The Massive Economic Impact If China Invades Taiwan

26:38So that's an incredibly important shift over the past 20 years that I think heightens concern. And then the third part is the political dynamics at play. Taiwan over the past 30 years of becoming a more full-fledged democracy, we've seen that go in parallel with changing attitudes on the island towards its relationship with China and its identity and how that relates to that cross-street relationship. And you look at polling today and the vast majority of Taiwanese identify as Taiwanese, not as Chinese, not as Chinese and Taiwanese, Taiwanese. And at the same time, support for unification, which was never that high, but was about 20 % in the 1990s, has dropped to below 5 % this year.

27:28So it's an incredibly unpopular idea. The vast majority of folks would just prefer the status quo, which is de facto separation. And then simultaneously you have on China and the mainland, a growing sense that China is a rising power, that creates both sort of a need and an opportunity to make progress towards these historic goals of territorial integrity and unification, which in their minds is all leading up to this national rejuvenation of China. And key to that is the idea of finally bringing China back together. That's their vision for what their end state should look like. And And Taiwan is one of the most important outstanding elements of that.

28:11So there's really sort of these divergent forces at play where Beijing is becoming much more focused on advancing progress towards unification and more concerned about trends in Taiwan, which are taking the island towards the idea of a very different sort of identity than it would share in a unification picture with China. I think it's worth mentioning the economic dynamics, which I actually think are secondary to the factors Jenny was mentioning, but the economics does matter. I think what makes it difficult, though, is that the direction in which it matters is not necessarily clear, right? So when the US and China, or the PRC itself, established diplomatic relations in 1979, Chinese GDP was one-tenth of US GDP, right?

28:56Now it's something like 66%, 70%, depending on which exchange rates you're using. So you might think, okay, so China is much more powerful now, which might make it more aggressive. But on the other hand, it has more to lose. It's much more integrated into the global economy. It is worth keeping in mind, however, that Chinese policies, Xi Jinping's policies, very much focus on industrial policy and self-reliance. In particular, they're worried about three things, the reliance on foreign technologies, which includes semiconductors, but is not limited to that, imported commodities, so things like oil and food and other things, And then finally, the reliance on the US dollar for international finance.

29:29And all three of these things are envisioning as efforts underway to address those vulnerabilities. I'm not saying this is just about Taiwan, but they do see themselves as being vulnerable. And there's definitely a geopolitical rationale for why they're worried about those things. And the more powerful and essentially insulated or robust, let's say, the Chinese economy and financial sector becomes, you might think they might have more confidence or less restraint as that single variable is concerned. And then, of course, there's the issue of Taiwan semiconductors, which is kind of like, in some ways, a gun pointing in both directions, right?

30:01Because yes, Taiwan makes most of the advanced semiconductors, but those primarily are going into inputs throughout Asia, including China. And so you could debate whether that's deterrence or not, because it could also mean that Beijing believes that other economies, particularly non-U.S. advanced economies, are less likely to intervene for those reasons. But it is part of the conversation. Actually, this reminds me of something I wanted to ask you, which is, you know, it's hard enough to model these types of economic scenarios because there are so many different factors involved. But also one of the things that makes it difficult is you're trying to model the response to whatever is happening.

30:38And so I'm curious when you're looking at something like the cost,$10 trillion or variations of it depending on the exact nature of the action, how much of that cost depends on or is affected by either the West's ability to ramp up things like semiconductor manufacturing or China's ability to, I guess, offset a bunch of resources being diverted to war? So we modeled one-year shocks. We actually internally were looking at and debating doing five-year shocks. The five-year shocks, the confidence intervals get much, much wider. And it's because you have to make bigger assumptions as to whether, for example, TSMC's production can move elsewhere.

31:24Would private industry have the resources in the middle of the war, for example, to get funding to say open a fab or whatever is necessary? I think with a one-year scenario, it's still speculative, but it's still difficult. but it's more plausible, which is that the economy in some cases could rely more on existing inventories of things. You would be more likely to see an immediate shock to production, say for things like autos or electronics. But if you're saying, okay, what about five years into this, how much of that is back online, then it gets more speculative. But that is part of it. Another part that I don't think we modeled directly is sort of wartime fiscal impacts.

32:01So you could imagine, particularly on the Chinese side, a lot of expenditures going into wartime measures, defense, et cetera. On the other hand, if you assume the conflict is, let's say, a few months or six months, depending on what your parameters are, it's probably not going to look like World War II. It's not going to be five years of ramping up and coming back, in part because what we're talking about in the extreme case is, from a U.S. perspective, at least mostly a naval and air war. and the U.S. defense industrial base, at least in my view, doesn't really have the capacity to replenish those forces quickly.

32:35So it's kind of a one and done in a very powerful way. There are others, I should say, in D.C. and think tank land that talk about the potential for a long war. I find that from a U.S. perspective not all that credible.

33:13We'll see you next time.

33:29Discover more at brightviewseniorliving.com. Equal housing opportunity. Hey, Ryan Reynolds here for Mint Mobile. You know, one of the perks about having four kids that you know about is actually getting a direct line to the big man up north. And this year, he wants you to know the best gift that you can give someone is the gift of Mint Mobile's unlimited wireless for$15 a month. Now, you don't even need to wrap it. Give it a try at mintmobile.com slash switch. Upfront payment of$45 for a three-month plan equivalent to$15 per month required. New customer offer for first three months only. Speed slow after 35 gigabytes if network's busy.

34:02Taxes and fees extra. See mintmobile.com. Right now, we are in a period in which there is a lot of talk about poor Chinese economic growth. Obviously, as your model shows, and just for any common sense, a war or any version of a war would be incredibly domestically costly at a time when already there's concerns about growth and frustration with the Chinese economic model. How does that play into Beijing's thinking or Xi Jinping's thinking about doing something at some point, the state of the domestic economy and the fact that any activity, maybe it would potentially reunify China and Taiwan, but would be extremely disruptive to all of the factories in China that rely on Taiwanese inputs?

34:52The narrative that some people will propose is that over time, if we assume the Chinese economy is weakening substantially, then the Chinese leadership will be more inclined to sort of pivot to nationalist concerns as a distraction. But it's worth noting at least two things. One, I don't think they're there yet. I don't think they think they're there yet, right? I don't believe Xi Jinping is all that pessimistic about Chinese economic growth. His New Year speech and other indicators suggest that he's still fairly optimistic. You could debate whether he ought to be, but I think that's basically right in terms of his view.

35:24The second is that I think we are both quite skeptical of the claim that some people make that China might pursue a, quote, diversionary war. And the reason for that is that this would not be diversionary. It would be all encompassing, right? And so do you really want to bet your house on a distraction? The answer is no. But in the longer run, I think there is a credible argument that if the Chinese economy is weakening, that the government might pivot to other priorities. And in fact, we can observe they're already pivoting to national security, right? There's a greater emphasis on national security and self-sufficiency now in Chinese policy than it was, say, five, certainly 10 years ago.

36:02And so over time, it might be the case that it changes their relative willingness. But at the end of the day, they would know how cataclysmic this could possibly be. And our general view, and Jenny might want to add to this, is that Xi Jinping probably doesn't have a specific timeline in terms of saying on 2028, we go. The timelines people talk about are more about military readiness, which is not the same thing. And ultimately, if I had to bet, in which in essence we are, if this ever does happen and be based on perceived provocations or crossing of red lines, it wouldn't just be sort of a unilateral bolt from the blue.

36:36Yeah, and I think just to add on to that, Beijing's stated preference is still for peaceful unification. And I think there's reasons to believe that that's true. One, I think they assess, as Jared was indicating, the military readiness issue. They haven't reached that milestone yet. And in fact, some of the reporting that our news colleagues have done on recent purges of senior military leaders, I think reaffirms the idea that there might still be concerns about corruption and the impact that that could have on readiness. And more broadly, this would be an incredibly risky and difficult campaign for any military military to undertake, you know, particularly if there's a risk of the United States getting involved, that's no small gamble to make.

37:22And it's not one that Chinese leaders would take lightly. I think to Gerard's point, it's more a question in their mind, I think, of whether or not their hand is forced if they would need to take that action to prevent Taiwan's permanent separation, which to them is, it is hard to exaggerate the importance that that plays in their calculus. and the costs that they would be willing to pay to prevent that from happening. I think if we were in a world in which they felt that that was necessary to take action, even if they didn't think they were militarily ready for it, the economic considerations would probably not be a driving factor in their calculus.

38:06I think what would be the overarching priority would be preventing that from happening at all costs and at all risks. So it really depends on, I think, their perspective of whether or not that's essential. And the economic considerations, I think, are more secondary in that sense. So the obvious parallel here would be Russia's invasion of Ukraine in the sense that it was something that was, you know, at once long discussed, but also very unexpected at that particular moment in time. And of course, there had also been a discussion of why would Russia ever do this given the economic costs involved and the risk of sanctions and things like that.

38:46how has the experience of Russia's invasion of Ukraine affected your thinking about Taiwan and China, if it has at all? So Jenny, you can jump in in terms of the Chinese perspective, but I'll just say kind of a more stand back perspective based on some of the work I was doing previously at CSI as the think tank. One observation is that the internal estimates in Russia of how bad it was going to be for their economy were actually worse than things ended up being. In other words, It wasn't a case that Putin was misled in terms of the economic pain. He actually thought it was going to be worse than it was.

39:21Wow. And yet he still went. So where was the delusion? The delusion was on the military side. He thought that they were going to roll into Kiev in two weeks or whatever, and then they could present the world with a fait accompli, and eventually they could dial back the economic sanctions or whatever. I actually think that there are definitely government versus private sector blind spots, But in general, I think a lot of people, including investors, might underweight nationalist considerations more than they should. And even believing that the Russian economy was going to take a massive shock, he still decided to roll the dice.

39:54And that, to me, is not necessarily indicative of what China would do. Xi Jinping is not Putin. I think Putin is more of a gambler in some ways and probably has a less sophisticated apparatus beneath him. But it is telling that that could still happen. And I think just to add on on Beijing's perspective, I think it's a mixed bag. I think, you know, on one hand, the fact that the war is approaching its two year anniversary when from the outset, it was largely expected that Russia's massive army would be able to pretty quickly overwhelm Ukrainian forces, especially with a surprise attack, is probably a cautionary tale in terms of how much more complicated invasions can be.

40:36And Russia's invasion, again, is a land invasion, which is a very different sort of operation than an amphibious one. In some ways, the hill is much higher to climb with the latter. So I think in that respect, it's a cautionary tale. On the other hand, the war is not yet over. And in particularly in this moment in time where there's a lot of questions about whether Western support for Ukraine will be sustained and what the end state of the war might look like. It's not entirely a case closed for Beijing in terms of whether or not a conflict is something that they can endure. As Gerard noted, the conflict has cost Russia less in terms of international sanctions and opprobrium than Moscow likely anticipated internally.

41:22and they are weathering the storm probably better than expected, which might in some ways provide a little bit of confidence to Beijing, which has in many ways more economic advantages than Russia does and might bet on the fact that Western countries might be less willing to sanction China to the extent to which they've sanctioned Russia. And I just have one last quick question. We're running out of time here. But what is the consensus on what the U.S. would do in some sort of some version of an attack? You know, what's the policy? And then, like, you know, suppose the U.S. didn't really do anything.

41:59And you think about ramifications. Do you think about variations where there are spillovers in which our other partners or other friends in the region where we have military bases? I don't know. Freak out. Get anxious. and that it's sort of like dominoes in some way, depending on the sort of confidence that other countries have in the U.S. security umbrella? There's a lot of debate about what the United States might do, and that's in part due to intentional U.S. policy to make that ambiguous. We call it strategic ambiguity about whether or not the United States would actually come to Taiwan's defense.

42:31If we look, though, at statements President Biden has made about how he personally would act in that situation. I think that's increased folks' sense that the United States would get involved in some way. From my perspective, I think, one, Beijing probably has to assume from a military planning perspective that they would be dealing with some sort of U.S. intervention because that is a risk that they can't afford to not calculate, given how important and critical it could be to the outcome. The second piece is, I think it really, in large part, might depend, again, on variables like, is there any warning before an attack?

43:14What is the duration of the attack? Because it's not just a question of intent, but also process and time to marshal a reaction to it. You know, there is a process laid out in the Taiwan Relations Act for the president to consult Congress before officially determining what to do. And then there's also the tyranny of geography when it turns to where US forces are located and their ability to respond to a conflict that is so close to China. And then to your question about the role that other countries in the region might play in terms of a conflict, again, I think that's going to really depend quite a bit on what Washington does.

43:54But also on what Beijing does, a lot of the war games that we have looked at have studied the possibility that Beijing, in an effort to try and keep the U.S. out of the war, might preemptively strike U.S. forces in the region, including some of our bases. And that could inadvertently draw not just the United States, but some of the partners that host those bases into a conflict. So a lot of this is very much variables at play. And that's why these war games can be a really valuable way of studying potential scenarios and their outcomes, because we might not be able to predict the future, but we have at least a good sense of what the key variables would be and what the future could look like depending on how those turn out.

44:37I was going to add in terms of sanctions. So this is something in DC that is talked about a lot over the past two years is would the US sanction China in any degree like it has with Russia? And my basic view is that in a conflict, the US probably would. People will say, but isn't China so much bigger, therefore wouldn't it be much more painful? Yes. But the question there is, are US forces directly involved? If the US is in an active naval and air war with China, I think that the political wherewithal would be there. But maybe the more important point, at least in the early days, is I do not believe the US and its allies will preemptively use massive sanctions unless they're very confident that a war is imminent.

45:22And Beijing would have already planned for that. So I actually don't think of sanctions as being a very useful immediate deterrent, but in a conflict, they probably would be used. Very quickly, we are recording this before the Taiwan elections. And by the time this episode comes out, we should have a result. What are you looking out for? What are the particular points or developments that we should be watching? I think the key thing on everyone's mind is going to be, well, first of all, this is an incredibly close race. And there's probably the closest race that we've seen, actually, in several election cycles.

45:56So there's a lot of questions about what the results on Saturday night are going to be. That's obviously the front of folks' minds. And then I think the second immediate question after that is, how does Beijing react to it? And already we've seen signals from China indicating that elements of their approach to Taiwan are very much going to be shaped by the election's outcome. There have been some senior officials kind of warning in not so subtle terms that this is kind of a key election for Taiwanese voters to think hard about what choices that they want to make. And then in more specific terms, a lot of connections between China's ongoing investigation to Taiwan trade practices and measures coming out of that that restrict Taiwanese exports that they've signaled they'll continue to take in the wake of the election depending on the policies of the new government.

46:47Jennifer Welch and Gerard DePippo, thank you both so much for coming on Odd Lots. Fascinating conversation on a topic that I definitely think we will be doing more on in the upcoming month. Thank you for having us. Thank you for having us.

47:13Tracy, I thought that was really fascinating. Well, I'll just say I found that really helpful because there is a lot of noise about the risk of some sort of invasion or attack or blockade, but actually sort of hearing about, well, why now? Why is there so much talk now? And how do you even attempt to sort of quantify these risks? I thought they were both great at explaining that. I learned a lot. The point about Russia actually estimating that the economic costs of invading Ukraine were going to be higher than they turned out to be. I thought that was really, really interesting. Absolutely. And in fact, Gerard made a really interesting comment there about investors sort of ignoring the nationalist impulse, right?

47:56Oh, totally. And so this idea that everyone's like, well, it wouldn't work. They'd lose a lot of money. They'd lose a lot of jobs. They wouldn't be able to sell as much oil. Therefore, it makes no sense. And I get why, like, that's like classic investor thinking, right? That it's like always going to come down to a profit and loss. But the idea that, no, like actually nationalism, the nationalist impulse is a real factor in decision making. And it's not all sort of strict materialism, I think is probably a good thing in general for investors to appreciate about both politics and geopolitics. Of course, like it just seems so obvious to me that like not everyone is ruled by pure economic considerations.

48:34But on the other hand, there are plenty of them at play in the China-Taiwan situation as that$10 trillion price tag actually indicates. The other thing I learned, I'm just looking at the big take that was published based on this report. I didn't know that Bloomberg has like a Taiwan stress index. I don't know if stress is the right way of putting it, but basically to see how intense the saber rattling is on this issue at any particular moment. And it has, it includes measures like exercises and flyovers into Taiwanese airspace and stuff like that. So really interesting. Everyone should go read that.

49:10It's on Bloomberg.com. The results of their work, A War Over Taiwan is a$10 trillion risk to the global economy. It's one of the cool things about working at Bloomberg is like, I'm always, you know, sort of pinch myself working here because how many different experts and sophisticated people who understand this stuff and the modelers who work on these different models went into this. So it's really quite a project. I thought the other interesting thing, Gerard made the point about a war were it to happen would not likely be a diversionary war and the idea that, oh, it's not going to be one of these things where, oh, they would do it because people, morale is bad and the economy is bad.

49:46So therefore we have to do something that actually it would be such an all-encompassing affair that it can't just be sort of, yeah. Also, Jenny's point about the blockade. So I remember, you know, two, I guess two years ago now, that was sort of seen as the foremost possibility that China could do something, but it wouldn't do an outright invasion because that was so risky and I guess would up the stakes so much. But her point that maybe now a blockade is basically seen as having all the downsides of outright military invasion in the sense that it could bring Western allies into the conflict, but none of the upside because it could be prolonged and, you know, drawn out.

50:33And maybe at this point, it's better to just do something quickly. That kind of shows how far things, that kind of shows how much things have changed just in a couple of years. And again, I suspect a lot of that comes from the Russia, Ukraine example. I want to do more this year for sure on the sort of defense industrial base in the US and China. And, you know, you see these stories. Of course, there was the recent Bloomberg report about how the corruption in the Chinese military and these missiles that were fired were actually filled with water and are not as advanced as thought. But on the other hand, you know, we certainly have in the U.S.

51:11all kinds of issues with our defense procurement and projects that get delayed forever and overspending on certain things. So I think this is an area of, for sure, more episodes to come. We should start war gaming, Joe. We need to get some dice. Start rolling them. I did not really realize that it was kind of like in the movies and they actually have these dice and maps and boats on a map and yeah we need to have like an odd lots headquarters where we have a bunch of maps oh yeah let's do it with little like figurines of various superpowers and we start moving them around the board these are the games that you play with your friends right in your house in connecticut right all these all these sort of gigantic board games right sometimes we play board games yes true shall we leave it there let's leave it there this has been another episode of the Odd Lots podcast.

51:57I'm Tracy Alloway. You can follow me at Tracy Alloway. And I'm Joe Weisenthal. You can follow me at The Stalwart. Follow Jennifer Welch. She's at That Jenny Welch. Gerard DePippo, he's at GDP1985. Follow our producers, Carmen Rodriguez at Carmen Armin, Dashiell Bennett at Dashbot, and Kel Brooks at Kel Brooks. Thank you to our producer, Moses Andam. For more Odd Lots content, go to Bloomberg.com slash Odd Lots, where we have transcripts, a blog, and a newsletter. And if you want to chat about this episode or any others with fellow listeners 24-7, go to discord.gg slash oddlots, or one of the verticals, one of the pages in there is a defense vertical.

52:36So go in there and weigh in. And if you enjoy Oddlots, if you think that Joe really should expand his board game playing away from just chess, then please leave us a positive review on your favorite podcast platform. Thanks for listening.

52:59Thank you.

53:23at Brightview Senior Living Communities enjoy enhanced possibilities, independence, and choice. Brightview Dulles Corner and Great Falls offer vibrant senior independent living, assisted living, and memory care services through various daily programs, chef-prepared meals, safety and security, transportation, resort-style amenities, and high-quality care. Take financial possession of your apartment by December 31, 2025 and save. Discover more at brightviewseniorliving.com. Equal housing opportunity. This is Rob Parker from The Odd Couple with Rob Parker and Kelvin Washington. Toyota-thon is on.

53:59So stop by your local Toyota dealer for incredible year-end deals on cars, trucks, and SUVs known for their legendary reliability. Like the stylish and efficient Camry. The ready-for-anything RAV4. Or check out a rough and rugged Tacoma or Tundra. All with great finance and lease options available to qualified customers. Visit BuyAToyota.com to find out more. Toyota, let's go places.