Odd Lots - The Massive Economic Impact If China Invades Taiwan

Episode Date: January 15, 2024

A possible Chinese invasion of Taiwan has become a top-of-mind concern in defense and corporate circles in recent years. But what would such an attack actually look like? And what would be the economic impact to world if it actually happened? On this episode of the Odd Lots podcast, we speak with Jennifer Welch, chief geo-economics analyst at Bloomberg Economics and Gerard DiPippo, senior geo-economics analyst at Bloomberg Economics. Jennifer and Gerard, along with a larger team of Bloomberg economists and journalists, recently undertook a massive exercise to game out the potential impact to the global economy of a war in the Taiwan Strait — which they estimate to be around $10 trillion. That would be significantly larger than the biggest disruptions in recent memory, including the Covid pandemic and the global financial crisis, leaving virtually no part of the world unaffected. We discuss how they go about assessing the odds of each scenario and how they evaluate the possible impacts.See omnystudio.com/listener for privacy information.

Thanks for listening to Odd Lots. Follow the show on Amazon Music for more future episodes or just ask, Alexa, play the Odd Lots podcast on Amazon Music. Hello and welcome to another episode of the Odd Lots podcast. I'm Joe Wisenthal. And I'm Tracy Allaway. Tracy, you know, for years, I've always thought that if you want to be like a smart sounding pundit at the beginning of the year, had someone asked you like, what risks are you thinking about right now? you like stroke your chin and look off and you say, I'm really worried about like geopolitical risk. And that's always like a safe answer any time, any year. Like that always makes you sound sophisticated.

Yes. Unexpected geopolitical risks are an evergreen category of punditry. This is true. There is one specific risk within that category that I feel like has come up every year for almost as long as I can remember. And that is the risk of something happening between China and Taiwan. And I have a really embarrassing confession to make. Okay.

I wrote my dissertation on, I wrote it in Beijing. And it must have been in like 2005 or 2006 predicting that China would invade Taiwan before the Beijing Olympics. I think that was like 2008 or something. So when people talk about the risk of China invading Taiwan or attempting to formally reunify, this is like 20 years people have been talking about this and it keeps not happening. Yes, and getting it wrong consistently for 20 years, or at least I have. But it does seem, right, like for whatever reason, and we'll get into it,

that we are once again in a wave of heightened concern. And, you know, there are two very active wars happening right now currently between Russia and Ukraine, the Israel and Hamas war. And so the idea of war, unexpected war is on people's minds. And then we know that tension has been building in various ways. Taiwan, there was all of the angst over the Nancy Pelosi trip a couple of years ago, for example, and the heightened awareness that the world has on semiconductors that are manufactured in Taiwan. And sort of a more aggressive posture, I believe, from Xi Jinping and the military of more

aggressive war games and exercises. So many people are concerned about some prospect of a hot conflict in the next few years. Yeah, you mentioned semiconductors, and I feel like this is really the key thing, which is in the past two or, well, I guess four years now since the outbreak of the global pandemic, we have had a sort of crash course in the importance of the Taiwanese economy to the broader world. And I feel like that's sort of done a couple things. So one, it's made everyone a lot more nervous about what could happen if that supply chain gets disrupted again, although in a very different way. And then secondly, maybe it's, it's given a little bit of ammunition to China to saber-rattle on this issue even more, right? If it threatens something against Taiwan, the whole world now knows what's at stake. Yeah, that's absolutely right. So this is one of these things that is you could feel it building. More and more people are talking about it.

My understanding and what I've seen is people say, oh, in D.C., everyone is, like, obsessed with this question. I don't feel like that's as much the case in New York, but I do get the impression that in D.C. talk of a war is very high. And so I think, like, you know, we have to do more on this. And I think geopolitics in general, thinking back to some of our conversations with Zoltan, et cetera, about, you know, this sort of rearranging world. Like, we need to dive into these questions a little bit more. Yeah, absolutely. And the other reason we need to do it is Taiwan is holding an election. In fact, we are recording this on January 9th. By the time this episode comes out, the election will have been held. And so we'll know who the winning candidate is, but in the meantime, like, there is clearly

a big reason to discuss this. Yeah, absolutely. Well, I'm very excited. We have two of our colleagues here at Bloomberg that we've never had on the podcast before, but they're the perfect guest to discuss this because they've been doing a lot of work in this area. We're going to be speaking with Jennifer Welch, Chief Geo Economics analyst at Bloomberg Economics, and Gerard DePippo, senior geo-economics analyst at Bloomberg Economics. They both published a lot of work on some of these questions, related questions, wargaming the risk, the economic stakes involved here. And so we're going to start to go down our path of understanding this tension better. So Jennifer and Gerard, thank you so much for coming on odd lots. Thank you so much for having us.

Glad to be here. I have a sort of very basic, I don't know, maybe it's not basic. Zoom out question. You know, we talk to like normal, talk to economists who, you know, they have their recession forecast or forecast a soft landing, whatever. And I sort of have some idea of how they go about, you know, modeling different scenarios. When it comes to war gaming and modeling the odds of a war or modeling how a war might go if one were pursued, what do geo-economics analysts, like what is the toolkit that you have to actually go about modeling the risks and the outcomes of war. That's a great question.

And let me, Jared, I'll start off and then if you want to jump in as well. So on the first part of your question of how do we estimate the probability of war, to be perfectly candid, this is definitely more art than science. What we did in the case of our recent project on Taiwan and the trajectory we might see in the Taiwan Strait was take a look at sort of baseline conditions. What are the sort of structures? in place there that lean towards stability or that lean towards increasing tensions and even to the extreme of a crisis or conflict. And we examined all those key variables and their trajectory and what

weight they might have. And to be candid, this is an area of a lot of debate among people who focus on the Taiwan street. You know, to what extent does Beijing wield the most agency over it versus Taiwan versus the United States, which has historically been a key balancing. power in the street. And then from there, we kind of developed our sense of probabilities. But again, this is a really complex and dynamic geopolitical environment. The election that Taiwan will be having in advance of this recording is an example of how things can really shift at quick notice depending on how events like that turn out. But overall, we think our sense of what the risks of crisis or conflict in the street are are meant to be.

standing the test of time and looking out over the next five years. And then in terms of how we study what the outcome of a war would be, were one to happen, this is a little bit more of a rigorous process. And there are a lot of think tanks. There are a lot of internal government entities, not just the United States, but Japan, Taiwan, all around the world that are increasingly looking at how a cross-rate conflict could play out. And it often is very much focused on the military dynamics. historically the origin of these war games is testing military tactics and battle plans and playing out how different scenarios can produce different outcomes depending on sort of what you go into the battle with and how different conditions can change those outcomes. So for that particular

exercise, there's a lot of different variations of war games related to Taiwan out there. And a lot of them produce a variety of results. It really depends on kind of the assumptions going into it on, you know, for example, how does the war start? Is there any warning of it? How prepared is Taiwan to defend itself? Does the U.S. get involved? But what all of them point to is a war would be incredibly costly at all sides. Most of the war games focus on sort of the military and the humanitarian impact of that. But we looked at also the economic impact. And what we found is, especially for China, Taiwan, and the United States, but also the global economy, the toll would be quite immense where the cross-rate tensions to erupt into a broader conflict. Maybe this is obvious, but I think

it's worth pointing out that we're dealing with something that's mostly beyond the historical sample set. So normally when you're trying to model something, you think of what's happened before. You think of like Tetlock's book Super Forecasters where they talk about outside-in analysis, right? And you look at what's happened before, they might be analogous and say, what are the chances that would apply in this case? Of course, there are many wars in history, including wars that are happening right now. But there aren't that many that involve China, and there are none that involve cross-rate conflict. And there aren't actually that many to involve a major, essentially continental power, seizing an island power, right? And so it actually is a quite limited sample set.

And what we essentially do with think of plausible outcomes and then kind of back in relative probabilities, at least compared to, other outcomes and then say, okay, that tells you sort of cumulatively what the odds are of these scenarios. Can you tell us a little bit more about how you choose which scenarios to focus on? Because obviously you can't examine the entirety of possibilities when it comes to Jared's point, like a relatively unknown and unpredictable conflict. But there are clearly some scenarios that are seen as more likely than others. And I remember when I was working in Hong Kong, we did a big piece on the news side of things about, you know, this is what a war between China and Taiwan might look like. And our source for that was we went out

and we spoke to geopolitical experts such as yourselves and we tried to get their sense of what the most likely scenarios were. But when you guys are doing it, who are you talking to? What are you looking at? Part of it is a constraint on how you're trying to answer the question. So in this case, we're trying to model economically what these outcomes are. The range of outcomes is more of a gradient. I mean, in a technical sense, there could be thousands of outcomes, right? But you can't actually model all of that. So what we tried to do was decide what are the sort of key outcomes

that are more or less analogous within themselves than try to model that. But I should also say we're putting out other pieces on the terminal that are actually more detailed and maybe more nuanced than you might have seen on the sort of econometric side in the big take. No, I think this is exactly right to kind of underscore the point on some of these scenarios have more direct economic implications than others. So, for example, there's a lot of different variations of what a major crisis in the street could look like short of a war. We chose to model a blockade because that's the scenario, even though it's one of the more unlikely ones for a lot of reasons we can get into, that would have more direct implications for the global economy versus something like, a seizure of one of Taiwan's outlying islands where it would be incredibly escalatory and risky

from a geopolitical perspective, but the impact to markets and to the global economy directly might be less so because it's not necessarily directly affecting trade. But all that to say, you know, in terms of what we looked at for the big take and the overall exercise was looking across the spectrum of possibilities from sort of best case scenario by which we define that as sort of an enduring or stable piece to absolute worst case scenario by which we define that as an all-out conflict, including a conflict between the United States and China, and then everything in between the status quo, kind of being the base case, something slightly worse than that, which we define as increased tensions. And there, there's a lot of variation in what specifically

that could look like. But the economic implications are probably not all that different across, those various inter-scenarios, and then major crisis short of a war. Again, a lot of different variation in there, but the one that we think would have the most impact on the global economy would be something like a block that directly interrupts trade. I'm June Grasso, inviting you to join me for the Bloomberg Law podcast. Every weekday, we help you make sense of the legal stories that shape the nation and the world. Listen for complete analysis of the biggest court cases. The latest actions from Congress and regulators and the legal moves driving the markets. From corporate law to constitutional law and from state courts to the Supreme Court. At Bloomberg Law, we go beyond

the day's headlines. We speak with top attorneys, judges, scholars, and policy experts to break down what the rulings really mean. We do this every weekday, then bring you the best conversations in our daily podcast. Search for Bloomberg Law on YouTube, Apple, Spotify or anywhere else you listen. On the East Coast, listen as you start your day. And on the West Coast, catch up in the evening. That's the Bloomberg Law podcast with me, June Grosso. Subscribe today wherever you get your podcast. So I should just say both Jared and Jenny have mentioned a big take, which is basically a Bloomberg piece based on the report that they did for Bloomberg economics, where they're estimating the exact, or rough, price tag of some sort of military action between China and Taiwan. They're estimating the price tag at about $10 trillion, which would be equivalent to 10% of global GDP, which would be more than, you know, the loss from Russia's invasion of Ukraine, the COVID pandemic, and the global financial crisis. So some pretty big numbers there. But Jenny, I'm curious why you say that the blockade

is in some respects a less likely scenario here, because my impression, was that that was kind of becoming, I don't want to say consensus, but like it was certainly a realistic possibility of what military action could look like. No, that's right. And I think it still remains a realistic possibility. I think though changing military dynamics suggests that it is probably one of the tactics that is likely lower on Beijing's list of preferred options. And I say that because a blockade is technically an act of war would be incredibly risky in terms of tipping into a conflict. For example, if China were to put in place a true military blockade of Taiwan and Taiwan were tried to challenge that Beijing would be forced to either use military force to keep that

blockade in place or to have to remove it. So it has a really high chance of tipping into a conflict. But at the same time, it's not guaranteeing an outcome, right? If Beijing was going to risk war, it would seem to make more sense to go for the all-out amphibious invasion, which has the chance of securing control over Taiwan, whereas a blockade isn't likely to do that on its own. All that being said, most of our understanding of what the Chinese military strategy might be for Taiwan, and in general, you know, how amphibious campaigns are carried out, we think that a blockade would be likely part of their campaign, part of a multi-step process where they try and undertake an amphibious invasion of Taiwan, to try and keep enemy combatants from leaving, to try and keep any third parties from intervening. It would be part of it, but to launch it in advance would also give

a lot of time and warning. And the ten times, and more recent military campaigns has been to try and take advantage of the element of surprise. And you lose that with something like a blockade, which is a very obvious demonstration of force. But all that being said, it could still very much be a realistic possibility, particularly one of the things that we've talked about, too, is it might not take the form of an overt campaign or an overt blockade. It could take the form of something that looks more like what we call law fair. or legal warfare, enacting, for example, a customs regime where you're trying to subject all craft that are coming in and out of Taiwan to Chinese customs. But you'd still need to enforce that in some way, shape, or form. So it still bears a pretty high risk of tipping into

something more kinetic. I have a very, I don't know, maybe rudimentary question. So I'm looking at this war game scenario that was conducted by the Center for a New American Security. And it's In their report, they have like this map that looks like a big risk board and they even have dice. So like it's like, is that really like a part of the sort of geo-economics analyst toolkit to actually have these sort of dice games and maps? Because you see them in movies and the general has that stick and they push things around. But is that actually like a real part of how this is done or is that just an affect for the report? The wargaming industry is skewed heavily towards actual military scenarios. The actual economic war games are quite.

rare. I mean, that's growing in part because it's Taiwan issue. I have played in a number of these, including at think tanks and in the U.S. government. The economic side is typically less sophisticated or treated as sort of just an effect or something in the background. And I think when you're doing military scenarios, you can

do things like saying, roll the dice if your fighter jets, take out the other fighter jets. And they really do that. So there's a serious military analysts rolling the dice on a glorified risk force. Yes, but it's much, with economics, there are far more actors involved and it's not like national decision making is everything because how do you simulate

quote the market right? Yeah. And or supply chains for that matter. And so the body of, let's say, economic war gaming literature when it comes to Taiwan is much, much smaller than the military war gaming literature. Well, why don't you talk to us about the economic modeling aspect of this? Because it seems hard enough to game out what military action could actually look like. But then when you start trying to estimate the cost of various types of action, that seems even more complicated. But you've put a number on it $10 trillion. So how do you actually go about doing that? Sure. So first, I want to give credit to our outstanding modeling team in Europe, mostly, as part of Bloomberg economics. They did most of the actual math work. What Jenny and I were doing was helping to define the scenarios

and then working with them to come up with essentially like scenario inputs that would be relevant into those scenarios that would have relevant economic outcomes. And so we already talked about how we develop scenarios. When it comes to the actual modeling, it's essentially layering on three things. The first is a sort of standard WTO trade shock model, which people use for tariffs and other stuff like that. We played with tariff rates in some ways to simulate the effect of sanctions. These models don't really have a sort of SDNing the PBOC effect button in them, but you can get

some of the trade shocks in there. There's also a financial model that is layered on top where you play with things like the VIX, and you can see how market uncertainty or capital flows move and what the economic outcome or effect is of that. But actually, in this case, because we're dealing with Taiwan, the most important factor in terms of the cumulative economic impact was supply chain impacts. And I know you guys have talked a lot about this on the show, the importance of Taiwan, TSMC in particular for advanced semiconductors. And what we did with that was talk to various industry research professional people, including at Bloomberg, who work on these things. And using the OECD trade and value added data and input output tables, to essentially estimate at the end of the day,

how much of certain sectors, and these are generally high-level sectors, it's just how the data is presented, how much of those would get knocked out if, for example, the world does not have access to TSM's chips. You could debate how bad that would be. And in fact, we got a range of estimates. We took sort of something in the middle that is, like, awful. But, you know, but not completely apocalyptic. But I think if you look at the bottom of the big take, there's a note explaining this. That essentially we knocked out in the war scenario,

something like 85% of global electronics production. So things like smartphones and all that computers, laptops, and then something like 62% of global autos and transport. So that's a massive shock. And it's actually doing a lot of the work in terms of the simulation of economic impacts. Yeah, and just to add on to that, shout out to our Bloomberg intelligence colleagues

who helped us better understand the role that these chips play in different industries. And the point that Gerard noted on what we call the golden screw problem of trying to determine, you know, a chip itself might not cost that much, but it's hard sometimes to know for sure how essential it is to a particular product. You know, for example, could the car be made without that chip? Is there the possibility that the manufacturer could substitute for something else? And as Gerard noted, we worked with our B.I. colleagues to kind of estimate within that range

of how essential these chips are. But our rough estimate is that chips we know are really important to high-end products like smartphones and PCs, but they also play a really critical role in other major industries, autos, home electronics, et cetera. And I think there's a huge question of not just what happens if those products can't get produced, but everything that relies on those products, in particular in our more advanced service economies, what that means going forward if you can't get new smartphones, if you can't get new autos and if you can't get new PC. So I think this is an important figure, the $10 trillion

one and the impact that we're estimating to advanced economies, but it is in some ways the beginning of the conversation because there's more work that can be done to really refine those numbers and then estimate the downstream impact. I want to ask a question that actually takes us step way back. And you know, as Tracy mentioned in the intro, and I didn't know, that she wrote a thesis almost 20 years ago predicting an imminent invasion. Thanks, Joe. Now I feel old. Old and wrong. Sorry. But why now? Why are we, this seems to go in waves of people concerned? What do you, like, set the stage for us of like, why are we at this point again where people are seriously running these scenarios and doing the math and talking about this and such a high level? Like, what are the

conditions that have got this, like, so top of mind, particularly in D.C. for people who think about these things. So I think the first thing to acknowledge is, I think Tracy was not far off in assessing back in the 2000 to 2008 period that there was a high risk of a conflict at that point in time. The reality is that risk ebbs and flows. It's not a particularly necessary, or I should not say it's not a particularly or essentially linear process, right? It depends on the various factors at play. The 2000 to 2008 period was a period of really heightened cross-street tensions owing to an administration in Taiwan that Beijing found to be incredibly problematic and very close to crossing its red lines. And there were a lot of periods of white knuckling

over how, for example, Beijing was going to respond to elections back in that time period. What I think has evolved since then that as to the level of concern are a couple of really important drivers of the cross-strait stability dynamic. And the first one is really the military balance, not just in this street, but more broadly. So since roughly 2005 to the late 2010, China has really eclipsed Taiwan militarily. There was a period of time where Taiwan still had, even though a smaller force, a much more advanced force. And that has really changed in recent years with all of China's investments in its military modernization. And we see that on a day-to-day basis where China is just overwhelming Taiwanese forces

with the amount of military planes it's putting into Taiwan's nearby airspace. The second piece of that dynamic, though, and arguably one of the more impactful ones, is the changing military balance of power between the United States and China. U.S. now regards China as its pacing challenge, as the military closest to matching it, And that's particularly important closer to China, where China has a lot of local advantages. And obviously for Taiwan being, you know, just across the street for China, they're right sort of at the center of that. So that's a incredibly important shift over the past 20 years that I think heightens concern. And then the third part is the political dynamics at play.

Taiwan, over the past 30 years of becoming a, you know, more full-fledged democracy, we've seen that go in parallel with changing attitudes on the island towards its relationship with China and its identity and how that relates to that cross-strait relationship. And you look at polling today and the vast majority of Taiwanese identify as Taiwanese, not as Chinese, not as Chinese and Taiwanese, Taiwanese. And at the same time, support for unification, which was never that high, but was about 20% in the 1990. has dropped to, you know, below 5% this year. So it's incredibly unpopular idea. The vast majority of folks would just prefer the status quo, which is de facto separation. And then simultaneously you have on China and the mainland, you know, a growing sense that

China is a rising power. That creates both sort of a need and an opportunity to make progress towards these historic goals of territorial integrity and unification, which in their minds is all least. leading up to this, you know, national rejuvenation of China. And key to that is the idea of finally bringing China back together. That's their vision for what their end state should look like. And Taiwan is one of the most important outstanding elements of that. So there's really sort of these divergent forces at play where Beijing is becoming much more focused on advancing progress towards unification and more concerned about trends in Taiwan, which are taking the island

towards the idea of a very different sort of identity than it would share in a unification picture with China. I think it's worth mentioning the economic dynamics, which I actually think are secondary to the factors Jenny was mentioning, but the economics does matter. I think what makes it difficult, though, is that it doesn't, the direction in which it matters is not necessarily clear, right? So when the U.S. and China, or the PRC itself, established diplomatic relations in 1979, Chinese GDP was one-tenth of U.S. GDP.

Right now, it's something like 66, 70%, depending on which exchange rates you're using. So you might think, okay, so China is much more powerful now, which might make it more aggressive. But on the other hand, it has more to lose. It's much more integrated into the global economy. It is worth keeping in mind, however, that Chinese policy, Xi Jinping's policies, very much focused on industrial policy and self-reliance, In particular, they're worried about three things. The reliance in foreign technologies, which include semiconductors, but it's not limited to that.

Imported commodities, so things like oil and food and other things. And then finally, the reliance on the U.S. dollar for international finance. And all three of these things are Beijing as efforts underway to address those vulnerabilities. I'm not saying this is just about Taiwan, but they do see themselves as being vulnerable, and there's definitely a geopolitical rationale for why they're worried about those things. And the more powerful and essentially insulated or robust, let's say, the Chinese economy and financial sector becomes, you might think they might have more confidence or less restraint as that single variable is concerned.

And then, of course, there's the issue of Taiwan semiconductors, which is kind of like, in some ways, a gun pointing in both directions, right? Because, yes, Taiwan makes most of the advanced semiconductors, but those primarily are going into inputs throughout Asia, including China. And so you could debate whether it's deterrence or not, because it could also mean that Beijing believes that other economies, particularly non-U.S. advanced economies, are less likely to intervene for those reasons, but it is part of the conversation. Actually, this reminds me of something I wanted to ask you, which is, you know, it's hard enough

to model these types of economic scenarios because there are so many different factors involved, but also one of the things that makes it difficult is you're trying to model the response to whatever is happening. And so I'm curious when you're looking at something like the cost $10 trillion or variations of it depending on, you know, the exact nature of the action, how much of that cost depends on or is affected by either the West's ability to ramp up things like semiconductor manufacturing or China's ability to, I guess, offset a bunch of resources being diverted to war. So we modeled one-year shocks. We actually internally, we're looking at and debating doing five-year shocks. The five-year shocks, the

confidence intervals get much, much wider. And it's because you have to make bigger assumptions as to whether, for example, TSM's production can move elsewhere. Would private industry have the resources in the middle of the war, for example, to get funding to, say, open a fab or whatever is necessary? I think with a one-year scenario, it's still speculative, but it's still difficult, but it's more plausible, which is that the economy in some cases could rely more in existing inventories of things, you would be more likely to see an immediate shock to production, say, for things like autos or electronics. But if you're saying, okay, what about five years into this, how much of that is back online, then it gets more speculative.

But that is part of it. Another part that I don't think we modeled directly is sort of wartime fiscal impacts. So you could imagine, particularly on the Chinese side, a lot of expenditures going into wartime measures, defense, etc. On the other hand, if you assume the conflict is, let's say a few months or six months, depending on what your parameters are, it's probably not going to look like World War II. It's not going to be five years of ramping up and coming back in part because what we're talking about in the extreme case is from a U.S. perspective, at least mostly a naval and air war, and the U.S. defense industrial base, at least in my view, doesn't really have the capacity

to replenish those forces quickly. So it's kind of a one and done in a very powerful way. There are others, I should say, in D.C. and think tank land that talk about the potential for a long war. I find that from a U.S. perspective, not all that credible. The news doesn't stop on the weekends. Context changes constantly. And now Bloomberg is the place to stay on top of it all. Hi, I'm David Gurra.

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Listen on Bloomberg Radio, stream the show live on the Bloomberg business app, or listen to the podcast. That's Bloomberg this weekend. Saturdays and Sundays starting at 7 a.m. Eastern. Make us part of your weekend routine on Bloomberg television, radio, and wherever you get your podcasts. Right now we are in a period in which there is a lot of talk about poor Chinese economic growth. Obviously, as your model shows, and just for any common sense, a war, how or any version of a war would be incredibly domestically costly at a time when already there's concerns about growth and frustration with the Chinese economic model. How do you, how does that play into Beijing's thinking or Xi Jinping's thinking about doing something at some point,

the state of the domestic economy and the fact that any activity maybe it would potentially reunify China and Taiwan, but would be extremely disruptive to all of the factories in China that rely on Taiwanese inputs? The narrative that some people will propose is that over time, if we assume the Chinese economy is weakening substantially, then the Chinese leadership will be more inclined to pivot to nationalist concerns as a distraction. But it's worth noting at least two things. One, I don't think they're there yet. I don't think they think they're there yet, right? I don't believe Xi Jinping is all that pessimistic about Chinese economic growth, his New Year's

speech and other indicators suggest that he's still fairly optimistic. You could debate whether he ought to be, but I think that's basically right in terms of his view. The second is that I think we are both quite skeptical of the claim that some people make that China might pursue a, quote, diversionary war. And the reason for that is that this would not be diversionary. It would be all-encompassing, right? And so do you really want to bet your house on a distraction? The answer is no. But in the longer run, I think there is a, you know, credible argument that if the Chinese economy is weakening, that the government might pivot to other priorities. And in fact, we can observe that they're already pivoting to national security, right? There's a greater emphasis

on national security and self-sufficiency now and Chinese policy than it was, say, five, certainly 10 years ago. And so over time, it might be the case that it changes their relative willingness, but at the end of the day, they would know how cataclysmic this could possibly be. And our general view, and Jenny might want to add it to this, is that Xi Jinping probably doesn't have a specific timeline in terms of saying on, you know, 2028, we go. It's more, the timelines people talk about are more about military readiness, which is not the same thing. And ultimately, if I had to bet, in which in essence we are, if this ever does happen and be based on perceived provocations or crossing of red lines, it wouldn't just be sort of a unilateral, both from the blue.

Yeah, and I think just to add on to that, Beijing's stated preference is still for peaceful unification, and I think there's reasons to believe that that's true. One, I think they assess, as Gerard was indicating, the military readiness issue, they haven't reached that milestone yet. And in fact, some of the reporting that our news colleagues have done on recent purges of senior military leaders, I think reaffirms the idea that there might still be concerns about corruption and the impact that that could have on readiness. And more broadly, this would be an incredibly risky and difficult campaign for any military to undertake, you know, particularly if there's risk of the United States getting involved. That's no small gamble to make.

And it's not one that Chinese leaders would take lightly. I think to Gerard's point, it's more a question in their mind, I think, of whether or not their hand is forced if they would need to take that action to prevent Taiwan's permanent separation, which to them is, it is hard to exaggerate the importance that that plays in their calculus and the costs that they would be willing to pay to prevent that from happening. I think if we were in a world in which they felt that that was necessary to take action, even if they didn't think they were militarily ready for it, the economic considerations would probably not be a driving factor in their calculus. I think what would be the overarching priority would be preventing that from happening at all costs and at all risks.

So it really depends on, I think, their perspective of whether or not that's essential. And the economic considerations, I think, are more secondary in that sense. So the obvious parallel here would be Russia's invasion of Ukraine in the sense that it was something that was, you know, at once long discussed, but also very unexpected. at that particular moment in time. And of course, there had also been a discussion of why would Russia ever do this, given the economic costs involved and the risk of sanctions and things like that? How has the experience of Russia's invasion of Ukraine affected your thinking about Taiwan and China, if it has at all?

So, Jenny, you can jump in in terms of the Chinese perspective, but I'll just say kind of a more stand-back perspective based on some of the work I was doing previously at CSI as the think tank. One observation is that the internal estimates in Russia of how bad it was going to be for their economy were actually worse than things ended up being. In other words, it wasn't the case that Putin was misled in terms of the economic pain. He actually thought it was going to be worse than it was. And yet he still went. So where was the delusion? The delusion was on the military side.

He thought that they were going to roll into Kiev in two weeks or whatever, and then they could present the world with a fait accompli, and eventually they could dial back the economic sanctions or whatever. I actually think that, you know, there are definitely, you know, government versus private sector blind spots, but in general, I think a lot of people, including investors, might underweight nationalist considerations more than they should. And even believing that the Russian economy was going to take a massive shock, he still decided to roll the dice. And that to me is not necessarily indicative of what China would do. She Jinping is not Putin. I think Putin is more of a gambler in some ways and probably has a less sophisticated apparatus beneath him, but it is telling that that could still happen. Yeah, and I think just to add on on Beijing's perspective, I think it's a mixed bag. I think, you know, on one hand, the fact that the war is approaching its two-year anniversary when from the outset, it was largely expected that Russia's massive army would be able to pretty quickly overwhelm Ukrainian forces, especially with a surprise attack, is probably a cautionary tale in terms of how much more complicated.

invasions can be. And Russia's invasion, again, is a land invasion, which is a very different sort of operation than an amphibious one. In some ways, the hill is much higher to climb with the latter. So I think in that respect, it's a cautionary tale. On the other hand, the war is not yet over, and particularly in this moment and time where there's a lot of questions about whether Western support for Ukraine will be sustained and what the end state of the war might look like, it's not entirely a case closed for Beijing in terms of whether or not a conflict is something that they can endure. As Gerard noted, the conflict has cost Russia less in terms of international sanctions and opprobrium than Moscow likely anticipated internally. And they are weathering the storm

probably better than expected, which might in some ways provide a little bit of confidence to Beijing, which has, in many ways, more economic advantages than. than Russia does and might bet on the fact that Western countries might be less willing to sanction China to the extent to which they've sanctioned Russia. And I just have one last quick question. We're running out of time here. But what is the consensus on what the U.S. would do in some sort of, some version of an attack? You know, what's the policy? And then, like, you know, suppose the U.S. didn't really do anything and you think about ramifications? Do you think about variations where there's spillovers in which

our other partners or other friends in the region where we have military bases, I don't know, freak out, get anxious, and that it's sort of like dominoes in some way depending on this sort of confidence that other countries have in the U.S. security umbrella. There's a lot of debate about what the United States might do, and that's in part due to intentional U.S. policy to make that ambiguous. We call it strategic ambiguity about whether or not the United States would actually come to Taiwan's defense. If we look, though, at statements President Biden has made about how he personally would act in that situation, I think that's increased folks sense that the United States would get involved in some way.

From my perspective, I think, one, Beijing probably has to assume from a military planning perspective that they would be dealing with some sort of U.S. intervention because that is a risk that they can't afford to not calculate, given how it is. important and critical it could be to the outcome. The second piece is, I think it really, in large part, might depend, again, on variables like, is there any warning before an attack? What is the duration of the attack? Because it's not just a question of intent, but also process and time to marshal a reaction to it. You know, there is a process laid out in the Taiwan Relations Act for the president to consult Congress before, you know, officially determining what to do.

And then there's also the tyranny of geography when it terms to where U.S. forces are located in their ability to respond to a conflict that is so close to China. And then to your question about the role that other countries in the region might play in terms of a conflict, again, I think that's going to really depend quite a bit on what Washington does. But also on what Beijing does, a lot of the war games that we have looked at have studied the possibility that Beijing in an effort to try and keep. the U.S. out of the war might preemptively strike U.S. forces in the region, including some of our bases. And that could inadvertently draw not just the United States, but some of the partners that host those bases into a conflict. So a lot of this is very much variables at play. And that's why these war games can be a really valuable way of studying potential scenarios and their outcomes, because we might not be able to predict the future, but we have at least a good sense of what

the key variables would be and what the future could look like depending on how those turn out. I was going to add in terms of sanctions. So this is something in D.C. that has talked about a lot over the past two years is would the U.S. sanction China in any degree like it has with Russia? And my basic view is that in a conflict, the U.S. probably would. People will say, but isn't China so much bigger, therefore wouldn't be much more painful? Yes. But the question they is our U.S. forces directly involved. If the U.S. isn't an active naval and air war with China, I think that the political wherewithal would be there. But maybe the more important point, at least in the early days, is I do not believe the U.S. and its allies will sort of preemptively

use massive sanctions unless they're very confident that a war is imminent. And therefore, and Beijing would have already planned for that. So I actually don't think of sanctions as being a very useful immediate deterrent, but in a conflict they probably would be used. Very quickly, we are recording this before the Taiwan elections, and by the time this episode comes out, we should have a result. What are you looking out for? What are the particular points or developments that we should be watching? I think the key thing on everyone's mind is going to be, well, first of all, this is an incredibly close race. And there's probably the closest race that we've seen actually in several election cycles. So there's a lot of questions about what the results on Saturday night are going to be.

That's obviously the front of folks' minds. And then I think the second immediate question after that is how does Beijing react to it? And already we've seen signals from China indicating that elements of their approach to Taiwan are very much going to be shaped by the elections outcome. There have been some senior officials kind of warning and not so subtle terms that this is kind of a key election for Taiwanese voters to think hard about. what choices that they want to make. And then, in more specific terms, a lot of connections between China's ongoing investigation to Taiwan trade practices and measures coming out of that that restrict Taiwanese exports that they've signaled they'll continue to take in the wake of the election depending on the policies of the new government. Jennifer Welch and Gerard DePippo, thank you both

so much for coming on odd lots, fascinating conversation on a topic that I definitely think we will be doing more on in the upcoming. Thank you for having us. Thank you for having us. Tracy, I thought that was really fascinating. Well, I'll just say I found that really helpful because there is a lot of noise about, you know, the risk of some sort of invasion or attack or blockade, but actually sort of hearing about, well, why now? Why is there so much talk now and how do you at least even attempt to sort of quantify these risks? I thought they were both great at explaining that. I learned a lot. The point about Russia actually estimating that the economic costs of invading Ukraine were going to be higher than they

turned out to be. I thought that was really, really interesting. Absolutely. And in fact, Gerard made a really interesting comment there about investors sort of ignoring the nationalist impulse, right? And so this idea that everyone's like, well, it wouldn't work. They'd lose a lot of money. They'd lose a lot of jobs. They wouldn't be able to sell as much oil. Therefore, it makes no sense. And I get why, like that's like classic investor thinking. right, that it's like always going to come down to a profit and loss. But the idea that, no, like, actually nationalism, the nationalist impulse is a real factor in decision making. And it's not all sort of strict materialism. I think it's probably a good thing in general for investors to appreciate about both politics and geopolitics. Of course. Like, it just seems so obvious to me that like not everyone is ruled by pure economic considerations. But on the other hand, there are plenty of them at play in the China. Taiwan situation as that $10 trillion price tag actually indicates. The other thing I learned,

I'm just looking at the big take that was published based on this report. I didn't know that Bloomberg has like a Taiwan stress index. I don't know if stress is the right way of putting it, but basically to see how intense the saber rattling is on this issue at any particular moment. And it has, it includes measures like exercises and flyovers into Taiwanese airspace, and stuff. like that. So really interesting. Everyone should go read that. It's on Bloomberg.com. The results of their work, a war over Taiwan is a $10 trillion risk to the global economy. It's one of the cool things about working at Bloomberg is like, I'm always, you know, sort of pinch myself working here because how many different experts and sophisticated people who understand this stuff? And the modelers who work on

these different models went into this. So it's really quite a project. I thought the other interesting thing, Gerard made the point about a war were to happen, would not. likely be a diversionary war, and the idea, oh, it's not going to be one of these things where, oh, they would do it because people, morale is bad and the economy is bad, so therefore we have to do something that actually it would be such an all-encompassing affair that it can't just be sort of, yeah. Also, Jenny's point about the blockade. So I remember, you know, two, I guess two years ago now, that was sort of seen as the foremost possibility that China could do something, but it wouldn't do an outright invasion because that was so, like, risky and I guess

would up the stake so much. But her point that maybe now a blockade is basically seen as having like all the downsides of outright military invasion in the sense that it could bring Western allies into the conflict, but none of the upside because it could be prolonged and, you know, drawn out. And maybe at this point it's better to just do something quickly. That kind of of shows how far things. Yeah. That kind of shows how much things have changed just in a couple years. And again, I suspect a lot of that comes from the Russia-Ukraine example. I want to do more this year for sure on the sort of a defense industrial base in the U.S. and China. And, you know, you see these stories. Of course, there was the recent Bloomberg report

about how the corruption in the Chinese military and these missiles that were fired were actually filled with water and or not as advanced. as thought. But on the other hand, you know, we certainly have in the U.S. all kinds of issues with our defense procurement and projects that get delayed forever and overspending on certain things. So I think this is an area of, for sure, more episodes to come. We should start war gaming, Joe. We need to get some dice. Start rolling them. I did not really realize that it was kind of like in the movies. And they actually have these dice and maps and boats on a map. And yeah, we need to have like an all-d-lots headquarters where we have a

bunch of maps. Oh, yeah, let's do it. With little, like, figurines of various superpowers and we start moving them around the board. These are the games that you play with your friends, right, in your house in Connecticut, right? All these sort of gigantic board games, right? Sometimes we play board games. Yes. Should we leave it there? Let's leave it there. This has been another episode of the Allot's podcast. I'm Tracy Allaway. You can follow me at Tracy Alloway. And I'm Joe Wisenthal. You can follow me at the stalwart. Follow Jennifer Welch. She's at that Jenny Welch. Gerrard de Pippe He's at GDP 1985. Follow our producers.

Carmen Rodriguez at Carmen Armin, Dashel Bennett at Dashbot, and Kel Brooks at Kel Brooks. Thank you to our producer, Moses Andam. For more Oddlots content, go to Bloomberg.com slash oddlots, where we have transcripts,

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