American Business Made China’s Fast Military Rise Possible

In mid-October, the U.S. Department of Defense sent a 212-page report to Congress about the rise of China’s military—and it read as a warning. China’s military is ready to fight wars and win them, it said. China controls key supply chains like ferromagnetic rare earth metals, the report warned.

Within the span of a generation, China’s military prowess has become second only to the U.S. in terms of a defense budget and No. 2 behind Russia in the number of active-duty military personnel. Is the U.S. afraid of Russia? Not really. We have been running proxy wars against Russia’s military for a decade—first in Syria and now in Ukraine. What about India? India, which makes the wings for the C-130J Hercules, has an extensive shoreline and the largest population of any country, is nowhere near China’s military capabilities on land or sea. But we are worried about China. No other country in history has risen so quickly from being a developing nation to being a near-peer competitor with the U.S.

How did China’s military rise so fast? We can find the answer by looking in the mirror: American capital and American businesses that outsourced to China turned it into the industrial and military powerhouse it is today. As much as we might not want to admit it, we created this Frankenstein’s monster.

China’s Military, America’s Capital

China’s defense industry has been built with the help of American capital—from Silicon Valley investments in military drones to Wall Street investing in defense contractors. In return, the U.S. defense industry is built with the help of Chinese goods. If tensions rise between China and the U.S., China could easily choke supply chains the U.S. relies on. Why would China want to supply the country it’s fighting with the hardware we need for weaponry?

This is a serious problem, and the defense industry knows it. The very companies that supply the Defense Department with fighter jets and aircraft carriers can’t get these things built without China. According to some, like Greg Hayes, the CEO of Raytheon, there is no replacement: Back in June, Hayes admitted that Raytheon can “de-risk” from China but could never leave it. “We have several thousand suppliers in China. Decoupling is impossible,” he said.

Since China entered the World Trade Organization in 2001, U.S. companies have outsourced goods production to China. China supplies the U.S. with everything from electronics for a motherboard in a fighter plane to the rocks and minerals crushed into powders to make electromagnetic equipment. China runs many supply chains thanks to years of outsourcing and its own smart moves to take a bigger share of the market.

Retail investors owning emerging market exchange-traded funds and mutual funds have put their money to work in the shipyards that built the Fujian aircraft carrier, a carrier that rivals the U.S.S. Gerald R. Ford currently powering off the coast of Israel in the Mediterranean Sea. Several Chinese-built ships are in the Persian Gulf right now, and for sure, Americans have been among their investors.

In short, Wall Street is funding China’s defense industry.

Wall Street Inaction

The federal government is making moves to limit American investment in China. In June 2020, President Trump put an investment ban on 31 Chinese defense contractors. U.S. investment firms held millions of shares in those companies—shares worth hundreds of millions of dollars—but under the ban, they were given one year to sell them. Then, in February 2022, President Biden nearly doubled the number of companies facing capital market sanctions to around 58, though some companies were not publicly traded.

But what about Wall Street? There, little seems to be changing. Investment management company Vanguard, for one, still invests in Chinese defense companies that are not on the government’s sanction list. CSSC Holdings Ltd. is the publicly traded arm of China State Shipbuilding Corp. Ltd. CSSC Holdings is not off-limits to investors, but China State Shipbuilding Corp. is. Vanguard owns nearly 9 million shares of CSSC Holdings, according to Morningstar. That’s roughly $29 million that China can count on for its military from American investors, based on share price and number of shares owned in two Vanguard funds. Vanguard’s $96 billion FTSE Emerging Markets exchange-traded fund also has holdings in 60 subsidiaries of Chinese military contractors and 20 companies that have been denied access to U.S. technology because they are deemed “military end users” by the Defense Department.

The Commerce Department, like the Defense Department, maintains a list of Chinese companies that face restricted access to American technology companies. Nvidia or Intel, for example, needs permission to sell to companies on those blacklists. Some of the companies are retail consumer goods manufacturers with crossover appeal to the military—technologies they’re using in their products can potentially have military usages. American companies selling computer hardware to Da Jiang Innovations (DJI), a Chinese drone maker facing export restrictions by the Commerce Department, need permission to sell hardware to it. But you and I can easily buy a DJI drone on Amazon, even though the Defense Department banned DJI technologies for U.S. military use in 2018.

Wisconsin Congressman Mike Gallagher, head of the new Select Committee on the Chinese Communist Party in the House of Representatives, said the Defense Department report should “send a chill down your spine.” According to the report, China currently has more than 500 nuclear warheads, a 25% increase over 2022. It has more long-range missiles than the Defense Department imagined, and its navy has 370 ships and submarines—up from 340 last year. That’s more than the U.S. Navy has. Gallagher said the report was “another wake-up call for the Biden administration to take action.”

But the Biden administration has taken action. It increased export restrictions. It expanded capital market bans on Chinese defense companies. What about if Raytheon took action? It’s already said it cannot, even as China sanctions the company. Instead of making the electronics and metals it needs here or, say, in Mexico or Brazil, Raytheon seems happy to source them from China. That’s Raytheon paying for China’s industry. And it’s not alone in doing so.

This is why China’s military has grown beyond what any other developing country’s defense industry has grown. The size of its industrial base is owed to its exports and to Wall Street, which long wanted an open market in China and got its wish. Billions have flowed into Shanghai and Shenzhen-listed companies since China opened those markets to foreigners, with the brakes being pumped by investors only within the last two years because of the pandemic and politics.

The Department of Defense benefits from keeping Congress worried about China—it controls the Department’s $700+ billion budget, after all. But what seems to be totally lost on the Defense Department is the fact that in the event of a real splintering of ties—a Soviet-style Cold War, which some will argue we are already in—the very contractors the department depends on are almost wholly reliant on China. They helped feed the beast the Defense Department is warning about. Good luck starving it.