The Day After Iran - China
The tipping point is the magic moment when an idea, trend, or social behavior crosses a threshold, tips, and spread like wildfire – Malcolm Gladwell
Prior to 1979, Iran had a strong secular society with deep roots and traditions dating back to the Persian Empire. Based on what I’ve read about expats and people still living under the current theocracy, most would gladly return to the past governmental structure. If the behavior of citizens over the past six months is to be believed, the people are ready to return to a secular society.
I expect that the current bombing campaign focused on erasing the current Iranian power structure – both cleric and IRGC – will succeed and will be replaced by a new secular head of state. Lastly, I expect the Iranian people to thrive under the new arrangement, unleashing tremendous untapped economic power.
So far, it sounds like a winning situation for the world and it is, for the most part but not for China and certainly not Xi Jinping.
Power is not a means; it is an end. One does not establish a dictatorship in order to safeguard a revolution; one makes the revolution in order to establish the dictatorship – George Orwell
Once again, I’m picking on Xi because like Khamenei, he’s made a terrible mess of things such that his people hate him. Xi is the architect of the Belt & Road Initiative (BRI) where China spent $1.3 trillion to stitch together a bunch of poorly governed, largely inhospitable regions with rail, air, and shipping investments. It was ostensibly designed to limit the reach of the ubiquitous US Navy and Air Force.
The BRI started in 2013 and I’ve always contended that it was a function of the tidal wave of money that hit China following the monetary expansion of Western banking systems in 2009. China had no idea how to invest this money so they built empty cities, redundant industrial capacity, and redundant infrastructure. Think of it like the behavior of blue-collar lad who wins a lottery and is bankrupt ten years later.
Iran was a critical cog in the BRI along with Pakistan giving China significant influence in Southwestern Asia and a presence in the Persian Gulf. Furthermore, when Iran was removed from the SWIFT system, or global interbank financial system, in 2018 China has been able to purchase 20% of its oil at a discount and in yuan.
To spend those yuan, Iran purchased manufactured Chinese consumer goods, hired Chinese firms to build infrastructure projects, and purchased Chinese military equipment. Iran has been the perfect captive customer for China. For all intents and purposes, Iran has been a Chinese colony since 2018.
It’s been reported that Chinese strategists didn’t think the US would ever hit Iran, believing the US to be both soft and hesitant in an election year. Furthermore, Chinese leadership had misguided confidence in Chinese made radar and missile defense equipment, billed as being able to detect and counter the vaunted F-22, F-35, and B-2 stealth fighters and bombers. Boy they were wrong.
It has been further reported that Xi needed medical attention when he learned the fate of Khamenei. It should be noted that Xi is under extreme pressure following his removal/assassination of his two highest ranking generals Zhang Youxia and Liu Zhengli – see this previous piece for more on this https://geovestadvisors.com/gone-too-far/
Xi Jinping owns the BRI – it’s his signature geopolitical strategy. Furthermore, Xi positioned the Chinese military as a counter-weight to the US military a couple of decades before being ready. Jiang Zemin and Hu Jintao were smart enough to maintain the façade of friendship with the West while quietly building China’s strength. Xi alerted the world to the CCP’s intentions and destroyed the careful image of partnership painstakingly constructed since Deng.
China is shaken by US and Israeli military success which is why their condemnation of US actions has been exceedingly mild. Due to his ineptitude, I don’t expect Xi to maintain power through the summer. Furthermore, I expect the reformists among the CCP such as Hu Jintao and Wen Jiabao to win the current power struggle in the CCP.
Military Prowess
The hasty stroke goes oft astray – JRR Tolkien
China boasted that its JY27A radar system could detect US stealth aircraft yet it failed in Venezuela and Iran. Early reports suggest that US electronic warfare planes used artificial intelligence to rapidly read the radar frequencies and immediately jam those frequencies, giving US and Israeli planes and missiles the opening to take out Iranian surface-to-air missile systems. China’s vaunted HQ-9B missile defense system failed to shoot down a single plane or missile even as they were destroyed on the ground.
As an aside, the US and Israel have massive competitive advantages versus similar Russian and Chinese electronic warfare systems due to advantages in jet engine technology. AI and advanced radar require extreme amounts of electricity to function and Russian/Chinese jet engines are more than a decade back in terms of energy produced by these engines. Russian and Chinese attack aircraft are unable to maintain speed while concurrently directing electricity to AI and radar. The advantage allows US planes to attack Russian/Chinese planes long before being spotted by the enemy in addition to the aforementioned electronic warfare capabilities.
These are just a few of the advantages on display and it’s why the US military is an order of magnitude beyond the capabilities of China and its proxies. The US cracked Venezuelan and Iranian air defense systems with relative ease. The Chinese military has been watching and now know they would be punching well-above their weight class in a confrontation with US forces. Taiwan may as well be 1,000 miles off the Chinese mainland instead of 100 miles.
Iran’s one area of military competence is in its missile arsenal. While lacking Western targeting capabilities, Iran’s missiles are both plentiful and lethal. But without control of the skies, they have a classic counter-battery problem where the moment they light-off a missile, US and Israeli radar can pinpoint the location of mobile launch platforms – or stationary launch tubes. This allows allied forces to immediately target launch platforms. The result is that Iran is rapidly running out of these assets.
The Iranian Air Force and Navy are virtually destroyed. The navy lost its drone aircraft carrier in the first 15 minutes of the conflict as well as most of their fleet of frigates. The only impactful ships left are two Soleimani-class catamaran corvettes that are both fast and lethal with two of the class already sunk.
Once the Iranian missile inventory has been depleted or rendered unusable, the US and Israeli air assets will be able to isolate surface combatants by destroying communication and transportation assets. This should be enough to allow secular forces to push for new management.
Impact
A friend to all is a friend to none – Aristotle
China has already lost its influence in the Persian Gulf because they are powerless to impact current military operations. Furthermore, they have lost significant influence with Pakistan which has been cooperating with the US more than in past years. It seems that China’s allies are always open to a higher bidder.
Nobody is going to want China’s military equipment after the results in Pakistan, Venezuela, and Iran. Furthermore, China can no longer purchase Iran’s illicit oil in yuan. This means that China is going to have to pay full market price for its oil and will need to pay for the oil in dollars.
I expect the last part of the last sentence to be significant. For the past eight years, China hasn’t needed to part with its declining stash of US dollars. This is going to put upward pressure on the US dollar because it represents a roughly $90 billion shift in annual trade in yuan to dollars even as exports to the US continue to decline.
Chinese claims to have $3.3 trillion in foreign currency reserves but it won’t divulge the mix of reserve currencies it holds. On October 1, 2016, the IMF named the yuan a reserve currency, joining the dollar, euro, yen, and British pound. This means that China can hold yuan in its reserve account. This is significant because US imports of Chinese goods has fallen to levels from 2006. This tells us that China is no longer generating the same number of dollars in trade as 10 years ago.
It's common practice to look at China’s trade surplus and surmise that it includes large inflows of US dollars but I don’t believe it to be the case. Consider their huge increase in trade with Russia where they send parts that can be turned into military goods along with cars, trucks, and other things formerly supplied by the West in return for commodities such as oil and gas. In this case, they are not receiving dollars despite the sharp increase in trade.
China has replaced US exports with exports to 3rd world nations along the Belt and Road where China supplies significant amounts of trade financing to these nations. It’s little more than circular financing.
China has reportedly spent $1.3 trillion on its Belt & Road initiative. At first, much of the money was considered grants but switched to loans after China’s finances tightened. Most of that money will never be paid back and should be considered worthless. When this becomes obvious, the world will realize that China has an enormous hole in its national balance sheet.
Conclusion
All treaties between great states cease to be binding when they come in conflict with the struggle for existence – Otto von Bismark
I believe the loss of Iran will prove to be a fatal blow to Chinese confidence and its global aspirations. Furthermore, I believe this loss will accelerate the downfall of Xi Jinping, to be replaced by reformists in the CCP.
It should be clear by now that China’s military industrial complex produces crap. If you have followed closely over the years, you would know that their navy is crap, their air force is crap, and their army is both divided and lacks the logistics to project power.
They have no chance of taking Taiwan by force – that was the main issue between Xi Jinping and Zhang Youxia. Zhang and Liu were battle-tested and competent; both knew successful invasion of Taiwan is impossible. Now the CCP knows that their air defenses are effectively Swiss cheese which means they themselves are the more vulnerable party.
After being embarrassed in the Philippines, Pakistan, Venezuela, and now Iran, China is the emperor with no clothes. Be patient but watch the currency markets because that’s where I believe they will ultimately run out of dollars and produce a tidal wave of losses through the Eurodollar markets.
If you’re interested in learning more, visit us at https://geovestadvisors.com/ and contact Paul Hurley.
Philip M. Byrne, CFA