South China Sea Dispute: The Flashpoint for a Market Meltdown

Forget the Turkish coup, and the arguments over whether it was staged or not. Forget Italian banks. And German ones for that matter. Forget the Fed, the RBA, interest rates and NIRP. And forget about the Aussie housing market. Forget all that, and cast your attention to the South China Sea instead.

Because, if there’s anything that could send markets into a real tizzy, it’s the prospect of skirmishes between the world’s major powers.

Of course, territorial disputes in East Asia are nothing new. The China–Japan row over the Senkaku islands (known as Diaoyu in China) has simmered for much of this decade, as China has expanded its naval and military muscle.

But the latest cracks in the hotly contested waters appeared in the wake of Filipino claims to a large territory of the ocean. These claims were backed up by the UN, which, last week, ruled that China had no legal basis to most of the South China Sea.

Who’s right? It’s hard to say. Oceans are very tricky things to dissect. There are no natural borders to define territories. Such disputes lead to lots of problems in regions where there are as many competing powers vying for supremacy, such as in East Asia.

If you looked at a map of East and South East Asia, you’d probably raise your eyebrows at some of China’s claims, which seem a long way from home, so to speak. But again, oceans aren’t like states. If you’re the world’s foremost naval superpower, as the US is, you can plant your carriers and submarines where you like. Anyone that wants to dispute your actions can take it up with your destroyer, if they’re so inclined.

China is merely doing the same thing with its claims, albeit on a smaller scale.

In any case, China’s territorial claims are a by-product of its inevitable rise to superpower status.

For China, there are geopolitical implications in having control over the seas that cradle eastern Asia. Protection of shipping lanes, access to important resources, and limiting the influence of US naval dominance in their backyard are all part of China’s strategic plans in the region.

This last point is perhaps the most important, as it underpins the tensions that have risen of late.

China is surrounded by nations which enjoy strategic partnerships with the US, which guarantees their safety. Japan, South Korea, Vietnam, Thailand, Malaysia, Taiwan, the Philippines and Indonesia all hold fears over China’s aspirations in the region. The US, meanwhile, uses its partnerships in the region to ring-fence China, ensuring that its expansion is kept in check.

It doesn’t take much then to realise that Washington was behind the Philippines’ counterclaims in the South China Sea. Or indeed that the UN would’ve been pressured by the US to rule against China at the tribunal. Without the backing of the US, the Philippines would never have antagonised China in the first place.

China versus the world: Hot or cold war?

The actual likelihood that we’ll get a ‘hot war’ between major powers (US included) abutting the South China Sea remains slim. Typically, major powers don’t engage in outright warfare. That type of thing is reserved for world wars. And, short of waltzing into the Third World War, the likelihood of outright military conflict between China and the US is negligible.

But a colder war, played out through proxies, is a whole different beast. And because contemporary warfare wears a number of different masks, you don’t have to fire a gun to kick things off. From China’s point of view, the UN ruling could’ve easily been construed as an act of war against China.

So how does a proxy war pan out?

Any such scenario would likely take the form of skirmishes on the seas at first. US support would be indirect, through the supply of intelligence, weaponry, and so forth. If the US involved itself directly, it would have far greater implications, almost certainly igniting a fuse for a much larger ‘hot war’.

Yet even this scenario of proxy wars remains slim, not least because of the ramifications of such a development. But that’s not to say that tensions won’t keep simmering.

For one, the UN ruling against China has defined where the ‘international community’ stands on the issue. But will that prevent China from dredging and expanding its territory in the South China Sea and beyond? Will it stop it from escalating its naval and military influence in Asia? Not likely.

What we’re left with then is the status quo: China keeps expanding its territorial claims…the rest of East and South East Asia grumbles about it…and the US continues making threats towards China, pushing through indirect sanctions against the Middle Kingdom.

The outcome of all this? More of the same.

China will continue about its business, and will probably ignore the UN ruling, paying only lip service to it in public. They’ll sit back and react to any further moves the US and its partners in the region make. These moves won’t be overt, but it’ll be obvious who’s doing the pushing.

The bad news for the global financial system is that the ‘proverbial’ would really hit the fan if this dispute blew up into something bigger. The good news is that it seems unlikely, as long as the US is willing to tolerate it. But with China sure to stay the course, only time will tell how long the US will allow China’s ambitions to manifest in the South China Sea — and beyond.

Apple and KFC bear brunt of public anger

On a more ‘light-hearted’ note, two indirect losers from the fallout over the tribunal decision were Apple [NASDAQ:AAPL] and Yum! Brands [NYSE:YUM] (owner of fast food outlet KFC).

Public opinion, at least in some quarters, has turned on the respective tech and fast food giants.

Videos have emerged of Chinese protesting outside KFC outlets, calling for a boycott of Colonel Sanders and his famed fried chicken.

Yet the brunt of the anger was reserved for Apple, with videos showing one-time Apple acolytes smashing iPhones into smithereens in protest.

As US-based conglomerates, it’s no surprise that such iconic brands were feeling the effects of anti-US sentiment in China.

That said, you suspect many of those that participated in the ritual will be buying new iPhones next week. Apple might regard that as something of a victory…

Mat Spasic,

Contributor, Markets and Money

PS: Closer to home, we might already be at the beginning of the next crisis, according to Markets and Money’s Vern Gowdie.

Vern is the Founder of The Gowdie Letter and Gowdie Family Wealth advisory services. As one of Australia’s top financial planners, Vern says the next crisis is already in motion.

Australia has gone through two credit bubbles in its history. The third, and latest, has built up over the past 65 years. When it pops, the impact will leave a lasting mark on the economy. One that makes the 2008 financial crisis look like child’s play.

The fallout of this crash could significantly damage your portfolio and wealth. But, as Vern says, you can safeguard your wealth from the worst effects of the coming crisis if you take action.

Vern will show you how to do this, and more, in his latest free report, ‘Global Financial Crisis 2016: 3 Crisis Scenarios, and How They’ll Impact Australia’. To get your free copy today, click here.

Markets and Money offers an independent and critical perspective on the Australian and global investment markets. Slightly offbeat and far from institutional, Markets and Money delivers you straight-forward, humorous, and useful investment insights from a world wide network of analysts, contrarians, and successful investors.

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