China is Preparing for War. What Should You Do About it.
Updated: Sep 22
This article is a high level overview of our market research. It will be updated from time to time.
“The historical task of the complete reunification of the motherland must be fulfilled and will definitely be fulfilled.”
- Xi Jinping, October 2021.
"In the face of wars that may be imposed on us, we must speak to enemies in a language they understand and use victory to win peace and respect. In the new era, the People’s Army insists on using force to stop fighting. . . . Our army is famous for being good at fighting and having a strong fighting spirit. With millet and rifles, it defeated the Kuomintang army equipped with American equipment. It defeated the world’s number one enemy armed to the teeth on the Korean battlefield, and performed mighty and majestic battle dramas that shocked the world and caused ghosts and gods to weep."
- Xi Jinping, October 2022.
Reviewing the past five hundred years, the Harvard Thucydides’s Trap Project has identified sixteen cases in which a major rising power has threatened to displace a major ruling power. Twelve of these sixteen rivalries ended in war.
Table of Content
The Bottom Line
Geopolitical risks in Southeast Asia have reached their highest levels since WWII.
The odds of an armed conflict between China and the U.S. are at 75%, based on data analyzed over 500 years. Yet, only 8% of experts surveyed believe it can happen in the next 10 years.
An invasion of Taiwan would represent a major generational shift in international relations and financial market dynamics.
Traditional 60/40 portfolios are facing strong headwinds.
Financial advisors and active traders must reintroduce geopolitical risks as a top risk factor.
Passive investors should consider allocating a sizable portion of their 60/40 portfolios to T-Bills (U.S.), T.I.P.S. (US) and GICs (Canada) with guaranteed yields above 5% and no downside risks.
War is not inevitable but a risk of collision is heightened if both alliances stay on their current course.
Some Context First
A few months ago, it felt right to consider averaging down on our long China EQ position, which had been our worst trade since the launch of 8X Wealth back in 01/21. Yes, we make bad trades, sometimes ;-).
After doing much obliged market, macroeconomic and geopolitical research on the “China Situation”, we came to a much different conclusion.
We came to a conclusion that is difficult to share with the world because we are no gloom & doom folks and don’t want to be perceived as such. We are proud global macro realists who change their minds frequently. Strong opinions, weakly held. Realism and skepticism set us apart from the great majority of investors who tend to always pick a side and dismiss arguments that do not fit their own thinking and experience.
Geopolitics are being dismissed by the great majority of financial advisors and portfolio managers. We do believe such dismissal is the Achilles heel of investment managers right now.
We are rebalancing our multi-asset long/short portfolio to take into account our dramatic findings. Geopolitical risks are now back in the front seat. They are driving a big part of the global market show...down.
The good thing is that, as an active investor, you can closely monitor them eyes wide opened.
It is also important to understand the Chinese nationalistic mindset as you go through this article. We have to go back 100-150 years to understand how Chinese nationalists then and now perceive Western influence.
Just a century ago, Chinese have witnessed, in their own words, a "Century of humiliation". It refers to the period of intervention and subjugation of the Qing dynasty and the Republic of China by Western powers and Japan from 1839 to the 1940s. The Opium Wars waged by Western powers in China are definitely a low point in the history of Western powers.
So when Xi Jinping talks about the Great Rejuvenation of China, you have to have this historical context in mind.
What is going on in China?
Early signs of the preparation for war can usually be seen when a country experiences or does the following, in the context of rising geopolitical tensions:
the economy is experiencing a systemic contraction as a result of a boom-bust cycle. China is currently experiencing a real-estate bust;
major companies are defaulting on their debt, in particular international debt; Evergrande and other real-estate conglomerates have defaulted on their international debt recently.
the youth unemployment rate increases significantly. In China, the youth unemployment rate has exceeded 20%, and some sources claim it has reached almost 50%.
a crackdown starts on entrepreneurs, influencers and religions. Key influential figures just disappear from the public stage.
key economic data is no longer published by the government.
businesses are encouraged to convert their international currency holdings to the local currency. Chinese businesses swapped $31.5bln for yuan with banks in onshore forward markets in July, the highest in record.
the army high command is replaced with a more radical leadership.
the narrative towards a new world order and war becomes prevalent. False claims from the authorities become prevalent. Government officials' speeches become aggressive towards its neighbors (here, the Philippines, Japan, South Korea and Taiwan mostly).
field hospitals are being built near launch bases - see what happened below when we tried to get more information about the new field hospitals being built in the Fujian Province ... the access was forbidden:
We found out that Fujian and several cities in the province began preventing overseas IP addresses from accessing government websites, possibly to impede tracking of China’s preparations for war.
commodities are being hoarded and stored by the government including oil, grains and metals.
lands are being seized to produce more grains or for military installations.
army recruitment increases significantly and new armement is built at an accelerating pace. From 2015 t0 2019, China's military spending grew nearly twice as fast as China's official GDP in real terms.
a divestment from international assets accelerates.
capital controls are put in place.
travel controls are put in place.
demographics are shifting against a desired trend.
new laws are enacted to allow the government to seize properties owned by foreign investors, to stabilize markets and implement drastic anti-spying laws.
bans on foreign companies and technologies are put in place.
the country doubles down on espionage, in particular digital espionage.
broadening economic and military alliances are put in place. China, Russia, India and Brazil recently invited Argentina, Egypt, Ethiopia, Iran, Saudi Arabia and the UAE to join the BRICs alliance in January 2024.
All of the above is happening right now in China.
Please watch the video from the Hudson Institute for a comprehensive analysis on the recent years' timeline confirming China's preparation for war.
Meanwhile, the U.S. pursues a silicon blockade against China, by cutting China off from advanced computer chips, chips that are essential to any country that relies on advanced technologies such as quantum computing and artificial intelligence.
As recently as last April, China spent more money importing semiconductors than it did for oil.
One could say that this export ban is a declaration of economic war against China. Could the plan backfire?
After all, the U.S. went to war to secure its oil supply. Could China go to war to secure its own supply of advanced semiconductors?
How it could play out
From a military standpoint, we believe that China would have the capacity to take Taiwan in just a few weeks.
However, China does not want to be viewed as the aggressor. It could therefore first implement an economic blockade enforced by the PLA Navy, similar to how the U.S. implemented a naval blockade of Cuba during the Cuban missile crisis.
A blockade would lead to either (1) a partial or full settlement over the Taiwan situation, trigger trade negotiations including on the semiconductors ban by the U.S. and its allies and redefine the U.S. presence in South East Asia, or (2) a military confrontation over Taiwan.
A Chinese attack on Taiwan could go like this:
preemptive, strategic and highly precise missile strikes on key Taiwanese installations to destroy their defense capabilities and effect a complete communication blackout on the island;
a 360 Naval blockade of the island to cut supply and foreign assistance;
thousands of paratroopers would be sent on the island to secure key infrastructure, in particular all TSMC semiconductor facilities;
A formidable amphibious assault force would land on multiple strategic landing zones to quickly encircle Taiwanese troops;
China would likely succeed at perfecting the modern form of Blitzkrieg with an extended use of advanced technologies, highly motived troops, real-time data, digital espionage and deceptive practices.
The Western world may not have enough time to do anything about it.
The PLA represents a formidable armed force with 2 million+ well trained troops and the biggest navy in the world. The PLA answers directly to the Communist Party.
In any event, we believe that the US would not come to the rescue of Taiwan and risk destroying key technology factories on the island. Moreover, the US needs a narrative to convince its population to go to war. An invasion of Taiwan and the global economic shock triggered by it, would certainly represent the catalyst for such a narrative, like the Japanese attack on Pearl Harbour did.
What about timing
US intelligence services think that an invasion of Taiwan could happen as soon as January 2024, when Taiwan will have its next elections.
The CIA said President Xi Jinping has set 2027 as a deadline for the Chinese military to be ready to carry out a Taiwan invasion
A US Air Force General predicts a war with China by 2025.
The reality is that nobody knows for sure other than the protagonists. However, we know it will start with a military exercise for obvious reasons : US Army satellites track unusual PLA troops mouvements so a justification must be provided.
Just like these:
These exercises will become more prevalent in the South China Sea and will disensitize the media about the probabilities of a real invasion.
That being said, government narrative is one of the most important indicator that one can track to assess a potential timeline for war.
We believe that we first need to see a change in the narrative (from belliqueux to extremely aggressive) from China officials or see an incident in the South China Sea or Gulf of Tonkin like incident before the invasion can happen - a government needs to create a story that sticks with its population and that will trigger its population's willingness to go to war. The current narrative does not seem to be aggressive enough towards Taiwan, South Korea or Japan although China has just recently increased the blame game towards Japan for releasing radioactive contaminated water.
UPDATE: the Chinese narrative is getting more aggressive towards Taiwan and the U.S.
We think an invasion of Taiwan before the 2024 elections would be unlikely from a current narrative point of view. However, we know that Chinese are very methodical planners and they will want to keep the element of surprise at all costs knowing its strategic importance.
In 1950, China entered the Korean war with a surprised offensive :
The initial PVA assault began on October 25, 1950, under the command of Peng Dehuai with 270,000 PVA troops. The PVA assault caught the UN troops by surprise, and employing great skill and remarkable camouflage ability, concealed their numerical and divisional strength after the first engagement with the UN. After these initial engagements, the Chinese withdrew into the mountains. UN forces interpreted this withdrawal as a show of weakness; they thought that this initial attack was all that the Chinese forces were capable of undertaking.
One optimal surprise scenario from the Chinese point of view, would be to act during a weekend when international leaders gather for a G7 or G20 summit. It would leverage the absence of international leaders from high military command, limiting their capability to respond rapidly. So lights should turn red when Xi Jinping announces that he will skip one of these summits, like the one in India scheduled on September 9-10 2023.
China does not want an all out war but it wants to send a strong message to the world that Taiwan belongs to China and that the US, Japan and other Western countries should stop meddling into the politics of the South China Sea region.
Russia's troubles in Ukraine are also adding pressure to Xi's own timeline. A prolonged war in Ukraine would weaken Russia's army, China's strongest military ally and "no-limit" partner.
The 2024 elections in Taiwan and in the US are going to be the most important elections of this decade.
Finally, watch the price action of all major asset classes. By watching the tape we can often notice that something is brewing. For instance, a cross-asset contraction of volatility on higher timeframes is a warning sign that a disruptive event may occur. Contraction of volatility always precedes expansion in volatility in liquid markets.
It is worth noting that a belligerent state can now profit from a significant, disruptive market event that it knows will happen. It means that China can finance in part the war it intends to wage by positioning itself in the financial markets before it triggers the event. That is something that could not be done decades ago. But with the opacity of multi-jurisdiction corporate structures, the ease of global financial transactions and the liquidity of international financial markets, it can be done today.
Moreover, China knows that it can substantially weaken Western economies by taking markets by surprise. A Chinese invasion of Taiwan would destruct Western wealth at a speed and to an extent never seen before. When about 40% of westerners live paycheck by paycheck, it's hard to ignore the chaos such an event would create.
By watching the tape carefully in these various asset classes, one can find interesting clues, sometimes.
Right now, the tape is telling us that something major is brewing.
Yet, only 3% of experts surveyed on the China-Taiwan situation believes China will achieve unification within the next five years.
The Downside
What would be the impact on a traditional 60-40 portfolio (60% stocks, 40% bonds) if a war breaks out with China and global commerce shuts down?
We think it is reasonable to expect a significant drawdown in 60-40 portfolios by as much as -50% to -60% in a matter of weeks (that's without the use of any leverage!). The US dollar and inflation would spike up. Stagflation would be almost certain for years to come.
When Russia invaded Ukraine in February 2022, the MOEX index lost 60% from its peak in a matter of a few months. A lot of investors got burned in that parabolic upside move at a time when market participants completely dismissed geopolitical risks. Note the blow off top in the last quarter of 2021, just a few months before the botched surprised invasion. The market has since recovered by about 50%. But we believe the Russia-Ukraine conflict does not represent a material strategic economic conflict at this time.
If China does invade Taiwan, one could argue that the stock market would sustainably recover from such a systemic event only after a few decades of stagnation.
That would represent a systemic return shock for most pension funds and future retirees. It would create an important retirement crisis.
Although we would expect China to try to repair its relationship with the world immediately after an invasion of Taiwan - such narrative being already highlighted in China's Global Security Initiative Concept Paper, especially if the invasion is quick and has low casualties, we believe trust will be lost for at least a generation and political and war economies will replace the just in time global economy we have seen since China joined the WTO in 2001.
Xi Jinping wants a new world order as part of the "great rejuvenation of the Chinese nation" and has further territorial claims in the South China Sea.
This conflict in Southeast Asia would change the macroeconomics and geopolitical landscape for a generation.
The Geopolitical Risks
Most investors got immune to stock market corrections: the market dips, reverses then makes new highs. Business as usual, right?
The thing is that the great majority of financial advisors and investors dismiss macroeconomics and geopolitical risks.
The geopolitical risks we are highlighting here are the most serious ones to ever occur since the rise of Nazi Germany and Japan's military Empire in the 1930s. But never in the history of mankind has the global economy been so interconnected.
So the impact of this kind of geopolitical shock can create a gigantic economic shock that no one can measure at this time.
But it would, for sure, represent a logistical nightmare for hundreds of Western technology companies, such as Apple.
Just remember that a huge amount of international commerce takes place from or within the South China Sea, Taiwan produces 90% of the most advanced semiconductors used in electronic devices across the globe. China also controls the transformation of key raw materials, in some cases up to 90% of the export market. It produces 60% of the world's germanium and 80% of the world's gallium, according to the Critical Raw Minerals Alliance. It also dominates supply chains for rare earth minerals used in many high-tech products, as well as the lithium, cobalt and graphite used in batteries. It just started to impose export controls on key materials used for semiconductors.
Moreover, under China's Belt & Road Initiative (BRI), costly projects financed by China in Argentina, Ethiopia, Montenegro, Pakistan, Sri Lanka, Kenya, Zambia, and elsewhere have pushed debt-to-GDP ratios to unsustainable levels and produced balance-of-payments crises. A war and strong US dollar would only exacerbate this problem and allow China to take over strategic assets if any of these countries default on their debt.
After Sri Lanka fell behind on payments for its troubled Hambantota port project in 2017, China obtained a 99-year lease on the property as part of a deal to renegotiate the debt. The agreement sparked concerns in Washington and other Western capitals that Beijing’s real aim was to acquire access to strategic facilities throughout the Indian Ocean, the Persian Gulf, and the Americas.
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The stakes for the rest of the developing world are enormous. This wave of debt crises could be far worse than previous ones, inflicting lasting economic damage on already vulnerable economies and miring their governments in protracted and costly negotiations.
Are you Proactive enough?
Successful investing should always put the focus on adequate risk assessment and risk management acquired through deep market research.
A great majority of passive investors has become way too much complacent and ignore these geopolitical and economic risks.
It is in time of peace and market complacency that investors should be proactive in addressing macro and geopolitical risk factors. Once events have played out, it's already too late. There is a time to play offense and there is a time to play defense. Right now, as a passive investor, you should consider playing defense.
Is your investment portfolio diversified and resilient enough to face these new geopolitical risks?
Chances are it is not.
We believe it is crucial you sit down with your financial advisor and review your portfolio allocation in light of this serious situation. Markets hate surprises and we believe China could take the market by surprise. Could it make sense to lower your equity exposure and increase your T-bill (US) or GIC (Canada) exposure? Maybe. Do not delay this exercise.
How 8X is preparing for it
At 8X, we are in the process of rebalancing our core macro portfolio with various long/short positions in international equities (to the short side, Taiwan and China equities in particular), currencies (mostly balanced but with a principal hedge in USD), bonds (mostly to the short side), commodities (mostly to the long side), long GICs (Canada), T-Bills and money market funds. These are just general guidelines. We are very active traders in 60+ global markets and rebalance our portfolio regularly.
Overall, we believe a war in the South China Sea would benefit India and Japan economies (but put additional pressure on the yen) as the Western Alliance would cease trade with China for an undetermined period of time. It would however create a lot of uncertainties for the economies of the former Indochina colonies (Vietnam, Thailand, Cambodia, Laos), Myanmar, South Korea and the Philippines which would be compelled to pick a trade partner.
War is not inevitable. Deterrence tactics on both sides are normal and can succeed in achieving just that: deterrence. However, we don't believe China will shelve its goals of reuniting with Taiwan and the tactics used to change the regime in Hong Kong are not replicable for Taiwan. The somewhat reckless tit for tat tactics aimed at each others' alliances are increasing the odds that something will eventually go wrong.
To learn more about our macro strategies, please join our live trading room here.
Supporting material
China is preparing for war - a timeline by hedge fund manager Kyle Bass at the Hudson Institute (July 2023): https://www.youtube.com/live/98kMSEkPiLo
Surveying the Experts : China's Approach to Taiwan
Full Article: https://chinapower.csis.org/survey-experts-china-approach-to-taiwan/
60 minutes Australia - a roundtable:
China Economic Spying Units:
The CIA Factbook on China
https://www.cia.gov/the-world-factbook/countries/china/
PLA News Website
Transcript: World Stage: China with Matthew Pottinger - The Washington Post (March 2023): https://www.washingtonpost.com/washington-post-live/2023/03/06/transcript-world-stage-china-with-matthew-pottinger/
MR. POTTINGER: Yeah. I suspect that he is going to make this his legacy achievement. He is determined on his watch, I believe, to try to resolve, as you put it and as he puts it, the Taiwan question. I don't know what that means in terms of timing.
We've seen him take a number of steps that I haven't gotten a lot of attention yet, basically preparing the society for war, passing new laws that are designed to mobilize the society, build out the reserve capacity. He's building combat field hospitals across Fujian Province right now, right across from Beijing. He's building air raid shelters right now. It's reminiscent of the 1950s with the Korean War and then with the Sino-Soviet split, when he mobilized, Mao Zedong mobilized, the society to start digging tunnels and moving a lot of their manufacturing into the underbelly of mountains and things like that. This is happening right now.
[..] I guess I would say that the relationship is at the worst that it's been since the Tiananmen Massacre in 1989, and then there was a slow road back to rebuilding ties. And the United States made a big gamble in the 1990s and following through in the early 2000s that we would bring China into the world, really enrich China, train its experts, its new business leaders and technocrats, even military officers, scientists and open our markets up in order to raise, help raise the standard of living in China with the hope -- and it was an explicit hope of successive administrations in the United States -- that over time, China would evolve into something friendlier and more liberal, first, as a more liberal market system, and then hopefully even its political system would follow.
As Economy Falters, China Looks to Army for Answers
Amid this crisis, Beijing’s decision to double down on defense spending—combined with the party’s shift from a “peaceful rise” to its increasingly bellicose “wolf warrior” diplomacy—is a deliberate strategy. Backstopped by credible threats, Beijing is in the process of wresting from the rest of the world the resources, market access, technology, and capital that it needs. In other words, the CCP is positioning to coerce—or, if necessary, fight—its way to riches.
https://foreignpolicy.com/2023/09/07/china-economic-slowdown-pla-buildup-taiwan/
Deterrence in Taiwan Is Failing
https://foreignpolicy.com/2023/09/08/us-military-deterrence-china-taiwan-war-east-asia/
China Ponders Russia's Logistical Challenges in the Ukraine War
https://www.rand.org/blog/2023/08/china-ponders-russias-logistical-challenges-in-the.html
What Drives Putin and Xi (Part Two)
A Conversation With Stephen Kotkin and Orville Schell
China's path to self-sufficiency in technology, energy and food
China's Propaganda & Patriotism
How Beijing Boxed America Out of the South China Sea- WSJ: https://www.wsj.com/articles/china-boxed-america-out-of-south-china-sea-military-d2833768
Beijing is becoming the dominant force in the South China Sea, through which trillions of dollars in trade passes each year, a position it has advanced step-by-step over the past decade. With incremental moves that stay below the threshold of provoking conflict, China has gradually changed both the geography and the balance of power in the area.
The disputed sea is ringed by China, Taiwan and Southeast Asian nations, but Beijing claims nearly all of it. It has turned reefs into artificial islands, then into military bases, with missiles, radar systems and air strips that are a problem for the U.S. Navy. It has built a large coast guard that among other things harasses offshore oil-and-gas operations of Southeast Asian nations, and a fishing militia that swarms the rich fishing waters, lingering for days.
Water Cannons and Lasers: South China Sea Standoff Around World War II-Era Ship Heats Up - WSJ: https://www.wsj.com/world/china/water-cannons-and-lasers-south-china-sea-standoff-around-world-war-ii-era-ship-heats-up-6d24d8d0
Video - Chinese Navy is conducting intimidation tactics on fishermen: https://www.wsj.com/video/series/shelby-holliday/chinas-maritime-claims-are-pushing-its-neighbors-closer-to-the-us/4ABAE244-6925-4791-9827-B1477B53F794
Xi Age of Stagnation - Foreign Affairs: https://www.foreignaffairs.com/china/xi-jinping-age-stagnation
For anyone who has observed the country closely over the past few decades, it is difficult to miss the signs of a new national stasis, or what Chinese people call neijuan. Often translated as“involution,” it refers to life twisting inward without real progress.
The government has created its own universe of mobile phone apps and software, an impressive feat but one that is aimed at insulating Chinese people from the outside world rather than connecting them to it. Religious groups that once enjoyed relative autonomy—even those favored by the state—must now contend with onerous restrictions. Universities and research centers, including many with global ambitions, are increasingly cut off from their international counterparts. And China’s small but once flourishing communities of independent writers, thinkers, artists, and critics have been driven completely underground, much like their twentieth-century Soviet counterparts.
China’s leadership shuns debate and feels no compulsion to explain itself.
The Delusion of Detente and China's Political Imperative :
https://reader.foreignaffairs.com/2023/08/22/delusions-of-detente/content.html
The CCP’s prime directive is to never let China be bullied or divided again—a goal, China’s leaders believe, that requires relentlessly amassing wealth and power, expanding territorial control, and ruling with an iron fist. As an economic late bloomer, China must use mercantilist methods to climb up global value chains long monopolized by the West.
With China surrounded by 19 countries, many of them hostile or unstable, the country’s leaders believe they must carve out a broad security perimeter that includes Taiwan, chunks of India, and most of the East China and South China Seas, where 90 percent of China’s trade and most of its oil flow.
Expansion is also a political imperative. The CCP justifies its autocratic rule in part by promising to recover territories lost during the century of humiliation. Demilitarizing those areas now would mean surrendering the CCP’s solemn mission to make China whole again and, consequently, diminishing its ability to use anti-foreign nationalism as a source of legitimacy.
https://www.amazon.com/Danger-Zone-Coming-Conflict-China/dp/1324021306/ref=sr_1_2
Trade is shrinking between China and the US:
China is pivoting toward Southeast Asia as an export destination. While its exports to the U.S. fell 17% on the year for the first half of 2023, its shipments to ASEAN grew 2%, according to Chinese trade data. Some observers believe that Chinese exporters are increasingly routing products through the region for processing to sell on to the U.S. and elsewhere.
https://asia.nikkei.com/Economy/Trade/China-no-longer-top-exporter-to-U.S.-as-trade-rift-widens
The Battle of Lake Changjin (Korean war)
The no. 1 movie in China
https://www.bilibili.tv/en/video/2005496564
I Will there be a NATO in Asia?
Podcast: https://www.urbankaoboy.com/p/kaos-theory-episode-3-scott-smitson
Copyright. 8X WEALTH INC. August 2023.