An overseas investment company is advising me not to keep too much money in Taiwanese banks (don’t worry, I’m not listening) based on this geopolitical strategist (Matt Gertken) outlook for conflict with China. You don’t have to agree, but it’s worth reading:
Subjective Probabilities:
1. War over Taiwan this year – 5%-17%. So far this year I have argued 5% but this could easily be upgraded to 17% or higher if conditions deteriorate sharply.
a. I give it low odds this year because (1) China did not act during the tumultuous transfer of power in the US (2) China wants to determine if the Biden administration will reverse course from the Trump administration on tech restrictions and Taiwan. (3) China has benefited from moving gradually and overtaking enemies at a point when there is little resistance, as with Hong Kong. The amount of resistance for Taiwan today is unknown but could well be excessive for China.
2. Crisis short of war over Taiwan in 2021-22 – 60% chance. While China may avoid war, it is still likely to impose economic sanctions which would prompt the US to use economic measures.
a. There could also be a miscalculation in the surrounding seas due to high pace of drilling and posturing.
b. China may wish to test the US’s resolve in order to determine whether to take more drastic action.
3. Eventual war over Taiwan – very high, say 75% chance. The Chinese have shown via Hong Kong that they are determined to assimilate Taiwan. Meanwhile the Taiwanese do not see themselves as Chinese anymore but as independent. See long-term public opinion trend below. The two systems of governance are irreconcilable. Taiwan is an island with defense forces and therefore more capable of defending itself at least somewhat.
The three red flags I’m looking for to upgrade the risk of war are:
1. China’s economy or political regime becomes internally destabilized.
2. The US attempts to transfer a game-changing offensive military capability to Taiwan.
3. Taiwan declares independence.
One or more of these factors occurring would cause me to upgrade my odds of war sharply.
The attached report has a game theory analysis comparing a US weapons transfer to Taiwan to the Cuban Missile Crisis. The conclusion is that China would attack Taiwan. It shows that the probability of 50%+ makes sense. But note that the US is not currently attempting to transfer offensive weapons to Taiwan, or to impose a total tech blockade on China. China is currently benefiting from its political and economic status quo and it won HK by biding its time. And Taiwan is not actively seeking independence.
Bottom Line – High risk of a diplomatic crisis over Taiwan this year or next. Lower risk of a full-scale war immediately. High-risk of full-scale war eventually. The current market exuberance is a good time to begin building safe-haven positions. Gold and TIPS are the best safe-havens at a time when inflation is also a rising risk.
