Saturday, November 19, 2011

New Chinese ASW aircraft

The long rumoured ASW aircraft has finally been revealed. In recent photos from an airport (my guess in Shaanxi AC), we see Y-8 ASW aircraft (dubbed HIgh New 6) amongst them. Here are some of its photos. You can see from here that it has a large surface search radar under its chin, a FLIR sensor, internal bomb bays on both side of of the middle section of fuselage, a series of antennas underneath the fuselage and MAD boom at the back. You can also see a large window on each side of the rear fuselage for observation purpose. The aircraft itself is using the Y-8 Category 3 platform as can be seen by the 6 blade propellers.

Before anyone gets overly anxious or excited about this ASW aircraft, one should remember that there are over 100 P-3Cs in service with JMSDF and over 150 P-3Cs with USN. Since this is only a second generation ASW aircraft, it's probably a generation behind P-8 Poseidon in terms of the platform and sensors. At the moment, there appears to only be 2 of this aircraft. When one considers all of the different types of Y-8 special mission aircraft and the production capabilities of Shaanxi AC (around 10 such platform a year), it's really hard to see this number will go much higher in the next years.

In the same set of photos, we also see the tails of other Y-8 aircraft. Two of the tails are for Y-8 ASW aircraft, two are for KJ-200 and the remaining two are for unidentified platform.

We also get a picture of these aircraft from outside. It seems to indicate the existence of 3 KJ-200 here.

We see a KJ-200 painted in PLANAF colours with number 9421. We've previously seen a KJ-200 with number 9371. This should be joining the same PLAN regiment. The other two maybe joining the same regiment too or maybe for a new unit.

I have a previous article on the Y-8 special missions series of aircraft here.

Tuesday, November 15, 2011

Gap between China and Russia

After I posted the last blog entry on rebuking Kanwa's support for Russian military industrial complex, there was quite a few passionate responses in the thread. More interesting, there was a thread on Sinodefenceforum about whether or not China is now ahead of Russia. As you can imagine, it turned into quite a heated thread.

For me personally, there has been several areas where China has exceeded Russia. This strategycenter article on CIDEX 2010 highlights the current disadvantage that Russia faces vs China in military development.

Russian specialists will point out that they are now at a huge disadvantage to the Chinese in two very significant respects.
One is that the commitment by the central government in resources to the defence electronics sector is both sustained and serious. “They can take a field where there is nothing but flat land and wild grass,” said one Russian company representative, “and the next thing you know there is a full-blown factory or design centre there turning out a world-class product.”

The other advantage to China is the unfortunate reality of actuarial tables. Younger scientists and engineers who are needed in Russia to form the next-generation of weapons designers are leaving the nation in droves. A few years ago the Russian Foreign Intelligence Service (SVR) estimated that 70,000 scientists and specialists from Russian defence institutes and military-industrial complex enterprises had left the country.
The consequence is that whereas the age of the average defence industrial scientist or engineer in China is about 30 and around 40 in the US – it is 50 years or more in Russia. China’s industry is growing and advancing, while Russia’s will effectively be dying off before too long.

The same article also talks about CETC becoming increasingly competitive around the world market. This is a trend we are seeing amongst all Chinese defensive firms where air shows and weapon shows are seeing more and more displays from Chinese companies.

With this advantage in mind CETC is beginning to turn its focus more towards expanding export markets. This is all mostly due to the fact that Chinese companies used to be limited to trying to sell to countries that could either not purchase from the West or only had the financial means to purchase low-cost Chinese products. Now the electronics giant is encroaching on territory such as South America that would have normally been the preserve of US or European firms.

With this objective in mind, CETC are now more actively participating in international defence expositions outside of China and establishing themselves as players in the competition in emerging markets. In this sense they are in the same category as other Chinese arms export companies like Polytechnologies or Norinco, both of which exhibited at the Eurosatory show in Paris for the first time ever this past June.

In the field of defence electronics, even the Russians are admitting that China has passed them. The other field that China has clearly surpassed Russia is naval shipbuilding. In both cases, we can see China's defense industry benefiting from the globally competitive civilian manufacturing industry. China's defense industry are still trailing in these areas, but have become increasingly efficient and cost effective. After the dissolution of Soviet Union, many Russian defense companies simply did not have the quality and efficiency to compete in the civilian market, so they have not made much progress in the past 20 years.

So, which areas are China still really trailing Russia and how long will that last? As mentioned in the previous article, I think China lags behind Russia the most in strategic systems. At current time, China is a couple of generations behind Russia in nuclear submarines and strategic bombers. China is probably conducting sea trials for 095 class SSNs right now, but I guess it will take another 20 years before it can build something on par with Yasen class (if that class turns out as good as Russians have claimed). China is probably similarly behind in SSBN. In the area of strategic bombers, China will probably catch up through the development of UCAV rather than building something in the tu-160 class. China is also behind Russia in ICBM and long range cruise missiles, but that gap is much smaller due to the significant funding toward Second Artillery Corp.

In conventional weapons, China has imported engines, large helicopters and SAMs from Russia in the recent years. These along with large transport/tankers are also the most obvious areas where it is trailing Russia. Propulsion has clearly been the achille's heel in all recent Chinese weapon development. We are finally seeing results from fighter jet engine projects like WS-9, WS-10A and WS-13. Production problems for WS-10A have been well documented, but the all important WS-10A is finally being mass produced and used in all the new fighter projects. More importantly, WS-15 is apparently making real progress and will be ready by the end of this decade. Theoretically speaking, China would've catched up to Russia in fighter jet engines by then, but we may still see a lot of production related issues hindering progress. We are seeing a whole host of new turbofan engine projects under way (from recent airshows) aimed at different military aircraft like fighter jets, transports, trainers and UAVs. High bypass engine for large transport and small turbofan engines for advanced trainers/UAVs have had slower development. In both case, China has put in less funding into these projects. China has been copying Russian/Ukrainian engines for these sectors. They are putting a lot of resource into high bypass engines for the purpose of military transport and also civilian airliner projects. In the latter case, I think they may find some assistance from more prominent Western companies on these projects, which may help speed up their development. I do expect China to catch up to Russia in different classes of turbofan engines by the middle of next decade. China has also experienced disruption in naval projects and army projects due to the weakness in propulsion technology. In both of these cases, they have been able to license produce some Western engines, while suffering constraints on other projects. For example, the second batch of 052C ships were delayed due to delays in the QC-280 project. Since the Ukrainians produced gas turbines during Soviet time, China is actually not behind Russia in naval gas turbine. However, it is playing catch up to Zorya and need some more years of development before it can develop the full line of gas turbines required by its naval. China is also behind Russia in both large helicopters and turboshaft development. In the latter case, it has been able to leverage civilian projects with European companies into co-development projects (like WZ-16) that should eventually yield fruit by the end of this decade. In the former case, China is working with Russia to develop heavy transport. It's uncertain when China will catch up with Russia or if it needs to catch up with Russia. Russia has a lot of expertise with larger helicopters whereas China has just been doing better with smaller helicopters due to its cooperation projects with European companies. Large military transport and refuellers are certainly areas where China need to catch up with Russia. Many domestic projects have been halted (like KJ-2000 and ABL) due to the lack of platform. The Y-20 project and C-919 should both be ready by 2016. At which point, China will have aircraft that are on par with Russian equivalents. However, Russia does have a lot more experience in developing large aircraft than China and have wider range of transports available. As seen in the recent agreement for co-development of wide body civilian airliner, China believes that it can still learn a lot from Russia in developing larger aircraft. Since both countries are putting a lot of funding in this area, it's hard to say when China will catch up to the R&D capabilities of Russia. With the development of HQ-9, HQ-10, HQ-12 and HQ-16, China has really been advancing in air defence weaponry in the recent years. In naval SAMs and CIWS, I think China has already caught up and surpassed Russia. However, I would say it's still trailing Russia in land based SAMs when one compares S-400 and S-300V to HQ-9. Buk-M1 and Tor-M2 are also more advanced than the HQ-12 and HQ-7 that China is currently fielding. I have certainly read a lot of rumours about new long range, medium range, short range and anti-ballistic SAM projects, but they are still years from deployment. Until then, China will continue to apply incremental changes to different modules of HQ-9 and HQ-12 air defence system. We should see continued improvement in range, guidance, ECM capabilities of these two system. I think China will probably catch up to Russia in 10 years at its current trajectory. Another area that China is clearly behind Russia in is supersonic anti-ship missiles, but I think that's because China is choosing to go the Western route of carrying subsonic anti-ship missiles.

There are also numerous other areas where you can make a resonable argument that China is behind Russia, but I think the greater investment toward China's defence industry will tilt things toward China in the near future. More than anything, the greatest weakness in China's defence industry is propulsion technology. From turbofan engines to gas turbines to nuclear reactor turbine to turboshaft to diesel engines to missile propulsions, China has needed outside help for most of these projects. If China can catch up to Russia in propulsion technology, it will be able to shake any remaining reliance on Russian imports.

On the other side, I think China has also surpassed Russia in several area. As mentioned previously, China's defence electronics industry is now ahead of Russia in most areas. We saw AESA radar deployed on KJ-2000/200 and 052C several years ago and Russia are still several years away from deploying operational AESA radar on AWACS/naval ships. We are also seeing what appears to be first generation of AESA radar on fighter jet on J-10B, while Russian AESA radars seem to have production issues as indicated in the strategycenter article. We have also seen a whole range of new air defense and battlefield radar that CETC is developing that are doing quite well in the domestic and export market. I have not seen the same portfolio of Russian products in the export market. From recent CCTV news reports, we have been able to contrast the combat central of domestic naval ships with that of imported Russian naval ships (kilo and Sov class). We are seeing that the domestic ships have much more digitized and informative system than the more analog based Russian ships. We have also seen the new electronic equipments and systems deployed with the army and PAP. In this blog entry that I read a few months ago, it talks about how Russian general Makarov sees Chinese army been capable to operate much faster due to adoption of modern digital technology.

The gap between China and Russia in naval shipbuilding seems to be just as significant. PLAN expansion has included small ship (Type 022s, 056s), large ships (type-071, submarine tenders, ELINT ship, type 920 and new replenishment ships), complex surface warships (052C and 054A), MCM ships and conventional submarines. Even China's major civilian maritime agencies have seen tremendous expansion in their fleet of cutters. Only the USN has seen more naval shipbuilding in the same period. The Russians have been able to build Soviet era designs for export like kilo class, Talwar class, Sov class and Gepard class. It has struggled building new shipping classes like Borei, Lada, Project 22350 and the Ivan Gren class. It has also struggled with refitting of large Soviet era warships. The cost overruns for INS Vikramaditya has been well documented. Russian shipyards have reduced capacity compared to Soviet times and simply cannot complete work on time or on budget. I've seen some ambitious Russian naval designs for export in weapon shows, but who really knows when Russia would actually be able to deliver those product. We hear and see a lot of new Russian naval subsystems like CIWS, SAM, AShM and FCR in weapon shows and don't hear that much about Chinese naval subsystems. However, we see so many new naval sensors and weapons being installed on test ships and later installed on new shipping classes. With the launching of the 3rd naval test ship (893), I can only imagine the pace of such development is further picking up. Many of the recently developed naval sensors/weapons (like the ones on 054A) are developed based on Russian subsystems, but the next generation of naval sensors/weapons should move China comfortably ahead of Russia. The new Chinese subsystems will be installed and tested out on new platforms, whereas the Russian ones have no platforms to be installed on. So, I think that Russia will also be falling behind China in most naval subsystems.

Other people may disagree, but I think China is also ahead of Russia in UAV technology and PGMs. In the recent Zhuhai air show and international air shows, we have seen many different Chinese unmanned systems displayed including UCAVs, unmanned helicopters, surveillance UAVs and Recon UAVs. China has exported some UAVs to Pakistan and is also developing and inducting new UAVs into PLA and PLAAF. I think it will be just a matter of time before those CAC UAV projects get inducted. At the same time, Russia really has not developed anything in UAV field. It has been importing different UAVs from Israel. China's development in different PGMs have somewhat been tied to its UAVs. Many new types of small SGBs, TGBs and LGBs have been developed, so that they can be carried by UAVs and internal carriage of next generation aircraft. We are also seeing miniaturized ground attack missiles and ATGMs developed to be carried by UAVs. Overall, we have seen a huge expansion in the arsenal of PGMs available for different Chinese aircraft. These new ground attack weapons have greater accuracy and longer range than what China had imported from Russia in the early 2000s. On top of that, they come in different sizes with different types of guidance. Even J-10s have developed greater multi-role capability with these developments. This is quite a feat considering that PLAAF desperately needed to import Su-30 and different ground attack missiles and munitions in the early 2000s to develop ground attack capability.

The other areas that I think China is clearly ahead of Russia (and most other countries for that matter) is short/medium ranged surface to surface missiles. China has been putting a lot of funding in this area in the recent years due to the Taiwan threat and the importance of Second Artillery Corp. Aside from the much talked about anti-ship ballistic missile, it has also developed new variants of DF-15, DF-21 and the mysterious DF-25 missile. At the same time this was happening, Russia did not develop this area due to the INF treaty.

There are other areas that where you can argue China is ahead of Russia, but I think it's quite significant that China has basically surpassed Russia in all of conventional naval weaponry. Considering where the two countries were 15 years ago, that represents quite a lot of progress for China and lack of progress for Russia.

I also want to explore the gap between China and European Union in the near future. With the disintegration of Eurozone, I think the European embargo might be abolished in the next few years. The question is what will China still want from Europe at that time.

Sunday, November 6, 2011

Rebuke against Kanwa

I’ve been a long time follower of Kanwa magazine. Even though I do not have much regard for the quality of writing, I do find its interviews and news from weapon shows to be quite good. In fact, Kanwa became a good PLA sources back in the days, because it had many contacts with Russian military industrial complex. Even though I don’t always agree with the view points of the people that Kanwa interviews, it’s always interesting to see what they have to say. However, Kanwa has been forced to do more and more of its own analysis in the recent years, because of China’s reduced reliance in Russian weapons. While the sections on weapon shows and Chinese imports/exports are still quite useful, it’s analysis have generally been extremely painful to read. The problem is that Kanwa has a very narrow view of Chinese military industry and believe that everything China produces must be somehow copied from Russia. As a result, it tends to vastly underestimate the capabilities of newer systems even though official news reports already disproved kanwa’s estimations. Even now, it still insists that Type 071’s displacement is under 10,000 ton when official reports put it at 19,000 ton (in reality, it’s dimensions are almost the same as San Antonio class). As I read through newer issues of Kanwa, I’ve often have to just skip through the ridiculousness of some of the Kanwa articles. In the November issue of Kanwa, there was an article so off that even I could not ignore it.

In this article, Kanwa tries its hardest to argue that the gap between Chinese and Russian military industrial complex is increasing rather than shrinking. I will just go through each of Kanwa’s points and look at whether they are accurate or not. Kanwa starts by looking at the nuclear technology between the two countries. Post Soviet Union, this is probably the one area that Russia has put in heavy investment to try to stay on par with America. Kanwa talks about the latest ICBM and the development of Borei/Bulava class. The cost overruns and launch failures on Borei and Bulava project have been known for a while. I do think that this new generation of SLBM and SSBN will join service in the next few years due to the huge investment that Russia has allocated toward it. It would be easy to argue that Russia is ahead of China in ICBM/SLBM technology (which is what Kanwa did), but it would be hard to argue that the gap between the two countries is expanding here. Considering what the Second Artillery was fielding prior to DF-31 and JL-2 as nuclear deterrent, the PLA leap in this field is quite large. Even if the 094 class is extremely noisy, that’s still a couple of generations ahead of operating something like the 092 class which could not even hold intercontinental ballistic missiles.

Next, Kanwa argues about the conventional forces. Interesting enough, instead of making any argument that the gap between Russian and Chinese designs is expanding, Kanwa ended up arguing that Russian weapons are still better. Well, I don’t think there has ever been any doubt that Russia is still ahead of China in many areas of weaponry. Looking at the weapon systems that Kanwa compared:
KJ-2000 - Kanwa thinks that it is in testing phase and has not reached maturity. It used the small number of KJ-2000s and China’s desire to purchase Phalcon system as the proof for this.
Reality: The limited number of KJ-2000 is due to the lack of available IL-76 or equivalent sized transports. PLAAF has been very pleased with its performance and have inducted both KJ-2000/200 into service. AEWC&C is one area where China is ahead of Russia.

Next generation fighter jet program – Kanwa argues that J-20 used AL-31FN and is a demonstrator, so it is behind the Russian program. Kanwa states that PAK-FA already has 117 series engine to be able to perform supersonic cruise and has AESA radar that is in second year of testing.
Reality: J-20 is unlikely a demonstrator program, because PLAAF has publicly stated that they expect its 4th gen program to be inducted by 2017 to 2019. In fact, SAC is also reported to have an ongoing 4th gen program. Even if J-20 is not 5th gen by Western standards, it is certainly a much large evolution over previous Chinese fighter jet than PAK-FA is. I see PAK-FA as basically just a stealthy version of Su-27. Neither aircraft are in the same league as F-22/35 in terms of stealth technology. Engine is clearly one area that China is behind Russia, but the WS-15 project is going pretty well by all report. J-20 will certainly not be fielded without AESA radar and the ability to cruise at supersonic speed.

SAM – Kanwa argues that the 125 KM HQ-9 is behind 200 km S-300PMU2 and compares even worse versus the 400 km range missile under development. In naval SAM, the 9M96E system is much more compact, modularized and digitized than China’s Rif-M.
Reality: I won’t argue that HQ-9 is better than S-300PMU2, because Russian SAMs have always been very impressive. HQ-9 is however a couple of generations ahead of the HQ-2 systems that it’s replacing. We will have to wait to see what comes after HQ-9. In terms of naval SAM, I don’t understand why it compared 9M96E to Rif-M instead of HHQ-9 or HQ-16. China is certainly developing its own equivalent of a MK-41 launch system, while Russian naval SAMs have to wait for their ships to be ready.

Anti-ship missile – Kanwa argues that China does not have any kind of vertical launch system for AShM or indigenous supersonic AShM.
Reality: China is simply going Western style of using the much smaller, high subsonic AShM. I do foresee that future PLAN VLS will be able to launch AShM. It’s hard to argue that this is a field that China is doing badly in.

Ground attack missile - Kanwa argues that China is behind Russia, because KD-88’s range is only 220 km compared to 300 to 400 km range of Club/Yakhont.
Reality: Clearly, a smaller missile like KD-88 will have shorter range than a larger missile like Yakhont or Club. PLAAF uses a combination of KD-88, KH-59ME and KH-31/YJ-91 for different strike and SEA missions. Range is not the most important factor in ground attack munitions. China has put a lot of investment in different ground attack munitions in recent years and has produced a whole new generation of advanced guided missiles of different sizes. I would say this is one area it has clearly surpassed Russia in.

Naval Propulsion – Kanwa states that the major combat ships are all using locally produced version of French and Ukrainian engines.
Reality: This is the Achilles’ heel of PLAN. 052C mass production was delayed because QC-280 (domestic version of DA-80) took a long time to be ready. Even so, it’s hard to argue that Russia has improved more here, since Russia is getting all of its gas turbines from Ukraine too.

Naval MFR – Kanwa argues that Chinese electronics industry is behind the west and have not made miniaturized version of 052C, whereas Russia has come out with Zhuk-AS.
Reality: China has not made smaller version of those AESA radars, because none of the recent ships have needed it. The larger radar panels are needed for something like 052C, so that they can have more power and track targets further away. The 052C radar arrangements mirror that of SPY-1D on Burkes. Zhuk-AS is not even equipped on any operational ships. If a new PLAN frigate needs a smaller MFR, it will be developed and tested. Kanwa does not seem to understand the basics of naval ships. This is clearly another area where China is ahead of Russia in.

Kanwa tried to use these examples to prove that China needs to spend more time to be good students of Russia. It stated that by copying from Russia, China fell in an ugly continually copying rather than developing its own stuff.

Kanwa is clearly allowing its loyalty toward Russian military industry influence every argument here. In many of its examples, China actually came out with products ahead of Russia. China learnt what it could from the Russian weapon systems that it imported and then developed a whole range of weaponry. One cannot underestimate the contribution that Russia has made toward Chinese military industry. At this point, China has to develop new products independent of the Russians and has done so in many different areas. Kanwa’s desperation to argue against this made most of its arguments extremely muddled. It did give credit to China for UAVs, T-99 project and naval shipbuilding program, but only spent one very short paragraph on that.

I think there are still several areas that China is behind Russia that it can learn a lot from. It is clearly behind Russia in strategic systems like strategic bombers, nuclear submarines and ICBMs. It is also behind Russia in aerospace engine, surface to air missiles, large transport/tanker, medium/large helicopters and diesel submarines. China still imports these weapon systems from Russia. However, China has also surpassed Russia in many areas. I think China will simply surpass Russia in more areas in the coming years as the domestic industries receive more and more funding. I have a terrible feeling that Kanwa articles will degrade even more in quality as Russia becomes even less relevant in PLA development.

Friday, November 4, 2011

My thoughts on economics and politics

As we all know and have experienced, the world has been in a prolonged economic uncertainty since 2008. Although many countries had economic recoveries starting from the second half of 2009, the world now seems to be falling into further economic hardship with the European Sovereign debt crisis and housing bubble bursting. For the former, I'm referring to the ongoing problems in Greece, Ireland, Portugal, Spain and Italy. For the latter, I'm mainly referring to the housing market problems in China, Australia and Canada. In such harsh economic climate, the debate of military expenditure is important for not just America and NATO countries, but all of the countries around the world. Both China and America are facing possible leadership changes in 2012. At the same time, governments around Western countries are facing the possibility of collapsing over austerity measures and general discontent toward banker bailouts. The topic I've been thinking about in the last few weeks are whether leadership around the world is up to the task of handling the problems that are facing us.

I often talk about the reasons behind the buildup of the PLAN fleet. My message has been that the Chinese economy is so much dependent on energy security and maritime trade that it needs a strong blue water fleet to protect the sea lanes. Of course, that's not the only reason we are seeing larger budget for the navy. Other reasons include the desire for projecting soft and hard power (achieve political influence), national pride, buying support from the military and supporting the military industrial complex. Even though I'm an avid military follower, I tend to believe that military buildup should only happen to support and ensure an environment for economic growth. Contrary to what the military industrial complex would like people to believe, spending toward the military does not naturally help the economy. If the weapons that are produced are not used in a way to enhance the economy, then they don't help a country's productivity. (Similarly, if a government spends the same amount of money on building roads that lead to nowhere, they will also be wasted.) In cases where a government puts too much spending into the military for non-economical reasons for a long period of time like in USSR, you eventually see a complete collapse where neither the economy nor the military survive. For all of the faults of the Chinese leadership, the one thing it did realize after Cultural Revolution is that economic development must take place before it can build a stronger military. Amongst many of its policies to liberate the market in the 80s, Deng Xiaoping also liberated the Chinese economy from the weight of military expenditure by cutting it 10 years in a row (or something like that). During this time, many domestic military projects had to be abandoned due to lack of funding. Even J-10, the most important project in PLAAF history, almost got axed in the 90s. I'm sure many people in PLA complained loudly back then, but it is hard to argue against the success of such policy now. Comparing this relatively orderly retreat in military budget to that of the complete collapse in Russia, I think most people would prefer to go down China's path. I'm not here to just applaud China and put down Russia, but rather to show the importance of keeping military expenditure in check even during times of security needs.

By now, many of us have the freedom to move to different countries around the world for better economic prospect. All of us want to be in a land where we can live comfortably and be prosperous. More than ever, countries around the world need to keep economic security so that it can attract the best talents around the world while keeping its best at home. For example, I moved from Canada to New York, because the job prospects are better here. However, I may move to a place like Singapore in the future that is well developed and has low taxes. Countries that can provide economic security and development will become more prosperous, technologically advanced and militarily strong. Clearly, America has always been one of such nation and has also benefited tremendously from absorbing the brightest around the world. In the past, a country's economic security is provided by a strong military, but that's no longer the case. Now, they can also be threatened in the major manufacturing industries, commodities markets and banking systems. Even though these threats generally don't kill people with bombs and bullets, they do bring hardship and eventual overthrow of governments.

For an example of threat to financial systems, the Icelandic economy collapsed a couple of years ago and the nation's banks were saddled with debts from market speculation. The Icelandic government initially bowed to IMF pressure to impose austerity measures and pay back the debts owed by the banks to British and Dutch creditors, but the Icelandic people revolted and overthrew their elected government. The new Icelandic government has since rejected all proposals that it views as unfair to payback foreign creditors. The similar drama is playing out in Greece except that they have not overthrown the government yet. At the moment, everyone in the country is striking over the austerity measures and Greece is barely functioning as a nation. They will definitely default (even if it's called voluntary) and probably will leave the Euro zone. In fact, the current debt problems along Southern European countries will probably result in the end of Euro as we know it. The more fiscally sound nations like Germany and Austria will use a new currency, whereas the remaining countries will use a much weakened Euro. Along the way, millions of people will suffer due to sovereign debt problems brought about by public sector debts and private sector debts that are guaranteed by government. Of course, the same threat is looming for China and America, which I will talk about later.

For example of threats from commodities markets, we only need to look at the Arab spring. From late 2009 to early 2011, there were a lot of inflation in the commodities market. Such inflation never shows up in our CPI (which does not include food and energy), but is clearly felt by everyone around the world. While some of that inflation is caused by demand in China, much of that is caused by speculation in the global commodities market and debasement of currencies around the world. So as a result of living in a globalized food and commodities market, Arab countries faced high inflation despite being mired in an economic slump. When faced with stagflation and lack of freedom, the local population rioted and threw out the dictators. I do want to point out that when people are faced with extreme hardship of stagflation (inflation + depressed economy), they will protest and riot against their government regardless of whether they are elected or not.

A large part of the reason behind inflation in global commodities market came from the so called currency war. For the past few years, most major currencies around the world have been eagerly debased by central banks in a way in order to stimulate the export sector. Some of the most well known cases of such currency debasement include the many rounds of QEs by the Federal Reserve, the pegging of RMB to USD, the efforts by BOJ to keep Yen down, the QE efforts by ECB and the hard cap set by Swiss national bank to hold up EUR/CHF exchange rate. Basically, every country kept loose monetary policies in order to not rise too much against USD and Euro. Contrary to what the politicians may tell you, this is not just a Chinese policy, but something that central banks of most major currencies try to keep their export industries competitive. When you combine this with cheap money and excessive lending practices in growing countries like China and India, the world faces an expansion in credit that results in inflation in spite of economic downturns in many countries.

At the same time, we are also facing the prospect of trade war between major economies. During good times, large trade distortion as we see now with China and US results in political tension. During bad times like the great depression, we see protectionism amongst the world economies and result in extended period of economic pain. When governments around the world put in stimulus packages in 2009, many of them put in "buy-at-home" clauses to try to stimulate the manufacturing industries at home. In spite of such clauses, we've seen recovery amongst major manufacturers around the world due to trading. With the recent rhetoric coming out of US senate, it appears that we are facing a looming trade war between China and America. I will talk about later why I think policies of politicians from both countries are not helpful.

And finally, we also face this sovereign debt war. Due to the abandonment of gold backed currency, countries around the world have been able to run prolonged period of fiscal deficits through fiat currency. It's safe to say that most countries around the world have lived beyond their means and now the market is punishing some of them with ever increasing interest rate. In the case of Greece, the country is on life support and will default at any moment now. The last minute voluntary haircut deals simply can't rescue the country from the ever increasing borrowing cost. And when it does default, the two main groups that will suffer are the Greek Pension fund and banks. The former leads to the collapse of social safety net and the latter leads to bank insolvency. The same problem is also facing other PIIGS countries, some peripheral European countries and states like California and Illinois. Even though pension fund reforms and some bank insolvency may be the best way to go, a lot of people will experience pain in the short term. My point is that perpetually running up deficits will catch up to a country sooner or later.

As I've watched the primary season for the past few months, I cannot help but be disappointed with the current political discussions. We have an economically illiterate president who cannot move past blaming all of his problems on the Republicans. The Republican primary debates never seem to move past who flip-flopped, who was once a democrat, how fast they will repeal the Obamacare and how much taxes they want to cut. Other than Ron Paul, it’s hard to find any honest politician not completely bought by Wall Street, the Koch brothers or the military industrial complex. There seems to be a belief from the democrat that the economy cannot start up again without more stimulus packages. And the republican belief seems to be that the economy will magically start to expand as soon as tax and regulations are cut. While I do generally side with conservative positions on lower taxes and regulation, I think the politicians really do underestimate the effect of the debt issues around the world. People in America are not going to start spending money again until they start to save more money and feel more optimistic about job prospects. As importantly, demands around the world are going to remain down with Euro sovereign debt crisis, political unrest in the Middle East and housing bubble bursting in China/Australia/Canada. And probably just as importantly, nobody is talking about what would happen to America once states like California, Illinois and New York face the same debt pressure from bond market that the Eurozone countries are facing. Will the federal government bail these states out like they've already done with the auto industry and Wall Street? And what would happen if the market turns its attention to the US treasury market? On the face of it, American public debt is even worse than many of the Eurozone countries that are already in trouble, but the interest rates are now at an all-time low due to the market perception of US dollar as the safe haven. If the interest rate goes up at all, that would have huge impact on federal budget. Just think about how many American individuals, banks and pension funds would be affected if the values of their government or state bond drop? Clearly, neither the US federal government nor the state governments can perpetually run up deficits. Numerous municipal governments have already filed for bankruptcy. Yet I continuously read about apocalyptical scenarios if defense spending or medicare or social security gets cut. The reality is that the excessive spending now will eventually have to be balanced somehow by either depreciated currency or default. By justifying certain things can't be cut now, the price will be much harsher later when austerity measures and inflation are forced upon the population as we are seeing in PIIGS countries. Once that happens, there will be rioting on the street like what we saw in so many other countries in the past 2 years. Instead of telling the truth to the country, most politicians only want to stay in power and blame other sides. Similarly, we are seeing the same blame game put on Chinese currency manipulation, because China is an easy target to go after. Aside from the fact that many major currencies are engaged in currency manipulation to try to increase export, it is also impossible to determine whether RMB is really undervalued or overvalued. As I explained in previous articles, on top of the 25% appreciation against USD in the past few years, China has also seen minimum wage go up 20% in many of the export dominated provinces in the last year. The minimum wages were increased due to rising inflation across the country caused by credit expansion. My point is that Chinese gov't cannot control laws of economics. Rather than blaming the currency manipulation, other reasons like cheap credit, business friendly labour laws, less regulation, lower taxes and market access contribute more to the trade imbalance. American gov't should fight for equal market access for its companies, but it should also try to be more pro-business.

At the same time, China is also nearing leadership change, since the next generation of leaders lead by Xi jinping will be taking over in 2012. In the past couple of months, we are really starting to see the housing bubble bursting in different cities around the country. The reality is of course the housing prices in many cities have gone up too much in the country due to cheap money and speculation and they need to come down to a more reasonable level. At the same time, many small businesses in the export provinces have gone under due to rising labour cost. Chinese banks are also on the hook for a lot of debts from cheap credit to big companies and local governments. It seems like China is heading into an economic downturn at the same time it is also fighting inflation issues. If past is precedent, inflation issues normally go away as soon as the economy slows down and unemployment rate goes up, so the latter may become a smaller concern. Hu jintao and the other leaders that are retiring next year would most likely not want any kind of economic turmoil to blemish their political legacy, which means they could try to bail everyone out, when they should allow for correction in the housing market and for certain local governments and businesses to fail. In the event of an economic downturn, Chinese leadership should allow for correction of imbalances caused by the boom period rather than trying to stimulate the economy further. It was painful in the late 90s in China when the government let many SOEs fail, but that became one of the major reasons for the past 10 years of economic growth in China. It was also painful for some people when China cut down the size of the government and stopped communist era food rationing, free housing and “universal health care”, but the liberalization of market has been an overwhelming success for most people. So, will Chinese leadership do the right thing this time and allow the market to correct itself? Unfortunately, I think China will try to further stimulate the export sectors and increase infrastructure spending.

Contrary to popular belief around the world, running a perpetual surplus is not a good thing. The two most popular examples to look at are the trade distortion between China/USA and Germany/Rest of Eurozone. In the former, China is exporting a lot of good to America without getting the same amount of goods back. In an ideal trading environment, that would lead the Chinese exporters to convert the currency back to RMB and increase the value of RMB vs USD. Eventually, the currency exchange rate move back and forth to reflect the productivity of the country’s work force. In the case of China/USA, China has very strict capital control, so exporters who get paid in USD would have to exchange with Chinese banks to get RMB back to pay its workers. As a result of trade imbalances, China has a huge reserve of USD. Unfortunately, China has to use that USD to buy things denominated in USD like natural sources or exchange it for another currency like EUR or JPY. In both cases, the transaction would simply depreciate the USD (and RMB as a result of currency peg) and increase the cost of the living for Chinese people. The other scenario is for China to take that and invest in USD denominated investments like treasury bonds, other fixed income securities, US Equity market or US companies. Those investments may go up or down. So the result of a huge Chinese reserve of USD is inflation for any currency tied to USD (including RMB) and a lot of USD held in America. We are already seeing the result of the inflation in China, where labour costs are going up 20 to 30% and low cost manufacturers are going out of business. If the large amount of USD is not eventually used to purchase more American goods for Chinese people, then that huge reserve will be wasted. And since the great American demand for foreign product results in spending beyond its means, you see large amount of private and public sector debts that are also held by China and other foreign creditors. America can either further debase USD or it can default on its debts. Either way, China’s USD holding will lose large portion of its value. So instead of getting back American products that can improve the lives of Chinese people, America ends up getting all the Chinese products for essentially free. In the case of Germany vs the rest of the Eurozone, the adoption of the common currency has allowed Germany to consistently run up trading surplus vs peripheral Eurozone countries due to its competitive advantage over them. Since the PIIGS countries cannot use export to grow their economy, many of them have grown through housing bubbles which have now burst. At the same time, German banks continually invested in these economies to help maintain the trade imbalance. We now get to the point where PIIGS countries are in heavy debts from the trade imbalances and are attacked by the bond market, because they don’t have a competitive domestic industry to export out of this debt. The German banks will suffer huge losses in the PIIGS countries, because they borrowed money to keep this trade imbalance going. Please note that US, Japan and UK have worse public sector debt (and also worth private sector in the case US) than PIIGS countries, because all of their debts is in their own currency that they can simply just print more.

What I’m saying is that China should not continue this export and investment driven growth, even though the Chinese politicians may find it easier just to continue this “formula for success”. I see that even though they publicly say that they do not want trade surpluses, their policies in the past have been to help the export industry whenever the economy is heading toward a slowdown. In the past, they have also invested in a lot of public infrastructure project that have helped grow the Chinese economy, but more and more of the new infrastructure projects in the recent years have proven to be wasteful. More importantly, China has recently adopted policies that are different from Deng’s time. It is adopting policies that are more confrontational with its neighbours. I think that Chinese leadership is throwing more weights around its neighbours, because it developed new confidence during the economic downturns of 2009. While I do think that China will eventually establish hegemony in its backyard like America have done in the Americas, it will have to do this slowly through greater economic integration and spread of its culture to neighboring countries. Many of the neighbours surrounding South China Sea have large Chinese expat population and similar culture to China and would probably support Chinese leadership better than other countries around the world. During a period of economic uncertainty as China is going through right now, it should concentrate more on building economic relationship with neighbouring countries rather than throwing its weight around. As China’s military grow with its growing economy, China will bound to make its neighbours feel uneasy. That’s why it has to work extra hard to have confidence building measures with its neighbouring militaries.

So, as I look at political situations in China and America, I see both countries facing similar issues with economic downturn looming. The major currencies of the world are already engaged in a currency war that is causing inflation, economic stagnation and political uncertainty. At the same time, the senate is passing a bill that could trigger a trade war with China, which will cause pain for all of us. The cheap exports that China sends to America would likely be replaced by other low cost third world countries while American consumers would face more expensive goods. There are structural issues that America needs to make to have less debt and become more competitive in the world market. At the same time, China also needs to make policy changes to shift away from export and investment based economic growth. Both countries are facing such economic firestorms that they need to spend less time thinking about how to preserve its leadership in the world and more time on solving economic issues facing the world. If the two countries spend more time on the former, we will continue to move in a path of confrontation. If the two countries spend more time on the latter, we could have more engagements, better relationships and better livelihood for everyone around the world. I also think that the economic problems that are now hitting Eurozone will spread to China and America, which will force both countries to spend more time shoring up domestic debts problems. At which time, I don’t think either military will be happy about their reduced influence.

This brings us to possibly the most shocking part of the recent debt crisis -> what I call the war against sovereignty. In the past week, we have seen democracy and sovereign completely removed from the hand of Greek people. For the past year, Greek Prime Minister Papandreou has been bowing to ECB, IMF, Sarkozy and Merkel by continuously imposing austerity pressure on Greek people and selling off any remaining profitable Greek assets. Austerity measures have only imposed more taxes on Greek citizens and choked life from the economy. Instead of reducing Greek debt, these continuous rescue packages only simply kicked the can down the road. Papandreou and his government has practically been stripped of all power and forced to do the bidding of unelected officials of ECB. When I look at Greece in the past year, I can only see politicians from both parties comply with the demands its EU creditors, whose only goals are to protect the European banks. The prolonged process has not only choked the life out of the Greek economy and its people, but also made Greek debts situation more unsustainable. The moment Papandreou tried to give power back to the Greek people to let them decide their own fate, Eurocrats from both inside and outside of Greece jumped in to crush any hope of referendum. Instead of giving Greek people a chance of voting for their future, the opposition party and Papandreou's own cabinet revolted to comply with the wishes of Sarkozy and Merkel. The worst part is that Greece is now certain to default and will be forced out of Eurozone. Greece should have defaulted much earlier and went back on the drachma, but now the entire nation has grounded to halt from all the austerity measures and strikes. Even if Greece had the strongest military in the Eurozone, it would not have been able to defend itself against this intrusion of its sovereignty by international banks and Eurocrats. Not a single bullet was ever fired, but the Greeks have lost all sovereignty and democracy. Similar attacks against sovereignty are occurring in all the other PIIGS countries. The bond market has started to attack the public sector debts in Italy, the third largest economy in Eurozone. When Silvio Berlusconi dared to land at the G20 meeting without any new austerity and reform plans, European leaders sent in officials to Rome to look over Italy's books to check the progress of previous reforms. Berlusconi is already facing charges of bribery and tax fraud; the added pressure from failing to please the Eurocrats has basically put his coalition government on the edge of collapse. The pressure on Italy will not stop after Berlusconi resigns. There will simply be more pressure on Italy, Spain, Ireland and Portugal to give up on their sovereignty and comply with the demands of ECB and Eurozone. All of these measures will only kick the can down the road and impose more unbearable austerity on the people. Right now, the financial market's attention is on the Eurozone, but the EU sovereign debt issues will eventually be resolved in one way or the other. After which, the market will turn its eyes on the unmanageable public sector debts in US, Japan and UK. These countries have the ability to print their own money endlessly, so it will be interesting to see how the debt situations in these countries will play out.

What I want to show is that aircraft, submarines and tanks cannot save a country from a war against on sovereignty by the financial markets, so addressing the debt issues is imperative. Greece has already lost sovereignty to the unelected ECB/IMF. Other PIIGS nations are losing sovereignty. China and America really cannot afford to get into an arms race when looming economic issues can bring both countries’ debts situations to the forefront. The two countries should work together to balance out trade distortion. That means China should loosen some of its capital control and market access, while America needs to create better environment for its business to grow. Having closely followed the American election season coverage and the incoming Chinese leadership shuffle, I feel like we will simply get more politicians who are not willing to make the tough decisions needed to avoid the problems we have already seen in Middle East and are seeing in Eurozone. Fiat currencies have allowed governments around the world to run up huge public debt. Cuts have to be made in all sectors of the government, while failing banks/enterprises should not be bailed out. Military spending must be part of the cut. If that means reduced global ambitions, then the country must be prepared for a more humble foreign policy.