Taiwan’s fragile state

This article is taken from our autumn 2023 edition of Equinox. You can view the full version here.

If you are ever sightseeing in Taiwan’s capital of Taipei and hear air raid warnings start to wail, don’t bother heading to the UK embassy. There isn’t one. 

Equally, there is no Taiwan embassy (or ambassador) in London. This reflects the tenuous sovereignty of the country, which is laid claim by China, protected by the US but self-governed by the Taiwanese. 

The threat of a Chinese invasion of Taiwan and the economic, political and military consequences if the US moves to protect the territory, has regularly been cited as global investors’ number one risk. 

No one except China’s president, Xi Jinping, knows for certain whether he plans to invade Taiwan. The government has called for “peaceful reunification” but a speech in 2001 laid out long-term plans for “national rejuvenation” before 2049 (1) To be fair, this speech did not talk about invasion but defeating any move by Taiwan towards independence. In any case, Xi will be 96 years old by this time and it will probably not be his decision to make. 

That said, China has been rattling its sabre loudly, especially in the last couple of years. 

China’s military has grown exponentially in the last decade (2) and they are buzzing around Taiwan, pushing the boundaries of airspace and territorial waters in what experts call a “grey zone campaign”, remaining just below the threshold of acts of war.

Military invasion options are limited, however, as the country lies 100 miles off the Chinese coast (three times wider than the English Channel) and there are only around half a dozen beaches suitable for amphibious invasion because of Taiwan’s rocky coastline. 

China is also being aggressive on economic and political fronts. 

China has vetoed Taiwan’s applications to access many international organisations such as the United Nations and the World Health Organisation. Indeed, you may have noticed that at the Olympics, Taiwan’s athletes cannot even parade their flag or play the national anthem on the podium. 

On the economic battlefront, China has recently offered hefty incentives for Taiwan’s experts to move to the mainland with one recent report suggesting that three thousand Taiwanese semiconductor engineers have relocated. Other tactics include cyber-attacks and even using Chinese TV and film actors to spread disinformation. 

Understandably, Taiwan remains on a state of high alert. Every July, the country carries out its annual air-raid exercise which includes mandatory evacuation drills which effectively shuts the country down for 30 minutes. On 25 July this year, Taiwan’s armed forces practised repelling an air assault on the country’s largest international airport for the first time. (3)

For their part, the US has undertaken to protect the sovereignty of Taiwan’s 24m population. This is enshrined in law through the Taiwan Relations Act and is broadly supported by US voters. In the last few years, the US has been building new naval bases in the Pacific Basin, particularly in the Philippines, although has procrastinated over supplying arms directly to Taiwan. 

There are other complicating factors; Taiwan produces around 94% of the world’s advanced semiconductors and any invasion would likely disrupt global supply. 

The Russian invasion of Ukraine has demonstrated to China the potential economic damage and isolation that it can cause; any military failure would be a very significant loss of face for a Chinese leader and likely undermine the governing party’s political power at home. 

Putting this all together, what are the potential outcomes and how do we manage these risks? 

The perceived risk of conflict is a key reason why many investors have sold their China shares and bonds resulting in higher financing costs for the nation’s companies. In the last five years (to end July 2023, figures from FE Analytics), the US and Taiwan stock markets have returned 76% and 55% respectively, the China market is -16%. 

A full military invasion would likely result in global recession as the nations of the world take sides, trade agreements are destroyed, and supply chains shattered. One study estimates that a single year of conflict between China and the US would cause US GDP to fall 5-10%. (4)

Peace, on the other hand, would result in an incredibly significant re-rating of China’s (and global) stocks and lift global economic growth. 

Between the extreme outcomes, there are many scenarios that could come to pass. 

In January 2024, Taiwan will be holding a presidential election and the relations between the winner and the US will be critical. The best form of defence for Taiwan is to grow and flourish as an economy supported by the US. The election of a firebrand leader who is at odds with the US could leave it isolated. 

As investors, we cannot invest for all scenarios. The main Taiwan shareholding in Equilibrium portfolios is the world’s largest semiconductor manufacturer, TSMC, which is a critical supplier of silicon chips for global technology companies. 

Our risk approach, like that of the Taiwanese people for the last forty years, is to assume the status quo continues but remain alert to changing circumstances, recognising that this local matter could quickly become a global issue. 

Past performance is for illustrative purposes only and cannot be guaranteed to apply in the future. 

This article is intended as an information piece and does not constitute a solicitation of investment advice. 

(1) US-Taiwan Relations: Will China’s Challenge Lead to a Crisis? Hass, Glaser and Bush, Brookings Institutional Press, Feb 2023. 

(2) Economist, 28 July “Gimme Shelter”. 

(3) FT: Taiwan’s military practises repelling Chinese attack on airport, 26 July 2023. www.ft.com. 

(4) War with China: Thinking the Unthinkable, Gompert, Cevallos and Garafola, 2016.