Implications of a China-Taiwan War: Microchip Supply & Dollar Dominance

The US and its allies are becoming increasingly concerned that Chinese President Xi Jinping could initiate an invasion of Taiwan, an action that would carry enormous implications not just from a military and national security perspective, but also on the domestic and global economic front. Despite the growing military pressure from Beijing in recent months and Washington’s ramp-up of military logistical preparations across the regional theater, President Biden declared that the US does not support Taiwanese independence after the island voted down the Beijing-backed presidential candidate. Was this Biden’s attempt to depart from the US’s historical “strategic ambiguity” regarding Taiwan’s independence and the US’s potential role in defending the island in the event of military conflict, or was this Biden’s attempt to get ahead of a potential escalation by Xi following the election? Regardless, we think it is an opportune time to examine some of the possible implications of a military conflict. Drastic Microchip Supply Chain Implications One of the most immediate impacts would be the loss of access to Taiwanese semiconductors, which are responsible for 90% of the world’s supply of advanced microchips. If TSMC and other foundaries on the island are damaged, become inoperable, or if their operating capacity is reallocated to the Chinese market, the range of industrial and commercial products that would be impacted (cars, planes, computers, phones, etc.) is comprehensive and would have far-reaching effects across every sector of the US economy. It is unclear whether the impact of a chip shortage on China would be similar in scope, but the US Administration’s Executive Order on chip production is a clear indication they are aware of the severity of this vulnerability. The problem is this order does not seem to have translated into tangible progress in US efforts to diversify its supply chain for this critical asset. The Global Role of the US Dollar Beijing’s Belt and Road Initiative and the expansion of the BRICS economic group are clear indications of China’s intent to reshape the global economic order. Another critical arena that has the potential to significantly impact the future of global finance is the digitization of national currencies through the development of Central Bank Digital Currencies (CBDCs). China is now years ahead of the US in this space, having already launched the digital yuan. Is this a purposeful attempt to dislodge the US Dollar as the world’s reserve currency? Absolutely. Do we assess the US is at risk of losing its economic preeminence if this occurs? Absolutely. Jason Lowery hit the nail on the head when he posited that US policymakers should view Bitcoin as a tool for national security and power projection in the digital realm (a cyber-finance instrument) rather than just financial technology. So, would the US or China be the bigger economic loser in the event of an armed conflict over Taiwan? The answer is both. Citadel founder Ken Griffin recently said a Chinese invasion of Taiwan would have "catastrophic" consequences for both the American and Chinese economies, and could spark a new Great Depression and an 8-10% drop in GDP. Bloomberg analyzed that a war could have a bigger economic impact than Covid. US Engagement Strategy The US has a complicated relationship with the world’s second largest economic power. While Washington devotes a significant amount of attention and resources preparing for a potential military confrontation, it is also aware that the battleground extends significantly into the economic sphere, and that asymmetric actions (cyber, economic espionage, etc.) also are part of the broader equation. Whether it is in Washington’s best interest to improve and increase engagement with its rival – on the economic, military, or other fronts – or take a harder stance is the million-dollar question, and one with which policymakers continue to struggle. Obviously, this is a snapshot summary of a few of the larger issues to be considered in the event of an invasion, but they are worth considering as we monitor critical policy and market issues in the digital asset and AI spaces, such as digital currencies, AI and Compute infrastructure development, and supply chain impacts. We would welcome client engagement and comments on this as we continue to assess the potential way ahead