Avoiding the Thucydides Trap: A New Bretton Woods and MAD for Markets

Book: Financial Cold War
Author: James A. Fok
ISBN: 9781119862765

Previous: Funny Money and Market Limits

Chapter 8 is Fok’s closing argument. Kissinger opens with a warning: a new Cold War would be a historic tragedy if conflict is avoidable. The book spent seven chapters building the case that financial imbalances, not just ideology, drive Sino-US tension. Now Fok asks what to do about it.

Four arguments summed up

First, the dollar system’s costs now outweigh its benefits, even for America. Second, China’s growth model is hitting limits and needs deeper financial reform. Third, policies in both countries favored corporations and the wealthy, fueling inequality and nationalist backlash. Fourth, geo-economic warfare hurts both sides because their economies are intertwined.

War is not inevitable. Military conflict would be catastrophic and both sides know it. But flashpoints abound: South China Sea, Taiwan, Korea, cyber weapons. Financial imbalances raise the odds that a small incident spirals. Tariffs raise US consumer costs. China dumping Treasuries would wreck China’s own holdings too.

Admitting the problems

Graham Allison wrote that neither “decadent” democracy nor “responsive” authoritarianism is fit for today’s tests. Fok agrees the first step is admitting flaws on both sides.

America’s free market ideology undermined markets’ social purpose. Corporate consolidation and winner-take-all tech stifled innovation and wages. Antitrust enforcement faded after AT&T’s breakup. Regressive taxes since the 1980s enriched the top while public debt soared. Progressive taxation is needed, but not punitive 1970s levels. Capital should not be taxed far below labor just because capital flees to Ireland.

Biden’s 2021 G-7 tax deal was a step toward ending the race to the bottom. Government spending matters too. Wars of choice drained resources while education and infrastructure rotted. Public investment in R&D and infrastructure can front-run markets, as Mariana Mazzucato argues.

China’s inequality is less acute for now but demographic pressure will tighten the screw. The tax system favors the wealthy. Urbanization and weaker family safety nets demand more welfare. Suppressing consumption to drive investment worked for decades. Exporting surplus capacity through the Belt and Road now backfires abroad and at home. Low wages and financial repression helped exporters but hurt workers and savers.

Xi’s dual circulation and “common prosperity” rhetoric acknowledge the shift. Details and side effects remain unclear. But the direction matters.

Domestic fixes in one country can clash with the other’s policies. Coordination is required. And neither country’s inequality fix alone solves the dollar problem at the center of global imbalances.

America chose deficits. Mercantilist partners did not force that choice. It enriched finance while manufacturers paid. Fixing US inequality could raise low-wage consumption and widen deficits further unless China also raises consumption. Even balanced bilateral trade leaves 60% of world GDP and massive capital flows unsettled.

A new Bretton Woods?

Britain after WWII could not keep absorbing global imbalances. Sterling was 87% of reserves in 1947. Capital controls, devaluation, and decades of adjustment followed. The dollar replaced sterling slowly. Inertia, sterling-denominated debt, and colonial ties dragged the process out.

America today is more overextended with a larger embedded dollar role. The impossible trinity forces choices: exchange control, free capital flows, or monetary independence. Pick two. The US has free flows and monetary independence at the cost of a structurally strong dollar. China keeps exchange control and monetary independence with capital controls. Hong Kong imports US rates through its peg and gets asset booms and busts.

Unilateral dollar devaluation or capital controls would shock the world economy. Inflating away debt hits American pensioners holding most federal debt. Selective default on foreign holders is practically impossible and would trigger retaliation.

Reform needs cooperation. Fok sketches three paths without endorsing one.

Path one: expand IMF Special Drawing Rights as a Keynes-style Bancor replacement. Covid pushed a $650 billion issuance in 2021, but SDRs remain illiquid and IMF-governed.

Path two: diversify reserves as sterling faded. Needs surplus countries to consume more and US austerity. Markets resist splitting liquidity. Renminbi rise needs reforms China hesitates on.

Path three: keep the dollar dominant but compensate the US for supplying global liquidity. Politically toxic and leaves China’s vulnerability intact.

None is perfect. Britain took three decades to unwind sterling. Dollar restructuring could take longer. Trust is the main barrier now.

MAD for markets

Venice, London, and Hong Kong worked as entrepôts because geography, diversity, intellectual openness, and strong property law created neutral ground. Trust is fragile. Elite capture killed Venice. Eurodollar growth turned London from a club of personal relationships into a rules-based but concentrated system.

China building CIPS parallel to SWIFT raises costs, splits trade, offers imperfect protection, and alarms Washington. Hong Kong remains the bridge both sides need. After 2019 unrest and the national security law, careful application of that law and Western respect for Hong Kong’s judiciary (including foreign judges on the Court of Final Appeal) serve everyone’s interests. British Foreign Secretary comments in 2020 questioning foreign judges seemed self-defeating.

Fok proposes financial mutually assured destruction. Deepen interdependencies so attacking each other’s financial infrastructure becomes suicidal. Link Western and Chinese structures with complementary roles.

Hong Kong’s Stock Connect and Bond Connect make its depositories the largest offshore custodians of mainland securities. But international investors cannot easily borrow against those holdings offshore. London Clearing House dominates global swaps clearing and does not accept Chinese government bonds held in Hong Kong as collateral. Linking LCH with Hong Kong’s bond depository would create mutual dependence: investors need Hong Kong for safekeeping, China needs London for sovereign debt demand. Either side attacking the other’s infrastructure would trigger equal damage.

It all starts with leadership

Kissinger said great statesmen act at the outer limit of what history allows. Bush Sr. kept channels open after Tiananmen at personal political risk. Deng’s 1992 Southern Tour saved reforms from conservative backlash. Today’s leaders need similar courage.

Fok lists three course corrections.

Stop threatening each other. Rhetoric forces escalation. Disagreements need respectful language. South China Sea patrols and intelligence flights are legacy provocations. Britain eventually exited the Western Hemisphere when America made naval presence costly. America could reconsider its South China Sea posture. China should compromise on territorial claims so neighbors stop welcoming US ships.

Abide by international rules. Both countries have acted unilaterally outside multilateral bodies. Each violation invites copycats. IMF quotas do not reflect China’s weight. The WTO lost credibility. Reform those institutions instead of bypassing them.

Invest in leadership. Education in morals and civic duty, not just vocational skills. Social media echo chambers make multi-perspective training essential. Pay public servants well enough to compete with Wall Street, as Singapore does. Restrict the revolving door. Campaign finance reform in the US. More press freedom in China.

Our leaders inherited domestic and global problems no country solves alone. Financial imbalances fed Sino-US tension. The problems are large. Fok still believes courage and cooperation can resolve them.

That is the book’s hope. Not that markets fix themselves. Not that one side wins a new Cold War. But that both admit the leaks are at both ends of the boat, and start patching before the water wins.

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