Ian Bremmer on the four challenges that could push China and the US to the brink of a new cold war. The interview is part of the Risk Response Network’s “What if?” series.

What is your main field of expertise and current research?
I view myself as someone who focuses on global political risk, on understanding how politics intersects with the global marketplace. The areas that I am most personally focused on within that space would be states in transition, which historically have been in emerging markets. However, frankly, when we look at today’s environment, states in transition are occurring all over the world. For example Europe is a group of states in transition right now. So it is on that macro level, looking at geopolitical risk in terms of the tectonics of how countries, states and regions interact.

Given your research, what would you say is the most under-appreciated risk?
I think that the most under-appreciated risk right now is the rebalancing that needs to occur between the United States and China. This is particularly true because the developed world right now is so focused on its own internal economic challenges. This is true in Europe, of course, and it is true in the United States given the fiscal crisis, the debt limit issue and budgetary issues. It is true in Japan with the political and internal crises along with recovering from the massive earthquake, tsunami and nuclear catastrophe. And then you have the Middle East.

People are focusing on these day-to-day headline issues; yet, the biggest change is that we have a world economy in which the largest economy is not doing so well. The world’s second largest economy is growing very, very strongly; yet in many ways they have very incompatible economic and political systems.

The ability to manage these relations in a smooth way is going to become an enormous challenge and the relationship cannot work the way it used to. This is largely because the Americans cannot buy what the Chinese produce, because the US Dollar is not what it used to be for the Chinese over the long term, and because the Chinese economy needs to fundamentally rebalance itself. So when you put all of that together it becomes by far the most important issue for everyone.

How would you frame this risk as a hypothetical scenario: “what if” this was to actually happen?
I think that it is in process, but it is under-appreciated and the signals are weak, the signal detection is weak. So those studying this are asking a question like: what if the United States and China become fundamentally disposed towards confrontation in their bilateral relationship?

In your analysis, how might this “what if” scenario unfold?
Well, I think that there are a lot of issues that will not cause big problems between the United States and China, and there are some that will.

For example there is a lot of concern about currency. The US has pressured the Chinese to revalue their currency in the immediate term which they are not doing. The Americans are not going to push very hard on this as they do not have much leverage, and so we know the Chinese are going to do what they want. China is going to be a piece in US elections, but it is not a big piece because the Americans are distracted by their budget issues and the US economy.

China’s political succession is coming up in 2012. Yes, there will be more nationalism, but they are not going to beat up on the Americans in a significant way. Furthermore, Taiwan is pretty much a non-issue – the Chinese have already effectively won that no matter their protestations about the Americans selling weapons.

So, those are the issues that will not cause problems, but there are some that will. I think that there are probably four big ones that I would worry the most, the things that could really precipitate a massive sudden deterioration in the relationship between the two countries.

The first is what if a big US industrial company decides to pull out of China? (For example, Boeing or General Electric.) We saw Steve Ballmer from Microsoft come out publicly in his shareholders meeting a while ago and say we are making 5% of what we should be in the Chinese market because of piracy and everything else. What if Microsoft says: we just cannot do it any more, and so we are withdrawing from China? The world’s biggest export market would be gone. Companies would create a big stink about it in the US and suddenly it would touch off this massive debate about how we do business in China.

A second factor would be a massive cyber security incident. Clearly, cyber attacks are getting much worse and overwhelmingly the concern is about US-China, and not Russia, rogues or WikiLeaks.

The Pentagon’s cyber strategy is focused overwhelmingly on spending money on defence. When was the last time the United States had a big new platform for a new military doctrine? That was when nuclear weapons came about and no one had ever dealt with these weapons before. This required a strategy of spending overwhelmingly on offensive capacity, not defensive capacity. Every time people talked about defensive spending such as missile defence, Brilliant Pebbles and Smart Rocks, which are key to defence initiatives, they got shot down (pardon the pun). They got shot down because there was recognition that if defence ever got really good, people might think that they had the ability to actually think the unthinkable which was a nuclear strike.

Now, we have for the first time a strategy on cyber and overwhelmingly the money is going to be spent on defence. That is a problem because it means that not only is war thinkable on the cyber side, it is expected. The reason they are spending on defence, of course, is because you do not know where these attacks actually come from and so as a consequence it is very difficult to credibly threaten mutually assured destruction when you do not actually know who you are supposed to be hitting – when you know the other side has plausible deniability.

This does not mean that we will not see escalation, this means that we will probably see escalation between the US and China – some of which will include industrial espionage, direct attacks at defensive installations and the rest – that has the potential to lead to a serious cold war environment and maybe something worse than that.

A third big risk: North Korea. The US has one perspective regarding North Korea while the Chinese have another and they are not prepared to play ball with the Americans in a serious way, because when North Korea eventually does go to a new leadership or when it falls apart, the Chinese want to make sure that that country does not move closer to the United States by forming a reunified Korea with nuclear weapons as an ally of the US.

This underscores that the US and the China do not trust each other on military issues, they do not have good conversations, and they do not have transparency. If North Korea blows up either inwardly or externally, you are going to have both countries on high alert and they will be on high alert mistrusting the other side’s moves, and that is very dangerous.

The final point would be Europe. The Europeans are in a very difficult situation right now. What happens if there is an actual crisis, a contagion effect in Europe because of the fiscal troubles?

Interestingly, there is no one who has a more strategic interest in a strong euro than the Chinese, because they desperately want to hedge away from the dollar as the world’s reserve currency towards something else. And so in a period of crisis, it is not what Moody’s is going to say, it is what the Chinese are going to say and do that really matters.

If the Chinese suddenly decide, we are moving away from the dollar and into the euro, but we are going to demand strong conditions, political and economical conditionality in return for us bailing these guys out. That could be the end of NATO. This would certainly be the end of the dollar as the world’s reserve currency, and would completely change the way we think about global geopolitics.

Those are the four things that I would focus on as serious problems.

Who would feel the impact the most, and how?
Any investor in the world, anyone involved in the world economy.

You are moving from an environment where the world’s economies are generally following the same rules and values, supporting increasing the globalization of the economy, to one where the world’s two largest economies are fighting against each other.

That is obviously going to have a significant negative impact on economic growth. It would have more of an impact on the Chinese than anybody else because they are much more vulnerable than the Americans. They are still a poor country on a per capita basis and so that kind of a fight would have more problems for China than a deterioration of the US economic position. If the dollar is no longer the reserve currency, Americans will be spending a lot less. Their interest rates for borrowing will go up and so Americans will be a lot less wealthy. But Americans are very wealthy, so it would not have a significant impact on US stability.

Is the world prepared for this? Are the Chinese, in particular?
No.

And the investors?
No. I think this is a weak signal, as I said to begin with. I do not think this is something people are paying much attention to.

What is your top mitigation approach for this risk?
My biggest suggestion would be that first there has to be honesty between the US and China on where they have problematic relations, so there are not any surprises, and also in areas where there is still cooperation. You need to disaggregate the relationship so it does not become politicized. The US needs to focus on taking the kind of steps that allow it to be more competitive so that it does not move towards a more populist policy-making perspective.

Do you foresee such frankness happening?
Well, responsible stakeholdership is problematic. I think that it will exist. For example, I think that there was honesty when Hillary Clinton recently said, when asked about human rights in China, that you really should not be criticizing your banker. That is the kind of candour we need which lays out the fact that, while we do not like some of the stuff going on, we are actually not in the same position we used to be.

We need to be honest, not just about what we want but also about what is credible. We need to be honest about our power position. We need to be honest about what is actually doable and the fact that our perspectives are different from those of other people.

On the flip side of risk, what opportunities do you see associated with this scenario?
The way that opportunity comes from risk is that when you realize that something does not work, you try to create something new. Certainly, the opportunity is to create new institutions that actually reflect the changing power structure of the world.

You have organizations – whether you are talking about the International Monetary Fund, the World Bank, NATO, the G7, the G20 or the West – which reflect an old structure, a post-war structure of the world that was dominated by the West and which is not the case anymore.

The opportunity would be actually to reconstruct those institutions, or construct new institutions, because institutions do not reform fast enough by themselves incrementally to deal with the radical change in power that has occurred globally since the financial crisis. So, the opportunity would be for this risk to force the hand, creating new institutions or undertaking a much more dramatic restructuring of existing institutions to reflect that order.

Do you think the rest of the world is ready to cope with this kind of possible dramatic change?
No. The problem is that this is happening at a time when it is not just about elections in the US, it is happening at a time when the US is completely consumed in budgetary issues. It is happening at a time when the Europeans are completely consumed with whether you can create a fiscal union to go along with the currency union, which is desperately needed. It is happening at a time when the Japanese are not engaged in foreign policy whatsoever. Therefore, the developed world is not capable of addressing these issues right now.

Pictured: A soldier of the Chinese People’s Liberation Army stands guard in front of the Great Hall of the People in Beijing (Reuters)

Ian BremerIan Bremmer is President, Eurasia Group and author of Every Nation for Itself: Winners and Losers in a G-Zero World. He is a member of the World Economic Forum’s Global Agenda Council on Geopolitical Risks.