Moody's Talks - Inside Economics - Taiwan Straits, Tough Geopolitics

Episode Date: June 9, 2023

Amid mounting geopolitical tensions over the independence of Taiwan, Mark and team consider various scenarios regarding how this is ultimately resolved. China appears to be taking a long-term perspective in its goal to unify Taiwan with the mainland, and thus the most likely scenario assumes the current uncomfortable, but peaceful status quo.  But much darker scenarios can’t be ruled out.For the full report on the China-Taiwan Scenarios, click here.For the full transcript, click hereFollow Mark Zandi @MarkZandi, Cris deRitis @MiddleWayEcon, and Marisa DiNatale on LinkedIn for additional insight. Questions or Comments, please email us at [e-mail]. We would love to hear from you.  To stay informed and follow the insights of Moody's Analytics economists, visit Economic View. Hosted by Simplecast, an AdsWizz company. See pcm.adswizz.com for information about our collection and use of personal data for advertising.

Welcome to Inside Economics. I'm Mark Sandy, the chief economist of Moody's Analytics, and I'm joined by a few of my colleagues, of course, my two co-hosts, Krista Redis and Marissa Dina Talley. Good to see you guys. Mark. I look a little tired. I guess it's very early there in California.

It is, yeah. Yeah. Just after 6 a.m. Oh, that is. And I got up at 4.30 for a meeting we had before this. Okay. So you've conquered the world. I'm a little tired.

Yeah, I don't blame you. I don't blame you. I'm a little tired. What's that, Chris? She's like the Marines, right? They can do more by 6 a.m. I know. Most people do all day long.

Fire up Zoom. Yeah, exactly. And we've got two other colleagues, Steve, Steve Cochran. Good to see you, Steve. Hey, Mark, good to see you. Steve, I'm embarrassed to say, but I think this might be your first time on. No. It is the first time, yes.

Oh, my gosh. It's a shocker to me. Because you, you know, Steve and I go back, how long? 30 years. 30 years. Yeah, 30 years. And you're running our operations in Asia, APAC. Right.

You've been doing that for how long now? I've been here five years now almost. Yeah, very cool. You're in Singapore. I'm in Singapore. Great place to be. I love it. Love it here.

So this is truly a global podcast because we've got Marissa sitting out in California, 630 in the morning, and you're sitting in. Singapore's 9 p.m. Eastern time. That's right. Yeah. What am I saying? It's 9. It's 9.

It's 9.m. It's 9 a.m. Eastern time. Yeah. Good. Good to have you, Steve, because we are going to be talking a lot about, well, exclusively about what's going on in APEC, China, and Taiwan. And also we've got Tim, Tim, Tim, Tim, good to have you. Good to be here.

Thank you. And you've been on before our chips, I believe. I have, yeah. Yeah. Call both the shortage and the turnaround. So if you go back to the first time I appeared in the podcast, you asked when it was going to turn around, and I called it the exact right quarter that it did the year later.

So, yeah, so I guess I have that going for me. The chip industry. So when you say it turned around, what turned around? Oh, that's essentially when the lead time started to drop. Oh, the lead time. That's the key indicator for chips, right? Yeah. And that had been increasing all throughout the shortage.

And so the question was, when is the inflection point? Yeah. And I guess, given the demand from all this AI craze, are our lead times now starting to extend out again? They're still relatively stable. It has to be said that there's a lot of inventory that was built up, especially over 2022, because a lot of companies were double ordering, even as early as the 2021 due to the pandemic, the chip shortage then. So I think it's going to take a little bit of time to work through all that access inventory

and also I think a bit of time for AI to really kind of take hold. Got it. Got it. I think last time you were on, Tim, you mentioned, though, that not all chips are created equal. There's a lot of heterogeneity, right? Oh, absolutely. It could be that the AI.

the high-end chips start to see some pressure, but the lower auto chips are fine. Is that accurate? I think your point on the chips not being equal is absolutely right. And so certainly if you look at lead times, I have this report that I look at every quarter and it's very, very heterogeneous. You have some lead times in excess of 52 weeks. You have some lead times well below 20 at this point. It really depends on the application, right?

And even between advanced chips and kind of these what's called older nodes, right? So advanced versus older nodes, older nodes being the ones that are used for cars, right? There's still tensions because a lot of the technology that's being developed, a lot of the fabs that are being built, are really for these newer chips. So you're right in that it's true that AI is obviously driving a lot of the demand for the newer chips, but there's also more supply for the newer chips. versus for the older chips, it's true that maybe demand is not really going up, but the supply is also really constrained because the margins aren't quite there.

And so I think the shortage there, and there was certainly a significant shortage, particularly during a pandemic, that hasn't completely gone away. It's slowly getting resolved, right? But yeah, I think it's still very much, I would say you would really have to look at each individual application. Is this like a logic chip?

Is this a memory chip? was this being used for, right? In what end product is it going into to really determine kind of what the, what the accurately time would be? Well, judging by Nvidia stock, investors are expecting a lot of chip sales here pretty soon, so I think it's coming. But this is a tangential to the conversation at hand. The listeners thinking, well, why this motley crew of Moody's analytics economy? What do we do in here? Obviously, the relationship between the United States, China and of course Taiwan has gone, I don't know, off the rails is the right way to describe it. It's certainly not going in the right direction here. And we've been getting a lot of questions

from listeners and clients about, you know, what might happen here with regard to Taiwan. Taiwan feels like kind of the flashpoint that could create the most difficulty for the global economy. And to that end, we have run a couple of different scenarios to try to understand the impact that different types of interventions between U.S. China and Taiwan might have on the global economy. We're here to talk about that. But before we dive into those scenarios and talk about that a bit, maybe, Steve, I can turn to you and you can provide a little context here. How did we get here? It feels like, you know, not too long ago, at least I'm getting older and not long ago. It might be very long for some people, but not long ago going back to the Obama administration, it didn't.

It felt like the China-U.S. relationship was going okay, you know, moving in the right direction generally, but it's all gone off the rails. What happened? And why are we here? It has gone off the rails. And it, in a sense, it's a shame. Because for many, many years, decades, you know, the relationship has been quite good, in fact, kind of symbiotic, right? If you go back, I don't know, you probably don't want to go all the way back to the day of Henry Kissinger and President Nixon, but certainly back to, say, 2001 when China entered the WTO and became a sort of a working partner in the manufacturing economy around the world, China and the U.S. had a very symbiotic relationship as U.S. manufacturers were looking at. looking for a low-cost place of doing business, places where they could offshore certain components of manufacturing and then bring it back to the U.S. for final assembly. And it worked very well for many, many years.

You know, our imports grew from China. It kept costs low. It kept inflation low. It was a very good relationship. I think when China then essentially at one point started. to be considered more of a competitor than a partner and an unfair competitor, if you will. And this was, I think, highlighted during the Trump administration when the allegations of lack of protection of intellectual property, government subsidies, illegal government subsidies,

giving Chinese industries a leg up over other countries. these were some of the reasons why Trump then jumped in and started the trade war and slapped on 25% duties, tariffs on so many goods. And then, you know, that might not have been so bad, but the rhetoric kept building up more and more and more, again, particularly during the Trump administration, that just made, I think, conditions even worse than they had to have been. the dialogue then no longer became constructive, if you will. And so moving into the Biden administration, the feeling that there was this unfair trade that had to be managed with China continued. The rhetoric slowed down a little bit. But there hasn't really been any improvement in terms of building up communication between China and the U.S. So there are many, many, many. avenues in which there are possibilities for misunderstanding simply because the U.S. and China

don't seem to be speaking directly to one another. Or they do at one point, two weeks later, something happens and it all falls apart. Then we began to get a little better. And then something happens and the communication falls back again. And then this, of course, goes beyond pure trade issues, but then moves into areas of national security, both, from the side of China and the side of the U.S., China, of course, trying to maintain its own security buffer around its country and the U.S. doing the same. And then Taiwan kind of stuck in the middle and the desire, of course, of China, ultimately wanting to reabsorpe Taiwan back into the People's Republic of China and the U.S.

stating fairly directly that they would protect Taiwan as an independent country. So we have these intertwined economic and geopolitical issues that are complicating things and making things even worse today than they were in the past. Yeah, I mean, it seems to me even under the Obama administration, there was growing concern about the relationship with China and what it meant for the U.S. economy. And Obama's strategy was the Trans-Pacific Partnership, the free trade deal with the Pacific Rim nations, which excluded China. And China could not enter into the free trade deal TPP until they played fair, whatever that meant. So using kind of a carrot to get them

to behave more like a responsible trading partner and partner in the global economy. President Trump blew that apart. I don't know if it was his first executive order, but it was in the top five. It was the day of his inauguration, right? I believe it. Okay. Was when he said, we're exiting the TPP, right? That in the Paris Accord, you know, the climate Paris Accord.

Right, right. He said, no, we're not doing that. And then not too there long after he engaged in the trade wars. And then since then it's been kind of downhill, you know, on all kinds of levels. I mean, I was just reading this morning, here we are in June, in June, and a Chinese air fighter came within 400 feet of an American jet fighter, military jet fighter, intentionally, obviously. I mean, that's not good. So that gives you a sense of, you know, where we are. So we've decided, given the direction things are headed and given such how important the direction things are headed and given such how important the,

this relationship is, and all the questions we're getting about, particularly now Taiwan, because that does, again, feel like if there's going to be a flash point here, at least militarily, it's going to be around Taiwan and Taiwan independence. We've run a couple of different scenarios trying to understand, you know, what that might look like, feel like, and what it might mean for the global economy. Before we dive into those specific scenarios, though, again, Steve, I'm going to turn back to you, in our baseline kind of view of the world, the kind of, you know, our forecast,

the kind of the most likely scenario, you know, how are we thinking about how this is all going to play out between China, U.S. and Taiwan? So Mark, in the baseline scenario, we do assume that there will always be some potential conflict around China, Taiwan, and the U.S.,

but that any potential conflict will be resolved in some amicable way, that there will be negotiations, there will be discussion, and that there would not actually be a conflict. And that in the end, China, Taiwan, U.S., all continue there, what really are, rather rich trading relationships between all three, to the benefit of all three, and those will continue. We do assume that the economies will continue to grow right now. Taiwan is in a recession largely because we're at the bottom of this chip cycle,

and we do expect that Taiwan will, the economy will be rather slow, kind of hindered over the next six, nine months, but ultimately comes back next year as the semiconductor cycle turns around. We assume that China, which is struggling to recover from its, It's a zero COVID policy will at least slowly, perhaps haltingly, as we can see. We actually, we got a number today from the official manufacturing purchasing managers index, which was very weak. 48.8, you know, anything below 50 represents a contraction in the manufacturing side of the economy. This is the second month in a row where it's contracted and the weakest number in four or five months.

So China is clearly struggling to get its economy back on its feet post-COVID. And we could spend a whole other podcast talking about this, but getting all the important components of the economy going. But our assumption is that it will. And then, of course, the U.S. economy is going to hopefully avoid recession this year and begin working towards faster growth next year. and beyond as well. And so that's the baseline forecast is a fairly benign forecast, no conflict, any issues between China, Taiwan, and the U.S. are managed amicably. And we work through those issues and allow the economies to continue on their way. First, do you buy that baseline assumption? Does it make sense to you? I think as a baseline. That's reasonable. You don't want to go

about too far on a limb here. But, yeah, certainly the risks are weighted to the downside. Okay. Okay, well, I guess the risks, you don't save with a lot of conviction. So I guess it does make sense to consider other scenarios. Yeah. Yeah. Okay.

Okay, let's consider them. And we ran two alternative scenarios. I'm going to say, before we dive into the meat of the matter, are when we say we run a scenario, what, what are we doing? What is, what, what exactly does that mean? Because, you know, we know this, we do this every single day, but the folks out there that are listening to this, they have no, they have no concept of what we're doing, you know, exactly how does that work? Do you see what I'm saying? Mercer.

You want me to answer that? Yeah, because you run, you run the train, you ship here, you know, you run these scenarios, you know, on a daily basis. So, maybe give us a sense of, you know, what that means. Right. So I guess the best way to put it is that. it's an alternative forecast around our baseline. Some of those scenarios that we run, we actually attach a probability to them. But that's not really what we're talking about here. We're talking about a narrative scenario. So it's an alternative story around our baseline. So as Steve and Tim have just laid out with the baseline cases for the China-Taiwan relationship,

vis-a-vis the rest of the world in the U.S., we can come up with more optimistic or more pessimistic other stories in addition to that baseline, right? And so in terms of how we actually do it, we always start with our baseline, and then we build in alternative assumptions that we overlay on the model, right? So we're being more heavy-handed in the forecast. We're saying, okay, we're going to make an assumption about, you know, a trade or military blockade, or we're going to make an assumption about a political regime and the fallout that might have on the economy or whatever the scenario is, right, interest rates or a war. So we are doing basically an overlay on top of the baseline to come up with an alternative story.

Does that make sense? Yeah. But you said model. And of course, we know what the model is because it's our lifeblood, our baby, are working with it every day. But the folks out there, you know, what are you talking about, model? What is that? Yeah.

Yeah. So we have an interlinked economic macro model that has 73 countries in it, including the U.S., China, Taiwan. And we run this every single month. we forecast, baseline forecast out, now we're going out, what, 80 years, I guess, every single month. It has tens of thousands of macroeconomic variables in it that include economic variables, demographic variables, financial variables.

And so it is a, basically a stylized view of the world economy, right? and all of these countries are linked together in this model through historical relationships of financial markets, economic relationships, migration patterns. And so we're using this global model to run our baseline forecast every month, plus all of these alternative scenarios that we do. the U.S. kind of sits atop the food chain in terms of this model. So Dr. Mark Sandy is the one whose point is sort of, you know, dominant in terms of the whole global outlook, right? Mark, you go first and you set the assumptions for the U.S. economy and some broad global assumptions around financial markets and such. And then we have an economist that covers every single one of these countries. I should mention we do more than 73. I think we're up to like, I don't know what the count is,

120 or so. There's some countries that we do every quarter. And so there's an expert on all of these economies. And Tim is our expert on Taiwan, for example. And then every month, everybody goes in and, you know, checks their forecast and overlays any assumptions they have about their particular country. Perfect. Okay, that's a great description. And because I just think people can't, I get that question all the time. Like, you know, like in the context of the debt limit debate, we were coming up with these estimates of it's going to cost X million dollars, X million jobs if we'd breach the debt limit. How do you guys do that? How do you actually do that? How do you think about that? I can't even get my, I can't even wrap my mind around what, what that, you know, how do you go about doing that? It is quite complex. Steve, any, you wanted any other

color there? You don't need to add any color, just anything we missed. Well, actually, what I wanted to point out is that a couple of features of the model make this pretty uniquely suitable. And I don't want to turn us into an advertisement. So no advertisement. Almost on the verge of an advertisement. I don't want that, but I just want people to understand what we're doing. But go ahead. Well, our model is quite suited to doing this kind of a scenario because it handles prices very well and it handles trade very well. And these, of course, are two factors in the economy that would be hit very hard by some kind of a conflict prices because of disruptions and supply chains and such.

And then trade patterns themselves because we know very clearly which countries are quite open to trade, which are closed to trade, which trade heavily with China, Taiwan, the U.S. We specifically model a relationship for every country and its largest trade. trading partners. So when we make assumptions about either the kinds of manufacturing and trade disruptions or maybe even more importantly, the kinds of sanctions that might be placed on companies or entities, we can quantify those assumptions and fit them into the model quite well because of the way the model's structured. Great. Got it. Okay, so let's come back, Tim,

to the scenarios around Taiwan. Tim, can you just describe, you know, the process? What are we doing here exactly? Yeah, so thanks, Mark. Yeah. So what we did was we really tried to see kind of how these existing tensions, right, which have been pretty elevated, how they escalate into conflict, right? And then we sort of constructed these scenarios in order to show two essentially somewhat different views of the world, right? A view of the world wherein the conflict is pretty severe but short in duration. And then a view of the world wherein there's a lot of uncertainty over how the conflict is resolved, but that that conflict does not cause a sharp of a recession. And the way that we've envisioned these scenarios, that sort of shorter, sharper conflict is what we call a military intervention scenario. We spoke with a lot of different people.

We read a lot of reports in terms of trying to get data around how could this unfold, right? If there would be a military conflict, what would be the length of the duration? who are some of the key players, right? How would they react, right? And really, how could the tensions escalate, right? We know that China right now, is doing a lot of, a lot of sort of gray zone warfare tactics, right? Certainly unprecedented, nothing that has ever been seen before. What did you say?

Rayson war? Gray zone, gray zone. Oh, gray zone, gray zone. Sorry. I don't know if my voice is muffled. No, no, no, no. I just, that's just me. Gray zone, you've got to explain that too.

Right, right, right. So I think that's really how, that's kind of the motivation behind the scenarios, right, is that we see that increasingly after, you know, the former Speaker Pelosi's visit, and then subsequently, signing Zwen's visit to the U.S., China's really accelerated, you know, what's called gray zone warfare, meaning that it's not really direct military warfare, right? So, you know, under international law, there's no grounds on which this could be punished, right? What it does is it just basically sends a lot of sand dredgers. It sends a lot of these sand transporting boats across the strait, right?

Essentially in an effort to overwhelm the Taiwanese Coast Guard, it's also sent a lot of military planes across the median line. Again, far more than what we've seen in previous Taiwan strait crises. There have been three. And then if you consider what happened shortly after Speaker Pelosi's visit, the fourth one, really the activity that we've seen, you know, along the Taiwan Strait was really unprecedented and is really pushing the boundaries of, you know, Taiwan's defensive capabilities. And in addition to that, you know, China's also engaged in a lot of, you know, cyber warfare. Certainly there have been reports that there has been disruption to network and communication lines in Taiwan.

And all of this really leading up to the potential for a screen to be created around Taiwan, right? And that's really kind of the genesis of these scenarios, right, is that if that occurs, right, and it does seem like there is the possibility that that could occur, right, based on what we've seen, right? Once again, I should reiterate what Steve said. Our baseline assumes that military conflict does not happen, right? And there's also a good reason why we assume that in the baseline, reason being that even China's own Xi Jinping has mentioned in the most recent party Congress that, you know, in his words, we will continue to strive for peaceful reunification with the greatest sincerity and

utmost effort. But also, we will never promise to renounce the use of force. And so if you consider kind of how this screen would be created, right, the natural sort of extension to that is what happens should that screen be created around Taiwan? Right. Got it. Okay. Okay, so let's come back, Tim, to the scenarios around Taiwan. And you laid out a nice kind of nice context. China does feel like it's tightening the noose around. Maybe that's too strong a word, but you use the word screen. I use the word noose around Taiwan.

Not quite there yet, I mean, obviously, but you ended by saying they could if they wanted to, you know, put that noose around. Taiwan and really make life very difficult and cut off Taiwan. And that now leads to the scenarios. One other question before we get there, though, what do the Taiwanese people think about all this? I mean, do they want independence from China generally? I mean, obviously, I'm sure there's a lot of diversity of opinion there. But, you know, how are they viewing this relationship with China and how is that changed over time? And where is it, where is it right now? So it's evolved a lot over time, I think, as you kind of anticipated Mark. I think the Taiwanese people, by and large, are used to this at this point, right?

I mentioned three previous Taiwan strait crises that have already occurred, four, if you include what happened after Speaker Pelosi's visit. So this is not something new, right? They're used to kind of China essentially saying that, you know, Taiwan is a part of China. and certainly there are, you know, segments of the population and even a political party within Taiwan that has, you know, pretty, I would say, friendly relations with the Chinese Communist Party. That being said, if you look at the most recent elections, if you look at a lot of the most recent surveys, the Taiwanese do believe that, or they would prefer to still be, they identify as being Taiwanese,

and they would prefer to still be their own sort of independent state, if you will, be a part of that. And so I think the identity has really coalesced around kind of the island as opposed to maybe in years past where there was more of a kinship due to the similarity in ethnicities. Okay, very good. So let's turn to the scenarios, the alternative scenarios to the baseline. And let's begin with the no military, what we're calling the no military intervention scenario.

And in my mind, that scenario feels taste kind of sort of like the Russian war in Ukraine, right? It's this kind of ongoing conflict that doesn't feel like it's ever going to have an ending to it. I don't know in our scenario whether we have an outright invasion of, of Taiwan. I don't think we do, but it feels like this conflict is just ongoing. Is that a fair characterization? Yes, I think so, Mark. Yeah. So I think this scenario is really supposed to kind of, in some sense, mirror the Russian invasion of Ukraine, as you said, in the sense that there's a lot of uncertainty around how it's going to be resolved. It lasts several years.

And there isn't really a strong, sharp recession, right? Precisely because, as you said, the U.S. and its partners do not really get directly involved militarily. That being said, they do impose sanctions, right? Sanctions are imposed on both sides. The U.S. does support Taiwan by providing, you know, defense intelligence. It also ensures that there's a corridor that's created in order to allow key goods like semiconductor chips safe passage, right? So there isn't a complete halt in supply chains that rely on key Taiwanese exports like

electronic equipment, metals and machinery, semiconductor chips, things along those lines. Why would China allow that? Is it because they just don't want a military intervention? They know that if they actually cut off the chip supply from Taiwan, the U.S. would be in a pretty tough spot. So the entire global economy would be in a pretty tough spot, and that would more than likely create a military conflict. Is that the logic? Yes. So it works both ways, right?

China's also heavily relying on Taiwan. And so both China and the U.S. are, in fact, two of the largest consumers of seven-conductor chips. But presumably the Chinese could get the chips from Taiwan, right? They could create the screen around Taiwan, cut off all access to Taiwan, except for Chinese companies, no? Right. But the U.S., obviously, as you said, would react very strong. Okay. All right.

Yeah. And we've spoken with certain people who I won't name, who have full confidence that they would be able to break any screen that would be created around Taiwan. And so I think that gives us some measure of confidence that even if there is a an attempt to create a screen, that there would still be a corridor that's created in both scenarios that would allow, again, key goods, right? We're not saying that there's no supply chain disruption. We're just saying that any supply chain disruptions will be mitigated by this corridor that's created around Taiwan.

Okay. Okay, very good. And how long, how does this ultimately resolved? Do we make an assumption about that as well? I mean, is it ever resolved? It's gradual, right? So basically after the brunt of the recession happens within the first two years, but then there's gradually basically sort of this recovery,

and it kind of fades into the rearview mirror, right? Much like, I think, you know, Russia, Ukraine, when it first started, it was such a big deal. It had such a huge impact, you know, particularly in commodity prices, right? In this case, it has very much the same flavor. where I think a lot of the shock to the global financial system, the global economy is in those first two years, right? But there are still lingering effects, right? And so here maybe I'll talk about some of the model mechanisms, right?

I think Steve mentioned trade. Trade is obviously one of the biggest kind of mechanisms through which the shocks are transmitted. In particular, trade in and out of Greater China really grinds to halt declines very sharply, as does investment into the region. Obviously, the currencies fall significantly. And furthermore, here is where I'll contrast it with Russia, Ukraine. So in contrast to Russia, Ukraine, where you have huge kind of shock to supply, right? In this case, you have a huge shock to demand, particularly for oil and other commodities, because China is the world's largest importer of these key commodities.

And so as a result of that, in contrast to Russia, here, you actually have prices falling pretty significantly. A price for bread basically drops below, you know, $50 a barrel in this particular, like, no intervention, no military intervention scenario. And that I said the price of bread. Did he say the price of bread? I thought he said the price of bread. Brent. Brent crude.

Sorry, I'm having a hard time. Okay. Price of bread. I don't know whether it's the sound or just like, let's get it. I think Mark is hungry. Yeah, that's famous Taiwanese bread. Okay, fair enough. Okay, boy, that is very detailed.

Go ahead. Sorry, I stopped you. No worries, no worries. Yeah, so I was just saying, I think in contrast to Russia, Ukraine, right, you have these oil and commodity prices falling through the roof. And so then you have inflation actually coming down instead of, you know, what you would expect, perhaps, with some of the supply chain disruptions. So coming down in the short run, but eventually the supply chain disruptions and more importantly, the decoupling and the

de-globalization that happens as a result of all this uncertainty around greater China, basically leads to inflation going above baseline in the medium term before reverting back to baseline. So it creates a lot of these really interesting dynamics that, again, are very different from Russia, Ukraine, just because of the nature of the conflict here. So what you're saying, one of the perhaps surprising or feels like a surprising result is the shock initially is disinflationary, deflationary, because it's such a hit to global demand, particularly for commodities, because China is a huge consumer of global commodity. So oil prices go down, metals prices go down, commodities more generally.

and that overwhelms the inflationary impacts of any supply chain disruptions. But ultimately, you know, eventually further down the road, the commodity price effects fade, and then you're left with the disrupted supply chains, just kind of a scrambled mess. And that ultimately results in shortages and higher prices and inflationary pressures. And also you pointed out longer run the inflationary impact of de-globalization. I mean, globalization lowered prices pretty consistently back after China entered into WTO. But in this case, de-globalization results in higher inflation. That's kind of the dynamic you're describing here that comes out in this scenario.

That's absolutely right, Mark. And I think that reorganization of supply chains, this de-globalization, really is the strongest kind of lasting impact in both scenarios. I think Tim is speaking Canadian. I think that's the problem. Have you noticed? Could be. How do you say reorganization? How did you say that again?

A reorganization. At least I didn't finance. If I said finance, that would be- Is that actually Canadian? That feels... I can tell you that finance versus finance, I think a lot of my American friends always is, you know, I'm a CFA, right? So all of my CFA friends always said, you're saying it wrong, man.

Like, you shouldn't be allowed. Like, you shouldn't even be given the sort of, like, qualification. You can't be in the club. man. That's right. That's right. So in a no military intervention scenario, it's a kind of a dark scenario that plays out over a long period of time. And it's darker than Russia, Ukraine, just simply because or in part because China's a big economy with lots of links with the rest of the world. Russia is a small economy with very few links to the rest of the world. Is that kind of sort of right? That's right. That's right, Mark. And I think just to kind of, you've hit

the nail in the head, right? China is just too big, right, for the world to decouple from completely. And so I just want to emphasize in these scenarios, we do not assume that China is just completely isolated, right? On the contrary, what we actually do is we have very specific assumptions around sanctions. So sanctions only being applied to sectors that are critical to national security in this no military intervention scenario. So those would be defense, you know, advanced manufacturing, you know, AI.

you know, chips to a certain degree are electronics. But they are not, you know, comprehensive and do not include other sectors. Because, yeah, as you said, Chinese demand is too important. Okay, got it. I mean, just ask a question. Yeah. Could you speak to the timing of the scenario? I think it completely matters, right?

If this is pushed out into the future, there's enough time for those supply chains to be moved around. There's already activity around that. But, of course, if it happens immediately. the effects would be greater. So what does the scenario assume? Yeah, that's a great question, Chris. So we had a lot of discussion around this. So let me preface by saying that, and here actually, this will go back to Mark and Marissa's point about scenario construction, right? We assume that the conflict starts the end of this year. This does not mean that we think any military conflict is going to happen this year, right? On the contrary, we believe that, first of all, the probability of

military conflict is very low. And even if it does happen, the earliest possible date would be 2027. There's a couple of reasons why we assume we made this assumption that the scenario of shock starts end of this year. One is that we want it to be far enough out in the future so that by the time the scenarios come out, the forecast come out. This would not be history, right? Which does happen sometimes with some of the sort of standard scenarios that we produce. But the other thing also is that we want this to have an important kind of impact in terms of measuring risks, right? As you mentioned, Chris, if this was too far out, if we started this out in 2027, right, then necessarily the impacts would be far more diminished, right, than starting it out

end of this year, right? And that's really, for the benefit of our clients, right, because we do have clients that are interested in sort of seeing and quantifying just how big of a shock this would be, right, to the countries wherein they have significant exposure. We started at end of this year. But Tim, to Chris's question, the no military scenario is about a two to three year length, right? That's right, that's right. So it starts, the conflict starts end of this year. The sort of conflict proper is for two years, right? And then there's a recovery, slow recovery, right, that lasts about five years in total. And then all of those, we mentioned the reorganization of supply chains.

That in total is about 10 years. So the reversion to Bayside doesn't happen until about 2030 or so. So very quickly, Tim, because I want to move on to the next scenario, what is the peak to drop decline in global GDP in this no military intervention scenario? Yeah, that's a great question. So in this scenario, we have 8% at the trough relative to baseline. And then long run is 6% below basis. And this is for the U.S.?

This is for the globe. The global GDP. Okay. This is global GDP. Okay. That's a lot. Yeah. Yeah.

I see a decline in the financial crisis, do you know? Probably like 5%ish. Yeah, I don't have off the top of my head, but I believe that's right. Yeah, because we calibrated this basically to be worse than anything that we've seen before. Okay, okay. The second alternative scenario is, okay, there's military intervention. So describe kind of the mechanics, you know, what happened there, what happens there in that scenario? Absolutely.

So this scenario, really, I think, and you played a big part of this mark. I did. At least to, that's how it felt. Okay, very good. You read the various iterations. It must be good. Okay, far away. So it must be good, right?

And I remember when we were discussing this, you specifically said you wanted a shorter, sharper. Oh, yeah. Right. As opposed to, in the past, we used to have like these prolonged conflicts. And there's good reason for that, right? You know, I think the scenario assumes that there's an immediate counteroffensive by the U.S. and its allies, and this catches China off guard. This is pretty important, right?

The counteroffensive leads to direct conflict, right? And this direct conflict is certainly a lot more severe than the no military intervention scenario, given that it now involves the entire world, right? This is no longer just China and Taiwan. This now involves the U.S., you know, Australia, the UK, you know, Japan, Canada, what have you. So it only lasts a couple of quarters.

And there's also much heavier sanctions, right? It's going to be sanctions on both sectors that are important for economic security, but also national security, right? So on top of your defense, your AI, your advanced manufacturing, now we're talking about banks, we're talking about professional services, we're talking about key sensitive sectors, you know, or even products, right, that are very critical for the trading relationship, you know, things like soybeans, you know, things like rare earths. Those will be covered, right, under this scenario because, you know,

there's going to be sanctions of both sides and pretty intense fighting for a short period of time. And certainly there's going to be more firms, especially Western firms that move away from China, as China is also barred from Swift. So this is really the scenario wherein you see kind of... Swift. You've got to explain that. Swift. Oh, Swift is a payment system that's used all around the world to facilitate all kinds of international transfers. And so that's really something that... You can't trade without Swift.

You need Swift to help to... That's right. It's not exclusively the case, but still it's pretty much the case, the SWIFT system, which is controlled, I think, by the U.S., right? Effectively. Okay. I believe so, yes. Yeah.

Okay. And so I think this is really the darker scenario, if you will, from a short-run perspective, right? Where we wanted to see just how bad could things get. That being said, because this scenario resolves, relatively quickly. The recovery is far stronger as well because there is just less uncertainty, right? Like you know that when the conflict ends, it ends. And we're in the clear, right? Because of that, you see that while the initial drop is more severe, so 10% below baseline

at the trough for global GDP, the faster recovery leads to long-term GDP impacts that's closer to 4% below baseline, as opposed to 6% in the no-military. intervention scenario. So I think that presents this very nice kind of contrast, right, between short-term impacts and long-term impacts. But I must say, though, that in the end, the one kind of overarching conclusion really is that nobody wins in either of these scenarios, not a single country benefits on net, right? Certainly there are, you know, countervailing forces, right? certainly during this reorganization of supply chains, you see a bunch of countries, especially in APAC, you know, sort of having, you know, more Western firms build factories

and plants in those countries to replace what would otherwise be built in China. The negative effects from just, you know, negative sentiment, the productive capacity that's destroyed as a result of the conflict, far outweigh any of, um, of the conflict. of these sort of positive countervailing forces. Right. Good. I'm just trying to think of what's the most realistic scenario. I mean, we have our baseline, but, you know, could it be the case that the way this plays out is the U.S.

becomes much less dependent on Taiwan. I mean, we're very dependent on Taiwan because of the chips. And that's one reason, key reason why the administration, Biden administration, past the Chips Act, the piece of legislation tried and sent more production here of chips in the United States. That's going to take time, obviously. Building a chip plant is a pretty difficult endeavor. It takes years to do. But if you look out five, ten years from now, presumably the U.S. is much less dependent on Taiwan. And other U.S. companies much less dependent on China. Because, you know, as Chris pointed out, U.S. companies are moving operations here,

pretty quickly. They're reshoring. They're pushing production into Southeast Asia. You know, Vietnam is the poster child for that. Mexico. And we are decoupling. We're just quickly decoupling. And this doesn't feel like that's going to change anytime soon. And so you look out five, 10 years from now, the two economies, two countries are just much more disengaged. And in that point, we just kind of the conflict fades away. I mean, I don't know what happens. It feels like Taiwan isn't a very tricky spot at that point, but it just feels like the U.S. doesn't have the interest that it has now to kind of, you know, protect Taiwan from China. Does that, does that sound right to you as a scenario or would you push back on that? I would say qualitatively, I share your sentiment,

mark. I think there is certainly a desire to be more diversified. But we, You were also joking at the top of the call that you wanted statistics, right? And so, and I'm not even going to make you guys guess. I'll just throw them out there. Go ahead. Go ahead. I'll make you guess. So I like to see Mercer always gets any, all these anyway.

So go ahead. All right. So what is over 90%? Something related to Taiwan. In chips? Related to chips, yes. But we did 90% of certain DRAMs from Taiwan. Oh, wow.

That's so specific. No, not really. I can pretty much tell you that absolutely, that very likely is wrong. I'm sorry to tell you that part. Korea has very strong D-RAM production. What do you say, Marissa? Korea.

Oh, I have no idea. No idea. No, I don't know. Is it a particular type of chip or application? It is a particular type of chip or a certain size of chip. I deserve credit for that. Come on. But being wildly wrong.

But DRAMs, Mark, all my South Korean friends will write me hate mail. And they're like, you know better than this, right? Like you read all these detailed semiconductor reports. Okay, what is it? What is it? A.I. Chips related to AI, 90%? Very close.

TSM. There's some wacko name for a chip that, you know. It's a X350 slash 801. He's just rattling off all these random chip types. I think those were made up numbers and letters strung together. I'm looking at the serial number for these PC is what I'm doing. Yeah. Go ahead.

So Steve was very close. So it's literally chips that are five nanometers and smaller, right? So these are the advanced chips, right? Of course. And certainly, I'm guessing Chris probably would have guessed that. I was on the tip of this time. I didn't want to say because it was so obvious. But yeah.

Yeah, but that was my easy, easy number, right? Here's another number. Yikes. And they're both related to, they're both related to Mark's point, right? Over 60%. What is that? Just over 60%. Another type of chip that we-

Still chips, but this is actually more general. Okay. We give. Over five nanometer. So it's actually over 60% of the world's semiconductors are produced. In total. Wow. in total.

In total. That's a lot. Yeah. Right. So I think while I share your sentiment, Mark, I think there's a desire to diversify, the reality is given how like just a preponderance of Taiwan. Oh, you're saying it's can't do it. All chips.

It's very hard to do. Interesting. Okay. It's very hard to do. Very good. Okay. I want to end this way handicapping these things because people are saying, well, okay. Well, you know, what's the, how big a deal is this?

So we've got the baseline. The baseline is sanguine lots of different ways you can get there. And let's say everything else, all other alternatives that involve some form of sanction slash conflict, you know, military or not. What's the what's the probability of that, of that alternative world, much darker than the baseline? Steve, what do you think? I would say 5%. Oh, geez. I think it's out there on the tail.

Yeah. That's way out on the tail. Okay. Yeah. And I think it is because, and we could see with the work we've done, what high economic cost there would be with the kinds of conflict that we've laid out. So I put it out there. So you think it's basically an accident.

You know, so there's an accident. Well, I mean, you talked about that. Two airplanes crashed together. That's right. Your example of today's fighter jets coming. within what, 400 feet, you said? Yeah. That's like so close to an accident,

and it only takes one of those to happen, and the lack of communication between China and the U.S. for something like this to blow up. And look at the brouhaha that occurred when we shot down the balloon over the Atlantic Ocean, and that was pretty benign. So, yeah. Okay, so 5%.

And it's basically some kind of, accident that results in a more involved conflict. That gets more involved. That's exactly right. Okay. Before I'm going to go to Tim last, but Chris, do you have a view on this? I tend to agree with Steve. Okay.

I think it's barely a little probably, and I think both sides recognize the consequences here. So it would have to be some type of mistake or accident. I think there's certainly the provocations that Tim talked about. I think they continue. But I don't know. At least I want to believe we don't cross the line so easily or cavalier. Just to be clear, I'm including the no military intervention scenario here too, not just the military intervention.

It's something that, okay, put it this way, something is meaningfully different than the baseline on the dark side. Okay. Okay. You're saying 5%. Yeah, I think so. Ooh, okay. Mercer, do you have a view?

No, I mean, I trust Steve. Okay. defer to the expert here. I have faith in Steve and Tim. Tim? Yeah, no, I'm with Steve. Yeah, I think definitely less than 10%. Yeah, I think I quoted Xi Jinping earlier,

but that is a sentiment that even, you know, goes back to like Deng Xiaoping days. And same thing in terms of, if you listen to what's come out of the White House, right? I don't think anyone wants military conflict around Taiwan. So hopefully we can keep our, you know, our jets away from each other, right? and leave peaceably, and I think everyone would love to have that outcome.

And that probability is also including, again, just to make sure that I understand, no military intervention. You know, strict sanctions, corridor for the chips, that kind of conflict. You would include that in your less than 10%. Mm-hmm. Okay. I think you guys are being too Polyanish, actually. Okay.

What's your percentage mark? 25%. Wow. Oh, yeah. for the no military conflict. No, anything that's not the baseline. Anything that's not the baseline. Take the distribution, put the baseline in the middle, look to the right hand side of the distribution.

I'd say it's 25%. Something palpably darker is going to happen here than what we think. Yeah. It just doesn't, we're moving apart at lightning speed on every level. Economic, political, social, we're disengaging. And I think it's just a lot harder to hit each other. over the head when you're disengaged like that. You know, when you're embracing each other, it's hard to pull your hand up and hit the

other guy on the head because you've got your hands around them. When you're apart, you can take a swing. And I think accidents happen, you know, so I don't know. I don't have a warm, fuzzy feeling here. And when I say 25%, I don't see, I'm thinking not next month next year, but over the expanse of this conflict that, you know, could play out over a decade or two. So this is not something that's going to go away quickly. This is something that's going to play out over a long period of time.

But you make a point there, Mark, I think that is worth noting, is if we're looking for that point where an accident might happen, it would generate a conflict if you've got a 10-15-year period where one accident could happen, well, that raises the probability just from the time frame that you're looking at. Simply cyber war, you know, it feels like, you know, maybe it's not jets fighting each other ships fighting each other. It's, we're fighting each other on the web. You know, we're shutting down each other's, I don't know, making it up, electric grid.

But you know what I'm saying? Yeah. Right. Okay. But how likely is it that no military conflict scenario? I mean, if we, I think sanctions would be interpreted as an act of war, right, if the U.S. were to unilaterally impose. Well, we're probably some sanctions now, though, aren't we?

But we're not. I think we're talking at a different level. Okay. Okay. for a. We're putting some tariffs, certainly, but not to the point of cutting off trade, as we've done with Russia to a very large degree. I think if that step is taken, then the next step towards war become, I mean, the reaction would be quite negative. I would. Well, isn't that what I'm saying? I mean, you say 5%. But yeah, but that's why I don't think, I don't see. Oh, oh, I see.

You said 25% is anything. I see. You're saying, I don't see that that no military action scenario actually has a lot is that viable because it either jump from this current daytime to war i don't see you can ratchet it up but not cross the line right right maybe yeah i think to mark's point i will say that and this is something that is really the rationale for that 2027 date that i had said earlier is that that is the date for the next party congress uh for the chinese communist party and certainly Xi Jinping has mentioned that he would like to leave a legacy and reintegrating Taiwan could potentially be part of that legacy. And so I think your point mark about a longer time horizon certainly changes the calculations

in terms of how likely there is to be a conflict over time. Yeah. Okay, very good. That was a great discussion. And, of course, we're going to be at, I'm sure, back at this in the not too distant future because this is evolving very rapidly. Any last words, guys? I know it was a bit of a bearer to do this.

A lot of conversations with lots of different people in all walks of life and here in Asia and the whole team was involved and a lot going, a lot of moving parts here. But you've got to cross the finish line. Congratulations on that. And there is a paper out there, a white paper. So if folks are interested, let us know, we'll get that to you as well. And the scenarios are in the databases for folks to use if you're interested. Any other words of wisdom?

Okay, hearing none. I'm always open for words of wisdom. Okay, still hear none. Okay, okay, going, going, gone. Thank you, dear listener. We'll talk to you next week.