October 21, 2020
We talk of the Fourth Industrial Revolution and in doing so note that economic and political power has always coincided with the ability to gain access to the essential raw materials and components of the time – coal in the first industrial Revolution, Oil and gas and electrification in the second, technological, revolution, internet and connectivity and digitalisation in the third and now AI and the internet of things for the fourth. Each occasion has led to its own form of globalisation and as investors we aim to participate in the capital flows in an agnostic fashion. Politicians however think differently and will seek to control access to those raw materials – either to secure their own access or to deny it to ‘rivals’. As such it is vital to seek to understand how they may shift the landscape for capital.
This context is important, because the narrative machine is gearing up with a new ‘story’ to follow on from the US Election – Taiwan. The issues are not new, but we are now being encouraged to think about them and, as is their wont, the markets are picking up pieces of the background propaganda and spinning them into a ‘story’. As ever, there are different groups, each with different agendas rather than one guiding hand, but risk management needs to consider how they may either reinforce or else offset each other.
Many are presenting this as a security issue, but we should not lose sight of the fact that this is really all about Semi Conductors and the central ambition of certain parts of the US foreign Policy establishment to undermine and ultimately wreck China’s Made in China 2025 (now 2030) plans. As we saw with the restrictions placed on Huawei, the US is aiming to compete with China by trying to block and sanction it in the name of National Security in order to deny it access to the key raw materials of the Fourth Industrial Revolution in this instance the Chip manufacturing capabilities of Taiwan. While the US does not itself completely dominate manufacturing of the highest specification chips, the leaders being South Korea and Taiwan, it does dominate the capital equipment needed to make the chips. As such the new US tactic of threatening any manufacturers who use any US equipment in their process means that the US believe they can control China’s industrial progress.
The GeoPolitical concern therefore is that far from China forcibly taking over Taiwan for Imperial and unification purposes, as some are suggesting, that it does so in order to secure access to its ‘raw materials’. In fact, we suspect that it is more likely that China focuses instead on developing its own Chip sector in the same way that it built out its own financial sector after the 2008 crisis. The logic for investors is that in a similar fashion to finance, the west will ultimately find itself largely excluded from its biggest market as a result. Currently China imports more than $300bn of chips every year, more than it spends on oil. That is a lot of exports for the west to ‘lose’.
Who is driving the narrative?
The markets frequently fall for availability bias, the more recent or frequent something appears to be, the more significant it is or the recency illusion – the fact that we have only just noticed something means it is ‘new’. This tends to mean that when the narrative shifts those who claim to have ‘discovered’ this news assume a position of expertise. As such it is important for us to examine their existing biases or ‘priors’.
To consider the narrative therefore we should consider some of the players. When looking at US Foreign Policy, it often pays to start with the Pentagon. In the same manner as Warren Buffet says you should never ask a Barber if you need a haircut, so you should probably never ask the Military if they need more weapons and it is clear that China is now central to Pentagon thinking. Thus, every year we have the publication of the Pentagon’s report with the blunt title of “Military and Security Developments involving the People’s Republic of China”. This is based on the underlying assumption that (to quote from the report) ” the Chinese Communist Party desires the PLA to become a practical instrument of its statecraft with an active role in advancing the PRC’s foreign policy, particularly with respect to the PRCs increasingly global interests and its aims to revise aspects of the international order”. Or to put it another way, ‘they are building a bigger army so we need to build an even bigger one.’
The Pentagon view of the role of the PLA may or may not be a true assessment of the situation, but it is certainly the Pentagon’s thinking, not least because it represents projection of US attitudes to the role of its own military. We then regularly see the Pentagon’s prose appear in multiple other places, especially terms such as ‘threats’ to ‘US National Interests’ and the ‘international rules-based order’ but also the criticism of the One Belt One Road policy as being ‘debt enslavement’ and ‘economic imperialism’. Much of this is, of course, a pitch for (yet) more resources and is followed up by frequent placed articles and reporting of ‘military exercises’ such as the latest one today announcing that they are developing a new marine force to ‘counter China’ – although this is also as a recognition that the ballistic missiles on the artificial islands in the South China have effectively made the 7th Fleet redundant.
Last year Pentagon rhetoric was picked up as part of the Hong Kong narrative. This year it is Taiwan’s turn.
This sabre rattling is sometimes intensified by Politicians, both at home and abroad. Last year for example, the Pentagon Prose was taken up by the Taiwanese government in an aggressive anti-Beijing strategy as part of their (successful) re-election campaign. Indeed as we noted at the time, several of the Op-Eds that appeared in Western establishment newspapers could have been lifted straight from the Pentagon report. Subsequently it was picked up by US Senators as part of the escalating Cold War with China. What is different this year though is that, whereas a year ago the focus of US desires to ‘counter’ China was on Hong Kong and the Freedom and Democracy Bill, this year it is clearly on Taiwan. Thus we note that, at the same time as the Pentagon are pushing their press releases, Op-Ed pieces are also starting to appear in establishment papers expressing ‘concern’ about Chinese ambitions, many from Taiwanese politicians. And thus the narrative builds. Investment Banks then start talking about the subject and in turn call in experts, most of whom will be from the Foreign Policy and military nexus, who will highlight their ‘grave concerns’. Markets will then identify this as ‘news’. and thus Taiwan has become the ‘story’ emerging from the noise at the moment.
So is it a real risk? On balance probably less than is being stated, not least when we consider the needs of those pushing the narrative to attract attention elsewhere. On balance, we would conclude that the usual annual sabre rattling from the US Military Industrial Complex is being framed around Taiwan and with the US Political Establishment locked into anti China rhetoric, the expansionist ambitions being projected onto China are almost certainly heavily exaggerated. Those wanting a military re-unification of Taiwan are the equivalent of those in the US wanting a hot war with Russia, or Iran. Occasionally very loud, but in the minority. Meanwhile, we would note that those claiming that the troops are going to invade Taiwan are the same armchair generals who repeatedly declared that the PLA would shortly be on the streets of Hong Kong. Again more likely noise than signal.
In fact, rather than China seeking to exploit any US Election disruption between now and year end, as some are claiming, it is more likely that it is in fact western elements seeking to provoke China into actions justifying ‘retaliation’ who will be the most active, similar to the way Bolton and Navarro escalated the trade war. Back then, markets took to listening too hard to dramatic statements and subsequently rowed back. Indeed, we sense that similar ‘provocateurs’ are already on manoeuvres and are in fact the main ones driving this new narrative. However, recent precedent suggests we can be reasonably confident that China will not let themselves be caught out in such a simple trap and that the PRC will instead wait to see how a new US administration really stands.
On balance we suspect China will ignore provocations
This is not to say however, that China will allow the US to cripple their Made in China 2030 plans. The Chinese are probably 5 years behind the cutting edge of chip technology, but they are undoubtedly investing heavily to catch up with their own domestic production capabilities. The impact is like that of any sanctions, they speed up the need for self sufficiency and create the very competition you fear. Short term loss to China, medium term loss to the west.
China will also be playing multiple soft power games, from incentives to US and Taiwan based engineers to re-locate, to greater integration with South Korea perhaps. They also have strategic cards to play, most obviously limitations of exports of rare earths, but also as we have seen with Australia, limit of imports of items such as coal and other ‘sanctions’ for following the US rhetoric too aggressively. As such, politicians have the ability to affect profitability of exporters to China. As we have often noted, China is the major trading partner for far more countries than the US is. The bottom line is we need to see Taiwan in context of the ongoing US/China power game and as investors we need to keep focussed on who retains access to the key resources of the Fourth Industrial Revolution.