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The New Depression

The business and political elite are flying blind. This is the mother of all economic crises. It has

We are living through a crisis which, from the collapse of Northern Rock and the first intimations of the credit crunch, nobody has been able to understand, let alone grasp its potential ramifications. Each attempt to deal with the crisis has rapidly been consumed by an irresistible and ever-worsening reality. So it was with Northern Rock. So it was with the attempt to recapitalise the banks. And so it will be with the latest gamut of measures. The British government – like every other government – is perpetually on the back foot, constantly running to catch up. There are two reasons. First, the underlying scale of the crisis is so great and so unfamiliar – and, furthermore, often concealed within the balance sheets of the banks and other financial institutions. Second, the crisis has undermined all the ideological assumptions that have underpinned government policy and political discourse over the past 30 years. As a result, the political and business elite are flying blind. This is the mother of all postwar crises, which has barely started and remains out of control. Its end – the timing and the complexion – is unknown.

Crises that change the course of history and transform political assumptions are rare events. The last came in the second half of the 1970s, triggered by the Opec oil price spike and a dramatic rise in inflation, which marked the end of the long postwar boom. Its political consequences were far-reaching: the closure of the social democratic era, the rise of neoliberalism, the discrediting of the state, the embrace of the market, the undermining of the public ethos and the espousal of rampant individualism. For the next 30 years, neoliberalism - the belief in the market rather then the state, the individual rather than the social - exercised a hegemonic influence over British politics, with the creation of New Labour signalling an abject surrender to the new orthodoxy.

The modalities of this present crisis are entirely different. Extreme as they may have appeared to be at the time, the economic travails of the 1970s were progressive rather than cataclysmic. The old system did not hit the wall, but became increasingly mired and ineffectual. What swept the social democratic era away was not the force de frappe of an irresistible crisis but that it was accompanied by the steady rise of a new ideology and political force in Thatcherism - and Reaganism in the United States - and its victory in the 1979 general election.

In contrast, the financial meltdown of 2007-2008 demolished the neoliberal era and its assumptions with a suddenness and irresistibility that was breathtaking. The political class, from New Labour to the Conservatives, is standing naked. They are still clinging to the wreckage of their old ideas while acknowledging in the next breath that these no longer work. The financial crisis is a matter of force majeure; political ideas and discourse change much more slowly, even when it is obvious that the old ways of thinking have become obsolete. Meanwhile, there is no political alternative waiting in the wings, refining its radical ideas in think tanks ready to storm the citadels of power as there was in the 1970s, notwithstanding the fact that think tanks are now far thicker on the ground. Instead, it has been the mainstream which senses that neoliberalism no longer works, fatally undermined by events and, ultimately, the author of its own downfall. This crisis will have the most profound and far-reaching political consequences and will in due course transform the political landscape, but it remains entirely unclear in what ways and when that might be.

In all these senses the financial meltdown has far more in common with the Great Depression than the Great Inflation. When the financial crisis consumed Wall Street in 1929 and proceeded to undermine the real economy, engulfing Europe in the process, it was not accompanied by a radical shift towards Keynesianism, but rather a reassertion of sound finance orthodoxy, followed in due course by the adoption of protectionism. The political mainstream as represented by Labour's Ramsay MacDonald and Philip Snowden and the Conservative Stanley Baldwin all sang from the same hymn sheet. Only Keynes and a faction of the Liberal Party enunciated a plausible alternative. Eventually a programme of fiscal deficits and public works was pursued by Franklin D Roosevelt in the United States, but in Britain Keynesianism was not properly embraced until rearmament and the approach of war. Indeed, it was not until 1945 that the combined legacy of war and the Depression belatedly resulted in a fundamental political realignment and the birth of the social democratic era.

The Grim Reaper has finally spoken:

a boom pumped up by credit steroids and a bust that takes us back to the 1930s

Since the financial meltdown dramatically intensified in September 2008, Gordon Brown has managed to ride the economic storm rather more successfully than the Conservatives, or, for that matter, than Tony Blair would have done. It is Vincent Cable, the Liberal Democrats' econo­mics spokesman, however, who has indubitably emerged as the political sage, unafraid of confronting neoliberalism's shibboleths, demonstrating a clarity of mind and the political courage to tell things as they are, in a way that has escaped all other prominent politicians. Although Brown was the economic architect of the past decade and was responsible, more than anyone else, for its excesses and was shaping up to be a rather disastrous Prime Minister, he displayed last autumn, at least initially, an agility of mind and nimbleness of foot that defied the expectations of those who believed he was capable of neither. He revelled in the sense of purpose and vision offered by the crisis, seemingly prepared to jettison the thinking that had imbued his previous decade as chancellor.

But Package Part I, widely hailed at the time and imitated elsewhere, proved woefully inadequate, and the financial system remains frozen. Meanwhile the waters are rising up the Good Ship UK, threatening to transform the banking crisis into a fiscal and currency crisis. It seems unlikely that, if that should happen, Brown will survive the next election.

Even if it does not happen, Brown faces a serious problem about his own past role, because Britain’s crisis has been greatly exacerbated by the soft-touch regulation, easy credit, runaway house inflation and overexpansion of financial services over which he presided and for which he is accountable. So far he has refused to admit or accept responsibility for his actions – he initially had the temerity (or foolhardiness) to argue that the UK was better placed than other countries to deal with the credit crunch, even though it has become abundantly clear since that the very opposite was the case. So while Brown remains in denial, the plausibility of his new turn, and his understanding of what is entailed, must be seriously doubted.

Indeed, after its initial boldness, the government now seems trapped by its past actions and its former ways of thinking. Brown's failure to accept the need to nationalise the banks suggests the limits of his new-found political courage, and his inability to embrace the logic and imperatives of the new situation. He is still a prisoner of his old timidity and his conversion to the neoliberal cause. It is his good fortune that the Cameron Conservatives have been hugely wanting in their response to the financial meltdown. Having spent his first years as leader of the opposition seeking to reassure the country of his centrist credentials, David Cameron, at the first whiff of gunfire, has turned on his heels, rejected Keynesianism and, at the very moment when events have shown Thatcherism to be deeply flawed and historically out of time, headed back to the Thatcherite womb of sound finance, arguing that a government must balance its books and that deficit financing, Keynesian-style, is reckless and irresponsible.

But all this, it must be said, is the small change of politics. The crisis threatens in time to sweep away the political world as we know it and those who fail to grasp its magnitude and meaning. Far more is at stake than the fortunes of a few leaders, be their name Brown or Cameron. Who knows where things will be this time next month, let alone next year or, indeed, in 2012? The financial meltdown now rapidly plunging the western world into what increasingly looks like a depression is the first great crisis of globalisation. There was plenty of warning. The Asian financial crisis of 1997-98 proved a salutary lesson about the dangers posed by huge capital movements that were subject to precious little regulatory control. Three economies capsized (South Korea, Thailand and Indonesia) and others stood on the brink.

There were other earlier warning signs, notably Mexico in 1995, when GDP fell by 9 per cent and industrial production by 15 per cent, following a run on the peso. These crises were blamed on the immaturity and fecklessness of national governments - in the case of east Asia on so-called crony capitalism (which, incidentally, prompts the question of how we should describe Anglo-American capitalism) - which the International Monetary Fund obliged to engage in swingeing cuts in public expenditure as a condition of their bailouts.

Yet what if such a crisis were to be no longer confined to the peripheries of global capitalism but instead struck at its heartlands? Now we know the answer. The crisis has enveloped the whole world like an uncontrollable virus, spreading from the US and within a handful of months assuming global proportions, at the same time mutating with frightening speed from a financial crisis into a fully fledged economic crisis. In so doing, it has undermined the foundations on which the present era of globalisation has been built, namely scant regulation, the free movement of capital, a bloated financial sector and immense reward for greed, thereby bringing into question the survival of globalisation as we now know it.

Enormous international flows of unregulated capital have capsized the international financial system - with disastrous consequences for the real economy - in a manner akin to the effect of a roll-on, roll-off ferry shipping too much water. We can now see the cost of free-market capitalism and light-touch regulation. Iceland may provide an extreme example of the consequences of the credit crunch but it also illustrates the dangers facing the more vulnerable economies, the UK included, in a deregulated world where the market rules: a small, open economy; a large, internationally exposed banking sector; an independent currency that is not a serious global reserve currency (of which there are only three); and limited fiscal strength. These propositions have constituted the core economic beliefs - from Thatcher and Lawson to Blair and Brown - that have informed policymaking over the past three decades and without which, it was claimed ad nauseam, an economy could not succeed. Heavy-handed regulation and an overbearing state would serve only to frighten off capital and condemn a country to slow growth, stagnation and global marginality. Now we know the fallaciousness of these claims and the consequences of "letting the market decide".

Like Iceland, albeit not as extremely, Britain has been living in a fool's paradise. A failure to regulate the banks and other financial institutions in any meaningful fashion allowed bankers to behave in a grossly irresponsible and avaricious fashion; a boom that was made possible only by a government-enabled credit binge in which people borrowed recklessly; a bloated financial sector that grew to represent over 8 per cent of the total economy and which was found to have been built on foundations of sand; an overvalued currency that made manufacturing exports uncompetitive and thereby resulted in an unnecessary and counterproductive contraction in the manufacturing sector which must now be reversed; an absurd belief that boom and bust had been banished for ever, allowing the banks to turn a blind eye to the inflating of various asset bubbles and display a profound ignorance of the history of capitalism; a persistently chronic current account deficit that can no longer be compensated for by inward capital flows; monstrous salaries for those at the top of the financial and corporate tree, which were justified in terms of a trickle-down effect that remained a chimera, and as the reward for risk which was, in fact, a reward for greed and failure; growing inequality, which was justified in the name of a more competitive economy accompanied by declining social mobility in the cause of an open and flexible labour market; and, finally, the mushrooming of what can only be described as systemic corruption on a mega-scale as the state ignored the gargantuan abuses of those who ran the banks and other financial institutions, while regulatory authorities willingly colluded in their excesses.

This is the sad story of the New Labour era.

The ultimate cost of this debacle as yet remains unknown. What began as a financial crisis is threatening, as the government seeks to bail out a bankrupt financial sector, to become a currency crisis, with foreign investors concerned about the effects this might have on the value of sterling, and perhaps even worse, ultimately a sovereign debt crisis, with growing doubts about the UK’s financial viability. Until there is some end in sight to the financial crisis, and a line can be drawn under the banks’ indebtedness, we will not know the answer to these questions. One thing is clear, however: whatever the limitations of the social democratic era, it was never responsible for such an all-enveloping and cataclysmic crisis as the one that the neoliberal era – and the Thatcherites and New Labour – have managed to produce. After all the boasting about the virtues of the Anglo-American model of capitalism, the Grim Reaper has finally spoken: a boom pumped up by credit steroids and a bust that takes us back to the 1930s.

There are two key aspects to this crisis: national and global, with the latter promising to be rather solutions are concerned, we are in uncharted territory, with close to zero interest rates, a Keynesian-style fiscal boost that may prove inadequate to the task and could well fail, a hugely indebted financial sector that threatens to leave us with an enormous future tax burden and a greatly expanded national debt. All of this, furthermore, must be addressed in the context of an open-market regime which is very different from those of previous eras, and which could render Keynesian-style national solutions ineffectual. What would greatly assist any national recovery is a co-ordinated global response to the crisis; in other words, global co-operation at the highest level. This cannot be ruled out, but it would be a brave person that would bet on it. It was exactly the lack of international co-operation that bedevilled recovery in the 1930s and eventually led to the Balkanisation of the world into regional currency and trading blocs.

The most important single question in this context is the relationship between the US and China. Will the Obama administration be able to resist the slippery slope of creeping protectionism? Will arguments over the revaluation of the Chinese renminbi be resolved amicably? If the answer is in the negative, then the global outlook will be very bleak indeed and so, also, as a result, will be the prognosis for national recoveries. Indeed, the prospects would look disturbingly like those of the 1930s, with growing international antagonism and friction and a continuingly intractable crisis at a national level, with only the very slowest of recoveries.

Around the world there is growing evidence by the week of a resort to national solutions at the expense of others: measures to subsidise industries that are in severe difficulties; the Buy American clause that was inserted by the House of Representatives into Barack Obama's latest package (though since weakened); the industrial action in Britain against foreign workers; the withdrawal of banks to their national homes; the attack by Timothy Geithner, the US treasury secretary, on China as a currency manipulator. No Rubicon has been crossed but the warning signs are clear. A retreat into protectionism and beggar-thy-neighbour policies will deliver the world into a second Great Depression.

So what will be the political effects of the financial meltdown? Some are already evident. Just as the Great Inflation of the 1970s played to the tunes and concerns of the right, with its invocation of the market, the New Depression suggests the opposite, the inherent limitations of the market and the indispensability of the state. Indeed, the speed with which the neoliberal refrains and invocations have unravelled has been breathtaking. The single most discredited aspect of the social democratic legacy was nationalisation, and yet the government, with the most extreme reluctance, has been obliged to nationalise Northern Rock and partially nationalise the Royal Bank of Scotland and the merged Lloyds TSB and HBOS. Who would have ever imagined, at any point during the past 30 years, that no less than the financial commanding heights of neoliberalism would have ended up in the hands of the state, with precious little opposition from anyone except a few disgruntled shareholders? Even now, however, the Labour government, still trapped in the ideological straitjacket of New Labour and displaying extreme timidity in the face of powerful vested interests, which has always been a New Labour characteristic, is running scared of the inevitable logic of the situation, namely that all the high-street banks should be taken into public hands until the mess is sorted out. Anything else leaves the public responsible for all the debts and risks, while the banks continue to be answerable to the very different interests of their shareholders. But such is the fury and depth of the crisis that this scenario is highly likely.

The state is experiencing an extraordinary revival. The credit crunch is the most catastrophic example of market failure since 1945. It became almost immediately obvious to wide sections of society that there was only one institution that could potentially sort out the mess: the state. Far from being a rational distributor of resources, the market had proved the opposite. Far from bankers and financial traders embodying the public interest, they have been exposed as irresponsible and dangerous risk-takers whose primary motivation was voracious greed. If trade unionists and the nationalised industries were the demons of the 1970s, bankers and the financial sector have assumed the mantle of public enemy number one in the late Noughties. In fact, the irresponsibility of bankers, and the damage they have inflicted on the economy, hugely exceeds anything that the unions could possibly be held responsible for in an earlier era. Meanwhile, the fallen heroes of the pre-Thatcher era, most notably Keynes, are duly being exhumed, restored to their rightful position, and pored over for their ability to throw light on the present impasse and what might be done; if the recession turns into a depression, Marx will once again become required reading.

This political shift is not just a British phenomenon, but a more general western one. The most striking feature of President Obama's inaugural speech was the way in which it embraced and legitimised African Americans for the first time in American history. But it also had another powerful theme, namely its invocation of the public interest and public service. After decades during which American political discourse has been dominated by the language of individualism and the market, it came as a shock to hear a US president articulate a very different kind of philosophy, renouncing private greed in favour of the public good. Obama's election can in part be seen as a response to the failure of the neoliberal era, as well as of Bush's neoconservative agenda; certainly his election represents a remarkable shift to the left in US politics, in contrast not just to Bush, but every recent US president, including Reagan, Bush Sr and Clinton. That Obama is the first African-American president also represents a remarkable redrawing of the political landscape. There is no more powerful - nor difficult - way of redefining society or to embrace a new form of representivity than to include a racial minority that has been excluded.

This brings us finally to what might be the longer-term global consequences of the crisis. Again, we are inevitably stumbling around in the dark because so much depends on whether the recession metamorphoses into a fully fledged depression and in what way and shape the world eventually emerges from the debacle. That said, two key points can be made. First, the credit crunch signals the demise of the Anglo-American, neoliberal model of capitalism, which has exercised a hegemonic influence over western capitalism and been the blueprint for globalisation since 1980. Because of its catastrophic failure there seems very little chance of its resurrection. The process of recovery - whenever that might be - will be accompanied by an overriding concern to ensure that the events of 2007-2009 are not repeated in the future, just as happened in the US in the 1930s with the strict regulatory framework that was introduced for the banks after their comprehensive failure in 1929. This will include the search for a new global regulatory framework that controls and constrains international movements of capital, as well as strict controls over the financial sector at a national level. A new set of political priorities - and with it a new political language - will be born.

Meanwhile, the influence and prestige that the US, and to a far lesser extent Britain, have enjoyed will vaporise in the same manner as their neoliberal model. Their 30-year project has failed and they will be obliged to pay the price in their reputation and the esteem in which they are held. The countries of the former Soviet Union and the casualties of the Asian financial crisis that were forced to swallow the neoliberal medicine will have good reason to feel aggrieved and resentful. The west has been forthright in accusing the non-western world of corruption. The financial meltdown suggests that the west has been guilty of huge hypocrisy. Systemic corruption has lain at the heart of the western financial system. An entirely disproportionate and extortionate level of bonuses has ensured the enormous enrichment of top executives in the financial sector, all in the name of reward for success, when in fact it was the reward for failure. In addition, we have had the collusion of the credit-ratings agencies; a regulatory system characterised by its failure to act as any kind of constraint; and governments that ensured the continuation of this web of relationships and applauded its achievements. The corruption was on a breathtaking scale as evidenced by the size of the bailouts required to rescue the banks. It will be difficult for western governments to make these kinds of accusations of others in the future. That Obama represents such a voice of hope will help to mitigate the inevitable ill-will towards the US, but this should not be exaggerated amid the euphoria surrounding developments in Washington.

The second point is more far-reaching. It is doubtful whether we can still describe ourselves as living in the American era or, indeed, the Age of the West. If not yet quite over, both are certainly drawing to a close, and it seems likely that the effect of the financial meltdown will be to accelerate the rise of China as a global power. The contrast between the situation in China and that in the US could hardly be greater, even though it has been partially obscured by the depressive effect of the western recession on Chinese exports and on China’s growth rate. While the US economy is contracting, China’s grew at roughly 9 per cent in 2008 and is projected to grow at about 6 per cent in 2009. Its banks, far from bankrupt like their US counterparts, are cash-rich. China enjoys a large current account surplus, the government’s finances are in good order and the national debt is small. This is a crisis that emanates from the US and whose impact on China has been essentially indirect, through the contraction of western markets. It is the American model that has failed, not the Chinese.

One of the factors that intensified the Great Depression, and indeed was part cause of it, was Britain's growing inability to continue in its role as the world's leading financial power, which culminated in the collapse of the gold standard in 1931. It was not until after the war, however, that the US became sufficiently dominant to replace Britain and act as the mainstay of a new financial system at the heart of which was the dollar. The same kind of problem is evident now: the US is no longer strong enough to act as the world's financial centre, but its obvious successor, namely China, is not yet ready to assume that mantle. This will undoubtedly make the search for a global solution to the present crisis more difficult and more protracted.

Martin Jacques's new column will be published fortnightly in the New Statesman. His book "When China Rules the World: the Rise of the Middle Kingdom and the End of the Western World" will be published in June (Allen Lane, £25)

the global downturn in numbers

    0.5%

    IMF prediction for global growth in 2009 - worst since WWII

    Up to 40 million

    Number of people who will lose their jobs this year, according to the International Labour Organisation

    $9.7trn

    Total pledged by the US alone towards solving the crisis

    3.6%

    Proportion of GDP pledged by the G7 and BRICs countries towards fixing the crisis (1.5% this year)

    2.3m

    Number of US properties that received a default notice or were repossessed in 2008. In the UK, 45,000 homes were repossessed - another 75,000 are expected to be taken in 2009

    14

    Number of major global banks which collapsed, were sold or were nationalised during 2008

    200,000

    Number of European companies expected to fail this year; an additional 62,000 are expected to fail in the United States. These figures represent record levels of insolvency

    52%

    Increase in UK company failures between late 2007 and late 2008

    14%

    Drop in level of Chinese exports during January

    1%

    Current UK interest rates (down from 5% in October 2008). In the US, rates have fallen to between 0 and 0.25%

How the crisis unfolded

13 September 2007 Run on Northern Rock begins when it is revealed that the bank has requested emergency support from the Bank of England

21 January 2008 FTSE suffers worst falls since 11 September 2001

February 2008 Northern Rock nationalised

17 March 2008 JP Morgan Chase takes over the US investment bank Bear Stearns

12 July Mortgage lender IndyMac collapses - second biggest US bank in history to fail

9 August 2007 European Central Bank pumps ?95bn into banking market

7 September Financial authorities step in to rescue Fannie Mae and Freddie Mac

9 September Bradford & Bingley becomes second British bank to be nationalised

15 September Lehman Brothers files for bankruptcy

16 September AIG, biggest insurance firm in the US, receives $85bn rescue package

3 October 2008 US government announces $700bn Troubled Assets Relief Programme

8 October UK launches its first bank bailout plan, making £50bn available

October 2008 Iceland's banks collapse. IMF extends £1.4bn ($2.1bn) loan a month later

24 November Alistair Darling announces a temporary cut in VAT from 17.5 to 15 per cent

23 January 2009 UK enters recession

28 January US Congress passes Barack Obama's $819bn stimulus package

5 February UK Monetary Policy Committee votes to cut interest rates to 1 per cent - the lowest in over three centuries

Michael Harvey

Martin Jacques is a journalist and academic. He is currently a visiting fellow at the London School of Economics Asia Research Centre and at the National University of Singapore. Jacques previously edited Marxism Today and co-founded the think-tank Demos in 1993. He writes the World Citizen column for the New Statesman. His new book on the rise of China, When China Rules the World, will be published in June.

This article first appeared in the 16 February 2009 issue of the New Statesman, The New Depression

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The Great Wall of Sand

China’s aggressive claims to sovereignty in the South China Sea have angered its Asian neighbours and raised fears of a showdown with the US.

“Hey, what are you guys doing this Saturday?” crew members of the US guided missile destroyer USS Lassen asked over the radio as it ploughed through the South China Sea last autumn. “We got pizza and wings. What are you guys eating?”

The questions were directed at the Chinese ship shadowing the Lassen as it moved into the 12 nautical miles of territorial waters claimed by Beijing off its newly constructed base on Subi Reef, a speck of land in the Spratly Islands. China has built a radar-
equipped weather station and stationed 200 troops there but its claim is disputed by several east Asian countries – and by the United States. The Lassen’s course was deliberately plotted to affirm the right to “freedom of navigation” in what Washington regards as an international maritime area through which any ship should be at liberty to sail.

After a short delay, the Chinese sailors responded to the questions from their US counterparts, talking about their home cities, their families and the ports they had visited. Then the two ships parted course.

The friendly conversation obscured a chilling fact: that these were crews of ships from two nations which, in some scenarios, are heading for an earth-shaking confrontation as they play out the “Thucydides Trap”, in which rising and status quo powers are bound to come into conflict along the lines of Athens and Sparta, as recorded by the ancient Greek historian. In this case, the protagonists are China and the US.

In 2012 Hillary Clinton, the then US secretary of state, said that America and China needed to “write a new answer to the age-old question of what happens when an established power and a rising power meet”. A year later, after a US-China summit aimed at producing understanding between the two powers, the national security adviser Tom Donilon said that the reformulation of the relationship was “rooted in the observation . . . that a rising power and an existing power are in some manner destined for conflict”.

According to Graham Allison, a professor of political science at Harvard, armed hostilities have been the outcome in 12 out of 16 past confrontations of this type in recorded history. These include the long confrontation between the established power of France and the rising challenge of Britain in the early 18th century, as well as the wars between Germany and Russia, France and Britain between 1914 and 1945.

The immediate theatre for the showdown is the huge expanse of the East and South China Seas. China’s increasingly expansionist drive to assert sovereignty there has led to confrontations over the past five years with Japan, Vietnam and the Philippines, which regard waters and islands claimed by Beijing as their own. Early this month, China said it had sent four warships with helicopters, one supply ship and special forces troops to carry out an exercise in the South China Sea.

The US is deeply involved because of its security treaties with Japan and the Philippines, its restored relations with Vietnam and its role as the main military power in east Asia since 1945 – the US 7th Fleet, based in Japan, has between 60 and 70 ships, 300 aircraft and 40,000 navy and marine corps personnel. The Americans also have nearly 30,000 troops permanently stationed in South Korea and an implicit undertaking to defend Taiwan if China were to threaten the island separated from the mainland since the Communist victory of 1949.

Admiral Harry B Harris, the US commander in the Pacific, has said that China “is clearly militarising the South China Sea . . . You’d have to believe in a flat Earth to think otherwise,” and he insisted this spring that his fleet will increase operations to assert freedom of navigation in the same sea. Summit talks between Presidents Barack Obama and Xi Jinping in late March and early April produced no agreement on the issue. A US aircraft carrier was subsequently refused entry to Hong Kong Harbour for a port visit on 15 April. The US then sent aircraft to fly by a disputed shoal off the Philippines where China appears to be on the verge of launching a new stage in its campaign of reclaiming reefs and islands that could act as a base in any open conflict.

Washington and Asian nations are also concerned about North Korea, whose nuclear policies have exposed Beijing’s inability to control its “little brother”. Although the Chinese government announced on 5 April that it was restricting some exports to its neighbour, it hesitates to cut off supplies of food and energy completely, for fear of causing instability across the border that might lead to reunification under the leadership of South Korea. All this makes the nations of the region look to the US as the guardian of their security, even as they seek to make the most of the economic relationship with China.

Other powers, including Australia, are concerned because of the importance they place on freedom of navigation, while China’s forceful defence of its fishing fleets has brought conflict this spring with Indonesia and possibly, in a murky episode at the end of March, also with Malaysia.

This is a huge region that is vital for the world’s economic health. Its manufacturing and trade have acted as drivers of growth since the emergence of Japan and the four “Tigers” – Hong Kong, Singapore, South Korea and Taiwan – in the 1960s. With China having vaulted to second place among the world economies and Japan still in third place, east Asia as a whole accounts for a quarter of the world’s GDP.

The matters of sovereignty in dispute are trivial in themselves, involving strings of small, often uninhabited islands and reefs. The claims that China has been pressing are based on old maps or tales of allegiance dating back to a misty historical past. Yet this does not make them any less significant, with implications that play into concerns about confrontation involving not just China and the US, but the entire region. News in February that China appeared to have deployed two batteries of eight surface-to-air missile launchers on one of the disputed islands added a new edge to fears that the build-up of forces and the lack of a diplomatic solution could boil over into open conflict.

***

Nationalism is on the rise in east Asia and national interests are becoming more deeply entren­ched. Amid a regional arms race, most countries are increasing their military spending. China’s military budget has been rising by 10 per cent a year as it builds up its “blue water” navy (capable of operating outside coastal waters in the wider Pacific), constructs a second aircraft carrier and develops its submarine and missile forces. Since 2000, it has added 41 new submarines to its navy and, at a big military parade in Beijing in September, the official commentary on the arms on show in Tiananmen Square boasted of missiles that the Chinese said could sink an aircraft carrier at the base the United States maintains on Guam, across the Pacific.

In Tokyo, Shinzo Abe’s government is pushing through changes to Japan’s pacifist postwar constitution to enable it to play a bigger military role in the region. Vietnam has acquired six submarines from Russia, which are due to be fully operational by 2017. Indonesia has ordered ten fighter jets from Russia, according to media reports in Jakarta. Military expenditure across the nations of south-east Asia (with the exception of Burma, Brunei, Cambodia and Laos) has risen rapidly from $14.4bn in 2004 and will reach an estimated $40bn this year, according to the Stockholm International Peace Research Institute.

The forceful way in which China has advanced its maritime claims under the banner of the “China Dream” of national rejuvenation championed by its no-nonsense leader, Xi Jinping, has provoked responses from its neighbours, for all that they value their commercial relationships with the world’s second-largest economy.

Vietnam has put its forces on the border with China on high alert. The Philippines has been stirred to take an unusually martial attitude in response to Chinese claims in the South China Sea, acquiring additional ships and filing a suit against Chinese expansion there with the United Nations arbitration tribunal at The Hague. China has refused to recognise the suit or the tribunal’s competence, and said this month that its position was backed by three regional states – Brunei, Cambodia and Laos – and by Russia. But the UN ruled itself competent to deal with the case at the end of last year and a verdict is expected by early June. A judgment in favour of Manila would test Beijing’s readiness to abide by international rules or whether, in the words of Daniel Russel, the US assistant secretary of state for east Asian and Pacific affairs, China is “prepared to be seen as an outlier that flouts international law”.

At the same time, historic animosities are being revived. Though each country is ruled by a communist party, China’s not very successful invasion of Vietnam in 1979 is not forgotten in its southern neighbour. Anti-Chinese riots broke out across Vietnam in 2014 after China deployed an oil exploration rig in waters claimed by both countries and after state TV broadcast video footage showing a Vietnamese fishing boat being rammed by a Chinese vessel and sinking.

The acute antagonism between China and Japan dates back to the humiliation of the Qing dynasty by the rising power in their war of 1894-95. It was then hugely increased by the ruthless occupation of much of the mainland by Japanese troops after they launched a full-scale war in 1937, epitomised by the Rape of Nanjing, in which up to 200,000 people died. The way in which some Japanese politicians honour their country’s dead at the Yasukuni Shrine in Tokyo, which memorialises over 1,000 convicted war criminals, is a cause of constant complaint by Beijing. The “Patriotic Education Campaign”, conducted in China since the 1990s, presents Japan as the main villain, one that plays a leading role in China’s narrative of its “Century of Humiliation” before the Communists won power in 1949.

The current confrontation between China and Japan, which comes amid falling Japanese exports to the mainland and reviews of investment plans, followed Tokyo’s nationalisation in 2012 of eight uninhabited islands and outcrops in the sea that were previously under private ownership. That set off anti-Japan demonstrations in a dozen Chinese cities. Japanese shops and cars were smashed and Japanese flags torn up. Beijing then pushed its claim that the islands, known to the Japanese as the Senkakus and to the Chinese as the Diaoyus, were Chinese because imperial voyagers landed there in the 14th century. They lie south-west of Japan’s southernmost prefecture, Okinawa, east of China’s mainland and off the north-western coast of Taiwan, near strategic shipping lanes and rich fishing grounds, as well as possible oil and gas reserves. Japan insists it owns the islands and there is nothing to discuss, accusing Beijing of a “forceful, coercive attempt to change the status quo”.

Foreign ministry officials in Tokyo have noted an escalation of China’s maritime and aerial probing around the islands this year. “The situation in the East China Sea is getting worse,” an official told the Financial Times in January. An armed Chinese naval vessel sailed into waters around the islands for the first time last December, and an intelligence-gathering ship was seen in the area at the same time. The rare meetings between Abe and Xi have been awkward, and there has been no word of the installation of a promised hotline to deal with accidental clashes. Last year China commissioned four new gas platforms close to the median line with Japan in the East China Sea and sent research vessels on 22 missions there, according to the Japanese foreign ministry.

Moves by the Abe government to loosen constraints on Japan’s military imposed after defeat in 1945 arouse concern in China, where Communist Party newspapers warn of a “nightmare scenario” if the constitutional restrictions on military activity are relaxed. Beijing accuses Tokyo of going “against the tides of history”. In Japan, a survey by the Pew Research Centre found that China was the second-biggest cause of fear among the population, after terrorism. Abe has bolstered security ties with Vietnam and signed a security pact with the Philippines, following this up with a joint naval exercise. In response to Tokyo’s move, the Chinese foreign minister, Wang Yi, mused to reporters: “I wonder what Japan has to do with the South China Sea.” Last month, Prime Minister Abe joined the US to accuse China of militarising the South China Sea.

Besides jostling with China for regional influence, both by expanding investment in south-east Asia and by trying to build bridges with South Korea to counter Beijing’s charm offensive there, Japan feels a very direct interest in freedom of navigation, given the volume of its trade and energy supplies that transit through the South China Sea. It is in talks to transfer anti-submarine reconnaissance aircraft and radar technology to the Philippines. The Japanese are not alone in their concerns. In February, worried about its shipping routes, Australia announced a big increase in planned military spending, especially on the navy. Canberra is now weighing whether to send a warship on a freedom-of-navigation exercise similar to that of the USS Lassen.

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The regional dynamics are at their most complex when one heads south. China claims much of the South China Sea using a map dating from 1947, which laid out historical claims in the form of a nine-dash line defining its area of sovereignty. This conflicts with claims by Vietnam, the Philippines, Malaysia, Indonesia, Brunei and Taiwan. Even more so than waters off the Senkaku/Diaoyu Islands, this sea is a vital shipping lane for $5trn in trade annually: one-third of global maritime traffic, carrying oil and raw materials to Asia and Asian consumer goods to the world. It also contains rich fishing grounds and potential energy and mineral reserves beneath the seabed.

China’s intervention has greatly increased the stakes in what had been a set of competing claims among south-east Asian nations. As Singapore’s prime minister, Lee Hsien Loong, put it in March in a Wall Street Journal interview about Chinese expansionism, “When you are the biggest participant in the game, and you do the same as other countries, the consequences are on a different scale.” China has long-standing claims to the Paracel, Spratly and Pratas Islands as well as the Macclesfield Bank and Scarborough Shoal off the Philippines. More recently, it has conducted a programme of building up reefs in the sea, up to 800 kilometres from the mainland, to turn them into small islands. Seven have been finished or are near completion. China claims the rights to territorial waters stretching out 19 kilometres from the “Great Wall of Sand”, built on previously uninhabited reefs and now staffed with Chinese military personnel.

Beijing, which began constructing “fishermen’s shelters” in the South China Sea in the 1990s, says its new bases are for humanitarian purposes, primarily to rescue those who get into trouble, but recent photographs show fighter aircraft deployed on the largest of the artificial islands in the Paracels, which are also claimed by Vietnam and Taiwan. Pentagon sources said evidence from satellite imaging in February showed Chinese HQ-9 surface-to-air missiles, with a range of 125 kilometres or more, on Woody Island in the Paracels; China has said it will not militarise the sea; and though it did not confirm the US report, which was backed up by Taipei, it said any country had the right to take defence measures on its territory. Beijing does not give out such information, but the defence department in Washington has estimated that the construction covers at least 800 hectares. Five of the sites, it said in a report on China’s military power, could be used for surveillance systems, harbours, an airfield and logistic support.

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China aims to establish “facts on the ground” or, in this case, at sea, projecting its regional power in a way that other nations may challenge but that they will not be able to turn back. This is in keeping with the higher profile in foreign affairs adopted by the Xi Jinping administration, which took over in Beijing in 2012-13. The time when China followed Deng Xiaoping’s advice to “hide your brilliance and bide your time” has passed. Xi, China’s most powerful hands-on leader since Mao Zedong, is pushing an agenda of centralised control and international expansion, undeterred by the slowing economy and multiple problems in the form of high debt, deflation, excess industrial capacity, the halting pace of much-needed structural reforms and an environment crisis.

A critical element of Xi’s “dream” is the projection of Chinese influence around the globe – or, as he put it in a speech in 2014, the need for China to pursue “great-power diplomacy with special Chinese characteristics”. This ranges through the grand scheme of the “One Belt, One Road” infrastructure programme through trade for south-east and central Asia and on to the underwriting of nuclear power stations in Britain. Beijing has launched the Asian Infrastructure Investment Bank as an alternative to the Asian Development Bank, winning wide backing (including from the UK) despite US opposition. China has become Vladimir Putin’s best source of support, with big, long-term contracts for Russian gas as well as finance for projects such as a 7,000-kilometre high-speed rail link from Moscow to Beijing.

Though China devotes a smaller proportion of GDP to its military budget than does the US (or the UK), modernisation of the 2.5 million-strong People’s Liberation Army (PLA) is a big part of Xi’s programme. In addition to sitting as general secretary of the Communist Party and state president, Xi chairs the Central Military Commission, which unveiled a streamlining of the PLA command structure this year and is fast developing China’s capabilities in submarines, missiles and cyber-warfare. This spring, he appeared in uniform as commander-in-chief of the armed forces.

In this calculus, the most immediate sphere for China’s power projection has been the one closest to its 14,500-kilometre coastline in the South and East China Seas. But the immediate effect has been to alarm other regional states, which are less than charmed by the thinking, expressed in 2010 by the then foreign minister, Yang Jiechi, that “China is a big country and other countries are small countries, and that’s just a fact”. This has led the smaller nations to seek shelter under the US strategic umbrella. Relations between the Philippines and China have become virtually frozen since a standoff in April-June 2012 that led to China seizing the Scarborough Shoal. Manila bolstered its small navy with purchases from the US and re-emphasised the defence treaty between the two countries, as well as submitting its suit to the UN tribunal.

The US defence secretary, Ashton Carter, has told his counterpart in Manila that Washington’s pledge to defend its ally is “ironclad”. Visiting Tokyo in June, President Benigno Aquino said he was reminded of how, in the late 1930s, “Germany was testing the waters and . . . nobody said stop.” A new defence pact in 2014 permitted deployment of US forces in the Philippines, and the Aquino administration has offered the US eight bases, two of them on an island near the South China Sea. In 2015 more than 100 US navy ships docked in the former US base at Subic Bay, and two nuclear-powered stealth submarines made visits in the first two weeks of this year.

The maritime quarrels spread to Indonesia at the end of March after eight Chinese fishermen were detained by a patrol vessel while trawling off the Natuna Islands, which lie across the southernmost section of the South China Sea claimed by China, over 2,500 kilometres from its southern coast. A Chinese coastguard vessel entered the area to recover the men’s ship. An Indonesian official in charge of maritime security said China’s action had created “a new ball game” that needed close attention from south-east Asian governments, and called Beijing’s claims to sovereignty in the area “fake”. The government in Jakarta then announced that it would deploy more troops to the islands, put in more patrol boats and strengthen its naval base there.

A US-Indonesia “action plan” envisages expanded military co-operation. Indonesia has protested against the way in which the “nine-dash line” appears to cover the Natuna Islands, and says it wants to hold regular naval exercises with the US near the archipelago in waters that the International Energy Agency says hold rich gas reserves. Indonesia and the US have also carried out joint maritime exercises involving surveillance and patrol aircraft.

At the same time, there was confusion about a reported incursion into Malaysian waters by 82 Chinese fishing boats; Malaysia’s national security minister appeared to confirm the reports, and said three ships from the Maritime Enforcement Agency had been sent to investigate. But then the defence minister, Hishammuddin Hussein, said there had been no trespass and “our waters are safe”. The People’s Republic of China has stepped up its investments in Malaysia over the past year and the government in Kuala Lumpur has been keen to maintain warm relations and ensure Chinese purchases of assets that it is selling off to reduce Malaysia’s debt burden.

Vietnam has reacted to China’s expansion by developing a dialogue with a former enemy: US naval ships pay frequent port calls. Carter and his Vietnamese counterpart, Phùng Quang Thanh, signed a “joint vision statement on defence relations” in June last year. The US is supplying Hanoi with coastguard patrol vessels. And Singapore signed an enhanced defence co-operation agreement with the US in December.

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As Xinhua News Agency warned that such developments could push the regional situation “to the brink of war”, the foreign ministry in Beijing questioned whether “military deployment and regional militarisation by the US [was] in line with the aspiration shared by countries in the region”. President Obama points to the region’s strategic importance, but some Chinese officials question what the US is doing there, given that it is not an Asian power. One answer is that, as Lee Kuan Yew of Singapore used to say, the region needs China economically but also needs the US strategically to maintain a balance.

The problem is that neither of the two leading powers has a properly thought-out policy towards the other. China and the US know they need a degree of co-operation but also want to hedge their bets to defend their own positions. There is a mutual lack of trust, complicated by the network of overlapping regional differences in a part of the world that lacks a strategic system to resolve disputes. The Obama administration’s declaration in 2011 of a “Pacific Pivot” to reorientate its foreign and strategic policy towards the Asia-Pacific naturally aroused China’s concern. As well as being hemmed in by the chain of islands running south from the Japan through Taiwan to the Philippines which hems in the Chinese navy, Beijing faces the prospect of the 12-nation Trans-Pacific Partnership (TPP), promoted by Washington to create a free-trade zone whose liberal economic rules would bar China. At least some regional leaders see the pact as essential to what Prime Minister Lee Hsien Loong calls “an overall substantive relationship” between the United States and Asia, because “without the interest in a broad range of mutual co-operation, America is just another country which has some claim or makes some assertion”.

Although the US “pivot” (since renamed a “rebalance”) has not been completely realised and the TPP deal is yet to be approved by national legislatures (among them the US Congress), the fear of containment – allied with the Xi administration’s desire to extend Chinese influence, including its alternative to the TPP – will prompt China to continue to press where it sees opportunities as it seeks to displace the US as the dominant power in east Asia. Washington’s policy towards the region has been hesitant but it seems to be adopting a tougher line. This was shown by the Lassen’s voyage and Obama’s meeting with leaders of the Asean grouping of nations in California in February to develop a cohesive response to China’s expansion in the South China Sea. The final statement from the consensus-seeking organisation of south-east Asian states was as cautious as usual, but it stated the importance of freedom of navigation, which Washington has made its central theme.

To date, the two big players and the associated states have managed to avoid hurtling into conflict, yet none has abandoned its position in the interests of a settlement. The ‘‘Thucydides Trap” may not be inevitable but it will continue to hang over a region of 14 countries that represents an area of critical importance for the prosperity and peace of the globe.

Jonathan Fenby is the author of “Will China Dominate the 21st Century?” (Polity Press) and “The Penguin History of Modern China”

This article first appeared in the 12 June 2016 issue of the New Statesman, The anti-Trump