Can An Economic War Transfom Into A Military War: Is WW III Brewing?

Can An Economic War Transform Into A Military War: Is WW III Brewing?

My introduction to economic warfare began in the early 1970s shortly after I launched my first business, a private non-profit economics consulting firm affiliated with UCSD where I taught economics. The CIA funded one of our early projects with the goal of simulating the likely outcomes of economic warfare between the world’s largest economies. Fast forward to today; a real trade war is actually hatching. How might it end?

Tariffs

Normally tariffs require the approval of congress, the independent branch of government that was created to check the power of the other two branches of government: the judicial and executive branches.

However, there are exceptions that allow the president to act quickly and forcefully to protect our national security and sovereignty. The president can bypass congress under the authority of several trade acts.  Two of Trump's signature personality traits preordained the course of events: 1) carrots don't work, big sticks do if you hit hard where it hurts; and 2) losers play by the rules and look to the past for guidance, winners make their own rules and sabotage anything that gets in the way.

Trump launched the biggest trade war in history against China and other countries triggering a series of retaliations, and threats of more to come. At the moment all participating economies are losing ground and the negative effects of tariffs are spilling over into non-participating countries. The reactions reflect defiance and anger. Heads of state are confused by Trump's departure from traditional diplomacy and withdrawal from international alliances.

Despite Trump's disregard for rules and norms, there are limits on the president’s ability to unilaterally
impose tariffs. For example, Trump must withdraw from NAFTA to impose tariffs in excess of 35% on Mexico (yesterday, Trump announced he would be terminating NAFTA and replacing it with a new agreement). Limits also constrain the tit-for-tat response of China to the escalating tariffs imposed by the US; tariffs can only be imposed on the value of goods a country imports. China imports $130 billion in goods from the U.S. while the US imports $500 billion from China. Trump has threatened to place tariffs on all Chinese imports. China cannot respond in kind once the $130 billion limits are exceeded.

 Weapons Of Economic War

But there are economic weapons beyond tariffs that can be even more effective, some have recently been deployed. Sanctions are potentially more damaging than tariffs. For example, Trump had initially threatened to severely sanction any country that buys oil from Iran. He has since backed off limiting oil exports from Iran to one million barrels a day.

Other countries could make it difficult or impossible for US companies to operate on their soil. China, for example, has nearly 300 "cybersecurity" standards recommended for digital technology used by companies. However, China can make burdensome standards mandatory for foreign firms. The standards could obstruct US  businesses operating inside the country forcing them to close or move elsewhere. In addition, many countries have tentative plans to shut down US businesses; Russia has considered, but so far rejected, shutting down MacDonald's along with other US companies. Likewise, China has a playbook mapping how to shut down Apple and other high tech companies with operations in their territory.

Last week Iran threatened to hit US and Israeli targets if either country "goes beyond economic sanctions" (the US has sanctioned Iranian cars, trade in gold, purchases of US dollars). Additional sanctions on banking and threats to punish any country buying oil from Iran are pending in November. Tensions with Iran dramatically escalated in May when Trump unilaterally withdrew from the Iran nuclear deal.

The US currently has a weapon not available to our adversaries: the US dollar is the "global currency". A global currency is accepted for trade throughout the world and is held by the world's central banks as foreign exchange reserves. 65% of all foreign exchange reserves are in US dollars. By comparison, the second most widely held global currency is the euro which accounts for 20% of foreign exchange reserves. The US dollar holds its supreme position because of the strength of its economy, the stability of its value, and 85% of foreign currency trading involves the US dollar. Fears of a currency war, in which the US has by far the most powerful weapons, has already disrupted international money markets (for example, India's rupee has declined 7% against the dollar based on the prospect of a currency war).

The primary currency war likely will be between the US and China with Russia intervening on behalf of China. Ten years ago, Russia and China began to pressure the International Monetary Fund (IMF) to establish a new international currency to replace the US dollar. That effort has not persuaded the US-controlled IMF to abandon the dollar but China and Russia have joined forces to create alternatives. In particular, Russia’s Deputy Foreign Minister, Sergei Ryabkov, just announced:

"With the US unveiling a new set of sanctions against Russia on Friday, Moscow said it would definitely respond to Washington’s latest sanctions and, in particular, it is accelerating efforts to abandon the American currency in trade transactions."

Even our European allies are beginning to protect themselves against the increasingly unpredictable financial and diplomatic behavior of the US. German Foreign Minister Heiko Maas proposed "a new international payments system independent of the dollar sphere, a new interbank transfer system, and a European Monetary Fund, to “protect European businesses from [American] sanctions. 

Can An Economic War Transform Into A Military War: Is WW III Brewing?

The US recently imposed new financial and arms sale sanctions on Russia in response to a nerve agent attack in Britain; Russia responded aggressively. Last week, Russia threatened to draw its own "red lines" if the US imposes harsh sanctions on Moscow for crossing our own "red lines" drawn by the White House and Congress. The Kremlin threatened to deploy tactical nukes in Syria and "other countries" if the US imposes additional harsh sanctions on Russia. A headline from the Express in the UK reads:
"World War 3 fears: Russia threaten NUCLEAR WEAPONS to Syria in response to US sanctions"

Missile Crisis 1962

In 1962 the Soviet Union and the US came frighteningly close to a nuclear war.
Nikita Krushchev had deployed 90 nuclear missiles in Cuba aimed at the US. President Kennedy enforced an embargo on further shipments of missiles and demanded that the Soviet Union remove all nuclear weapons be removed from Cuba. It first appeared that the strength of the US resolve caused Krushchev to retreat. However, it was not the stick the US wielded but the wise use of a carrot that prevented war; Kennedy had intelligence information that Krushchev was pressured by soviet hawks and needed to appease them. Kennedy made a secret deal to quickly and quietly remove US missiles from Turkey (he knew the Republicans in congress would not have approved his action).

There are important lessons learned from this incident. Good intelligence, from both domestic and through our allies, is essential to anticipate and prevent global disasters. A president must know how and when to use the carrot in place of the stick. And a wise president is an indispensable asset in troubled times.

Russian Ships in the Mediterranean Sea Yesterday

The current situation is dangerously close to the edge of military war. 1) China and Russia joined forces to defend against the aggressive US tariffs and sanctions. 2) Russia is placing nukes in Syria aimed at Europe and America stating, “We must respond to the emergence of components of the US missile defense systems near our borders.” 3) Today, NATO announced, “The Russian Navy has dispatched substantial naval forces to the Mediterranean, including several ships equipped with modern cruise missiles.” 4) Russia and China have agreed to join military forces to stage the biggest war games since the fall of the Soviet Union

To be more precise about the danger of escalating conflicts, I think there is a better than 10% chance that there will be a major international military conflict, perhaps not called a world war, in the next two years. I say that not because major powers will attack each other but because “small seeds grow big weeds:” Both WWI and WWII were seeded by a shuffling of alliances between countries. It is not the military blustering or tariff disputes that I see directly starting a war, it is the resulting shift in alliances.

WW1 officially started with the assassination of Archduke Franz Ferdinand and his wife Sophie of Austria by a Bosnian Serb, but the stage was set earlier. A realignment of alliances, one between Germany and Austria-Hungary and another between Russia and France ensured that France would stand with Russia in the event of a balkan war, and Germany would side with Austria-Hungary. Eventually, Germany invaded Belgium and Britain declared war on Germany. The rest is history.

WW2 officially started September 1, 1939 when Germany invaded Poland but the seeds were planted before that date when Germany, Czechoslovakia, Austria , and Rhineland bickered about territory and two major European powers, France and Britain, pressed for a stronger Germany hoping that would prevent the growth of communism. Alliances between countries began to shuffle and the rest is history.
So is a military war brewing? Yes, it is brewing, but let's not let it go from fermentation to maturity.