Central Markets by Robert Lloyd, CFA

The information contained herein has been obtained from sources believed to be reliable, but the accuracy of the  information cannot be guaranteed. All opinions and outlooks are subject to change.

  • Robert Lloyd, CFA

China, Taiwan and the Big Enchilada

Updated: Oct 13, 2020

  • China and Taiwan have a long, bitter history

  • Taiwan is vulnerable to Chinese military action

  • US policy to defend Taiwan is deliberately ambiguous

  • China is constrained by the consequences of taking Taiwan



The Situation in the Taiwan Strait


China continues to make aggressive motions to provoke Taiwan and the United States in the Taiwan straits. Most recently, Chinese fighter and bomber aircraft repeatedly crossed a line traditionally used to separate Taiwanese and Chinese airspace (1). China makes the obvious point that an attack on Taiwan could happen suddenly, with tremendous force, and at a time of their own choosing. Additionally, there are signs that Taiwan has neglected to build up their defense forces and instead rely on the ambiguous promises of the United States and the US Navy to defend them from getting absorbed into the People's Republic of China.


A Short History of Taiwan


China wants Taiwan for several reasons. First, there is the political history. The founders of modern Taiwan were remnants of the Republic of China (ROC) forces that had lost the Chinese civil war to the Communist Party of China (CPC). This power struggle began in 1927 and did not finish until the CPC won on mainland China in 1949. The communists see Taiwan as unfinished political business and they want some closure, apparently.


Second, Taiwan has built a thriving economy and nurtured some of the biggest and most successful technology companies in the world. One of them, Taiwan Semiconductor (TSM), provides approximately half of the world's semiconductor supply (2). Until recently, TSM provided chips to Huawei, China's flagship technology company. Taiwan is also home to FoxConn, one of the largest contract manufacturers of technology equipment in the world. Their customer base is long list of household names: Apple, Google, Microsoft, Amazon, etc.


Third, China needs access to US technology made at TSM for their own purposes. For example, let's look at Huawei, a gigantic Chinese technology company. Imagine a company that is Apple+Google+Cisco+Verizon+Dell all rolled into one. This is Huawei. Rumor has it they have done extremely well by copying their competitors designs, then re-selling them on the global market cheaply to capture market share. Even worse, in the last few years, the US government has become concerned that Huawei communications equipment includes back doors that allow the Chinese government to conduct espionage or sabotage. The response of the United States to this situation has been to cut off Huawei from their supply of TSM chips by using US trade law to prevent Huawei from using US technology. China is very unhappy about this. (3)


Is 1940s Japan An Analog For China Today?


Many strategic thinkers look at the rise of China in the Far East and can't help comparing it to the rise of Japan in the 1930s. As the military took over Japanese politics, their gaze turned outwards towards territories they wanted to control and exploit for economic purposes. This led to the invasion of China in 1938. The US responded with a series of embargoes on Japan, that gradually escalated into a broad trade embargo in July 1940. This was followed by the freezing of Japanese assets and a complete end to US oil exports to Japan in July 1941 (4). Prior to this action, Japan had imported 80% of her oil needs from the US. The supply had to be replaced, so the Japanese moved to take the oil fields of what is now modern day Indonesia. Losing their supply of oil was a key catalyst for Japan's attack on the United States in 1941 and its South Pacific invasion at this stage of the war.


China, like Japan, is a rapidly modernizing nation eager to project power and develop its own sphere of influence. Taiwan's geographic location is perfectly situated to project Chinese power well outside China's current geographic and political limits. Taiwan is a wealthy country with critical technologies that China needs to support its own economic growth. Taiwan produces a significant amount of the world's semiconductors; if controlled by China, perhaps the Chinese would hold more leverage when negotiating with other nations on the world stage. Additionally, Taiwan has a weak military and a population not terribly interested in participating in their own defense (5). The key question here is, at what point does China roll the dice and take Taiwan by force? (6)


Geography, Politics, and the Big Enchilada


Most analysts are specialists. If you are a defense analyst, you study defense companies for investment or our enemies to evaluate how to fight them. If you are a political analyst you study policies, laws, political movements and diplomatic statements to determine what policy to recommend. If you are a technology analyst, you study companies to grasp their profitability, growth and competitive environment. It is very difficult to pull each view together to get a clear picture of what might happen.


Militarily, Taiwan is a sitting duck and relies on the US to defend them from a Chinese invasion. Politically, China has an ax to grind with Taiwan and the US has an ambiguous policy for defending Taiwan. Economically, Taiwan has many attractive assets that China covets. Geographically, Taiwan is difficult for the US to defend from outright assault; we don't keep troops there and the population isn't that interested in defending themselves.


However, China's desire to take Taiwan is blocked by two mutually exclusive goals: 1) Taking Taiwan and their technology industry intact, and 2) Retaining free-trade privileges afterwards, especially with the US. This is the dilemma China has faced for a long time.


In 2019, China shipped $451 billion worth of goods to the United States. Since the U.S. exports to China were only $106 billion, that created a $345 billion Chinese trade surplus. Taiwan's 2019 GDP was $605 billion, and TSM's revenues that year were $35.7 billion. Taiwan also had a 2019 trade surplus with the US of $23 billion (Imports of $31b and Exports of $54b).


The current economic calculus is extremely negative for China. Any move on Taiwan will only harden the US government's trade rhetoric and potentially close off one of China's largest export markets. Taking Taiwan will probably cost China $505 billion in annual exports ($451b Chinese exports + $54b of Taiwan's exports). Despite all the hostile talk and behavior, China cannot ignore the Big Enchilada: their enormous US trade surplus. Taiwan should be safe for the time being.


Of course, if the US trade flows continue to decline with China from either stricter trade policy or weak economic growth, then the cost of taking Taiwan will fall. As long as China values their exports, Taiwan should be safe from a military invasion. Looking at Japan's experience in 1940 indicates there is a point at which the country receiving trade embargoes has nothing to lose. At that point, the embargoed country becomes very, very dangerous.


(1) https://warontherocks.com/2020/09/the-painful-but-necessary-next-steps-in-the-u-s-taiwanese-relationship/

(2) https://www.nytimes.com/2020/10/01/technology/taiwan-china-tsmc-huawei.html

(3) https://news.yahoo.com/huawei-stop-smartphone-chip-production-115049198.html

(4) Morison, Samuel Elliot, History of the United States Naval Operations in World War II, The Rising Sun In The Pacific, Volume III, 1948.

(5) https://thediplomat.com/2019/08/taiwans-all-volunteer-force-transition-still-a-challenge/

(6) https://www.usni.org/magazines/proceedings/2020/september/dont-let-china-conclude-its-opportunity-now-or-never


Robert Lloyd, CFA® is President and Chief Investment Officer of Lloyds Intrepid Wealth Management, and author of the book CENTRAL MARKETS. Since 1994, he has held positions as a trader, analyst, portfolio manager, and wealth manager while working at Invesco, CCM Opportunistic Advisors, and Merrill Lynch. In another life, he served 8 years in the U.S. Navy as a Naval Flight Officer flying in the S-3B Viking. For a complete resumé, visit his profile at LinkedIn.

Lloyd holds a BBA from the University of Notre Dame and an MBA from the University of Chicago.

Lloyd is a Chartered Financial Analyst.


Lloyds Intrepid LLC is doing business as Lloyds Intrepid Wealth Management. Lloyds Intrepid LLC offers investment advisory services in the State of Texas where registered and in other jurisdictions where exempted. Registration does not imply a certain level of skill or training. Lloyds Intrepid LLC and its advisers do not provide legal, tax or accounting advice. Lloyds Intrepid LLC formulates retirement plans, investment strategies, portfolio construction and investment due diligence for clients with signed investment advisory agreements with us. The information contained herein has been obtained from sources believed to be reliable, but the accuracy of the information cannot be guaranteed. All opinions and outlooks are subject to change.

© 2020 Lloyds Intrepid LLC

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