Opinion | Cold war 2.0 would exact a much higher economic price

In her address to the Stanford Institute for Economic Policy Research titled “Geopolitics and its impact on global trade and the dollar” on May 7, Gopinath observed that global economic ties are changing in ways not seen “since the end of the Cold War”.

This is obviously true. It is beginning to look as though the changes will lead not to a hot war but a new ice age where US- and China-aligned blocs coexist in an environment of slow growth and tension.

Interestingly (and rather depressingly), the International Monetary Fund sees global economic growth as likely to slow significantly over the coming three to five years compared to the past decade or so.

This rather gloomy scenario – sketched by officials during an IMF briefing in Tokyo I attended after Gopinath’s presentation – contrasts with the shorter term optimism in the IMF’s most recent World Economic Outlook over the resilience the global economy has shown since the Covid-19 pandemic.

A longer term slowdown would have causes beyond mounting geopolitical and geoeconomic tensions. Adverse demographics and declining productivity are among them but a fragmentation of the global economy and of trade and investment loom large.

Gopinath suggested that threats of economic fragmentation have yet to significantly affect growth but that is scant consolation given what is at stake from what is becoming undeclared economic warfare.

After years of shocks, including the pandemic, Russia-Ukraine war and ideological conflict centring upon (but not limited to) the United States, China and Russia, countries are re-evaluating their trading partners based on economic and national security concerns, she noted.

Foreign direct investment and trade flows are being redirected along geopolitical lines and some countries are re-evaluating their heavy reliance on the dollar in their international transactions and reserve holdings.

For China and China-leaning countries, IMF research shows the dollar’s share of trade finance payments has dropped since early 2022 while the yuan’s share has more than doubled to 8 per cent.

Likewise, the yuan’s share in the cross-border transactions of Chinese nonbank entities with foreign counterparts was close to zero 15 years ago but has risen to around half since late last year while the dollar’s share has fallen from around 80 per cent in 2010 to 50 per cent.

If these trends continue, the risk is that the world could “end up moving dramatically away from a global rules-based trading system”, said Gopinath.

New trade restrictions have more than tripled over the past five years while financial sanctions have expanded sharply, according to the IMF. The geopolitical risk index has spiked and private sector concerns about fragmentation have surged.

There are not yet overt signs of deglobalisation, at least at the aggregate level. Since the 2008 global financial crisis, the ratio of the world’s trade in goods to its gross domestic product has been stable at between 41 and 48 per cent but beneath the surface, there are increasing signs of fragmentation.

02:18

US Treasury chief Janet Yellen in China aiming to further stabilise bilateral trade ties

Notably, China’s share of US imports fell by 8 percentage points from 2017-2023 after trade tensions flared up while the US share of China’s exports dropped by about 4 percentage points. And direct trade between Russia and the West has collapsed.

Things could have been much worse given the degree of decoupling between geopolitical rivals but for the emergence of what the IMF calls “connector” countries – the re-routing of some trade and investment via these third countries is helping to offset the erosion of direct links between the US and China.

Since 2017, many countries that have seen a growing Chinese business presence have also seen their exports to the US increase. Notable among these “connector” countries are Mexico and Vietnam, whose role as go-betweens appears to have helped cushion the global impact of decoupling. But the IMF questions whether this can continue.

This economic fragmentation is not significantly different from the initial years of the Cold War. But fragmentation is much more costly this time around because unlike back then, when goods trade made up just 16 per cent of the global economy, it now takes up a much larger 45 per cent.

Back then, too, countries within blocs were generally removing trade restrictions “while right now, we seem to be much more in the environment of, just, many countries becoming protectionist and looking inwards”, Gopinath observed.

If we are indeed at the start of a new cold war, we would do well to recall that the last one endured for nearly half a century. “It’s really crucial to make sure that we preserve the big gains that have come from having this kind of economic integration,” said Gopinath. “We need to have enough guard rails to make sure that you’re not throwing the baby out with the bathwater.” National leaders need to listen.

Anthony Rowley is a veteran journalist specialising in Asian economic and financial affairs

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