The Department of Economic Warfare
US Economic Security Priorities and a Failing Bureaucracy
This week DC was abuzz with news that the Biden administration was finally coming around to developing a sanctions package in order to deter Beijing from invading Taiwan. Over the last 18 months, there has been an increasingly vocal chorus of voices in Congress and the China hawk community advocating for such a plan. While most commentary on US-China relations has focused on the military elements involved in a possible conflict over Taiwan, economic warfare as a key element both before and during conflict should not be ignored or belittled. To be clear, sanctions and other means of economic warfare are not unilateral means of victory or deterrence. Rather, they are a critical tool in a comprehensive strategy of attrition instead of the fatal blow. Today, I’d like to explain the critical components of economic warfare, both offense and defense, and then propose a new bureaucratic structure to overcome the repeated conflicting interests in the US government that hobble our own ability to conduct economic warfare against a determined but intertwined opponent.
Economic intertwinement, even after some signs of decoupling, is often listed as a reason that the US and China would never go to war. Notably, this argument is infamous for also appearing in European popular politics in the years before World War I. The British had an economic warfare strategy for crushing the German economy in the event of war, but what the US lacks today is not only an economic warfare strategy in the event of conflict, but also a clear strategy for economic conduct in support of an effort to compete and contain the People’s Republic of China. China is an economic powerhouse, but one that is heavily reliant (for now) on overseas finance, investment, and raw resources. Therefore, a clear economic strategy to counter China should have three core elements: new trade agreements with allies to expand US investment and offshore industry from the PRC and its neighbors to other countries, restrictions on US capital outflows to the PRC, and options at the outbreak of conflict. While not comprehensive, these three lines of effort should remediate US relative disadvantage to Chinese economic power, reduce exposure in the lead up to and outbreak of conflict, and finally reduce Chinese freedom of maneuver in the economic space during conflict. In order to effectively and efficiently execute such a strategy, the US must realign the various national security-related elements of the bureaucracy under one entity: the Department of Economic Warfare.
One of the greatest failures of over the last decade was the US abandonment of the Trans-Pacific Partnership agreement. Half of life is just showing up, and the US failure to be present in one of the most important trade agreements of the 21st Century, and certainly in the Indo-Pacific, was a political and economic failure from which we still have not recovered. In the years since we floundered over TPP, Chinese trade and investment continued to be the best game in town for many developing countries in the Indo-Pacific and even some developed countries. As we’ve learned from the ongoing supply chain crisis as a result of COVID-19 and Ukraine, the US and its allies are heavily dependent on the PRC for key materials and products that the PRC has demonstrated a willingness to use to coerce whole countries to their political favor in times of crisis. The US response must not be about ‘Made in America” protectionism that only concerns itself with reshoring long-lost low-skilled manufacturing jobs and production back to the United States. Rather, we should “near-shore” and prioritize new trade agreements, modifications of existing ones, produce research agreements in the vein of AUKUS, and favor US foreign direct investment into other developing nations within the Indo-Pacific. The exception here is for semiconductors. TSMC, based in Taiwan, produces close to 90% of the world’s high-end microchips of more than 10,000 unique designs. If you plug it into a wall, drive it on the highway, or carry it in your pocket, chances are the chips inside were made in Taiwan. Matched with production by Samsung in South Korea, a great majority of the world’s finest semiconductor manufacturers are at risk of economic or military coercion by the PRC in its near-abroad. The equivalent to this problem would be during the first cold war if nearly all nuclear material and guidance systems for ICBMs was found in Free Berlin and West Germany. The US has made some efforts to onshore TSMC facilities to Arizona, and the passage of the CHIPS and Science Act will help jumpstart further new production facilities in the US. Unfortunately, because of those supply chain delays, demand shocks, inflation, and worker disputes, the soonest any of these facilities will be online will be in the 2025-2026 timeframe. Nor will these new facilities offset present TSMC capacity. The US’ chip investments are one of our smarter decisions, if late in the game, but it will still take well over a decade to get the US on par with our partners in Asia in terms of production capacity. That’s why in EX SUPRA, I talk about how the loss of the TSMC facilities on Taiwan would mean throwing the world into a global depression for a decade.
The second element of pre-war economic strategy involves reducing the American investment capital exposed to the PRC and the not significant percentage that aids PRC military-civil fusion (MCF) and the development of its weaponry. The most recent example here is the US company that aided Chinese companies’ worth money and material (including microchips) through non-blacklisted third-party companies. The US cannot keep pace with the rapidly changing market environment and clever PRC tactic of spinning off companies under new names to evade blacklists and sanctions. Therefore, the alternative is to make investors understand that the PRC is not the place to invest. Initial decoupling from 2018 to the outbreak of COVID was effective, but sluggish economic growth in the aftermath compared to China’s made it profitable to invest in China again. Asset managers like Blackrock have parked tens of billions in China over the last few years. In particular, US state and local pensions funds are particularly exposed, sometimes by more than half of their portfolio to Chinese companies through these asset managers. In the event of conflict, imagine the economic disruption and political instability caused to the US and its employees when hundreds of thousands if not millions of people wake up to their hard-earned pensions cut in half (and that is even factoring in the losses faced by the shock of conflict to the US market). Relatively speaking, Chinese companies and pensions are far less exposed to US markets than their American counterparts in Chinese markets. And in the last year, Xi has demonstrated a willingness to not only punish Chinese companies with too much domestic influence, but with too much new exposure to the US market such as Didi. While many of the most public decoupling moves made in the last decade by the US under Trump, the Chinese have made great inroads in securing their economy in time of war, but there are weak points.
The final component of our economic strategy is genuine economic warfare during a conflict. One might term this the “nuclear dollar” option. Nearly all Chinese small and mid-sized companies and banks are reliant on the underlying US global financial system, including trading in the dollar, to operate. Cutting these companies off from that system and from the dollar even when dealing with other countries via sanctions would be the most basic step. Additionally, as the CCP steps up its efforts to insulate itself from external market shocks (including economic warfare), it is seeking to undermine the US sanctions regime and leverage by implementing a new alternative to the current underlying global financial structure, which would support the Digital RMB, through blockchain technology. That the CCP has stated it is willing to incur losses in order to rapidly implement this new system and digital currency suggests that this is of vital interest to Beijing’s strategic outlook. Thus, cutting Chinese smaller banks and companies off from the dollar may only be effective until the end of the decade as a form of leverage. Indeed, a more effective plan would be to coordinate with allies and partners to cut off trade during wartime with China, even if the US must go it alone militarily. However, as we’ve seen with Russia, there are still swaths of the world willing to trade with a large economy under sanction by the US and China will likely use its increasingly lopsided relationship with Russia to hoard resources well below market rate. As the PLA now possesses the world’s largest Navy and the CCP has invested in Central Asia trade routes, the idea of simply physically constricting the PRC until it submits is no longer viable. Economic warfare will only work if we can insulate ourselves prior to conflict and be able to execute sanctions on day one. In order to do that, we need a central coordination authority whose mission and interest is in national security, not unregulated economic growth or corporate interests.
In battling CCP influence in the United States and limiting our exposure to Chinese investment, one of the greatest obstacles has come from within. The very agencies, like the Bureau of Industrial Standards (BIS), the Office of Foreign Assets Control, and others, have slow rolled, watered down, and downright obstructed the executive’s ability conduct economic warfare against China. Now I want to say ahead of time I don’t entirely blame these entities. They presently exist in departments whose job it is is to ensure the US economy functions and runs smoothly. We should want that. And when we were just sanctioning Iran or freezing terrorist assets, this setup wasn’t a problem. But the US and China are far more intertwined and the people in these orgs are undermanned, underfunded, underequipped, and not exactly interested in policy that hurts US growth in the short term even if it protects the American people in the long term. So we have organizations with conflicting interests, lack of direction, and lack of funding for what they need. And even if the Biden administration has recently made an increased effort to do things like synchronize entity lists and even consider outbound capital restrictions to China, it’s been far from an efficient policy and the voices advocating for such policy are drowned in the bureaucracy.
Enter the Department of Economic Warfare…or whatever the bureaucrats want to call it to make it sound nice. The DEW, as we’ll call it, would have a stated mission of ensuring the synchronization of US security and economic policy. It would be its own agency, housing offices like OFAC and BIS under one authority whose priority is economic security at home and the disruption of economic security threats abroad through sanctions, allied coordination, export controls, and overseas investment regulation. Think of the DEW as the security partner to USAID, the US independent agency charged with investing government dollars abroad for promoting economic development and foreign aid. In addition to existing economic security agencies, the DEW would also create a new board (under the authority of the Defense Production Act) to oversee the establishment of a new allied semiconductor ecosystem and ensure that companies and regulators are cooperating with the intent of the CHIPS Act and US national security objectives. By realigning these formerly dispersed agencies under a singular authority with a singular mission and voice in the executive branch, advocating for, legislating, and executing an economic security strategy will be much more streamlined, effective, and timely.
In summary, it is in the best strategic interests of the United States to focus on the containment of Chinese military expansion and economic influence. Any grand strategy focused on China must have a near and long-term game plan. While the long-term game plan for the US must feature its own economic development and growth, the short term is the most dangerous window for conflict. Therefore, an economic warfare plan for the competition phase and conflict phase must be devised and centered around three key lines of effort: coordinating new trade agreements with partners while building on old ones, reducing American market exposure during peacetime to the Chinese economy to both limit American investment in Chinese MCF and potential economic shocks during conflict or crisis, and finally cutting China off from its resources and the global financial system in the event conflict does break out. This strategy should be considered a framework, one meant to be flexible to shifts in market conditions and strategic competition, but at its core any economic warfare plan must equally reduce weaknesses brought about by trade while pouncing on the opponent’s vulnerabilities in order to complicate strategic calculus. By centralizing the various economic security agencies in the US bureaucracy, managing the strategy will be easier and more nimble under one agency than coordinating across many with competing interests. This framework and a Department of Economic Ware should provide a strong footing to accomplish just that, and hopefully assist in closing the PLA’s window to operate against Taiwan, or at minimum, reduce the cost of war to the US while increasing it for the PRC.
If you would like to read more about the future of US-China conflict, its economic and policy challenges, and what the world looks like if Taiwan falls, check out my novel, EX SUPRA. And if you have any suggestions for topics for future newsletters, please send them my way on Twitter @Iron_Man_Actual.