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Investing Pioneer – 6:55 PM EST – 11/17/2022
Major conflicts are an ultimate catalyst and contributor to the unpredictability of economies. At Investing Pioneer (www.investingpioneer.com), when potential conflicts hit the radar, due to their likelihood, imminence, and potential widespread impact, denoting and understanding the probabilities and range of possible outcomes are paramount to establishing a fair economic outlook to form a sound investment and business thesis.
Black Swans are black swans, sure. Meaning some may postulate such exercises are a moot point, as in a sound portfolio, the confluence of potential outcomes is inherently accounted for, and historically, shouldn’t prove an issue.
For entrepreneurs, businesspeople, or stakeholders in specific sectors with outsized exposure to China, Taiwan, related industries, and second+third order effects that would arise from a major conflict between the neighboring nations, the story is different. You’d probably want to keep a finger at the pulse of the evolution of the economic and geopolitical contributors fueling or de-escalating tensions (meaning, this article is especially for you).
That said, for a major conflict, the impacts would be far-reaching, to almost every person on Earth, in some way or another.
Either way, understanding to the best of our ability what could be to come based on present and past developments is a fair endeavor.
The COVID-19 pandemic accelerated monetary expansion while creating supply issues and widening the gap between the true productive capacity of the economy and the amount of available credit. Naturally, high inflation followed. Indeed the highest for the U.S. in ~40 years. Subsequently, Russia invaded Ukraine, a military maneuver with widespread and long-lasting effects.
With this, the economy is being stress tested, exposing severe issues relating to energy, real estate, and the financial system at large.
After the series of destabilizing events over the past several months and years, it can be hard to imagine worse to come.
But the fact is, underlying economic and geo-political factors are coming to a head. That means more potential turmoil, especially for China and Taiwan.
From an economic perspective, a Taiwan conflict may prove one of the most significant events over the next five years. But many have grown weary of China’s talk – is it all talk?
Taiwan’s sovereignty is at real risk. Only 130 km off the coast of mainland China, it represents an established and burgeoning capitalist entity with great infrastructural systems in place for the production of a key resource. Some call it the new oil (though of course, in literal terms, it doesn’t supplant oil in the context of energy).
As certain well-positioned companies have moats, – proprietary technology, resources, techniques, infrastructure, etc. (which may not be replicated effectively or at all in due notice) – countries can as well. And Taiwan certainly does.
TSMC, the company responsible for this outsized industry, comprises 55% of chip production globally, accounting for over $400 billion in revenue a year.
Because of recent limited sanctions on semiconductors by the US, and the growing importance of the advancement and supply of computer chips in the context of growing military and technological rivalries (as the rift between China and the US widens), Taiwan appears at severe risk of a military invasion from China within the coming years.
For decades, speculation surrounding the potential for an invasion of Taiwan has been prevalent. Its proximity, economy, and the CCP’s official narrative make it hard not to assume it’s possible. Putin’s invasion of Ukraine in February added fuel to this conversation. For some, the risk suddenly felt more tangible, and people were quick to draw parallels. That said, there are several key differences between the two scenarios.
Though it’s certainly a matter of if (they ever do invade) – it’s more a question of – when. Are external or internal factors more integral for the initiation of such an invasion? How is the rapidly evolving global economy – leading to heightened turmoil – poised to affect contributing geopolitical variables?
What developments would compel China to invade Taiwan, due to which they probabilistically perceive the risks and downsides of an invasion are lower than the potential benefits for the mainland nation?
Maybe most importantly,
What would such an invasion look like?…
To what extent would the United States intervene?…
What would the global effects be, both economically and geo-politically?
Let’s dive in.
Historical Background of China and Taiwan
In 1911, China underwent a revolution, with the Chinese Nationalist party gaining control, beginning the age of republicanism for China, ending thousands of years of imperial rule (with a different dynasty every couple hundred years on average).
In the decades following, China would experience a communist revolution, leading to the creation of the People’s Republic of China, formally established by Mao Zedong on October 1st, 1949. The opposition leader of China prior, Chiang Kai-Shek, with his government and army, retreated to Taiwan the same year. Over a million migrated to the Island Nation, with an army on the island consisting of approximately 500,000 troops, serving as a reason to prevent any easy invasion by mainland China to conquer the last major bastion of organized resistance to China’s communist movement.
With the outbreak of the Korean war in 1950-53, the US arrived to intervene in the region to quell hostilities by dispatching a fleet in the Taiwan Strait.
The United States signed a treaty in 1954 to pledge support for Taiwan in the context of an invasion by the PRC.
However, in 1979, the Taiwan Relations Act established that the United States would support their ability to defend themselves, but would not directly participate in the conflict (in the form of troops, etc.). The act represented a major step towards appeasing mainland China.
This stands in contrast to a recent statement by Joe Biden saying US forces would defend Taiwan in the context of an invasion, a step further than the intervention the United States is currently providing to Ukraine, in the face of the invasion by Russia, which includes the shipment of military supplies and designated government spending.
“Biden says the U.S. would intervene to defend Taiwan if China staged an attack.”NPR
Since 1949, mainland China has consistently rebuked Taiwan’s claim of sovereignty. The US held the opposite view against mainland China with the global stage signaling the same. This started to change by 1971 under Nixon. The PRC received enough votes that year in the United Nations general assembly to establish the PRC as representative to China, in contrast to its island counterpart. The year following, Nixon would visit China, opening the country to the west in a historic way, sparking the major trade relations that continue to this day. That’s why “everything” says “made in China”.
By now, only 13 of the 193 UN nations worldwide accept Taiwan’s sovereignty, an effect of foreign policy decisions by the US in the 70s, and a reflection of China’s growing dominance and influence on the world stage.
In response to the concern that the United States and Taiwan were drifting away from the mindset of unification, in part triggered by Clinton’s move of granting the President of China a visa to visit the United States, and other events establishing a worrying pattern in mainland China’s eyes, tensions rose and a series of military tests as a means of posturing occurred. This would be known as the third Taiwan Strait Crisis, and involved a series of missile tests, air and naval-based exercises near Taiwan with commensurate verbal threats as well.
At that time, China’s economy and military strength were meager relative to the US, to say the least. Predicated on that fact, an order by the Clinton Administration to position two aircraft carriers in the Taiwan Strait meant the crisis quickly came to a close. More than 25 years later, China’s economy and global importance have grown immensely, with a significant investment toward military spending having occurred during the same period. This begs the question of how a “fourth Taiwan strait” crisis would play out. Indeed, the risks associated with escalation have changed greatly since then.
This coincides with the general theme of US dominance globally, and how it will evolve. Is the invasion of Ukraine and a potential invasion of Taiwan a reflection of rebellion against the US in the face of diminishing power? Putin said in a recent speech (translated to English): “America has nothing to offer the world except world domination”.
Are these key movements by nations a reflection of a broader trend to establish a more “multi-polar” world? The creation and growth of BRICS indicate this could be the case.
Effectively, what Putin is saying is that for too long has the United States taken advantage of other nations and that other nations should push back, creating a multi-polar world instead. Of course, political dogma is subject to distortion, inaccuracies, and strong biases, and any speech or statement from Putin should be treated accordingly. Nonetheless, it may provide some context for broader motives and trends that may grow, not just for Russia but others standing against U.S. hegemony. Whether this derives from a longer-term principled outlook, or is based on short-term self-interested purposes remains to be seen.
In another statement by Putin, he said, “where once to see a country disagree with the United States was rare, today it has become common.” Though this is true in certain respects for certain timelines, there have been several instances in the past, to say the least, of countries disagreeing with the U.S. (as Putin puts it). Whether the rate has truly increased needs further investigation.
As we enter a period of economic contraction, self-preservation and a reduction in the globalism of the economy may be seen. Such a period may mean a diminishment of the current hegemony, and instead more bilateral agreements, ousting the dollar and US from control or increased benefit. This does not mean the United States will not remain the leading superpower.
BRICS, Multi and Bilateralism, Trust and Protectionism
After the Russian invasion of Ukraine, the United States and several other nations and companies cut ties with and sanctioned Russia and Russian companies. Saudi Arabia instead strengthened investment and ties with the country.
“Taken together, the moves represent a distinct Saudi tilt toward Moscow and away from the United States, which it has typically aligned itself with.”
“Obviously, Saudi-Russian ties are deepening”-NYT, Bill Richardson, a former U.S. energy secretary and ambassador to the United Nations.
Saudi Arabian and OPEC defiance of the United States is nothing new, to be fair, though as shown above, it may represent a shift from long-standing behavior.
Analyzing the general global trend for the last decade or so, a pattern emerges:
Standing for Brazil, Russia, India, China, and South Africa, it originally was an acronym coined by the economist Jim O’Neil (then BRIC) in the early 2000s. Then, it turned into a more cohesive organization, in theory serving as a competitor to G7 nations. The first BRIC summit was held in 2009. Now BRICS, the 14th annual summit was held in Beijing on June 23rd, 2022.
This year, it has been stated Argentina, Egypt, Turkey, Iran, and Saudi Arabia express a willingness to join the economic coalition. Whether these moves are significant in terms of progressing any formal and organizational power of BRICS remains to be seen.
Since 2000, multiple marked economic and geo-political moves have been made, with several commentators saying it indicates the fall of the US dollar as a world reserve currency is underway.
These catalysts referenced include the 2008 financial crisis, sparking the years of QE, adding to the base money supply. Shortly following 2008, many suggested high inflation or even hyperinflation would soon follow due to the monetary policy pursued by the Federal Reserve and other central banks in response to the great financial crisis.
This has not proven true yet, of course. There is a very simple principle that explains this. If you create, as an example, 1 trillion dollars, but keep it in an account, does it cause inflation? No.
This is why the average velocity of the total money supply has fallen. At the same time, the price of financial assets has risen greatly and consistently in this period. This includes the stock market. Indeed, Quantitive Easing has fostered the rise in prices of publicly traded securities. The sustainability thereof is called into question. The answer isn’t just a simple recession or moderate pull-back in prices.
Monetary expansion was most marked in 2020-2021. Commensurately, this explosion in liquidity fostered speculative endeavors with a rise in the share price in stocks. Particularly, ETF Fund AARK fell victim to this speculative rally driven by the expansion in credit. Smaller stocks like GME, OCGN, and hundreds of other tickers garnered massive communities and saw unprecedented rises in share price as well.
Of course, such speculative rallies are nothing new. Take the dot-com bubble of the late 90s and early 2000s.
Continuing, China and Russia began using their respective currencies to settle bilateral trade in 2010, bypassing the US dollar. The Atlantic Council called them “partners in de-dollarization.”
In 2011, the former President of China said “the current international currency system is the product of the past” (Washington Post, 2011).
A question, of course, is whether this is merely political dogma with little connection to reality. Today, in 2022, the dollar, as indicated by the DXY (a basket of currencies measuring the strength of the dollar relative to those currencies), is at multi-year highs.
A series of other bilateral agreements, including between China & Japan, India & Japan, Russia & Japan, and others happened in the last decade.
Mike Maloney, a well-known economic and monetary commentator, who believes the US dollar is poised for a sharp decline in purchasing power (in effect, hyperinflation), calls these events “nails in the coffin” for the dollar and the current financial & monetary system as a whole.
Speculating, in the context that such a collapse does occur and runs its course, the United States’ dominance would not necessarily be as reduced as some postulate. Indeed, such an event involves the entire financial system, meaning all countries will be affected.
Some of this may be trust breaking down. A byproduct of this, as Maloney has discussed in several presentations, is several countries requesting the repatriation of their gold or even further, purchasing record amounts of gold.
In a recent video, Maloney indicates how central banks are purchasing more gold since 1967 – when the monetary system was still based on gold (US dollars were backed by the gold reserves of the Fed).
Against this economic backdrop, certain factors relating to the geopolitics surrounding the US, China, and Taiwan may be better evaluated. There can be no doubt that on a global scale, most or all countries will suffer as inflation and interest rates become a more unwieldy issue. Note, inflation has proven to be higher on average for nations other than the United States.
As well, china alone is potentially facing a severe economic crisis.
With this, we can begin to review specifics surrounding Taiwan. Recently, China’s communist party adopted the rejection of Taiwan’s independence itself into their constitution.
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Recently, sanctions by the U.S. regarding computer chip manufacturing and trade have left China in a vulnerable position, potentially increasing the incentive for an invasion of Taiwan to intervene or obtain TSMC’s infrastructure and technology. It is said in the context of an invasion, the factories would be destroyed by Taiwan itself. In theory, this should reduce the economic incentive of China. Of course, the political incentive remains.
An important aspect to consider when discussing a proxy war between the US and China is rare earth metals. US military reliance on Chinese exports of rare earth metals is significant, as China accounts for about 80% of exports globally (according to a U.S. geological survey released in 2019).
Due to this fact, in recent years, the US has planned to decrease reliance on China by allocating investment to US-located rare earth metal mines. If China caps exports of rare earth metals, previous production amounts (military and commercial means) will be difficult or infeasible.
In January 2021, the Ministry of Industry and Information Technology of China proposed controls on the export of rare earth metals. Presumably, this has military motives. A Financial Times article stated, “China targets rare earth export to hobble US defense industry.”
A smaller, yet potentially important factor is the exportation of javelin missiles from the US to Ukraine which is said to be diminishing supply to the extent that if an invasion of Taiwan occurs soon, the ability to help could be diminished if capacities are not replenished. This seems less probable due to the timeline of an invasion of Taiwan, which realistically may begin at the soonest, in one to two years, if at all.
Going back to recent U.S. sanctions on computer chips, this negatively affects China’s supply of computer chips, AKA: cutting off the supply of advanced chips.
The Chinese Commerce Minister, in response to NVIDIA being told by the U.S. to halt top AI chips to China, made statements urging the U.S. to “stop wrongdoing immediately”.
Kirian Van Hest (@desogames on Twitter) has said what the US just did is somewhat equivalent or similar to the oil embargo by the US to Japan before Pearl Harbor and the declaration of war (WW II) that followed.
Indeed, this coincides with the popular statement in recent years that semiconductors are ‘the new oil’, or rather a new oil, as oil is not supplanted as they don’t serve the same basic purpose. The catchphrase comes from the importance of semiconductors, often called the ‘backbone’ of the modern economy. Of course, the hierarchy of importance favors energy.
Conclusion and Outlook
Considering any shortage in supply (for high-tech computer chips) for China, the increasing provocation of Taiwan in their narrative and military practices, and the proximity of Taiwan coupled with a progressively more unstable global economy (macro-economically) and the fact that the Mecca of semiconductor production is located only 100 miles off the coast of mainland China makes Taiwan at considerable risk of invasion in the coming years.
Accordingly, as a direct impact, the price of semiconductors is expected to potentially rise significantly in coming years.
It remains somewhat unclear what the United State’s role would be in the context of an attempted invasion (in terms of, to what extent they would intervene).
The present situation could be resolved if in the coming several months it appears tensions fall, and factors associated with an increased chance of invasion are reduced. To do this, less protectionism and more cooperation would be necessary.
Inflation will continue to prove an issue, and the economy will get much worse before things get better. The unique alignment of macroeconomic variables may warrant an altered investment strategy for the foreseeable future, relative to the past several decades.
Indeed, value investments that tend to perform well in most economic headwinds will never be, by and large, bad holdings on a long-term timeline. This said, a general shift in capital to non-productive assets is expected. Meaning, although cliché, gold, and silver are expected to outperform in the following 12-48 months. These expectations are not a certainty.
The above does not construe financial advice. The author, nor the website, are not, nor construe the role of financial advisors. The author or site are not responsible for investment or financial decisions based on the above article. The contents of this article is for informational and educational purposes only.
This publication is for informational purposes only and is not intended to be a solicitation, offering or recommendation of any security or investment.