How Taiwan Could Defeat America

Philip Pilkington argues that serious conflict over Taiwan could have disastrous consequences

Philip Pilkington is a macroeconomist and investment professional based in London. He writes regularly for American Affairs and Compact, among others, and tweets @philippilk.

We are watching the world order shake before our very eyes. When the earthquake is over, the world will look very different from how it looked last year. These changes are taking place so rapidly that it is hard to keep up. Western policymakers and commentators seem disoriented and confused, desperately trying to summon into being a world that is evaporating before their eyes. This mismatch between perception and reality raises the real possibility of miscalculation. And this possibility of miscalculation, when it comes to Taiwan and U.S.-China relations, could lead to the demise of the United States itself.

Real Life Lessons in Hybrid War

If anyone doubted the profundity of the impact of so-called hybrid warfare waged on a major geopolitical rival, the present conflict with Russia should provide clarity. In the wake of the Russian invasion of Ukraine in February 2022, the Western powers have imposed massive economic sanctions on the country. The stated goal was to collapse the Russian economy. It was hoped that this would lead to the demise of the present Russian government.

None of this has happened. The impact of the sanctions on the Russian economy was minimal. Russia had a brief recession but is already beginning to recover. Meanwhile, skyrocketing energy prices caused by the war and the sanctions have massively increased Russia’s overall wealth. At the same time, Europe faces complete collapse. European reliance on Russian natural gas and other basic inputs, such as fertilizer, has been brutally exposed. Europe now faces permanently higher energy prices and possibly even deindustrialization.

Many in the West assumed that waging hybrid war on Russia would turn it into an isolated pariah state. Once again, however, the opposite has happened. In the wake of the invasion of Ukraine, China and Russia immediately announced new trade deals. As if that was not enough, a variety of new countries—including previous Western ally and key oil producer Saudi Arabia—have lined up to join the Russian- and Chinese-led BRICS alliance. Soon after, the BRICS announced that they would be pursuing a new multipolar reserve currency to unseat the U.S. dollar.

In the twentieth century we learned that large-scale wars restructure the global economy. The First World War spelled the end of the British Empire’s influence over world trade. The Second World War allowed the United States to ascend to the position previously occupied by Britain. Yet what the Russian intervention in Ukraine is teaching us is that a full-scale global war is not required to achieve these shifts—a hybrid war waged against a geopolitical rival is more than enough.

The likely long-term consequence of the Russo-Ukrainian war of 2022 will be the demolition of Europe and the emergence of a rival BRICS+ bloc that will likely be more economically powerful than the United States. There is also a chance that the United States will not weather the demise of Europe well. In the 1930s the European economy collapsed and dragged America down with it, into the depths of the Great Depression. That could easily happen again. Only time will tell.

But even in this worst-case scenario, the United States will remain a serious global power—although it will no longer be a unipolar hegemon and it will be unlikely to possess the global reserve currency. If America plays its cards right, it can still wield enormous influence in the new world order that is emerging. It may even be able to help Europe rebuild and form a serious Western economic bloc that can counterbalance the new BRICS+ alliance.

But there is an elephant in the room. One that threatens to stampede over even this suboptimal outcome. That elephant is called: Taiwan.

Biden versus Beijing

While American officials still claim that the goal in Ukraine is to either expel Russian forces entirely or leverage the war to topple the Russian government, one cannot but sense that their heart is not really in it. The blasé attitude toward the European energy crisis on the part of the United States—an attitude that has shocked Europeans, even if our leaders refuse to express this publicly—seems to suggest that those in charge of American strategy have largely written Europe off. Their attention seems instead to be turning east, and the mark on the map in the Pacific that draws the most attention in the island of Taiwan.

The pivot on the part of the Biden administration toward a hawkish position on China is one of the most important and least commented on trends in Washington this past year. It was only a few months ago that politicians and commentators on the conservative side of the aisle—especially those aligned with the Trump movement—chastised the Democrats for being soft on China. Sometimes criticisms went far beyond even this and pointed instead to overt corruption of these politicians by Chinese financial interests. Yet now the Biden administration is indistinguishable, in terms of its China policy, from the previous Trump administration.

Why is this? Among Trump-aligned conservatives, the criticism leveled at China was always clear. Conservative China hawks made the case that the country is the natural successor to the Soviet Union on the world stage, a new Evil Empire. There is some truth to this. China is still more of a Communist country than nineties neoliberals would have us believe. Much of the economy remains under the thumb of the CPC. Yet despite this, the lip service the CPC pays to Marxist ideals seems hollow, and China completely lacks the desire to spread the Communist revolution to other countries. Whether China is still a Communist country is an open debate. Whether it is identical to the Soviet Union in key respects is not.

That is the conservative hawk position on China. But what is the liberal hawk position? In truth, that position has yet to be articulated. It seems like events are moving faster than narrative. The Biden administration reverts to talking points about freedom and democracy in Taiwan, yet the reality is that many in the party admire the Chinese model of doing business. This was especially apparent during the COVID-19 pandemic, when liberal commentators looked east and praised China for their harsh lockdown policies.

The evolution of liberal attitudes toward China will be worth watching in the coming years. But regardless, the foreign policy pivot to China now seems set in stone. The only question remaining is what this pivot will look like.

America’s Pacific Tombstone

Future historians will likely read the Russo-Ukraine war as the death of Europe, at least in its present form. The question is whether they may end up reading a future conflict over Taiwan as the death of America. There is little doubt that a serious conflict, especially a military conflict, over Taiwan would spell the death of America. Yet those in foreign policy circles seem blissfully unaware of this rather obvious situation.

When looking at the debates around China, one gets a strong sense that a sort of collective amnesia has spread among our policymakers and commentators. Until very recently, it was widely discussed how much leverage the Chinese possessed over the American economy. But all this wisdom seems to have completely evaporated and has been replaced with a moralizing mist. Yet the facts have not changed; the extent of China’s leverage over the American economy remains profound. Let us briefly review.

The first point of leverage the Chinese possess over the American economy is their holdings of dollar reserves and U.S. government debt. The Chinese accumulated these treasures after many years of sending cheap goods to America. Since America could not offer China products in return in sufficient numbers, they handed over debt and paper currency instead. How big is this war chest exactly?

China currently holds $980 billion in United States Treasuries. This is equivalent to around 14 percent of total foreign-owned Treasuries. In addition to this, China holds around $3.48 trillion worth of foreign currency reserves. The composition of these reserves is top secret, but a fair guess would probably be at around 40 percent of them, or $1.4 trillion, held as U.S. dollars. How exactly would this monetary leverage work on the American economy in the case of a conflict scenario?

The Chinese would likely start by dumping its Treasuries. This would initially lead to interest rates on government debt getting completely out of control and spiraling upward. To stop this, the Federal Reserve would then have to step into the foreign Treasury market and start buying them up with newly printed dollars. This would mitigate the government debt crisis, but the new dollars would start a sell-off in the foreign exchange market for U.S. dollars. The debt crisis would turn into a currency crisis.

At this point, the Chinese could pile on and dump their U.S. dollar reserves onto the market. Then the market for U.S. dollars would collapse completely. Consider that the daily turnover of U.S. dollars in the foreign exchange market is around $6 trillion. This is the total amount of U.S. dollars that change hands every day on global currency markets. These change hands for any number of reasons: to facilitate trade; to hedge against future currency changes; to simply speculate; and so on.

If the Chinese dumped their Treasuries and their U.S. dollar reserves the volume of U.S. dollars that needed to find buyers would rise from around $6 trillion to around $8.4 trillion—an overnight increase of around 40 percent. These additional dollars would be effectively useless to traders and so they would crash the value of the dollar. U.S. imports would rapidly rise in value and very high inflation would take hold in the United States. Living standards would crater immediately.

Some have suggested that America could avoid this outcome by freezing China’s foreign exchange reserves and their Treasury holdings. After all, this is what they did to Russia in the wake of their invasion of Ukraine. The United States could do this, but it would be tantamount to a massive default on debt and currency that they issued. This would completely shake global confidence in the American financial system, which would soon collapse and bring with it all the same ill effects that would have taken place if the Chinese had dumped their holdings.

The second point of leverage the Chinese have over the United States is China’s exports. Many China hawks seem to assume that China only exports cheap plastic junk to America. This may have been true in the nineties, but it is not even close to the reality today. Take the example of capital goods. Capital goods are the goods used to make other goods. Think: robots, machine tools, and so on. Without capital goods factories cannot operate and nothing gets made.

In 2019, China exported around $191 billion worth of capital goods to the United States. In that same year, total new orders for nondefense capital goods from domestic manufacturers was less than $60 billion. While these two statistics may not be perfectly comparable, they make the point clearly that Chinese-produced capital goods are an integral part of the American economy. If the Chinese placed sanctions on the exports of these capital goods in response to military conflict in the South China Sea, the American economy would grind to a halt.

The combination of a rapidly depreciating currency and the shutting down of large swaths of industry is one that we have seen many times before in history. It typically precipitates hyperinflation—and hyperinflation typically precipitates social and political collapse. The United States is already a febrile place politically. Its populace is divided and polarized. There is little chance that the country would survive a hyperinflationary collapse of its economy.

All this is without even considering the potential for military humiliation. America’s Pacific strategy relies almost wholly on its naval power in the region. Yet there is every reason to think that this naval power may have been rendered redundant by recent technological developments. Consider, for example, the fact that China has recently shown the world that it has access to hypersonic missile technology. Hypersonic missile technology is generally seen as being completely immune to air defense systems. Modern navies rely on air defense systems to protect them from aircraft and cruise missiles. But if China has access to cruise missile technologies that can overcome U.S. naval air defense, this renders American ships in the South China Sea sitting ducks.

To get a sense of how dramatically this technology has changed the battlefield consider some simple costs. A Russian-equivalent hypersonic cruise missile—the 3M-54 Kalibr—costs about $6.5 million to produce. Chinese costs should be roughly the same as Russian. On the other hand, a U.S. Navy carrier battle group costs around $30 billion with 7,500 souls on board. For every carrier battle group, the Chinese can purchase around 4,615 hypersonic missiles—and that is not even considering the incalculable value of 7,500 U.S. naval servicemen. In reality, it would likely only take a handful of hypersonic cruise missiles to sink a U.S. battle carrier group. The manpower losses alone would be humiliating to America, not to mention the optics of the USS Ronald Reagan sinking beneath the waves.

Some have claimed that the U.S. Navy could instead pivot to blockading trade routes, most notably energy trade routes in the Middle East. This would entail the United States escalating the Taiwan crisis into something resembling a world war. After all, blockades are an act of war and the Middle Eastern countries being blockaded would be within their rights to view blockades as such. Once again, technological developments may mean that the U.S. Navy would be putting itself in a very vulnerable position if it were to do this. Take two recent examples of technologies that can be produced by relatively unsophisticated players to get a sense of this.

The first example is the Abqaiq-Khurais attack waged by the Iranians on Saudi Arabia in response to President Trump’s assassination of General Qasem Soleimani. The Iranians succeeded in overcoming an American MIM-104 Patriot air defense system by using a swarm of low-cost suicide drones. This “swarming” technique seems to be an extremely effective, low-cost way for less sophisticated countries to overcome sophisticated air defense. Could such technology be used to attack American naval vessels engaged in an energy blockade? It is hard to see why not.

The second example comes from the Russo-Ukrainian war. In April 2022, the Ukrainian army succeeded in sinking the Russian flagship in the Baltic Sea, the Moskva. The Moskva was equipped with a sophisticated S-300 air defense system. Yet it appears that the Ukrainians succeeded in sinking the ship with a low-cost, relatively unsophisticated, domestically produced subsonic cruise missile called the R-360 Neptune. Such weapons systems are not hard to come by these days, and once more the U.S. Navy would be provoking their use if they engaged in a naval blockade.

A Modest Leap Forward

There is no doubt that Taiwan is a strategically important asset to the United States. It has been referred to as the “unsinkable aircraft carrier.” Yet the above arguments raise two questions. First, how valuable is Taiwan relative to the potential collapse of the United States itself? Secondly, what is the long-term plan of maintaining the status quo in Taiwan?

It seems obvious—to the present writer, at least—that as important as Taiwan may be to the United States, it is not worth risking what is left of American economic and geopolitical power. Nor is it worth risking the complete political and social destabilization of America itself. It does not seem obvious, on the other hand, how long the status quo can be maintained in Taiwan. Trade between Taiwan and China, for example, is now enormous. 22 percent of Taiwanese imports and 42 percent of exports are with China. Meanwhile, 23 percent of Taiwanese imports and 32 percent of exports are with the United States. As time goes on, the Chinese market will become more and more important to the Chinese economy.

The notion that Taiwan will stay in America’s sphere of influence from here to eternity seems fanciful. The history that drove a wedge between China and Taiwan is just that: history. Trade relations will shape future outcomes, and trying to turn Taiwan into a heavily-armed autarky seems like a weak strategy on the part of the United States.

What are the alternatives? There are many ways to skin the cat diplomatically when it comes to Taiwan. One suggestion is that floated recently by Elon Musk. Musk suggested that the island might become a special administrative zone of China, thereby allowing Taipei to continue to exert a good deal of independence. Another possibility is to allow for a gradual reunification, in some shape or form, but over a very long time horizon—maybe thirty to fifty years. This is how the British managed the transition of Hong Kong.

But ultimately, the right approach will have to be found through trilateral negotiations involving Taiwan, China and the United States. In these negotiations, the United States will need to work out their key areas of influence in the Pacific and lay these down formally. The Pacific will have to be carved up between China and the United States in a manner that will prove stable over the long term. This should be achievable. But only if both countries approach the matter in good faith.