by Bill O’Grady | PDF

In Part I, we described China’s situation using Japan as a historical analog.  This week, we will complete the analogy and examine in some detail the potential motivations of Chinese and U.S. policymakers. As always, we will conclude the discussion with potential market ramifications.

China’s Situation
Similar to Japan in the 1930s, China has become a large economy showing geopolitical power that is threatening the established order.  Similar to Japan in the 1980s, it has an economy overly reliant on investment, trade and debt.  And, like Japan, it is dependent on sea lanes it does not control.  Finally, as was the case with Japan during both the 1930s and 1980s, China has reached a point where the U.S. is refusing to accommodate its rise.  However, unlike Japan, China is not as dependent on the U.S. for its security (although it is quite vulnerable to a blockade).

It is arguable that Deng realized China would eventually reach this state and thus encouraged Chinese leaders to bide their time.  Simply put, Deng wanted to extend China’s ability to stay “under the radar” for as long as possible before it would inevitably trigger a response from the U.S.

It is important to realize China is not acting in a vacuum.  The U.S. has a clear role in how this situation evolves.  The American response to China’s rise appeared to be guided by two principles.  The first is that eventually China would accept U.S. hegemony and the trading system America had created after WWII.  The second was that communism was fundamentally flawed and China would eventually develop into a capitalist democracy.

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