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April 2008 - Bremmer, president of New York-based Eurasia Group, a global political risk advisory firm, warns that “There are problems that will become increasingly obvious as a result of Chinese growth,” especially as it comes into conflict with isolationist and protectionist trends in American politics.

Bremmer supports the commonly held view that the balance of global economic power is shifting from west to east. “The growth numbers tell the story: China has been growing at 10% per annum for almost 30 years now; India has been growing at almost 10%. They have large bases of consumer demand and large bases of commodity demand. At the same time, American companies that are doing well now are increasingly companies that are global in orientation and that have significant exposure to global emerging markets, especially Asian emerging markets.”

Equally, Chinese companies are investing to a large degree in the United States, in American companies and in American equities. “It is not just a story that China is growing, the United States is declining, and the USA needs to watch out. There is that element to the story, but the real story is much more complicated than that,” said Bremmer.

In fact, the Chinese and American economies are intertwined, as Chinese

companies actively invest in the USA, at the same time as American

companies and investors are looking to Asia. Because of this recoupling, said Bremmer, “it matters to China in an immediate way if the United States does or does not do well.”

China’s continued growth is going to create problems both domestically and in terms of its relations with the United States and other western countries, stressed Bremmer. But to the Chinese government, maintaining growth is essential for maintaining social stability.

“The political leaders in Beijing are focused on the political stability of the Chinese government. They understand that to pursue that stability, they must continue to pursue aggressive growth,” said Bremmer. “China is very different from India in that regard. China grows and is seen to grow because of the Chinese government; India grows and is seen to grow despite the government.”

Bremmer believes that this policy of maintaining stability at all costs will lead to serious problems in the long term. “This is one of the reasons that the Chinese do not shut down the incredibly high polluting coal mines. They can’t afford to - it would threaten their stability.”

But he noted that the long term is longer than we think, because “the Chinese can take a lot of pain on the environmental front, far more than we can handle in the United States or Australia or many other developed countries.”

There are two reasons for this. One is that it is an authoritarian state. The other is that baseline standards of living are so much lower than in developed nations, and thus China is willing to accept a fair amount of environmental catastrophe as a cost of improving that. “Americans are reluctant to give up their SUVs - the Chinese are willing to absolutely devastate their country, well beyond what we have seen in the west,” said Bremmer. “This is going to cause cataclysms in China in the long term.”

In addition to the environmental costs of Chinese growth, this growth policy will inevitably create friction with the United States, and this is a risk that will become increasingly apparent through the course of 2008. Not only is this an election year in the US, but at the same time the US is moving toward recession. The spectacle of the Beijing Olympics is likely to heighten already simmering tension. “A lot of people are not happy that the Chinese appear to be profiting on the back of American insecurity. I think you are going to see a lot of talk about protectionism, about limiting sovereign wealth funds, about

product safety, about all these issues. It is a real risk,” said Bremmer. “China is in a position of maximum growth, at a time of increasing American insecurity on the economic front, and they are throwing the world’s biggest party.”

To Bremmer, this points out a strategic weakness in China. “The possible upside of the Olympics is that they finish and the whole world says China is the most exciting market - but everyone already thinks that. There’s no real upside, and there’s a lot of downside.

Staging the Olympics is a dramatically short-sighted move, and it shows

the ability of the Chinese to overplay their hand.” This tendency may come into play as we move into the medium term, where the biggest question mark on the political risk front remains the US-China relationship. As Chinese companies are increasingly going to be competing with American companies, both for export and internally as the Chinese focus on investment in their own market, the fact that Chinese companies are politically preferred in an opaque system will become even more problematic. As it becomes harder for American and European firms to make the same profits margins, there will be more calls for regulation and even sanctions. “It is going to be harder for a continually resurgent China to co-exist easily in the context of a western Europe and a United States that have a very different trajectory,” asserted Bremmer.

Bremmer sees three possible outcomes, but it is too early to predict the outcome. “The Chinese could willfully restrict some of their growth, knowing that the alternative is that they are going to get into a fight. Or they could refuse to do that and take a more nationalist tack, and then it becomes an economic ‘cold war’ that the US and China will fight country by country. Or the third possibility is that China falls apart. When growth starts getting constrained because they start to come up against environmental and resource limitations - or because of an extraneous shock - then you can imagine a situation where social discontent within China grows like crazy and the Chinese cannot hold it together.”

But Bremmer points out that, barring an extraordinary event, like a major

world terrorist even or avian flu, “In the next two to three years, I do not see serious instability. I see China growing like crazy.” As the United States struggles to come to terms with China’s growth, the role of sovereign wealth funds (SWFs) is a complicating issue. “There is going to be a fight in the US over whether these funds are playing by the same rules, whether they should be regulated. I think a lot of this is overplayed. But we do need to recognize that the risk management capacity and experience in Chinese SWFs is nowhere near what it is in Singapore or in Norway,” said Bremmer. As the Chinese SWFs get bigger and start taking active management stakes in major companies in frontier markets, they may make mistakes and run them into the ground.

“We’re talking about creating more global economic inefficiencies in

economic systems.” International calls for increased corporate governance may be heeded by some SWFs, the Gulf States and Singapore for example, but are more likely to be ignored in China and Russia. “This is what will lead to protectionist legislation in the United States,” maintains Bremmer. “I think

it is quite possible that come 2012, one of the major presidential candidates will be effectively isolationist. I don’t think he or she will necessarily win - but that sentiment has become so important for the US electorate that it will be impossible not to play ball.”

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