The Novel Coronavirus (COVID-19), the Trade War, and 5G
The United States has had a complicated relationship with China over the years. We have outsourced a great deal of our manufacturing to China and as a result, have been able to buy and sell inexpensive products because of their low wages and minimal regulations. However, China is well known for stealing our intellectual property, preventing U.S. products from being sold in China, and using government resources to give their businesses an advantage over ours. This disproportionately beneficial association has led to the current trade war. The U.S. informed China that we would no longer turn a blind eye to the situation and then, in the middle of trade negotiations, the world was struck down by a global pandemic originating in Wuhan, China, further complicating the matter. As we continue through this period of health and economic recovery, we need to consider what kind of relationship we want to have with China in the future.
Dean Cheng, the Senior Research Fellow on Chinese political and security affairs with The Heritage Foundation, graciously agreed to provide some insight into these interconnected issues so that we can have a better understanding of China as we make decisions for the future.
Is there a connection between the novel coronavirus (COVID-19) and the U.S.-China trade war?
“It is interesting that you link these issues together because I think they are linked. I think that what we are seeing with regard to China and COVID-19 is partly a byproduct of the fact that before COVID-19 you had an almost two-year-long trade war. That trade war did affect the Chinese economy. It almost certainly contributed to the slowing down of growth. There were also other factors that contributed to China’s slowing growth rate and a lot of it has to do with China’s economic reforms. That pretty much ended as of 2004, long predating President Xi Jinping. But, as a result, we are watching the Chinese economy become slower and creakier.
“The other piece is China’s demographics. China’s population is aging and aging rapidly. Its workforce stabilized around 2016 and 2017. Because of the one-child policy and the previous baby boom, you are seeing China’s labor advantage steadily shrink. So, these were factors that were already starting to take shape even before the trade war which preceded COVID-19.
“I think that the trade war and its impending end with Phase 1 of the trade deal in January may have actually contributed to the Chinese policies on COVID-19 because COVID-19 came about towards the end of 2019. We are not sure exactly when. We are not sure exactly where. But, there are these reports that they started seeing odd, atypical pneumonia and other cases beginning in mid-December.
“The problem here is that this would have been hitting right as Chinese New Year or Lunar New Year was about to begin. Keep in mind that lunar new year is a ten-day holiday. It is the biggest holiday on the Chinese calendar. It is also a significant family event and one of the biggest human migration events. Literally hundreds of millions of people will take to China’s railways, airlines, cars, and busses. So, limiting population movement, limiting business, shutting down the country at that point, would have had an economic impact, a family impact, and therefore would have had a political impact, especially, given that you had an economy that was starting to slow down.
“I suspect that there may have been a number of motivations in Beijing in Xi Jinping’s circle. Do we declare to the world that there is an emergency? Do we tell the world that there is an emergency? Do we tell Chinese officials that there is an emergency, or do we sort of hope for the best and keep things tamped down? And from there we are where we are, which is a global pandemic, global economic shutdowns, a global loss of GDP on the order of probably 4-6%, massive unemployment around the world, and massive chaos.”
What was the origin of the novel coronavirus (COVID-19)?
“Point 1) The generally accepted position right now still is that the novel coronavirus emerged out of a very specific wet market in Wuhan and it spread from there.
"Point 2) Among the initial cases, the Chinese themselves said we are really not sure this is correct because at least half of those cases had no ties at all back to that wet market. To which a number of epidemiologists agreed, but they said that although they may not directly have had it, they would have had family or other connections, given the virulence of this disease.
“We know that there were some reports from people like Dr. Li Wenliang in China about a new strain of pneumonia that did not pop up as a pneumonia bacterium. These reports seemed to start emerging in late December, early January. We are now pretty sure that it was COVID-19.
“We have the genetic mapping of COVID-19 that came out of a Shanghai facility that the Chinese then closed for “rectification.” We are not quite clear what that even means in a medical sense or a scientific sense. They closed that facility down in late February, and it is unclear whether that facility has reopened. Apparently, the release of the genetic maps was unauthorized.
“We now have the Chinese confirming that they had samples of COVID-19, or what we think is COVID-19, from early January which they had ordered to be destroyed. This raises some questions about motivation. It raises the question, what were those samples? What did those samples show? Since they were destroyed, we don’t know.
[The point of this was to note that we don’t know if these samples, if Dr. Li’s patients, were tied to Wuhan, and specifically the wet market there.]
“So, these are some of the things we know. We know that there are laboratories in Wuhan that engage in viral research. But, keep in mind, Wuhan has over 11 million people, so the fact that there are research facilities there does not necessarily indicate a source. We have had accusations made, including part of the U.S. administration, that it may have escaped from some of these labs.
“There are three points here. There was a claim that the virus was deliberately created as a bioweapon, and this has generally been rejected by biological researchers around the world. There is the accusation that this was created as a research tool, and that is a source of controversy. And then a third issue is that it may have simply escaped, and those are three very different things. And unfortunately, as with the labs, there’s a lot of conflation that goes on.
“There is a Wuhan Institute of Virology which is generally seen as a Biological Safety Level 4 (BSL-4), which may be associated with the Chinese military, and may engage in bioweapons research. But, there is also a separate Wuhan Center for Disease Control and Prevention, which seems to be a BSL-2 or BSL-3 facility, that does seem to do research in a variety of viruses including bat coronaviruses. So, again when people say it escaped from “the lab” they don’t always say which lab they are referring to. So, all of these puzzle pieces are on the board, and how they all fit together is often muddied.”
Did the Chinese lie to the world about the threat of the COVID-19?
“Well, the Chinese Mayor of Wuhan went on Chinese television and said he had more information that he was specifically told not to disseminate, and this led to 5 million people transitioning out of Wuhan. Over the course of this pandemic, the Chinese version of the story has evolved. Early on the Chinese themselves recognized and admitted that they had not fully disseminated information. But, as time has passed, they have altered their narrative more and more to say that they have been open, that have told everyone everything, and that their hands are clean. If you go back to January and look at what the Chinese themselves were reporting, that's not quite the story they were promoting at the time."
Did the U.S. outsource, and potentially fund, coronavirus research to China?
“That I don’t know. My understanding is that there are certain types of research that the U.S. has chosen not to pursue but that we may have in a sense outsourced to China. A number of things have been outsourced to China because China is willing to do things we often choose not to do. To give you a non-biological example, China did not have a lock on the world’s rare earth minerals, but China does have, at the moment, a very heavy lock on the processing and refining of rare earth ores. That is because this is highly polluting and produces a number of fairly dangerous byproducts including radioactive thorium and people are willing to let China bear that environmental burden. So, are there aspects of biological research that we don’t want to do here but we were willing to let China do there? Yes. It would not surprise me if there were aspects of biological research that had a similar pathway as rare earth refining.”
Is Chinese investment in U.S. ports and infrastructure concerning?
“Well, they have been investing in our ports, for example, for years. I remember hearing the head or deputy head of COSCO, the China Ocean Shipping Company, not the big box store, talking about working with the longshoremen in Boston to get Boston Harbor turned into a very modern containerized port facility, as well as in meetings with New Jersey longshoremen, to get various ports in New Jersey up and running. So, China has been investing in American ports, along with ports all around the world, for many years."
“The reality is that what has changed is not the Chinese investments, but how we look at those”
“Now, I think that we do need to recognize that U.S.-China relations have also been evolving. So, what was acceptable in 2007 or 1997 is perhaps a lot more problematic in 2020. The reality is that what has changed is not the Chinese investments, but how we look at those investments.”
Did China Threaten to Withhold Medication from the U.S.?
“The Chinese government, and for that matter, Chinese pharmaceuticals, never threatened to withhold drugs from the United States. That was a financial planner in the pages of, interestingly enough I believe it was Xinhua.
“Now, this becomes very muddy because the problem here, of course, is that on the one hand Xinhua, People’s Daily, and all of these newspapers including the Global Times are all state-owned. So, if it were truly something that the Chinese government totally disagreed with, like “Taiwan should be independent,” it will not see the light of day.
“But, at the same time, it’s pretty clear that there are a number of views that are sometimes published in Chinese sources that are not official. Now, you could argue, and I think it is reasonable to say, that this is purely plausible deniability. They will throw ideas out there, and if they run into a hailstorm of flak then they will say, oh it was just some random person, and by the way, we have freedom of expression, and if it gains more traction than another, then you will hear it echoed.
“So, it is important to note that on the specific issue of drugs and ‘let the Americans drown in the sea of COVID’ which I think is a charming phrase, then that is not the official government position.
“Now, what is striking, however, is that the Chinese have imposed export controls on Personal Protective Equipment (PPE). This is in fact more troubling because much of that PPE was contracted by 3M and other companies, so this is openly interfering with what had already been paid for. So, you have a very mixed record here of, 'Well, the Chinese haven’t actually cut off anything.” Well, yes they have, not drugs, but PPE.'
Should we be concerned about Chinese ownership of U.S. debt and their ownership and control of U.S. ports and other critical infrastructure?
“I think that is something of a misnomer. China is the largest foreign holder of American debt. The American people, including the U.S. Department of the Treasury, are the largest holders of our debt. China holds about $1 trillion of our debt of (pre-COVID) $24 trillion. They are the second-largest holder (after Japan). This is about 5% of our debt, as of 2018 or so.
“The other piece to consider is why China owns our debt at all. China owns our debt, not because they want to be able to use it as leverage, not because of the generosity of their hearts, but because of the reality that China 1) generates huge trade surpluses, which are typically denominated in dollars. Those surpluses are not just from the United States but from other countries as well and 2) there is no place for that money to go. If you keep it in China, the money is not convertible because you can’t use the dollar in China. If you keep it in China, you might as well build the world’s largest mattress and just stuff all those dollar bills underneath. If you want a return, then you’re probably going to have to put it somewhere else, other than in China.
“If you go outside of China, where do you put it? Well, first of all, you go to the world stock markets. But nobody is going to let China put the hundreds of billions of dollars that they have into stocks, because that would mean owning, or having substantial minority ownership, of a company. The Japanese won’t let you own Mitsubishi. The Germans are not going to let you own Siemens. The UK is not going to let you own British Aerospace. We are not going to let you own Google. So, stock ownership is very limited.
“What about bonds? Well, consider that the American bond market, by which I mean American government bonds and T-bills (Treasury Bills). They are the only ones paying a positive rate of interest at this point. Although, I think we are about zero now, but as of say two years ago, or a year ago, we were the only ones paying a positive interest rate. The Bank of Japan and the European Central Bank were both charging negative interest rates. So, if you bought a million-euro bond you are going to get nine hundred and ninety thousand euros back when all was said and done. That’s not a great deal.
“The other point to consider is that because of our spending, even pre-COVID, we have the largest bond market. We can handle the sheer amount of money that the Chinese were chucking around in a way that not even the Europeans could. There are other people who would be happy to have you buy their bonds, but the Chinese look at Argentina, which just defaulted for the 9th time, or Greece and say I’m not really sure I want to put this money into those kinds of bonds. So, who is reliable? Who has a reasonable rate of return? Who has absolute credibility? Who has the capacity? We have never missed a bond payment or a T-bill payment. The U.S. is almost the only game in town.
“This may be going off on a tangent, but I do think it is important. How would China hurt the United States on bonds? Well, for example, let’s say they have a trillion dollars worth of our bonds, and they could just sell those bonds. First of all, nobody can handle that much all at once. So, let's say the Chinese have a trillion dollars of US bonds to sell, and choose to get rid of 250 billion as a start. Okay, option 1) they go out there and say they are going to sell 250 billion dollars’ worth of bonds, and other people buy those bonds. Why does the United States care if it's bought by Japan, Britain, or the Netherlands? Those three countries are, by the way, some of the other largest holders of U.S. bonds. Then the U.S. Treasury and the Fed (Federal Reserve Board) pay out those coupons on the T-bills, except it is to Her Majesty’s government, the Bank of England, rather than to the People’s Commissar of the People’s Bank of China. There is no difference. We don’t care.
"Option 2) So, China is going to flood the market, and nobody is going to want to buy those bonds because it is just too much.
"Okay, so if you can’t sell a dollar’s worth of bonds at a dollar, and you really want to hurt us, then what do you do? You are probably going to lower the price. So, you go to 95 cents on the dollar. Okay, and you are going to take 95 cents for a dollar bond. Okay, China takes a loss, and we still don’t care because the Brits bought it. Okay but the Brits say we are full. Okay, 90 cents, 85 cents, 80 cents, at some point, it will be worth it for the U.S. government to step in and say I will buy those bonds you are getting rid of at 80 cents on the dollar, and then we can retire those same bonds at 80 cents on the dollar. You, China, just gave us a 20% discount on the bonds that you bought from us for a dollar.
"Finally, how would we pay for those bonds? We would give them dollars which puts us right back at step one. It's a little bit different if the Europeans buy those bonds because then they get euros, then the Chinese get euros, and maybe they like the euro. Although, with the instability of Greece, Spain, Italy, and now Brexit, that may or may not be a great bet.
“All of which is to say that at the end of the day this whole financial system is much more complex than ‘China owns our debt, and they can call in those bills.’ It's not like a mortgage. It's not like China can foreclose on Yosemite Park or the Port of Boston.
“It's not like China can foreclose on Yosemite Park or the Port of Boston.”
“That is not to say that Chinese investment is not a problem, especially in key infrastructure where they can do other bad things. They could gain a lot of intelligence, could shut down a port facility in the middle of a crisis, or maintain awareness of where shipments are going. There are lots and lots of reasons why Chinese investments need to be carefully monitored, and why Chinese sales of bond holdings could certainly introduce a lot of chaos in the short-term.
“If they went on the market tomorrow and said: ‘I’m going to sell $250 billion of U.S. bonds,’ that is going to have an impact. It will have an impact in terms of views, in terms of people's confidence in the U.S. economy, etc. At a moment like this, that would be a bad thing to do. But, over the longer term, especially if we are not going to go to war or something like that, the impact eventually flattens out.
“If you have control or management of a port located in a place like Hampton Roads, then you have an enormous amount of intelligence-gathering potential that is separate from building out the infrastructure. So, that is a very different problem to my mind than simply building out port facilities in a less strategically valuable location, as opposed to key strategic locations such as Savannah, Charleston, or Norfolk. Savannah is one of our major ports of embarkation for military operations throughout Europe and the Middle East. Norfolk has the largest naval base in the world and is part of a tremendous concentration of military facilities. I don’t want to give the impression that there are no problems with Chinese investments. There are problems. However, I prefer to keep things in relatively delineated lanes, recognizing that they are interconnected. But, the issue is the intelligence issue and the strategic issue, not necessarily the financial issue of purchasing U.S. debt. There are going to be impacts from a financial aspect as they can gain influence, legislators, local support, and voter support. However, those are separate issues from intelligence and strategic threats.”
How does COVID-19 impact the trade war?
“Well, this is a good question. First of all, does Phase 1 of the trade deal still apply? Both President Trump and President Xi Jinping made comments that almost sound like they want to pull out, and both have made comments suggesting that they shouldn't pull out.
“It’s quite likely that the Chinese will miss their targets for Phase 1. How much of that is due to COVID-19 and their economic slowdown, and how much of that is due to them not living up to their commitments is unclear. If it is a matter of them not living up to their commitments, it is certainly going to make Phase 2 moot. As it is, other non-economic issues such as Hong Kong, Taiwan, and the South China Sea, all of these, are going to make Phase 2 delayed at best. The Chinese can read the calendar as well as anyone else. They know that we have elections coming up. I doubt that they like Mr. Trump very much so they are probably not going to want to give him any kind of victory, which is what Phase 2 could be seen as doing. Now, the Chinese, however, I think are smarter than the Russians in the sense that they tend to think in longer terms. The Russians I think are fairly short-term. So, if the Chinese calculation is that Donald Trump is going to win anyway, then they might be willing to give him a victory on the grounds that, ‘look, we are going to have to live with this guy for four more years. Antagonizing him now will only make those future four years more difficult.’ So, part of the question of ‘will there be a Phase 2 before November’ goes to Chinese calculation of ‘is Donald Trump destined to win?’
“So, the other things that I think are important to note here are 1) do the Chinese have a global view, and 2) are they thinking about COVID-19? I think this is very important because while almost all of the West is focused on COVID-19, how they get out of lockdown, etc., I think the Chinese have been actively trying to put together a number of issues relating to COVID-19.
“One issue that they must deal with is the PPE issue. Why did China claim to send aid to a number of countries including Italy and Germany when in fact they were merely sending things that had already been bought and paid for? They were trying to shape the international narrative with the message that China is a good supply chain partner; China is a reliable partner; China does a lot of things out of the goodness of its own heart. Most of this is nonsense, but that is the message that they were trying to send. The second issue is the steel fist inside the velvet glove: rely on us, you need us, don’t make us angry. The third issue, which goes back to the first, is that China is a good and reliable partner for 5G.”
Should the U.S. be concerned about China and the future of 5G and will COVID-19 have an impact?
“And why does 5G tie back to COVID-19? Bandwidth. A lot of people have been using a lot of video conferencing over the course of this lockdown, and that has meant an enormous growth in the demand for bandwidth. And what is bandwidth in the next generation, but 5G. 5G has gone from ‘You know this will be cool when we have it, and it will be good to have it, and we will figure out what we can do with it besides downloading movies faster,’ to ‘Wow, we really need 5G yesterday. Look at all of these Zoom and Webex calls. Look at all of this teleconferencing. We need to have this now because I’m tired of the stutters and the drops.’
“Meanwhile, Huawei is just sitting there waiting to pounce because they already have a lot of the technology, and they are more than willing to sell it at a fraction of the cost of anybody else. It’s called subsidies from the Chinese government. Why are the Chinese willing to do that? It is because 5G is an enormous intelligence collection opportunity. I mean this is the equivalent of monitoring Hampton Roads, except that it is in cyberspace, not physical space. This is a chance to gain intelligence. This is a chance to create dependency. This is a chance to do a lot of other things. So, the Chinese have made a play toward Poland, toward Austria, toward various other European countries. They have made very nice pitches to less developed countries. ‘Look at all of the aid we are sending you. Look at all of the PPE we are sending you.’ All of this is to help generate a positive opinion that will help shape the thoughts of decision-makers when they ask, ‘Should we let Huawei build our 5G network?’
“Now, this cuts both ways. Arguably, the UK’s bad experience with the Chinese on COVID-19 PPE is part of why the UK seems to be pulling back on letting Huawei build out their 5G network. You may well see a reaction in Europe along those lines, but in Africa, in the Middle East, in South America, I suspect that the Chinese have had less negative attention. They may have had problems where things didn’t work, but they had a lot less of the bad press. So, all of this feeds into how China wants the world to view it when we come out of lockdown. They would like to see a world marked by two things: a China that has a better reputation in at least certain key quarters, and a world that is willing to keep Taiwan in a box.”
The U.S. does not appear to have plans to develop its own 5G network. Should we be concerned about any national security concerns if we allow China to build our 5G network?
“So, the Chinese advantage that Huawei provides, is that it is ‘soup to nuts.’ Huawei makes cell phones. Huawei makes tablets. Huawei makes computers. Those are the ways that you get onto the 5G network. They make the base stations (the 5G equivalent of cell phone towers), and they make servers and routers, which in the early days, they blatantly stole from Cisco Corporation. But, these days, they actually make them on their own, and have demonstrated some ability to make innovations on their own. So, you have, very broadly speaking, the three big pieces. Huawei makes all of them.
“The U.S. has Cisco. That’s pretty much it. That’s servers and routers, but Cisco does not make cell phones. You have T-Mobile, and folks like that, working through manufacturers like Ericsson, Motorola, etc. So we have the physical networks. Ericsson and Nokia are probably the biggest European manufacturers of 5G cell phone handsets. Samsung makes tablets and phones. Samsung is the most likely rival to Huawei because they are working on the other pieces of the system. There are Samsung routers and Samsung servers being developed, and they are definitely working on base stations. So, you can imagine a Samsung network rivaling Huawei. We won’t go into price issues, because that would get into subsidies, but in terms of ‘I just wanted to buy something that is soup to nuts right now,’ Huawei is the only one. You can cobble together something with Erickson or Nokia with Samsung, or LG (formerly Lucky Goldstar, a Korean company), with Fujitsu or with Cisco. But anytime you have different manufacturers you have the possibility that maybe the stuff won’t work perfectly coherently. That’s Huawei’s current advantage.
“Fast forward five years, it’s not still clear that Huawei still has that advantage. At the moment, and for the immediate term, one to two years, Huawei absolutely has the advantage. The problem is that an awful lot of people, and honestly, I don’t understand why, are saying we need to make a decision now. Well, if you are going to make a decision right now, Huawei is your best choice. If you say I need to make a decision within the next five years, it’s a lot less clear. But, Europe in particular has decided that it needs to make decisions about 5G networks and who will build them right now. Now, maybe that will change with COVID-19. A lot of people are in a lot of debt. I’m not sure how many governments are going to have the money to spend on 5G, as we dig our way out of COVID-19. But, at the same time, South Korea is still having trouble with its COVID problem, which may affect Samsung, so its R&D efforts were also hit by COVID-19, so I am not sure it's a wash.”
The Future
Mr. Cheng’s insight into the political, economic, and national security issues relating to the pandemic, Chinese investments in the United States, as well as China’s goals for the future, have helped to bring some clarity into our relationship with China. As we move forward with the trade deal, consider future transactions, and make plans for 5G, we will have a better understanding of China’s thought processes and how we should interpret their actions.