China: America’s Greatest Threat

The United States has gotten China wrong for the better part of four decades. Politicians, policy makers, academics, businessmen, and others naïvely assumed that China’s communist totalitarian system would evolve toward democracy and freedom. These elites did not understand that engaging with the 94 million-member Chinese Communist Party (CCP) is like having unprotected sex.

It is only recently that those who control the commanding heights in the United States have given due regard to the reality that CCP-controlled China, which regards democracy as an existential threat, is a menace to American’s security and prosperity. The reasons why are apparent from China’s activities in the South China Sea.

If there is to be a great power military conflict in the future, it will most likely involve a rising China challenging a predominant America. The list of China’s strategic initiatives is lengthy; everything from becoming a world leader in science and technology to economics and business to military might. The U.S. now faces a rising power, a confident, ambitious country that wants to supplant America’s role as the current global hegemon.

This goal is demonstrated by China’s actions in the South China Sea, which is strategically important to China’s goals and is one of the battlefields on which the competition between China and the United States will play out.

The South China Sea is a part of the western Pacific Ocean and borders southern China, Taiwan, Vietnam, the Philippines, Malaysia, Indonesia, and Brunei. More than $5 trillion in trade flows through it, roughly 30 percent of all global maritime trade. A major shipping route, the sea also accounts for about 10 percent of the world’s fisheries and a potentially significant amount of oil and natural gas deposits.

As the region’s link between the Indian and Pacific Oceans, the South China Sea is a vital trading and military route for the countries that surround it as well as for larger Asian economic powers, including Japan and South Korea. The country that controls the South China Sea has a strategic advantage in the region and a huge influence over global seaborne trade.

Xi Jinping, general secretary of the CCP, claims all of the South China Sea — lock, stock, and oil barrel — as sovereign territory. He backs up his claims by building aggressive military installations on existing islands, dredging new islands out of the sea itself and building airfields, “missile defense systems” and harbors that are essentially naval bases.

China bases its claims to the South China Sea on historical records from the Zia and Han dynasties that are thousands of years old. It is unlikely that Japan, Vietnam, and South Korea will stand by while China exploits them. The United States, as an ally of Japan, South Korea, and the Philippines, could be drawn into disputes surrounding these claims. It is worth noting that actions by China’s maritime forces aimed at the Japanese-administered Senkaku Islands in the East China Sea are another area of concern.

Following an appeal by the Philippines that China’s actions violated the United Nations Convention on the Law of the Sea, the Permanent Court of Arbitration ruled in 2016 that there was no legal basis for China to claim historic rights, while also finding that there had been several violations of the obligations set out in the Convention.

China refused to accept the court’s ruling and has continued militarization of the artificial islands with impunity. This is an expression of China’s newfound military and political power and its might-makes-right approach to international affairs. China’s expansion in the South China Sea is equivalent to Russia’s annexation of the Crimea in 2014.

America should not try to contain China unilaterally, but rather assemble a broad coalition with nations including India, South Korea, Japan, and the Philippines to confront, resist, and sanction China in the same way as it partnered with NATO and others to contain the Soviet Union during the Cold War.

Poker And Risk Management

Gambling – the willingness to take actions whose outcomes cannot be known for certain – is a basic human instinct. The riskier you perceive a particular action to be, the higher its potential payoff should be to justify your taking the action.

As it happens, the risk inherent in many actions can be roughly quantified. You can rank actions by their estimated riskiness, compare them to each other and to their potential payoffs, and make intelligent judgments about which (if any) actions to take.

This is known as managing risk. And the widespread failure to manage risk sensibly was a major reason why the financial industry melted down so catastrophically in the fall of 2008. To their peril, Wall Street firms relied on oversimplified models for managing their risk.

Many people insist that financial markets are simply a large collection of gambling casinos that offer investors a variety of “games” to bet on. This is almost right – but the almost is significant.

When you walk into a casino, you face an immediate choice. Are you going to play slot machines and table games like roulette and craps, or seek out the poker rooms?

If you choose slots or table games, you are likely to lose because you are playing against the house. The payoffs of these games are structured (with the blessings of state gaming commissions) to give the house an edge that assures you will lose in the long run. This is unlike the situation in the financial industry.

But if you choose the poker rooms, you have a chance of winning, because you are playing against other gamblers like yourself. The house simply hosts the games (i.e. provides the space, tables, and chairs, decks of cards, professional dealers and so on) and takes a modest cut of the pot for doing so. This is a lot more like the situation in the financial industry.

You can sit down at a table and become a “player” (which is like being a “professional investor” in the financial industry). But you have another option.

You can engage in side betting. People who visit poker rooms simply to watch the games can place side bets among themselves about the winner of the next hand. But since they’re unable to influence the hand’s outcome, their betting decisions simply reflect their estimates of the raw probabilities. These bettors are spectators with no influence over who wins the next hand.

But there are ways to refine your initial assumption about the win/lose probabilities.

One way is to simply watch a half-a-dozen or so hands and see which player or two seem to be dominating, then make a subjective judgment about the player’s probability of winning. Another is to look at the chip stacks in front of each player. If one player’s stack is twice as large as anybody else’s, it may be evidence of that player’s superior poker skills.

But suppose you recognize at the outset that one of the players is Jennifer Harman or some other highly regarded poker maven who tends to win a significant percentage of the hands they play. You reflect this by assigning him or her a higher win probability. You place most of your bets on the maven winning, possibly adjusting the size of each bet based on how well the maven is doing as the game progresses and what kind of payoff odds you’re getting from the other spectators.

An important point stands out about this poker example: You have a relatively large number of variables to keep track of, and their interrelationships and relative impacts are constantly changing.

This is especially true in financial markets. During the years leading up to the beginning of 2008 many firms bowed to the temptation to oversimplify their models. Many of them turned out to be less than worthless when the proverbial expletive hit the fan and blew up the world or at least lit the fuse.