Is a war in Taiwan likely?
President Biden’s public support for the defense of Taiwan, coupled with China’s increasing aggressive tactics in the South China Sea, have increased concerns about an invasion of Taiwan by the PRC. Elections in both Taiwan and the U.S. in 2024 could exacerbate existing tension. Despite the growing problems, the risks of war for China are too great. China is likely to engage in quietly threatening behavior within a “grey zone” that will rattle financial markets and cause strains in supply chain management but is unlikely to result in outright military engagement.
For investors, however, rising uncertainty means:
* Supply chains will be reconstituted as Taiwan moves some operations to Southeast Asia and reduces dependence on China.
* China will seek to re-shore offshore manufacturing, although this will be difficult in the key semiconductor sector due to the lack of skilled talent and access to American design equipment.
* Equities will be volatile partly due to rising security concerns and inconsistent US-China relations.
* Uncertainty will force investors to reduce exposure to a region in the world that is becoming more unstable.
* Fixed asset investment by western firms into China will decline due to political uncertainty and greater domestic hostility to western firms.
* “Passive” capital exposed to fixed income and some equities, particularly in Hong Kong, will continue. Despite rising defaults among local SOEs and LGFVs, investment will rise, as most credit will be back-stopped.
* Hong Kong’s legal decline due to the National Security Law will take some time to evolve, leaving the city state as an attractive investment target.
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