Feature Article: The Probability of a US-China War Over Taiwan Is Increasing

The Financial Times’ John Dizard recently observed that, “War risk is consistently underestimated by money people” (“The Battle Ahead: War Is Coming For Your Money”). Of course, this doesn’t only apply to people in the financial sector. Strategic surprise is a common theme throughout history.

One of my favorite quotes about its root cause comes from Thomas Schelling: “There is a tendency in our planning to confuse the unfamiliar with the improbable. The contingency we have not considered seriously looks strange; what looks strange is thought improbable; what is improbable need not be considered seriously.”

At the turn of the 20th century, the world economy had reached unprecedented levels of integration, with international trade at an all-time high. This led many to believe that war was unthinkable, because its economic costs would be so high. Yet World War One still occurred.

In 2019, the value of goods and services trade between the US and China was over $600 billion; between the EU and China it was closer to $700 billion. Once again, many people believe that China would not go to war over Taiwan because the potential economic costs would be too high. Unfortunately, accumulating evidence suggests a rising probability that they are wrong.

Specifically, four developments have caused us to change the forecast we made last October (“Will Xi Jinping Launch a Surprise Attack on Taiwan Before the 20th Party Congress of the CCP in November 2022? And What Happens if He Does?”):


1. The surprise declassification in January (shortly before the Trump administration left office) of the “US Strategic Framework for the Indo-Pacific Region.”

2. Publication of “Xi Jinping’s Conception of Socialism” by Charlie Lyons Jones of the Australian Strategic Policy Institute (ASPI).

3. January changes to China’s National Defense Law.

4. Testimony given at the US China Economic and Security Review Commission’s February hearing on “Deterring PRC Aggression Towards Taiwan.”

US Strategic Framework for the Indo-Pacific Region

This document contains the following points about China:

• Under “National Security Challenges” – “How to maintain US strategic primacy in the Indo-Pacific region and promote a liberal economic order while preventing China from establishing new, illiberal spheres of influence...

• Under “Assumptions”:

• “Loss of US preeminence in the Indo-Pacific would weaken our ability to achieve US interests globally.”
• “Strategic competition between the United States and China will persist, owing to the divergent nature and goals of our political and economic systems. China will circumvent international rules and norms to gain an advantage.”
• “China aims to dissolve US alliances and partnerships in the region. China will exploit vacuums and opportunities created by these diminished bonds.”
• “Chinese economic, diplomatic, and military influence will continue to increase in the near-term and challenge the US ability to achieve its national interests in the Indo-Pacific region.”
• “China seeks to dominate cutting-edge technologies, including artificial intelligence and bio-genetics, and harness them in the service of authoritarianism. Chinese dominance in these technologies would pose profound challenges to free societies.”
• “China’s proliferation of its digital surveillance, information controls, and influence operations will damage US efforts to promote our values and national interests in the Indo-Pacific region and, increasingly, in the Western Hemisphere and at home.”
• “China will take increasingly assertive steps to compel unification with Taiwan.”

Xi Jinping’s Conception of Socialism

“Is Xi Jinping more Hitlerian or Stalinist in his view of Chinese socialism? The answer to that question is important because it bears on the policy choices China’s adversaries will need to make.

“George Kennan, the godfather of America’s policy of ‘containment’ of the Soviet Union, made clear in his 1946 ‘long telegram’ that Adolf Hitler’s vision of ‘national socialist’ modernity wasn’t a force that could be contained; the reason was that Hitler had a timetable according to which the Third Reich was to achieve global domination and his strategy could be thwarted only by annihilating Nazism by means of total war. The Soviet Union, in contrast, could be contained through Western domestic resilience and a resolve to counter territorial revanchism. That was because Joseph Stalin had in mind no specific time by which the world would need to reach the communist phase of development.”

“Precisely where Xi Jinping sits on the spectrum of totalitarianism is a matter of dispute. Elements of Xi’s ideology are notably Hitlerian. His ambition to achieve ‘the great rejuvenation of the Chinese nation’ introduces a nationalist character to the Chinese Communist Party’s understanding of socialism. Unifying China and Taiwan is one revanchist mission driving Xi’s ‘great rejuvenation’, but revanchism is only one part of the nationalism Xi has begun to emphasise in CCP ideology—militarism and capitalism are the others…

“The party has allowed China to undergo capitalist industrialisation since Deng Xiaoping, having repudiated Maoist collectivisation, but remained committed to a strong supervisory state. The political economy Xi has inherited is thus similar to the economic structure Hitler presided over in the Third Reich. The problem for the CCP, however, is that China’s state-supervised yet market-oriented economy necessarily repudiates any notion of socialism being driven by Marxism. To a political party that supposedly follows traditional Marxism-Leninism, that contradiction constitutes an existential threat. The way to negate it, for Xi, is to unify ‘state and race’ by integrating nationalist notions of China’s ‘great rejuvenation’ into CCP ideology. China’s economic model has forced Xi to take a leaf out of Hitler’s book…

“Xi views leadership in terms of a sacred bloodline and believes nationalism to be essentially ethnic. He probably sees the nationalisation of socialism as his personal mission on behalf of the Chinese nation.

“National socialist images of a sacred bloodline have now become a feature of CCP ideology … The national socialist mission of unifying race, party, nation and state seems to have taken on singular import for the CCP, while its Leninist role of securing a path to communism has been subordinated. Nationalism is no longer a necessary step on the road to communism, but the driving force behind Chinese socialism…

“The CCP’s role in securing China’s path to communism is being subordinated to Xi’s vision for China’s nationalist resurgence. The likeliest result of this phenomenon is a less patient, more erratic and risk-hungry foreign policy. Indeed, the prominence of Beijing’s ‘wolf warrior’ diplomats and the CCP’s track record of economic coercion are good indicators that Chinese foreign policy is already taking on that distinctly Hitlerian quality.”

January Changes to China’s National Defense Law

• Changes to the National Defense Law have transferred important powers from civilian officials (the State Council) to the military (the Central Military Commission).

• The CMC is led by Xi Jinping. After the changes, it now has full power to mobilize military and civilian assets to defend national interests both within China and abroad. The Chinese military is now completely under Xi.

• For more discussion on these changes, see “China’s Updated National Defense Law: Going for Broke”, by Ben Lowsen of the Jamestown Foundation

Hearing on Deterring PRC Aggression Towards Taiwan

Testimony by Lonnie Henley, retired Defense Intelligence Officer for East Asia at the Defense Intelligence Agency

• “The PLA has systematically built the capabilities they believe they need for a war with the United States over Taiwan. They probably have achieved initial capability.
• “A failed Taiwan landing would not end the war. The Communist Party (CCP) leadership could not afford to accept defeat. The passions aroused by the war itself and by the propaganda effort in support of the war would not allow the Party to stop short of a political outcome they could credibly sell as a victory. China would continue the conflict by whatever means available, primarily blockade. The PLA would have the advantage in that extended phase of the conflict even after severe losses.

• “Most of the operational approaches available to US forces would not serve to end the war.

• Defeating the amphibious landing
• Destroying the PLA Navy and Air Force
• Cutting off China’s international trade
• Trying to spark internal unrest or crises on China’s periphery
• Other “cost imposition” strategies

• “Penetrating a Chinese blockade of Taiwan would be a slow, grinding battle stretching over many months… If we cannot defeat the blockade, we will not prevail.

• “Taiwan’s will to resist is vital but unknowable. Equally vital, and knowable but inexcusably not known, is their ability to endure a long-term blockade and what they would need to survive.

• “The military center of gravity of this conflict is the PLA integrated air defense system in southeast China. If we can disable that, we can win militarily. If not, we probably cannot…

• “Over many years of participating in Taiwan Strait war games and tabletop exercises, I observe that Taiwan’s air defenses are almost always disabled within the first few days of the conflict, but China’s integrated air defense system (IADS) along the Taiwan Strait remains effective for as far into the conflict as the exercise examines. This in turn limits the United States to long-range stand-off weapons or precision-strike incursions by stealth platforms. I assume I am not the only person to have observed this and that US forces are working on the issue.

• “Success in this area would have the greatest impact on the overall conflict, more even than finding a way to defend US air bases from Chinese missile strikes. Poorly defended bases will still generate some combat sorties, particularly as the conflict drags on and the Chinese expend their inventory of theater-range missiles. But a functioning air defense network greatly reduces the impact those sorties can have. Conversely, defeating the Chinese IADS would open the door to the kind of air campaign that has proven decisive against less capable opponents.

• “More specifically, enabling US air operations over the Strait would be our best hope for getting cargo into Taiwan’s western ports. The PLA’s short-range anti-ship assets can be extremely effective under a tight air defense umbrella, but much less so in the glare of US air power. The PLA air blockade, meanwhile, simply ceases to exist without the IADS.

Testimony by Oriana Skylar Mastro, Center Fellow, Freeman Spogli Institute for International Studies, Stanford University. She also serves in the Air Force Reserve, as a strategic planner for the US Indo-Pacific Command

• “Cross-strait deterrence is arguably weaker today than at any point since the Korean War. Impressive Chinese military modernization, U.S. failure to build robust coalitions to counter Chinese regional aggression, and Xi Jinping’s personal ambition, all coalesce to create a situation in which Chinese leaders may see some aggregate benefit to using force. I support this assessment.

• “The most realistic pathway to conflict used to be that Taipei or Washington crosses a redline that precipitates conflict. For example, if Taiwan were to declare independence, China would undoubtedly use force to reverse the decision, potentially even using the opportunity to push for ‘reunification.’ In case we needed reminding, the Chinese Ministry of Defense clearly stated on January 28, 2021 that “Taiwan independence means war.”

• “But the basic argument in my testimony is that the situation has changed. The greatest threat now is that Beijing will launch a military operation to force ‘reunification,’ irrespective of Washington’s or Taipei’s policies or actions. Specifically, I believe Xi Jinping will use force to compel Taiwan to unite with the mainland once he is confident in the Chinese military’s ability to succeed in relevant joint operations, like an amphibious attack…

• “Because of [organizational] reforms [focused on improving the ability to conduct joint operations] and the modernization of Chinese equipment, platforms, and weapons, China may now be able to prevail in cross-strait contingencies even if the US intervenes in Taiwan’s defense. China’s improved anti-access/area denial capabilities and its strides in cyber and artificial intelligence also contribute to the weakening of cross-strait deterrence. In the words of Michèle Flournoy, ‘In the event that conflict starts, the United States can no longer expect to quickly achieve air, space, or maritime superiority.’ As Beijing hones its spoofing and jamming technologies, it may be able to interfere with US early warning systems and thereby keep US forces in the dark. Worryingly, other analysts have concluded that Chinese interference with satellite signals is only likely to grow more frequent and sophisticated.

• “China also possesses offensive weaponry, including ballistic and cruise missiles, which if deployed, could destroy US bases in Western Pacific in days. Finally, the US intelligence community warns that, “China has the ability to launch cyber attacks that cause localized, temporary disruptive effects on critical infrastructure—such as disruption of a natural gas pipeline for days to weeks—in the United States.”

• “Because of these aforementioned capabilities, many US experts are concerned with a fait accompli, a scenario in which China takes Taiwan before even the most resolved United States could act decisively. Recent war games jointly conducted by the Pentagon and RAND Corporation have shown that a military clash between the United States and China over Taiwan would likely result in a US defeat, with China completing an all-out invasion in a matter of days.

• “In the end, Chinese perceptions of their likelihood of victory are more important than the reality in determining if they use force. It is not a good sign that Chinese sources express an increasing confidence that the PLA is well prepared for potential military confrontation with the United States over the Taiwan issue. The multiple large-scale military exercises (at least nine) conducted simultaneously in the Yellow Sea, the South China Sea, and the Bohai Gulf by the PLA in August 2020 are considered a credible demonstration of its ability to conduct complex, intense joint operations. While Chinese strategists acknowledge US military superiority generally, the conventional wisdom is that China’s proximity to Taiwan, corresponding access to operational resources and resolute stance, makes the local balance of power favorable to Beijing.

• “The bottom line is that for the first time in Chinese history, Xi will believe that he has at his disposal a military capable of forcing unification. While many Western observers think China will be able to do so in the next five to eight years, Chinese military leaders have told me that they will be ready within a year. It is telling that, in Xi’s first order to China’s armed forces in 2021, he emphasized the importance of “full-time combat readiness” and said the PLA must be ready to “act at any second”…

• If Beijing thinks the US will intervene on Taiwan’s behalf, then time becomes crucial. Chinese military strategists believe that if you let the United States fight the way it is used to, which includes time to mobilize and amass firepower in theater, then victory is unlikely.

• “Thus, if Chinese leaders believe the US is likely to intervene, they are more likely to move quickly to the highest level of violence that the scenario requires to force Taiwan’s capitulation to Beijing’s demands before the US can intervene. If China’s objective in the scenario is unification (versus punishing Taiwan or compelling a reversion to the status quo) and it expects US intervention, then it could even preemptively hit US basing in the region to cripple Washington’s ability to respond.

• “In other words, US deterrence and defense are working at cross purposes. The more credible our resolve to fight, the more likely Chinese leaders are to escalate rapidly and hit US forces in the region in their opening salvo – thus making a US victory less likely. But if there is a possibility that the United States will stay out, Chinese strategists would avoid such a move, as it would inevitably bring the United States into the war. In this scenario, as China focuses on compelling Taiwan’s capitulation at lower levels of violence, the United States would have time to mount an adequate defense” …

• In response to Commission members’ questions about Mastro’s testimony, she acknowledged that since the United States’ place in the world would be at stake if China invades Taiwan, Chinese leaders almost certainly assume that the United States will intervene. While on one hand this would argue for a very strong “first strike” attack by China on the United States, Mastro also noted that Chinese leaders are well aware of the reactions that followed similar surprise attacks on Pearl Harbor and 9/11.

• Elsewhere, Mastro has written about the challenges China would likely face in trying to limit the escalation of violence once a war with the United States had begun (e.g., “Can China Stop Wars Once They Start?”).

• “The United States does not usually accept a return to the status quo antebellum after blood has been spilled. If China uses force against Taiwan, US leaders may want a war termination settlement that sufficiently punishes Beijing for this action—likely by demanding concessions on Taiwan’s political status that Beijing will not make. In this scenario, Beijing will turn to its tendency for disproportionate escalation to bring about an end to the war on its terms. China will start by increasing the costs on US military forces in the region; if that does not work, they will consider civilian targets in the United States. However, due to range limitations (China has limited conventional options25 for hitting the US homeland), this is more likely through nontraditional means like cyber or counterspace attacks. This is one of the few scenarios in which the leadership may consider using nuclear weapons, though I do not believe they would use nuclear weapons first.

• “Maintenance of the status quo is no longer desirable for Chinese leaders. Xi has publicly called for concrete movement toward ‘reunification,’ an explicit demand that stakes his legitimacy on progress in that direction. By doing so, he moved the goalpost from preventing Taiwan independence, which means living with the 40-yearlong status quo, to an actual change in the nature of the cross-strait relationship, which is substantially less achievable without the use of force. Xi Jinping has stated multiple times his position that his program of national rejuvenation cannot be complete without ‘reunification.’ His ambition to “resolve the Taiwan issue” during his tenure is common knowledge among the Chinese people. Xi has also expressed in various ways that he is more willing than his predecessor, Hu Jintao, to use force. Additionally, in a major speech, Xi articulated that “the long-existing political discrepancy is the root cause of cross-Strait instability, it cannot go on generation to generation.”

• “Xi also seems to be ruling over an increasingly impatient Chinese population. A recent Global Times poll revealed that around 70 percent of mainlanders support war to unify Taiwan, and 37 percent of them think it best if war occurs in three to five years. (The next most popular answer is one to two years, with only approximately 10 percent saying unification can wait for more than 10 years.) Furthermore, 64 percent of mainlanders anticipate a full-scale war to unify Taiwan, and 72 percent of them think China would definitely win. Luo Yuan, a major general in the Chinese military, recently said that China’s leaders “can only follow the will of all Chinese nationals [and] realize reunification by force,” should Taiwan refuse to cede to Beijing’s leadership.

• In response to Commission members’ question about her testimony, Mastro made a critical point: “Military success is not the criteria for success in the Chinese view of the world. The key question for them is can the application of military force achieve our strategic objectives?” From this perspective, and given his personal ambitions, Mastro noted that Xi Jinping might see significant military losses as being worth the political benefits of conquering Taiwan by force (not to mention the very substantial negative impact this would have on limiting the United States’ access to advanced semiconductor chips produced by in Taiwan Semiconductor Manufacturing Company’s (TSMC) fabs on the island. Xi is also very likely to be tempted by the potential benefits of imposing a military defeat on the United States, which would make China the de facto hegemon of Asia.

• Mastro concluded that, “When Xi Jinping is confident that his military can win a war across the strait, I think he’s going to go for it… The key is reducing his confidence that he can win… Our number one concern today is not deterring China; it’s deterring Xi.”

Testimony of Mark Cozad from The RAND Corporation

• Cozad argues that, “even though Beijing’s confidence in all elements of PRC national power has increased significantly over the past two decades and continues to grow, Chinese political leaders probably remain cautious about the PLA’s ability to execute high-intensity operations, most notably a major campaign to force unification with Taiwan. Even though the PLA has made great strides over the past two decades, military publications, official statements, and reform programs suggest that its modernization has not progressed as rapidly as Beijing thinks necessary in several areas critical to fighting modern wars.”

• In particular, while the PLA has made substantial progress in upgrading its doctrine and equipment, “Beijing remains concerned about the PLA’s overall level of experience and proficiency [particularly in conducting joint and amphibious operations]… PLA self-evaluations often address qualitative concerns, such as personnel quality, decision making, reliability, and command. These evaluations deal heavily with internal PRC and PLA issues of demographics, organizational culture, and differing cognitive styles… PLA modernization imperatives—such as informatization, jointness, and systems warfare—cannot be realized without qualitative intangibles, such as capable personnel and efficient, effective command.”

• “Based on the nature of PLA weaknesses, a key question in our understanding of China’s calculations regarding the use of force against Taiwan is how Beijing’s views of the PLA’s weaknesses might shape or constrain its decision to take military action against the island.”

• In their discussion of Cozad’s testimony, Commission members agreed that a critical indicator would be any successful small-scale “real world” demonstration by China of its amphibious and joint operational capabilities, which would serve as a test run for a much larger invasion of Taiwan. A likely candidate would be a Chinese amphibious attack to retake small islands that Vietnam claims and has fortified in the South China Sea.

Conclusion

In our October 2020 feature article, we asked, “What Is The Probability That China Will Launch A Surprise Attack On Taiwan Before The 20th Congress Of The CCP In 2022?”

We concluded then that there was a 25% probability that China would attack Taiwan before the 20th CCP Congress, which is scheduled for November 2022.

Based on the latest evidence, we now estimate that the probability has significantly increased to 50% (+/- 10%) between now and March 2024.

It is almost certain that the increasing risk of war between the United States and China is not fully reflected in asset class prices today. For example, Chinese equities account for almost 40% of the MSCI Emerging Markets Index today.

In terms of our macro regime probabilities and their implications for portfolio asset allocation, an increasing likelihood of a Chinese attack on Taiwan should initially lead to a relative increase in the probability of being in the High Uncertainty regime.

Once the war begins, and assuming it results in severe disruption of supply chains and capital flows, there would likely be an initial burst of shortages and inflation in some product categories (the largest US imports from China are electronics, such as computers, cellphones, and related products). However, this would also be accompanied by a sharp reduction in private consumption and investment spending.

What comes next likely depends on the nature of the war. If the war begins with a surprise Chinese attack on broad range of US assets, including civilian assets located in the United States (e.g., pipeline and power grids), causing significant loss of life, it would, like Pearl Harbor and 9/11, almost certainly trigger a sustained national mobilization. If the US defeats China, this would very likely lead to an eventual transition from the High Uncertainty to the Normal regime.

However, if the US suffers a defeat in the Western Pacific, a global crisis of confidence in the United States would ensure, and the slump in private consumption and investment spending would almost certainly deepen, leading to increased insolvency problems, and likely a transition to the Persistent Deflation regime. Whether the very substantial increase in national anger, will, and defense spending and the accelerated replacement of foreign supply chains following a defeat would be sufficient to escape this deflation is a toss-up.

In sum, we are almost certainly entering a period of substantially higher uncertainty that has not yet been recognized by investors and reflected in asset class valuations.