Taiwan crisis: from where to where?

A difficult first half-year is over. Practically all asset classes show a negative performance in the sixmonths to end-June. Central banks face tough policy decisions, the effects of which could be troublesome for capital markets.

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• Due to its geographical proximity to mainland China, the first contacts between today’s Taiwan and China most likely already existed in the first millennium.
• In 1517, the Portuguese discovered the island and named it Formosa, Portuguese for beautiful.
• The first documented settlement by Chinese, as laborers, took place during the colonial rule of the Dutch at the beginning of the 17th century.
• From 1683 to 1895 Taiwan was ruled from mainland China.
• After China’s defeat in the First Sino-Japanese war, China ceded Taiwan and the Pescadores to Japan. From 1895 to 1945, Taiwan was a colony within the Japanese Empire. This period also witnessed significant economic, industrial and cultural development as well as armed resistance against the Japanese occupiers.
• Following Japan’s defeat in World War II in 1945, the island was incorporated into the Republic of China then represented in the UN by Chiang Kai-shek’s Koumintang government. In the Chinese civil war this Kuomintang government lost all Chinese mainland territory to the communist forces under Mao Zedong. And in 1949 the Kuomintang fled to the island, making Taipei the seat of government. This relocation resulted in an immigration to Taiwan of some 1.5 million Chinese refugees who today make up about 14% of the population.
• The Republic of China (today’s Taiwan) was China’s official representative to the UN until 1971 when the UN accepted the People’s Republic of China as the sole representative of China against the will of the US and other Western countries (UN Resolution 2758). UN recognition of the People’s Republic of China involved the expulsion of Taiwan from the organization.
• In 1979, the US also ceased to formally recognize Taiwan. And today no EU or G7 members recognize Taiwan as an independent sovereign state. Only some 15 relatively small countries do so.

Taiwan today

• The second half of the 20th century was characterized by strong economic growth.
• From the 1980s onwards, a gradual democratization began under its then Kuomintang government.
• Today, Taiwan ranks third in Southeast Asia and 11th in the world out of the 167 countries in the Economist Intelligence Unit’s Democracy Index 2020.
• The country is now highly industrialized, with semiconductor production its most important industry according to CNBC. Today, Taiwan supplies around two-thirds of the world’s semiconductors. This dominance makes Taiwan an important strategic asset.
• 98% of the 22.7 million inhabitants are of Han Chinese descent. Indigenous tribes make up the remaining 2%. With 640 inhabitants per square kilometer, the country is the second most densely populated territorial state (i.e., excluding micro and city states) after Bangladesh.

Current situation

The atmosphere between China and Taiwan is fundamentally tense. The communist Peoples Republic of China has never accepted the Taiwanese archipelago as an independent territory.

The unofficial “friendly visit” of Nancy Pelosi (number three in the US political hierarchy) to Taiwanese President Tsai Ing-wen is seen as a provocation by China. Russia, Syria and Iran have also condemned the visit as an affront. China has not only sharply criticized the visit, it has imposed sanctions on Taiwan and Pelosi and launched massive maneuvers in the Formosa Strait and around Taiwan, thus isolating and repeatedly violating Taiwan-claimed territory. China has also simulated an attack on Taiwan with missile fire as part of the maneuver, whereupon Taiwan began mobilizing its own armed forces. The whole region is on alert with the world is watching nervously.

A critical assessment

Due to China’s sanctions and warlike behavior, Taiwan suffers from restricted trade flows and pays a high price for American “support”. The isolation of Taiwan due to China’s naval blockade has worrying implications for global supply chains. Taiwan produces 66% of all semiconductors manufactured globally. The basic input for semiconductor production is sand, the supply of which from mainland China has already been stopped. Moreover, other sources cannot be tapped for the duration of the maneuvers and may well be limited thereafter. There was already a global shortage of semiconductors before the current crisis, which is not only putting additional strain on the technology sector, but also on other sectors where semiconductors are an important input.

In the super league of the great powers, China cannot back down on this issue without losing face, either domestically or externally. China’s domestic problems (including the real estate crisis) pose a threat to her stability and the conflict is a welcome distraction. At present, we must assume that the crisis will not be resolved quickly. This autumn there are elections in both China and the US. Neither side can afford to show weakness on the issue. Since both countries have long-range missiles and nuclear warheads – and the nuclear threat is in any case heightened by the war between Russia and Ukraine – the atmosphere is as tense as during the Cold War. The old notion of a “peace dividend” is history.

Hopefully, there will be no worsening of the situation – neither in terms of conventional military threats nor nuclear ones – and the situation will ease. However, an acceptance by China of the previous status quo looks unlikely.

Conclusions

For Taiwan, the economic consequences of the naval blockade and Chinese sanctions will be severe. Global supply bottlenecks are likely to be stressed once again, limiting the availability of goods and keeping inflationary pressures elevated.

Pressure on her military budget will limit China’s willingness to continue the maneuvers. And we currently rate the probability of a further escalation, triggering an invasion and thence to intervention by the US, as low. However, tensions in the region will remain heightened.

A benchmark or slightly underweight equity allocation appears appropriate in view of the increased risks. Technology stocks and the automotive sector are likely to be hit hardest by any deterioration in the conflict over Taiwan. In general, we think the recent recovery of the equity markets, which has been supported by good quarterly corporate results, is likely to face technical resistance.

Contact: Christoph Sieger, Portfolio Manager
Telephone: +41 58 680 60 56

Disclaimer: Information and opinions contained in this document are gathered and derived from sources which we believe to be reliable. However, we can offer no undertaking, representation or guarantee, either expressly or implicitly, as to the reliability, completeness or correctness of these sources and the information provided. All information is provided without any guarantees and without any explicit or tacit warranties. Information and opinions contained in this document are for information purposes only and shall not be construed as an offer, recommendation or solicitation to acquire or dispose of any investment instrument or to engage in any other transaction. Interested investors are strongly advised to consult with their Investment Adviser prior to taking any investment decision on the basis of this document in order to discuss and take into account their investment goals, financial situation, individual needs and constraints, risk profile and other information. We accept no liability for the accuracy, correctness and completeness of the information and opinions provided. To the extent permitted by law, we exclude all liability for direct, indirect or consequential damages, including loss of profit, arising from the published information.

Disclaimer: Produced by Investment Center Aquila Ltd. Information and opinions contained in this document are gathered and derived from sources which we believe to be reliable. However, we can offer no under-taking, representation or guarantee, either expressly or implicitly, as to the reliability, completeness or correctness of these sources and the information pro-vided. All information is provided without any guarantees and without any explicit or tacit warranties. Information and opinions contained in this document are for information purposes only and shall not be construed as an offer, recommendation or solicitation to acquire or dispose of any investment instrument or to engage in any other trans action. Interested investors are strongly advised to consult with their Investment Adviser prior to taking any investment decision on the basis of this document in order to discuss and take into account their investment goals, financial situation, individual needs and constraints, risk profile and other information. We accept no liability for the accuracy, correctness and completeness of the information and opinions provided. To the extent permitted by law, we exclude all liability for direct, indirect or consequential damages, including loss of profit, arising from the published information.

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