By Eric Vandenbroeck and co-workers

How To Reduce The Vulnerabilities That Free Markets

The world has entered an era in which economic conflict can increasingly determine the fate of nations. While using financial tactics to gain geopolitical advantage extends back to ancient Greece, globalization has amplified the consequences of potential disruptions in trade and money flows, leaving the United States in unfamiliar territory. When the last great-power rivalry ended in the late 1980s, the value of world trade was about 37 percent of GDP globally. Today, as great-power tensions rise again, global trade is 57 percent of the world’s GDP. Perhaps even more important, U.S. economic integration with China was far greater than the Soviet Union during the Cold War. Before the fall of the Berlin Wall in 1989, U.S. imports from the Soviet Union were about $500 million, far less than one percent of total U.S. imports. Today imports from China are roughly $500 billion, representing 15 percent of all U.S. imports. As an example of this U.S.-Chinese integration, consider that Apple, the world’s largest company, relies on China for one-third of its production and nearly one-fifth of its sales. Such interdependence has created a paradox: the United States is once more economically vulnerable and more powerful than ever in its history.

Washington, however, is still getting ready for this period of leverage and vulnerability. The economic security powers of the United States reside largely in the U.S. Treasury and Commerce Departments, and the tools these agencies have can be potent. But the decision-making infrastructure that supports these tools is not adequate for a period of great-power tension, in some cases having been designed to target terrorists after 9/11. As a result, the United States has practical, tactical tools but often needs more information and coordination needed for sound decision-making. Ideally, major escalation and conflict can be avoided, but if not, Washington and its allies must ensure that free economies are better prepared to defend free people.

 

Tools Of The Trade

The United States has several broad powers that have not been designed explicitly for economic security but that can be used to advance its cause. For instance, trade policy cannot only open markets and advance free trade but also prevent certain countries from trading with the United States. Similarly, fiscal policy can be used to encourage the production of strategically essential goods in the United States, as the CHIPS Act, which President Joe Biden signed into law in August 2022, has done for U.S. semiconductors.

In addition to these broad authorities, the U.S. government has created tools to protect U.S. economic security. The tool with the most limited target set is the Committee on Foreign Investment in the United States. CFIUS is an interagency committee chaired by the Treasury Department that plays the important role of ensuring that U.S. companies with strategic technology cannot be purchased by foreigners who could use that technology against the United States. Yet CFIUS is, by definition, reactive: a foreigner needs to initiate a transaction to trigger its review. For this reason, CFIUS would not be useful in periods of high economic tension, as acquisitions would likely come to a halt anyway. To complement CFIUS, Washington is exploring whether to adopt rules governing outbound, as opposed to inbound, capital flows—for instance, a U.S. company funding strategically sensitive research and development in China. These rules could affect U.S. companies more generally, not just those acquired by a foreign entity, and could, therefore, significantly expand the monitoring of cross-border capital.

The Commerce Department manages export controls, another tool designed to protect the country’s economic security. Export controls allow the United States to supervise foreign access to sensitive components and technology proactively.  Although export controls can be applied broadly, their use has often been targeted in practice. For example, when the Biden administration restricted semiconductor exports to China, the White House focused largely on the most valuable technology to the Chinese military.

Finally, there are sanctions, which have historically done the heaviest lifting of all these economic measures. They can be used to freeze the U.S. assets of, and prohibit U.S. entities from transacting with, a sanctioned entity. Sanctions can therefore restrict their targets from much of the world’s trade and financial system. The U.S. government developed the institutional infrastructure to implement sanctions after 9/11. At that time, the Treasury Department established the Terrorism and Financial Intelligence Division to go after money-financing terrorists. This division has evolved admirably over time to adapt to broader needs, and today it targets not only terrorists and drug lords but also countries. Yet when sanctions have targeted whole economies, as has been the case with Iran, North Korea, Venezuela, and Russia, they have been relatively small, driven mainly by one industry: oil. TFI is skilled at deploying its tools of economic coercion, but it does not have the necessary infrastructure or personnel to navigate a potential great-power economic conflict. It mainly comprises dedicated public servants with expertise in financial crime, intelligence, and the tracking of illegal funds. Still, it is not a team built to analyze the complex economic and financial links that would be implicated in a great-power clash.

 

Economic Wargaming

A fundamental problem for U.S. economic security is that no agency or group is charged with the regular and systematic assessment of the United States’ vulnerabilities. The National Security Council can pull together departments such as Commerce, Defense, and Treasury to assess specific areas of concern, such as semiconductors. Similarly, a team in the White House is focused on international economics. Still, it is a small group responsible for coordinating the frenetic pace of day-to-day policymaking across the government and planning events such as the G-7 and G-20 summits. This team cannot routinely assess economic vulnerabilities or examine long-term financial security questions. No group has a standing responsibility to examine, for instance, how the U.S. economy would be disrupted if tensions with China escalated sharply.

Similarly, no U.S. government agency is explicitly mandated with assessing how offensive economic actions would play out should the United States employ them. When the United States and its allies sanctioned Russia in response to its invasion of Ukraine in February 2022, there was little Russia could do to respond commensurately. If Washington were to take similar actions against China, Beijing would likely respond, and the reaction from other countries would be varied and complex. Yet Washington does not have a team that prepares for economic conflict like military planners game out war plans and scenarios.

U.S. policymakers must think several steps ahead, developing intuition and understanding of how the international economic chessboard could evolve where tensions escalate between China and the United States. Would China sell its U.S. debt and equity market exposure if the United States sanctions Beijing? How would markets react? Which parts of the U.S. industrial supply chain could be under severe pressure? On which allies would the United States become more economically dependent? And what if countries such as Brazil or India do not cooperate with the United States? What would that do to both the U.S. economy and the Chinese economy? Although these questions are not new, the answers keep changing and must be routinely analyzed. Despite the need for this kind of information, neither the treasury secretary nor the commerce secretary has a dedicated team that can provide it. Meanwhile, in the traditional national security sphere, government agencies constantly plan and prepare for risks in their domains.

Part of the problem is that bureaucracies naturally operate in silos. Expertise at the intersection of economics and national security is primarily split between the State Department, which has a division devoted to economic affairs; the Commerce Department, which handles export controls; the U.S. Trade Representative, which focuses on trade; and the Treasury Department, which chairs CFIUS, designs and manages sanctions, and has expertise on domestic and international capital markets. The Treasury Department has expertise split into three main policy divisions: domestic finance, international finance, and TFI. But strategic questions cut across these silos. Sanctioning China would certainly affect domestic capital markets and global supply chains. Still, the sanctions lawyers and money laundering experts in the TFI division need a deeper background in markets or economics, which resides instead in other parts of the department. Therefore, it falls to the few political appointees who have a view across silos, such as the secretary and deputy secretary, to stitch together the complicated potential consequences of sanctions. Such an arrangement is far from ideal. These officials should have the benefit of well-developed thinking from their teams. Plus, their appointments are temporary, while the need for continued expertise survives any administration.

 

Not Enough Imagination

Perhaps the most critical consequence of Washington’s lack of economic security infrastructure is that strategic thinking remains underdeveloped. The United States is used to imagining conflict from a military perspective, in which the country has held a dominant position for the last several decades; its military spending is as much as the following nine countries combined. But the U.S. economy is roughly the same size as Europe’s and, in Asia, the same size as China’s and Japan’s. This means that Washington must think differently about its ability to project economic power than it does about its ability to project military power. Bringing allies along is more essential in creating effective economic pressure than adequate military pressure, as Washington is now discovering with both Russian oil sanctions, for which India’s support would be instrumental, and Chinese semiconductor controls, for which cooperation from Japan, and the Netherlands is critical. If tensions with China escalate, Washington needs to be ready for even close allies to see the world through a slightly different lens. For example, Europe and Japan each export over two times more to China as a percent of their GDP than the United States. U.S. leaders need a clear view of their partners’ economic interests to plan accordingly and consider what it would require to build a moral consensus among free nations in the face of Chinese financial pressure.

Similarly, the thinking in Washington lacks depth about a basic trade paradox: trade can make war less likely because of the interdependencies it creates, but it also increases vulnerability if hostilities erupt. A group within the U.S. government should be charged with rigorously evaluating these strategic tradeoffs. In some sectors, such as raw materials, it could be in the United States’ interest to export goods and create leverage over rivals, or in other sectors that require advanced technological know-how, exporting technology could undermine U.S. national security. The export control regime focuses on items that need protection, but the government does not give enough attention to exports that could provide leverage in great-power competition. Trade is neither all good nor all bad from a national security perspective, and properly understanding its strategic implications is essential for the world’s largest economy.

The government also lacks resources dedicated to supporting strategic thinking on the role of the U.S. dollar in the global economy. The dollar’s position as the world’s principal reserve currency confers numerous benefits on the United States and its allies, and the viability of the dollar’s dominant position over time will be set primarily by the market based on the relative strength of the United States economy and its institutions. Nevertheless, for the first time in modern history, global economic power has made it a clear objective to erode the dollar’s standing. The Chinese government’s 2016 and 2021 five-year plans explicitly mention the renminbi's internationalization as a goal. Several Chinese officials have reiterated this point, including Li Ruogo, the president of China’s Import-Export Bank, who said, “Only by eliminating the [dollar’s] monopolistic position [will] it be possible to reform the international monetary system.”

The United States must therefore think seriously about how China might try to unseat the dollar. This includes questions such as the role of central bank digital currencies, which China is launching, and China’s efforts to build an alternative to SWIFT. This secure messaging platform connects banks worldwide to price commodities in non-dollar currencies. Other than the Treasury Department’s technical work to monitor exchange-rate manipulation, however, questions about the dollar are generally taken up by ad hoc task forces that deal with particular issues and are not the focus of continuous planning. For instance, the department occasionally convenes the President’s Working Group on Financial Markets to study digital currencies. This team produces valuable reports, but it does not meet regularly or have a dedicated staff, and it considers digital currency primarily from a regulatory perspective without considering China’s broader efforts to undermine the dollar’s international primacy.

 

People Power

The Treasury Department, the Commerce Department, and the White House must adapt to better manage U.S. economic security. The Treasury and Commerce Departments should set up offices focusing on long-term economic security issues. These offices should conduct and maintain what might be termed a financial leverage and vulnerability assessment to understand better the economic levers the United States possesses and the vulnerabilities that could be exploited if geopolitical tensions escalate. The Treasury Department would focus on markets and financial flows, and the Commerce Department on industrial production and supply chains. These new offices should also establish private-sector working groups, following the model of public-private coordination adopted for cybersecurity. As with cybersecurity, U.S. businesses will have to build much of the required resilience. By working with the private sector, including running tabletop simulations as is also done with cybersecurity, the government can identify economy-wide vulnerabilities and alert companies to geopolitical risks. A political appointee, not a civil servant, should head each office, but a permanent professional staff should be maintained across administrations, providing continuity of expertise and experience. The political appointee should report directly to each secretary, allowing the office to operate across departmental silos to develop a holistic view of U.S. economic security.

The White House should also continue expanding its international economic team to include a group focused on long-term financial security planning. This group would coordinate with the new offices at the Treasury and Commerce Departments and other agencies to understand the choices and tradeoffs the United States will face if it employs its economic leverage, how to guard this leverage over time, and how to coordinate with allies. An expanded White House team would ensure the National Security Council regularly considers these issues.

The goal of these changes should not be to threaten other countries or undermine dynamic markets, which are foundational to American strength. Instead, it should be to prepare the United States, and its allies, for a period of increased geopolitical tension. By developing a deeper understanding of its economic security posture, the United States can reduce the risk of surprises and ensure that if it acts, it will have a well-developed sense of the likely economic ripple effects. Further, focused planning for how free markets might be used against free countries will allow the United States and its allies to prevent economic disruption better. As in traditional national security, having a strategy is a far better deterrent than not being prepared.

 

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