(Bloomberg Businessweek) -- First came tariffs on Chinese imports, then several rounds of sanctions and an outright embargo on exports of state-of-the-art computer chips. Now, America's multiyear campaign to deter, counter and stymie Xi Jinping's China—an effort that started with President Donald Trump and has escalated under the current administration—is shifting to a new battleground where the stakes are even higher than in trade or technology: finance.
Last August, in Executive Order 14105, President Joe Biden directed the Department of the Treasury to draw up rules barring US investments in entities suspected of helping to develop next-generation weaponry for China's war machine. Soon, probably in the next few months, that ban will go into effect.
This won't be the first time America has throttled the flow of capital to China; both Trump and Biden prohibited US investors from buying a range of publicly traded securities with military ties. But in its scope—potentially encompassing any Chinese company or organization, public or private, involved in semiconductors, quantum computing or artificial intelligence—EO 14105 has no precedent. It covers vast swaths of the economy and, effectively, aims to asphyxiate entire industries key to China's capabilities on the battlefield and in cyberspace.
“The problem with designating specific entities is that it becomes a game of whack-a-mole: Every time you go after one, another pops up,” says Rick Sofield, a partner at law firm Vinson & Elkins who formerly oversaw national security reviews of acquisitions at the US Department of Justice. “Here, they're defining whole categories based on the nature of the business. That's not something the US has ever done before.”
While the full extent and potential impact of the boycott won't be known until the Treasury Department publishes a draft of the rules and invites comment from interested parties, the broad outlines—and points of contention—are already clear. According to an August notice from the department, the range of covered transactions is likely to include mergers; acquisitions of minority interests; private equity, venture capital and greenfield investments; joint ventures; and convertible-debt financing. In 2022, total US foreign direct investment in China rose 9% from the year before, to $126.1 billion.
For most of the postwar era, sanctions were tools of economic coercion, a way of punishing “bad actors” such as Cuba, Iran and North Korea for harming US interests and forcing them to change behavior. By 2018, however, the thinking had changed—at least as far as China was concerned. Kurt Campbell and Ely Ratner, then former officials with expertise in Asian affairs and national defense, argued in a landmark essay in that American efforts to “shape China's trajectory” had utterly failed and US policy needed to reflect “a more realistic set of assumptions.”
The consensus that has since emerged in both the White House and Congress is that China must be treated not as a partner willing to give and take but rather as a strategic adversary. And today, Campbell and Ratner are key architects of Biden's blueprint for US power and influence in Asia.
US officials believe the Chinese government under President Xi is exploiting every opportunity to obtain cutting-edge technology via the private sector and redirect it to military and security applications. That's what drove the US Department of Commerce to restrict chip exports in October 2022, so China couldn't use advanced processors such as Nvidia Corp.'s A100 and H100 to power AI engines. When Nvidia modified its chip designs to skirt the controls, the Commerce Department banned them, too.
Now the government is extending that concept to outbound investments. “This is absolutely a weaponization of economic tools toward national security ends,” says Adam Smith, who heads the international trade practice at Gibson Dunn & Crutcher and formerly specialized in sanctions on foreign governments in senior roles at the Treasury Department and the White House. “The door is open to much broader restrictions on investment flows.”
Beyond resolving the obvious moral dilemma of enabling Xi's hostile ambitions, such as the absorption of Taiwan, there's an official rationale for targeting capital flows to China. As Biden explained in his August executive order, US investments risk exacerbating the threat that China presents, because they confer prestige and credibility and often are accompanied by helpful counsel, market access and additional financing. He declared the situation a national emergency.
One pitfall, of course, is that China's military-industrial complex can easily get money from non-US sources. Unlike high-end semiconductors, which are expensive, difficult to produce and supplied by only a few companies, such as Nvidia, dollars are ubiquitous and fungible.
“Do we really think the Saudis or the Emiratis or the Qataris won't invest?” says Gary Rieschel, a longtime tech executive who founded Qiming Venture Partners in Shanghai in 2006. “Over 90% of the money going into VCs in China is renminbi. They don't need US capital.” He thinks the US should focus instead on extending its technological lead in key industries and catching up to China in others, such as electric vehicles.
Then there's the problem of overcompliance. As currently envisioned, the new rules will explicitly ban transactions involving technologies and products that the government deems a “particularly acute national security threat.” A second category of transactions—those that “may contribute” to the threat to US national security—will require self-reporting. In other words, any US entity investing directly or indirectly in China's semiconductor, quantum computing or AI industries will face deciding whether to notify the federal government.
“It's all reliant on the private sector to interpret and implement,” says Smith, who like Sofield advises US clients on foreign investments. “No one wants a knock on the door from Treasury or the Justice Department.”
Treasury Secretary Janet Yellen has denied repeatedly that the Biden administration is seeking a “decoupling” from China, and in its August notice her department said the forthcoming rules are “not intended to impede all US investments into a country of concern or impose sector-wide restrictions.” To the China hawks in Congress, that doesn't go far enough. A bill introduced by Michael McCaul, the Republican chairman of the House Foreign Affairs Committee, and Gregory Meeks, a Democrat, adds hypersonics and supercomputing to the proposed list of prohibited investments.
For many, the net effect is confusion and uncertainty. Corporate boards and management teams may determine it's safer to “self-sanction”—i.e., not invest—than to risk noncompliance. In a sign of the descending chill, the main pension fund for US federal employees, the Federal Retirement Thrift Investment Board, in November moved to exclude China and Hong Kong from its portfolios, citing the possibility of yet more restrictions on Chinese investments.
“China has had limits on outbound investment for decades,” says Sofield of Vinson & Elkins. “We in the US operated with this conceit that by having free trade with China, they'd become more like us. We never thought it might make us more like them.”
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