The US Wars with China and the War with Itself

The US is currently at war with China over trade, economic policy, technology, capital and
geopolitics (Dalio, The Changing World Order, 2021, Chapter 13). While the US has no formal
treaty obligation with Taiwan and President Nixon and Secretary of State Henry Kissinger
recognized China’s claim five decades ago, President Biden repeatedly said the US would
intervene militarily to defend the island. Only a global hegemon could make such a threat.
China is destined to once again be a great dynasty, as it has been at least twenty times over the
last 22 centuries. The US was the sole global hegemon by 1945 as all the major empires of the
world were at this stage in decline, setting the stage for a century (the historical norm) of global
dominance. But within two decades, with the ascendance of FDR protégé Lyndon Johnson, a
War in Vietnam and a “Great Society” at home, the US was in decline.

In spite of the creation of OMB in 1970, the flight from the dollar that forced President Nixon to
default on gold convertibility in 1971 and the creation of the CBO in 1974 to stem the debt
crisis, starting in 1975 30 states petitioned for a federal balanced budget amendment. Since
then, US debt has grown 100-fold, current spending is twice revenue, the Federal Reserve is
financing half that deficit and the dollar has fallen 98% relative to gold. Such debt super-cycles
end in national bankruptcy-ending empire the way Hemmingway described: “slowly at first,
then all at once.”

National denial has global consequences. Britain entered into the Great War as a declining
power to thwart Germany, then a rising power. World War II was really an extension of the
Great War, when a German veteran, a lance corporal, came to power on the false narrative that
the Bolsheviks and Jews caused their loss. Britain lost the empire but remained in denial until a
speculator dethroned the pound Sterling in 1992. Similarly, the Soviet Union was in denial (as
was the US CIA) right up to the point of total collapse from within in 1989.

The US is now arguably in the position of Great Britain prior to the Great War as a military
power, but faces internal dissent that is arguably worse than that of the former Soviet Union. It
can follow the British path to weaken the rising power while restoring US hegemony, remain in
denial and continue on its current path toward civil war or revolution, or seek a softer landing
based on a restoration of US founding principles. Faced with these choices politicians generally
find war more politically palatable than the short-term pain of restructuring, even when that
results in complete destruction, asserting “nobody could have seen this coming.”

The Game of Thrones

Civilization began about 12 millennia ago with specialization; that required trade. Politics came
7 millennia later, soon followed by clashes between communities over land and other
resources. The Game of Thrones began about 4.5 millennia ago, with empires predating the
development of nation-states by over 4 millennia. While specialization and (free) trade was
inherently mutually beneficial (due to “comparative advantage,” David Ricardo, On the
Principles of Political Economy, 1817), the Game of Thrones is win or lose. Winning is also
expensive, as resources are devoted to military control of trade routes.

Successful dynasties, later empires, had to either generate more wealth through trade, extract
more from their populations in tribute, or manufacture more money. The use of gold and silver
as money, a store of value, predates empires. The early European empires, first the Venetians
then Dutch were based on mutually beneficial trade, whereas the Spanish “New World”
empire focused on the extraction of gold and silver, which requires risky transport and storage.
The later French and British empires adopted the “mercantilist” approach in North America, as
did the Chinese in the late 20th and early 21st century, which required a favorable balance of
trade to generate a surplus that funded the military necessary to protect trade routes and
empire. Trade between empires and their vassals or colonies isn’t necessarily free and mutually
beneficial.

Capitalism emerged in Europe about five centuries ago as an economic system that, combined
with free exchange, is responsible for the rise in human longevity and wealth since.
Competitive market capitalism is a win-win for workers and owners of capital. It provides the
economic surplus, the incentive to save it, the safety to invest it and the incentive to invest it
where ever and in whatever will generate the highest return for savers. Global financial markets
developed to fully exploit its potential. The industrial capacity of capitalist production and
finance has since been a major source of imperial power.

The Rise of Global Money Managers

Since the origins of banking in 12th century Venice access to money has influenced the rise and
fall of empires. Perhaps the most consequential (and unfortunate) monetary intervention was
when British Treasury agent John Maynard Keynes seduced Wall Street bankers to finance the
Great War long past the point of their ability to repay even in victory, with disastrous
consequences for most of the 20th century. The most transparent triggering event by money
managers was the bet made by George Soros and his protégé Scott Bessent (currently US
Treasury Secretary) against the British pound Sterling in 1992 which marked its end as a reserve
currency, although President Eisenhower had made the threat to do so behind the scenes in
1956 to end British control of the Suez Canal.

Within the past few days, Ray Dalio of Bridgewater Associates, one of the largest global
investment funds, expressed fear of something much greater than a recession in the US. Dalio is
much more than an economic or financial pundit. As a global investor, he has a deep
understanding of investment risk, which he transparently explains in his most recent book
referred to above. Dalio’s study was quantitative, non-partisan and published after the first
Trump term. (My intent is to provide a faithful if not comprehensive summary of the Dalio
study and its implications). While his scope is world history, his sole focus is on political
economy, explaining why empires rise and fall. What sets it apart is the most extensive data
base on the topic that allowed him to model and quantify all the potential causes and their
correlation. History always rhymes, if not repeats, making the future statistically predictable
based on the historical cycles that virtually all empires have gone through. Government
agencies and Departments also build models of, e.g., the impact of economic and financial
sanctions on their adversaries, but not transparently and probably not including “unintended
consequences,” e.g., did President Clinton expect the Chinese to respond to his sending the
Seventh Fleet to the Taiwan Straights in 1996 by building a navy that exceeds that of the US?
Successful global investment requires cold detachment from economic and political ideology.
Systemic risk swamps business investment risk, which is estimable and diversifiable. Most
systemic risks fall into the categories of “country” or “political” risk and “natural disasters,”
although losses from e.g., conflagrations, pandemics and tsunamis in the 21st century largely
reflected political factors.

Publication of his analysis and conclusions coincided with the beginning of the Biden
Administration. In brief, his “power score” for the US: of 21 key indicators, 2/3rds were flashing
red (in decline). The only indicator flashing green (improving) at the time (governance, rule of
law) is (in my opinion) now also flashing red. US allies scored similarly. In contrast, half of
China’s indicators were flashing green, with only four flashing red. “Money” can now be
directed to investments anywhere, and redirected, with a few keystrokes. As the US dollar, the
only current global reserve currency for trade, defaulted on gold convertibility more than a half
century ago, the willingness to hold dollars as a store of value depends entirely on the ability of
the US to remain on the throne.

Comprehending the Current Trade War

Ricardo’s treatise was on “political economy” as was Adam Smith’s in the prior century, a field
of study going back to Aristotle. “Political” has since been dropped to make the field seemingly
more comprehensible by allowing assumptions that facilitate mathematical models of
economic behavior such as most economic models of comparative advantage. The economic
theory of comparative advantage likely explains most trade prior to the creation of political
empires and nation-states, when politics became the more important consideration. Trading that reflects sub-optimal political policies may reduce their costs, but with unintended side
effects.

Empires and nations focus on their own interests at the expense of others and generally pay
little mind to detrimental long term, e.g., environmental consequences, especially those borne
by others. Since shipping by Sea has provided the cheapest form of transport for trade, empires
have mostly been sea powers over the last six millennia. Hence the first political priority of
trading empires is to generate a surplus to fund and fuel a navy to protect and control sea
lanes.

Consider the rise of the seafaring British Empire. After denuding the forests of Scotland to build
sailing ships for the British navy, landing parties had harvested the forests of Plymouth for a
half century, providing the clearing for the Pilgrims to settle on in 1620. While the British
outlawed slavery in their colonies (and on the high seas) in 1834, it still traded for cotton
produced in the Southern colonies, later states, by cheap slave labor. (Cotton was historically
considered to reflect cheap slave labor, although subsequent research indicated that slave
labor costs were comparable to “free” labor after emancipation: it was the availability of land,
and the willingness to over use and deplete it, that provided (and still provides) the cost
advantage to US agricultural products.) The British patented many new industrial innovations
during their industrial revolution. American history is replete of daring thefts of British
technology, which was then used and improved upon to fuel the US industrial development.
Formalizing trade relationships in treaties rather than imposing them with military might is a
relatively recent phenomenon. The first such agreement specifying the terms of trade and
reciprocity was the the Cobden-Chevalier Treaty of 1860. Virtually all global trade has since
been governed by political agreements. The World Trade Organization (WTO), has been
responsible for setting and enforcing policies to facilitate and “liberalize” trade rules since its
founding in 1995.

The US trade deficit with China has grown continuously since China was admitted to the WTO in
2001, approaching a half trillion dollars annually. Most economists maintain that the deficit is
beneficial, as the savings will be productively reinvested. The lunacy of this was exposed when
the sub-prime lending debacle in the US from 2005-2007 caused a global economic collapse in
2008. Then US Federal Reserve Chairman Ben Bernanke, who as a Fed member had previously
encouraged the reckless mortgage lending, blamed the massive policy-induced US over-
consumption of housing on Chinese savers with only one fortieth the income of US consumers.
Virtually all the theoretical rationalizations of the US trade deficit since then have continued to
assume the counterfactual that the savings from cheap Chinese goods will be productively
reinvested in the US economy rather that squandered by consumers and, particularly, the
federal government.

Geopolitical pundits initially rationalized the detrimental consequences to the US industrial
base of the resulting decline in US manufacturing as a price worth paying for China’s transition
from Communist dictatorship to democracy, which never happened.

The issue from the US perspective is, how much of this trade gap can be explained by
“economic” versus “political” comparative advantage (including the direct costs of trade: China
incurred $258 billion in transport costs in 2023)? Some of this deficit can be explained by the
“absolute advantage” the US currently has in some goods, particularly services. This doesn’t
explain the loss of the US industrial base, with tremendous indirect social as well as economic
costs, or the loss of a supply chain for military goods. Three political explanations, technology
theft, environmental policies and politically distorted incentives to work and save, may explain
most of this trade deficit.

Stealing technology isn’t new, but it is much easier than in the past. China employs various
methods to acquire U.S. technology, including espionage, cyberattacks, and talent recruitment
programs. For instance, the Chinese government has been accused of using cyber intrusions to
steal intellectual property and trade secrets from American companies. (AI). Technological
advantages aren’t safe under the WTO over the normal investment cycle.

While there are many consequences of human action on the environment, I’ll focus on one,
energy – the use of fossil fuels. Access to energy supplies was a crucial determinant of the
outcomes of WW’s I & II. Energy for the military directly and for the industrial base that fuels it remains the key to economic power that meets both imperial and citizen needs. In response to the demands of the environmental movement, the US and its allies have imposed extreme limits on their own fossil fuels, and the only scalable clean energy alternative nuclear power, at tremendous cost. Rising economic powers, particularly China and Russia, have taken maximum advantage. The result has been little global reduction of fossil fuels consumption. When the full environmental costs of the alternative are taken into account, there is arguably little or no
benefit to the global environment for this self-inflicted national sacrifice.

In spite of a more rapid rise in Chinese than US per-capita income since 2000, it is still only 15%
that of the US. In spite of that gap, their savings rate has averaged about 45%, ten times that of
the US, since their WTO entry. One likely cause: they have no unfunded retirement system like
Social Security. They work about 10% longer per week than the 40 hour US average, their labor
force participation is higher and they work harder. Socialists (social democrats in Europe,
progressives in the US) maintain that their policies do not affect the incentives to work and
save, but the work week of our social-democratic European allies has fallen to about 30 hours.
Since the introduction of Obamacare – subsidized healthcare for the working population – sixty
percent of able bodied adults on Medicaid report no earned income. The Chinese labor
advantage is partly cultural, but mostly political.

How the Chinese View Themselves: The History of Chinese Empires

The current Chinese empire is their fifth in the last 14 centuries, with the prior four far
exceeding the power of any that followed except that of the US. They remained at peak power
for an average of a century, but even as they bottomed out they generally remained the most
powerful empire in the world until the rise of the British empire in the 18th and 19th century.
China produced much that Britain wanted but not vice versa, so the British engaged in the
Opium Wars to addict the Chinese to that export. The current Chinese export of fentanyl to
Britain and the US may be viewed as revenge for their “Century of Humiliation.” They view their
current rise as restoring the natural order of things.

China has always been governed from the top down to the family, but the Chinese have
demonstrated an entrepreneurial spirit everywhere they settled. Their culture and religion
emphasize the good of the community over the freedom and happiness of the individual, an
advantage over libertarian governance in the Game of Thrones. While the current leaders are
members of the Communist Party, it is not currently affiliated with any international movement
so it doesn’t make much difference what they call it. Whereas the Soviet Union treated other
communist countries as Soviet (realistically, Russian) vassals under their boot heel, China
historically required respect and tribute but otherwise exercised less control. That seems more
likely going forward, but only time will tell.

Dalio concludes that their mix of capitalism and socialism is no more oriented toward the latter
than the political system in the US or Europe (and arguably less so). China faces numerous
challenges, demographic and economic. But their current plan calls for doubling real output in
the next decade and again in the following decade. That goal is about double the output of the
US and Europe currently, but would still leave it behind the US per capita, hence not unrealistic.

The Rise and Fall of US Hegemony

The success of the US Revolution against the British reflects the ability of perhaps America’s
greatest genius, Benjamin Franklin, in pitting one empire with ambitions to control North
America, the French, against the other with the same intentions, the British, while ultimately
foiling both. The Founders’ goal was libertarian self-governance, domestic free market
capitalism, and mutually beneficial trade with other countries while otherwise being left alone,
protected by the oceans from external conflict. Reality set in when it needed to protect the
trade routes from the Barbary pirates. From the perspective of the native population, Mexico
(and Canada) the US was imperial. But American imperialism (with a few exceptions) was
limited to keeping European powers out of North America, the purpose of the Monroe Doctrine
in 1823, until its entry into the Great War.

The US first participated in the Game of Thrones when Joining WW I to bail out US bankers
(later done by taxpayers) and promote the League of Nations to “make the world safe for
democracy.” Both failed. WW II was really an extension of the Great War. The political economy
of the US resembled that of Europe prior to WW II as FDR made a recession into a Depression
then made that Great. But the US became the reluctant global hegemon due to a victory in
which it was protected by its surrounding oceans from damage to the homeland. A trick played
by Treasury Undersecretary Harry Dexter White, a communist spy at the time, who put a secret
last-minute footnote into the Bretton Woods Agreement in 1948 had the effect of replacing the
pound Sterling with the dollar as the global reserve currency.

Post WW II, it was in the interests of the US to support all potential allies against its then
recognized competitor the Soviet Union with US financed defense and favorable trade
agreements to rebuild their economies. Given the war devastation, these allies focused their
own resources on internal reconstruction and social programs.

The US period of undisputed global hegemony lasted a paltry two decades even as all potential
competitors to the throne continued to decline during this period. The cause was arguably, as
Alexis de Tocqueville warned in his seminal work, Democracy in America (published in 1835 and
1840), the tyranny of the majority and short-term thinking in democratic governance, that led
to fiscal irresponsibility. The favorable treatment of allies has extended for another six decades
past that point.

MAGA 1.0 and the Biden Administration

On the international front, Trump held the Russians at bay while attempting to provoke NATO
allies into a credible defensive posture. They would have to completely restructure their
economies to compete fairly and generate a sufficient surplus to provide for their own robust
defense, heresy at the time to European social democrats. He negotiated a trade deal with
China, but his tariffs were more protectionist than reciprocal. Their energy policies made them
a Russian dependent.

US productivity has lagged during the 21st century, a consequence of policies favoring
consumption over saving by both households and governments, and over-taxing business,
leading to insufficient private investment. The 2017 tax bill favoring investment, reduced
business taxes from the highest among OECD countries to the middle of the pack, (passing
without a single democratic vote. Regarding the 2018 spending bill, Democratic Senator Chuck
Schumer declared: “This spending agreement brings the era of austerity to an unceremonious
end.”

The incoming Biden Administration inherited numerous US strengths (Dalio, pg. 514): “strong
capital markets and financial center, its innovation/technology, its high level of education, its strong military, its reserve currency status and high economic output. Its weaknesses are its
unfavorable economic/financial position and its large domestic conflicts.”

My updates: The Biden Administration took a much more aggressive role in the allocation of
capital. Technology centers are moving from the US to China. Critical weaknesses in higher
education have since been exposed. The military was seriously weakened by the war in
Ukraine, which exposed serious supply constraints. The fall of the dollar is now a few keystrokes
away. Some argue that government spending, the major source of the Biden rise in GDP,
should not be included in the measure of economic strength. Dalio’s first measure of economic
weakness, Net International Investment Position (NIIP) almost doubled from -$14.09 trillion in
2020 to -$26.4 trillion in 2024, further threatening the dollar’s status as a reserve currency.
Things got worse across the board.

But Dalio’s second weakness, internal disorder, ranking worse than in any major country, is the
most problematic. Here is Dalio’s assessment (pg. 157) just prior to Biden’s election based on
his promise to unify the country: “When lots of these conditions are in place (greater than 80%)
there is around a 1-in-3 chance of a civil war or revolution…. The US is in the 60-80 percent
bucket today. (2021)” He further predicted this would occur with the (inevitable) next recession. Post Biden, 55% of democrats believe it is acceptable to assassinate President Trump and 49% to assassinate his DOGE Administrator Elon Musk. I interpret that as “improving” the odds from 1 in 3 to at least 50/50 or “more likely than not.” Ten percent of the US population died in the last Civil War. That’s 35 million people today.

It’s true that humans choose relative social status over absolute living conditions. It is also true
that a competitive dynamic capitalist economy produces wildly different levels of income and
wealth, a major source of conflict in Dalio’s findings. But his findings related to other mostly
non-capitalist empires reflect all the activities that fall within the broad category of win-lose
political elitism or more accurately “political corruption,” for which opportunities abound in a
highly regulated economy with a $6 trillion annual budget. The US historically provided
opportunity based on merit, which, unlike political corruption, is win-win: the large rewards for
entrepreneurial achievements filter down to improved living standards for all, something
Americans historically seemed to understand in spite of progressive narratives to the contrary.

This is not a normal response to a leader promising to make his country great, or to an
administrator exposing a trillion dollars annually of waste, fraud, abuse and inefficiency of
taxpayer funds. It cannot be attributed to current economic stress. The US has the largest
economy and is the wealthiest among larger economies. The poorest states would be among
the wealthy in Europe. The average (after tax and transfers) income of US households in the
bottom income quintile is about $50k/year (about 20% more than the average for all Germans).

The progressive movement has now merged three carefully crafted but historically false
narratives: the anti-capitalist narrative; the racist narrative and the environmental narrative,
the first two over the past century and the last over the last half century. These narratives
reject the US political and economic system as exploitive. This is the message of the current
Sanders (the leading 2020 Democratic presidential candidate) and AOC (the current leading
2028 Democratic presidential candidate) “Fighting the Oligarchy” tour. Progressive
indoctrination of these myths begins in primary public schools and continues through higher
education, to adult mainstream media news outlets. Patriots are now terrorists. Ironically, the
primary source of the rise in income inequality during the 21st century isn’t oligarchy or
capitalism, but progressivism: the massive fiscal deficits financed by the Federal Reserve, a
form of political corruption, that has driven up asset prices.

MAGA 2.0

President Trump was much better prepared to start his second term and is unencumbered by
the political exigencies of re-election, but the challenge is greater than he faced in his first
term.

On taxes, whether or not he can avoid a massive tax increase by maintaining the 2017 tax
reform is currently problematic.

On expenditures, the US needs to restore an affordable balance between US capitalism and
socialism, but there are only a few examples of a democracy that is capable of providing the
necessary budget discipline, e.g., British Prime Minister William Gladstone in the late 19th
century and Argentina currently, where Milei has recently imposed the necessary fiscal
discipline without any special authority from the legislature. There is no painless way. On tariffs, the Democratic Party supported Trump’s position when he was a member, now stand in total opposition. Reciprocity is a defensible concept. However the “tariff wars” ultimately play out, it is already assured a historical treatment as a disaster.

None of this will matter without changing the destructive narrative that threatens the US
economic and political system from within. Trump is addressing DEI from the top down, but the
larger narrative is too deeply ingrained for this to make much difference. Some, likely Bernie
Sanders, may believe the narrative. But insincerity and political corruption are widespread
among the various groups that have promoted these narratives. It is particularly ironic that they
are destroying Tesla, once the symbol of environmentalism, while threatening the former
poster boy for their movement with assassination. Burning Tesla dealerships is apparently
funded by major Democratic Party players like Soros and largely with taxpayer dollars, all in
defense of waste, fraud, abuse and inefficiency. Cui bono?

While accusing president Trump of being an authoritarian dictator, his executive powers have
actually been restricted with lawfare. Senator Schumer defended himself against the recent
attempt at progressives to over-throw him by touting the 230 progressive judges he appointed
during Biden’s term.

This political divide cannot conceivably be bridged before the next recession. Reversing this
poisonous narrative may take generations. Hence, collapse of American hegemony is inevitable, and not necessarily a bad outcome for the US. Avoiding being pushed into either a foreign or domestic war to shift political blame should be the highest priority. Avoiding the collapse of the political and economic foundations of the US republic comes next, then setting the framework for recovery.

What might the new world order look like? A US with close ties (and a mutual defense treaty) with
Canada and Greenland, a strengthening partnership with Australia and a similar re-arrangement
with Europe?

These would all be MAGA achievements. But don’t expect any statues.

Kevin Villani