breakneck economic development, they will not willingly close profitable corporations that pollute. And without a strong and independent judiciary, there is no way to enforce all of the centrally-promulgated laws that should preclude any such polluting activities from occurring. Sadly, I do not foresee a law-based system in China developing before the environment has reached the point of no return.

As for the American economy, the Chinese criticisms are important because they speak to a lack of proper regulation (read: lack of effective law). The repeal of the Glass-Stiegel Act during the Clinton Administration and the subsequent emasculation of regulatory and oversight agencies by the Bush Administration has brought the American economy to its knees. Yet because the law is still the final arbiter of justice in America, the passage of new laws that reinvigorate the American regulatory framework should alleviate some of the more acute American economic woes. Despite its current problems, the American economy will rebound because of its strong legal foundation.

The Chinese government is right to fault the Bush Administration for its failure to effectively regulate the American economy. But the irony is that, because of foundational differences, though the disastrous economic policies of the Bush Administration may not destroy the American economy, the brilliant economic stewardship of the Central Government may not be able to save China’s.

The first Cold War ended with the fall of the Soviet Union almost 20 years ago. Economic implosion was ultimately responsible for the collapse of the USSR. The USSR’s economy simply could not compete with the pressure from the financial and spending power of the United States. The Cold War was marked by an arms race, and the two superpowers were, as the theory goes, held at bay by mutually assured destruction. The United States could flatten the Soviets 27 times over had the Communists decided to start a hot war, and vice versa.

But the present situation in Sino-U.S. relations is one move past mutually assured destruction. The USSR was bankrupted by the arms race and folded, while China has modernized and continues to fund its military while maintaining a healthy economy. Its military spending is set to increase 17.8% this year (up to around $45 billion) while its economy grew a reported 11.1% in 2006.

Today, a hot war serves the interests of no country. As Henry Kissinger and others point out in the Wall Street Journal, nuclear proliferation and mutually assured destruction are no longer viable options in the modern world. Instead, the way to succeed in a competitive struggle for influence is through economic warfare. What has emerged is a chess match between governments, moving piece by piece in a coordinated effort to outmatch and trap competing countries’ economies into reliance or even suffocation.

A recent media blitz has focused on the use of what are called “sovereign wealth funds.” Such funds are essentially government-run investment groups that invest in and acquire companies that serve the government’s interests. According to The Economist, the United Arab Emirates’ fund, founded in 1976, has an estimated worth of almost $900 billion. The United States fund, also founded in 1976, is a modest $35 billion. China’s funds, founded in 2007, are estimated in total to be worth $300 billion. Such monster funds can easily swallow majority shares or acquire key companies such as GE, Ford, or Dell. Fears of foreign takeovers are behind the recent blocking of China’s attempted acquisition of Unicol, an American oil company, or the failed bid that would have given a Dubai company control over some American ports.

State-owned enterprises are listed on foreign and United States stock exchanges, such as the oil company Sinopec. The desire to buy stock in such companies is enticing—after all, if a company is owned by the government and considered essential to national strategy, it’s natural to assume the firm would never be allowed to fail. By giving money to Chinese government companies, are U.S. investors funding an anti-U.S. strategy? Or, is the act of allowing foreign ownership in a Chinese government-owned company a sign of trust in a country that was shut off to foreigners less than 30 years ago?

As The Economist reports, sovereign wealth funds were behind the massive bailout of Citigroup and Merrill Lynch this past week. However, this bold move onto Wall Street is also potentially building public backlash. But that doesn’t mean sovereign wealth funds will go away—they’ll just start using more clandestine and obtuse routes in order to achieve the same ends.

Since direct investment in a competing country is controversial—regarded as xenophobic by some and justified by others—countries can instead encircle and thereby pressure another by investing heavily in neighboring countries and jockeying for resources. Take, for example, the 2005 acquisition of Ecuadorian oil field rights by Chinese government-owned CNPC for $1.42 billion, a deal brokered by a group called Andes Petroleum. Pawn to E4. CNPC also in 2005 acquired the Canadian company PetroKazakhstan for $4.2 billion. Bishop (non-Vatican approved, of course) to C4. In 2007, CNPC acquired a majority stake in an oil sands project in Alberta. Qh5. This competition for positioning in turn could leave smaller countries, such as Bolivia, Ecuador, and Nigeria, with much to gain by leveraging access to their resources. And with current U.S. popularity declining abroad, these countries might be more favorable to firms from other countries.

The 1997 currency crash in Southeast Asia bears witness to the power of economic weaponry, if focused. Soros’ funds had, earlier in 1997, taken positions that shorted the baht. Soros is being held as a scapegoat when the cause of the crisis may have been due to weak financial institutions. Investors such as Soros simply capitalize on the opportunities presented to them by what are often poor policy decisions by central banks.

However, the difference between private investors and sovereign wealth funds is the motivation behind investments. Private investors seek to make a profit—governments seek national strategic gain, and also profit. But governments can forgo monetary gain and even take a loss, yet profit by gaining strategic advantage. And unlike individual investors, it’s much more difficult for state-owned funds to run out of money after a bad investment.

China’s intentions in the long term are unknown to the West. Throughout its millennia of history China has been an imperialist in few instances, in stark contrast to Soviet Russia, which saw itself as propagator of the faith by forced conversion. On the other hand, there is little transparency in countries’ sovereign wealth funds. Countries may form “patriotic funds” that pairs a government’s strategic goals with private capital. Such a strategy is by no means new—private enterprises were conscripted to help the United States government in both World Wars.

As John Ikenberry points out in a recent Foreign Affairs article, the United States’ power is declining and China’s is rising, leading one scholar to remark that if such trends continue “the United States and China are likely to engage in an intense security competition with considerable potential for war.” Checkmate (Qxf7#) may come when one country gains a stranglehold on resources, or the financial ability to ravage another’s economy. Ultimately, whether growth comes with the help of other nations—or at the cost of them—will be determined by forces inside each government. The board may not be so black and white.

Purchasing Power Parity is the measure of the nominal exchange rate between two countries obtained by comparing the price differential between goods in the two countries. For example, if a Big Mac costs $1 in the U.S. and ¥10 in Japan, then the exchange rate should be ¥10 to $1. But the ratio of prices between two countries based on only one good may not be an accurate estimate—there could be a myriad of other factors that impact price, like the availability of beef, for example. Thus, studies must use the prices of goods across a wide variety of sectors. The 2005 study of PPP used the prices of 1,000 goods and services.

Interestingly, a 1999 paper published by Chen Kai at the World Bank comes to the completely opposite conclusion from the Economist—that by using PPP, China’s GDP should be much higher than listed. However, this paper addresses China’s GDP from the period of 1980-1991, different from the 2005 calculation reported in The Economist.

Is it possible for China’s GDP to be grossly underestimated by using the PPP approach in 1991, and then be radically overstated 15 years later? One explanation might be the stratification of China’s economy. China’s growing wealth gap could very well be reflected in the prices of goods and services. China’s urban class is growing in wealth while the rural poor, the majority of China’s population, remains impoverished. Prices in shops and restaurants around Beijing vary wildly in price, based on location and intended audience (34 RMB for a Venti Frappucino in Zhongguancun; 2.5 RMB for half a dozen baozi in Dahongmen). The goal of selecting 1,000 different goods to compare is so that such disparities even out. But with China’s much more bipolar economy, how effective is it to compare price differentials?

Some might question the role of income disparity and point out that the China’s Gini coefficient is similar to America’s. Thus, differences in economic price structures shouldn’t matter since both countries have similar income gaps. But the Gini coefficient is a measure of the inequality of wealth distribution, a measure in which the size of a country’s GDP doesn’t matter.

In addition, the Gini coefficient does not measure income derived from wealth. The booming stock market in China amounts to very significant gains in wealth for the small fraction of Chinese who can afford to invest, thus significantly increasing the wealth gap. Stock ownership in China in 2006 was estimated to be less than 10% of the population, compared to about half of the U.S. population in 2004. Further, the Chinese middle class is estimated to be only 13% of the population, while in the United States it’s closer to 45%-50%.

Even the economic measurements in a country with very open information, such as the United States, have a margin of error. With much data about the Chinese economy is left opaque—such as the inner management of state-owned enterprises and sovereign wealth funds—the margin of error for measurements is much greater. It’s not out of the question that GDP is grossly overstated.