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Nathan Hunt:  This is the Essential Podcast from S&P Global. My name is Nathan Hunt. We are in a unique and, in some ways, uniquely grim geopolitical moment. Russia's invasion of Ukraine has happened perhaps not coincidently at a moment of historically bad relations between the U.S. and China. Most people might assume that a new financial cold war has already erupted between these 2 economic powers. But wars, even cold wars fought with financial weapons, are destructive and wasteful.

My guest today is James A. Fok, author of the new book, Financial Cold War: A View of Sino-U.S. Relations from the Financial Markets and a veteran financial and strategic adviser to corporations and governments. He has written the rare book that does not pick a side but instead seeks to defuse tensions through mutual understanding. One can only hope that this is a book that finds a wide audience in both Washington and Beijing. James, welcome to the podcast.

James A. Fok:  Thank you very much, Nathan.

Nathan Hunt:  James, I was initially surprised by the amount of the book that was dedicated to describing the development of financial markets in both the U.S. and China. Why did you feel it was so important to explain the origins and basic assumptions of each system?

James A. Fok:  I came on quite a long journey myself. I started my career as an investment banker in Europe back in the late '90s, early 2000s. And I found myself 10 years ago working at the Hong Kong Exchange. We started, in the end of 2012, working on what became the Shanghai-Hong Kong Stock Connect program.

And in 2013, at some point, I found myself in heated discussion with my opposite number at the Shanghai Stock Exchange, a gentleman by the name of Fu Hao. And I was getting quite frustrated in that I was pushing for a point of implementation, which followed international market practice. And he was pushing for something quite different.

And I was growing frustrated because I thought that he just simply didn't understand. And at one point, Fu Hao turned to me and said, "Why do you want to do it your way?" And I said, "Look, this is international market practice." And he looked at me and he said, "But why?" And it suddenly dawned on me that it wasn't that he didn't understand what the international market practice was or wasn't aware of it.

He just looked at it, and he did not agree with it. And to my shame, frankly, I couldn't explain why it was the way it was. It just was that way. And I certainly wasn't in a position to articulate clearly why the Chinese position was the way it was. And it made clear to me that I needed to deepen my level of understanding very significantly if we were going to continue to work together.

Over the years since, I had the opportunity to spend a lot of time with a lot of senior policymakers, decision makers and senior regulators. And I've often been struck by how little awareness some key decision makers have of some very fundamental bases of the financial system and the interaction between China and the U.S.

And so when I went about writing this book, I thought that if you're ever going to resolve conflict, you have to be able to put yourself in the shoes of the other side in order to understand both their desires and the constraints within which they operate. And so that's the reason why so much of the book is dedicated to the background to give people a really firm and grounded understanding of where both the Americans and the Chinese are coming from.

Nathan Hunt:   James, as someone who lives in the United States, I'm much more familiar with the rhetoric around American grievances leveled against China. But to simplify -- and these grievances are fairly simplistic to begin with. But to simplify, the accusation is that the Chinese steal American jobs by manipulating their currency. But you introduced to me at least a much subtler argument about the advantages and liabilities of being a reserve currency. What are these distorting effects of being a global reserve currency for the United States?

James A. Fok:  Well, quite simply put, the U.S. dollar is a global utility. It is the utility unit through which international trade and investment is transacted. And in order to serve in that role, the U.S. is required to constantly expand the supply of U.S. dollars to meet the growing needs of international trade and investment as that expands.

When the system relied on gold as the standard, this is back in the 1920s and 1930s, what we found was that because the expansion of the supply of gold just simply wasn't able to keep up with the growth in global trade and investment, there was a big liquidity crunch, which was a big driver for the Great Depression and one of the big reasons why the Great Depression was as deep as it was and lasted as long as it did.

So the U.S. currency is extremely important and it's extremely important that it continues to expand in order to serve the growing needs of international trade and investments. What that requires the U.S. to do is effectively to run a balance of payments deficit. And that is absolutely fine while the U.S. economy is growing at least as fast as the rest of the world. But for a very long time now, the U.S. has been a very large and mature economy, and other countries have been growing much faster.

And so in order to continue serving in that role, the U.S. has had to go into higher and higher levels of debt relative to its GDP. And that has created a fundamental fragility at the center of the U.S. financial system. And because of its central role in the international system, it's created fundamental fragility at the center of the international financial system.

How this has fallen on you depends really where you sit. Everyone understands very well this argument about exorbitant privilege at the expense of other countries. And we've seen certainly a lot of emerging markets, governments or companies that have been forced to borrow in dollars have found themselves in hot water when their currencies have fallen relative to the dollar.

It's precipitated difficulties in repayment. It's precipitated job losses and a huge amount of economic misery in the afflicted countries. But what's less looked at is the cost to the U.S. itself. And the costs really depend on where you sit in U.S. society.

If you happen to be the fortunate shareholder of a large U.S. corporation that's been able to take advantage of this overvaluation of the dollar, the dollar is overvalued because of the huge amount of international demand for dollars, if you've been able to take advantage of this, then you have been able to lower your costs. You've managed to outsource your production, and you've been able to increase your profit margins. And you've seen your share price increase in leaps and bounds.

But if, on the other hand, over the last 40 years, you've been a U.S. manufacturing worker, the experience that you've had is quite different. Your experience has been one of job loss, displacement, at best, wage stagnation. When you talk about currency manipulation by China, there's certainly a degree of truth in that for a decade between 1995 and 2005, China fixed its currency to the U.S. dollar.

And even after that, it managed the level of its currency relative to the U.S. dollar. From the Chinese perspective, that's really been an attempt not so much at mercantilism but to avoid the pitfalls of huge currency volatility, which befell many other Asian countries during the Asian financial crisis. For the U.S., though, China could not have done this without some degree of complicity.

And the complicity in the U.S. has really been at the top levels of U.S. society who've actually benefited massively from this because they happened to be the owners of these large U.S. corporations that have benefited from outsourcing their production to China and other low-cost centers. And so I would say that while there's truth in the argument about currency manipulation, this is only half of the story. There could not have been currency manipulation without some degree of complicity by the U.S. itself.

Nathan Hunt:  James, when we talk about some degree of truth, there is also some degree of truth to the Chinese accusation that the United States manipulates the institutions of the global capitalist system to American advantage. But it also seems clear to me from reading your book that there are some domestic policies in China that are also creating limits on China taking a more active role in the global economy. What are those?

James A. Fok:  China over the last 40 years has seen massive growth in its economy, and this economic miracle was made possible by several things. One was the fact that it had a massive demographic dividend. Like a lot of countries, they had a baby boom, which happened to come into its working life at the outset of Deng Xiaoping's beginning of reforming and opening up in the late 1970s.

Added to that, what were 2 additional factors, 1 being that a lot of people have been politically marginalized during the cultural revolution began to roll back into the cities from the country side in the 1980s and rejoined the workforce. And in the meantime, a 1-child policy that was instituted in the late 1970s massively reduced the number of dependents per head of working age population that China had.

So this resulted in a -- first, a big labor force, but also created the opportunity for Chinese workers to accumulate a lot of savings. And China, through various policies both to suppress consumption and direct those savings towards China's priority infrastructure and other development goals through the government's control over the state-owned banking sector, really enabled that economic miracle to occur.

And unlike a lot of other emerging markets, countries, the government, at least through the 1980s, largely issued the heavy use of foreign debt. And so when the Asian financial crisis came back, actually, China was largely immune to the fallout from that because unlike Thailand, Korea, et cetera, it hadn't accumulated large amounts of foreign currency or U.S. dollar debt.

So the Chinese economic model fundamentally has been, for the last 40 years, a top-down investment-led one. And while that was very successful in the outset of China's path towards economic development and growth, it is a policy which I believe now has run to the end of its useful life quite simply because the Chinese economy is now so large and so complex, it really defies the ability of state planners to really allocate capital in any efficient way. And the continuation of this top-down investment-led model runs the risk now of ever greater capital misallocation as China goes on.

Nathan Hunt:  I think it's important to note that your book is much more analytical than polemical, which is unusual with this topic area. To borrow a phrase, you don't seem to have a dog in this fight. What are you hoping to accomplish in presenting a more even-handed perspective?

James A. Fok:   I'm not sure that it's correct to say that I don't have a dog in this fight. I'm from Hong Kong, and my family is all here. And Hong Kong really sits betwixt China and the Western world. For most of our history since the mid-1800s, we've served as an entrepôt between China and other international markets.

And Hong Kong's prosperity and long-term survival, I believe, depends very significantly on some degree of continued interaction, and frankly, harmonious coexistence between China and the United States. And even if you look at my family, I'm mixed Chinese-British. My wife's American. Our kids are growing up with Chinese nationality and American nationality.

Actually, this is something that is deeply personal to me and my family. I certainly have a very vested interest in seeing China and the U.S. continued peaceful coexistence. But also, my Chinese grandfather used to say one thing of Eurasians, which is that Eurasians have 2 brains. And that's not to say that Eurasians are any smarter than anyone else.

But by growing up with 2 cultures, 2 different languages and 2 different ways of thinking, it's just entirely instinctive to be able to put yourself in the position of 2 vastly different frames of thinking, 2 vastly different cultures. And I felt that I was in a position to understand where each side were coming from, what the biases -- very deeply embedded unconscious biases that existed on both sides and be able to try and convey that in a way that was both absorbable to different people reading it and hopefully conveyed in a way that's engaging and helps bring back the empathy, which I think is key to resolving current tensions.

Nathan Hunt:   James, I want to return to the story you started with. Having done the research for this book, having done the work of your life, when you think about Chinese markets today versus Western markets, do you consider the differences in Chinese markets to represent an aberration that must be corrected for China to move forward? Or are these differences merely reflections of a different, although equally valid, system?

James A. Fok:  I think that the policies that both sides have pursued exist along a spectrum. I think that the extremes of communism are an aberration just simply because removing economic incentives is clearly not a successful way of running any economic system, and that was proved very clearly during the 20th century.

But at the same time, I think extremes of laissez-faire capitalism ultimately is not a great path either simply because although capitalism is extremely efficient as an allocative system, it doesn't actually allocate capital based purely on merit. Resources in society in a capitalist system are ultimately allocated based on the ability to pay.

And when you combine that fact with the fact that over time, capitalist systems have an accumulative tendency, you can see very easily that over a period of time, unchecked capitalism will allow significant wealth concentrations to build up. And you've seen throughout the course of history that, that has tended to lead to bad outcomes, even for the very wealthy at the top of the pile, think back to the French revolution.

And so in that sense, I don't think that either country at the moment is pursuing either extreme. Both of them are existing along a spectrum of capitalism with some level of socialist redistribution mechanisms. They just happen to be at different ends of that.

And I think in many ways, if you look at what's happening in the U.S. today with the wealth and income concentration that exists or has built up in recent decades, I think that there is certainly a need for the U.S. to reflect on its own economic policies and how it might more evenly distribute the fruits of economic growth. For China, I think there's one additional problem, which is the issue of property right protections.

China's economic growth today is largely powered by the private sector. And although the Chinese government's moves to curtail monopoly practices by some of the large Chinese Internet platforms are very commendable, the lack of due process that it follows in pursuing those admirable objectives can serve as a disincentive to private entrepreneurs and private investment.

And so I think that China needs to be very careful in the way that it goes about that. And both countries, I think, are facing a real challenge of elite capture of the organs of state. In the U.S., this is manifested in electoral campaign funding and in the revolving door that exists between public office and private business, where I think there are significant perverse incentives which are resulting in unfair outcomes for the wider U.S. society. And in China, the lack of checks and balances on the power of the state similarly has created significant tensions within Chinese society that, I think at the moment, it's struggling to resolve.

Nathan Hunt:   James, there are a few points in your analysis of the development of markets in China where you seem to be offering subtle commentary on how past mistakes of the Chinese leadership might hold lessons for present policy. My question is, do you feel like there is an audience within the party for respectful suggestions? Or is the leadership mostly aligned around the current, I suppose what people have called, more hard-line approaches?

James A. Fok:  My own experience has been that some of the fiercest debates that I've had about policy have taken place in China. I think there are certainly drawbacks with the Chinese system. But equally, the Western narrative about this complete authoritarian system within China, I think, is somewhat wide of the mark in that I think that policy debate and constructive criticism are very welcomed.

Although the constructive criticism is not given in a very wide public forum, there are the chat boards and social media in China where a lot of that takes place. But any real serious criticism and debate about the system tends to take place behind closed doors.

And I think there are drawbacks to that certainly. But also, given the sensitivity of some of the topics and frankly a very wide divergence of opinion across Chinese society and the legacy of significant violent and other struggles within society, within relatively recent memory, it's not necessarily a bad thing that some of that debate does take place in a more closed forum.

Nathan Hunt:  To simplify the much more subtle argument you make in the book, you are not a believer in the necessity or inevitability of a financial cold war between the U.S. and China. Why is that?

James A. Fok:   Well, I think a financial cold war has been going on for a very long time. My definition of financial cold war is actually the invisible conflict that's already been taken place through the structure of the international financial system and national financial policies, which have resulted in significant imbalances.

I don't think that a financial hot war, i.e., sanctions, tariffs and other harder measures, is in the interest of either country. To illustrate this, I'll give one example. China has around about $35 trillion right now sitting in bank deposits. This is the second largest store of Chinese household wealth.

If you look at China's rapidly aging demographic, it's very clear that unless some of that money moves into capital markets to generate a yield and return, the government's going to face a very heavy social welfare burden for these people when they come into retirement. And those people's lifestyles in retirement will not necessarily keep up with the standards to which they've become accustomed.

China's market is large, but they're not large enough to absorb that amount of capital in any short space of time. The respective equity and debt markets are around about $12 trillion and $15 trillion, respectively. So if that money flows into Chinese markets alone in a short space of time, it's going to precipitate huge asset price bubbles.

It is clearly in China's interest to get that money out into international capital markets. And it would be in the West's interest to receive it. Think about the infrastructure investment, the research and development and other good things that could result from that tidal wave of Chinese money hitting the international capital markets.

The problem that exists right now is that for Chinese investors investing outside of Mainland China beyond Hong Kong, they're entirely dependent on a Western-controlled international financial infrastructure of custodians, depositories and payment networks. And the Chinese policymakers have looked at the means of effecting Western financial sanctions on Russia in the wake of 2014. And they've just simply said, "We cannot possibly put ourselves at this financial security risk."

And so while it's in the interest of both sides to have the money come out and have the money come out as portfolio flows rather than foreign direct investment, which is the main channel for Chinese investment outside today, which has significant potential tensions associated with it because Chinese companies and particularly SOEs going out and buying whole companies and assets in other countries inevitably leads to questions and sensitivities over foreign influence, foreign government influence, technology transfer and jobs transfer, whereas 1,000 Mrs. Wangs from Chongqing buying a few shares in Apple or Google are not going to lead to the same sorts of sensitivities.

And so I think it's in the interest of both sides to find some neutral way of getting that money into the international financial system. And in order to do that, I think that both sides need to operate via some sort of system that enforces mutual trust. And that way of enforcing mutual trust, I think, is by removing the possibility for either side to weaponize the financial system against each other.

Nathan Hunt:  What are the dangers for both countries if they continue on their current paths? Are we looking at a scenario where, to quote Larry Fink of BlackRock, we are confronting the end of globalization?

James A. Fok:  I think that it's impossible to tell what the trajectory is based on history. I think we can conjecture that the likelihood of continued financial conflict and the continued tensions could well lead to quite disastrous outcomes. Deglobalization would be a disaster for everybody around the world because quite simply, it will reduce prosperity in both China and America and around -- the whole of the world. And I believe that, that is only likely to exacerbate many of the social tensions that we already are seeing.

Nathan Hunt:   How do we pull back from financial cold war? Are there solutions? And if so, is there the will to pull back?

James A. Fok:   Quite simply put, the way of resolving the financial cold war is to find a way of making sure that the fruits of economic prosperity and growth are better distributed. I'm not talking about equality of outcomes, but I'm talking about a greater degree of equality of opportunity and less extreme concentrations in the distribution of wealth and other resources.

And in order to do that, I think that there are a number of tried and tested paths that those include using tax policy to better redistribute. It includes using competition policy and antitrust enforcement to lessen the degree of corporate concentration. It involves certainly reforming some of the incentive structures, the perverse incentive structures that exist in both public office and private business.

But I think when you look at this in the context of the level of globalization that we have today, you have to take into account a huge number of butterfly effects. If a policy has changed in one country today, it can very well have huge reverberations in other countries down the line. And so some level of international cooperation and coordination is desperately needed in order to enable that to happen.

I think certainly, the U.S. dollar-centric global monetary system has outlived its useful life even for the United States itself and that there needs to be a very serious reflection on how we move forward from here. It's quite notable, in fact, that the Chinese have actually not pushed very heavily for the renminbi to replace the U.S. dollar simply because they're quite conscious of the huge price that the U.S. has paid for allowing its currency to serve in that role.

If you remember back to 2009, the then Governor of the People's Bank of China, Zhou Xiaochuan, advocated the expansion of the use of the International Monetary Fund's Special Drawing Rights or SDRs as an international unit and as a global reserve unit. I think that, that's something which needs to be explored but can only be explored with a level of cooperation.

And that inevitably leads to a question of leadership on both sides. These are problems that have come about or accumulated over many, many decades. And the current generation of leaders have inherited these problems. They are very complicated to resolve, and it is a mightily daunting task.

But if we think about how important this is for our future peace, stability and prosperity, it's a task that we can no longer put off. And I hope that leaders on both sides will have the courage to resolve their differences and begin to tackle these challenges.

Nathan Hunt:   James, one final question. In this moment in time, I think or maybe I hope we can see the beginnings of, to stretch the cold war analogy, an attempt at détente between the U.S. and China, specifically on the topic of Ukraine. Do you think that there is the possibility that the shock of war might bring these countries to reconsider their shared interests?

James A. Fok:   I believe it was Rahm Emanuel that said that you should never let a crisis go to waste. In corporate life, I often found that actually, some of the greatest progress was made during periods of extreme difficulty and crisis. Leaders on both sides have an option now.

They can pursue continued antagonism and allow the Ukraine tragedy to exacerbate that or they can use this tragedy in a way that hopefully brings about some good in resolving the conflict between them. If you look at the rhetoric right now in that there's a huge amount of criticism of China for not imposing Western financial sanctions on Russia, if you think about this from the Chinese point of view, China has a very long and clearly articulated stance of noninterference in the affairs of other countries.

What war Russia is doing in Ukraine today to the Chinese mind is fairly horrific and completely runs counter to this Chinese principle. Chinese leaders certainly share some Russia's sensitivities in that they face many of the same problems in the South China Sea with the U.S. chokehold over the -- or naval chokehold over the Straits of Malacca through which China imports most of its energy and food.

But when you look at it from China's perspective, China has, precisely because of that U.S. naval chokehold over its key supply routes, had to diversify its suppliers. And so it's become more and more dependent on imports of Russian oil and gas and grains across the Siberian border. So it cannot let Russia hang in the wind.

It also happens to share a 2,600-mile border with Russia, and Russia is vital to the security and stability of a number of Central Asian countries on China's western border. And so although Chinese leaders are probably morally just as outraged as many in the West by what's going on, I think they are walking a very fine tightrope where they cannot afford to alienate Russia for obvious reasons.

But they do not want to have Western financial sanctions imposed on themselves either. And so I think that it's in both sides' interest to see as quick and as peaceful a resolution to this conflict as possible at this stage. And I think that it would certainly be in Western interest for China to be engaged in helping to pressure Russia into some form of an armistice and resolution.

Nathan Hunt:   The book once again, Financial Cold War: A View of Sino-U.S. Relations from the Financial Markets. James A. Fok, thank you so much for joining me on the podcast today.

James A. Fok:   Thank you very much, Nathan.

Nathan Hunt:   The Essential Podcast is produced by Kurt Burger with assistance from Kyle May and McManus. At S&P Global, we accelerate progress in the world by providing intelligence that is essential for companies, governments and individuals to make decisions with conviction. From the majestic heights of 55 Water Street in Manhattan, I am Nathan Hunt. Thank you.