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Profits of Doom
Will China invade Taiwan?
China, Chicken Little and Your Supply Chain
What is the probability that China will invade Taiwan? Or that there is a two week or more disruption to supply chains in Asia over the next ten years? Or that companies will reduce their exposure to China by more than 50% over the next five years?
Miniscule, very low, and probably low but varies widely by company.
So many of the doomsday scenarios that fill our conversations about what to do with supply and demand chains in Asia are rooted in false premises and unrealistic scenarios. Measured, methodical examination of our current challenges reveals that change will come but much more slowly and less dramatically that most predict. It is time we stopped wasting managerial time and effort theorizing and preparing for improbable events, when our time will be much better served analyzing the facts that are more likely to impact the bottom line.
Contrary to widespread commentary, the world order is not likely to change abruptly. Analysts like Peter Zeihan spin entertaining dramatic arguments for the beginning of the end, but like Tom Friedman and much of “All the news that’s fit to print”, Zeihan is mostly long on shocking fearmongering rhetoric, parroting angertainment that is short on historical accuracy.
These pundits profit from doom, but they fail to provide actionable intelligence. Yes, the world is a mess. We are in flux and the chaos will linger until the Boomers cede the stage to the next generation. Perhaps, like the 1960’s and 70’s, we face a tumultuous decade or more as new leaders search for and then articulate a new path. The new normal.
We could easily list dozens of reasons to lie flat, especially related to China, which seems to have a hot hand these days in doing all the wrong things to attract investors. But if one calmly reflects on reality, what should we do in China? What are the probable outcomes for the issues that are top of mind?
What is the probability that China will invade Taiwan?
Put in terms of business calculus: what is the probability of a dramatic change in the status quo and what are the appropriate contingency plans to ensure continuity of supply? We posit that war in Taiwan should come up in boardroom discussions a bit more often than asking if we are ready for a lightning strike. And like lightning, beyond ensuring sound engineering of facilities, analysis yields little new insight.
One fundamental reason that this conversation is unproductive is that most of those talking know not of what they speak. Informed military strategists will tell us that the main reason China will not invade is that the odds of success are low. Retired US General H.R. McMaster tells us that China is good on parade, but their military is untested. Moreover, there are very few examples of a successful invasion of an island. Even the US at the height of its power in WWII selected the nuclear option rather than invade Japan. The island hopping toward Japan in the Pacific was a bloody mess. Blockades have a dubious record as well.
Given the tenuous Mandate of Heaven, China cannot afford to fail, nor can it just lob missiles at Taiwan as Russia did in Mariupol. Therefore, for the near term, China will likely continue the campaign of maximum harassment. That is the prudent bet.
What is the probability there is a two week or more disruption to supply chains in Asia?
Many companies are acting as if the yesterday’s supply chain disruptions are likely to repeat, but the next problems will be different. Unfortunately, China continues to push the narrative that it can hold back the tide of an unstoppable highly transmissible pathogen. It seems the administration has determined that it is not yet time to change tact. In an odd way, the average person on the street here in China believes they are safer on this side of the wall. Their statistics tell them less people have suffered. Less have died. But economics and politics as well as alternate facts dictate that changes to Covid policy must happen before the national grain reserves are depleted beyond repair. The economy is in freefall. People are restless. The unemployment rates are untenable.
We expect that changes to Covid policy will be announced along with the naming of a new Covid Tsar before the end of the year, barring any massive outbreaks, particularly ones based on new strains. So sometime after November expect the pronouncement: “We won! Covid has been downgraded to an endemic disease and now Wang Momo is taking over our Covid task force. And by the way, get vaccinated with the new and improved Sinovac.”
But in the meantime, even if there are Covid outbreaks, will supply chains be disrupted? Not likely. China has developed robust containment strategies, so while it probably makes sense to add thirty days to buffer stock (assuming that you have managed to work through your inventory!), it is not helpful or realistic to plan for another 90-120 day “shut down” (except where it has always made sense for single-source items for which there is no alternative).
Will companies reduce their exposure to China by more than 50%?
Rather than fighting yesterday’s war, it is sensible to invest in a thorough analysis of the supply chain strategy for the next ten years. As a base case, we continue to find that for many companies the most effective straw man to start the conversation is China plus one.
China continues to offer competitive and, in some cases, irreplaceable supply of intellectual and physical capital. Take garment makers: They left China fifteen to twenty years ago for the cheaper shores of Bangladesh and the like. But to this day, China continues to be a source for intermediates—fabric, accessories, and all the other bric-à-brac that goes into our bling.
Along with supplying these inputs, for low-volume, high-mix as well as prototyping, there are very few places that can compete with China along the price, lead time, cost continuum. From tires to furniture to metals and most consumer goods, the China plus one strategy makes sense as the default hypothesis to prove or disprove.
Perhaps what has become most evident is what was true all along: The 21st Century will not be China’s. There are too many demographic challenges combined with ill-conceived policies that stifle the only path to dominance: productivity growth. Most long-time China watchers—even the optimistic pollyannish ones—now conclude that China is in decline. Indeed, we have argued that the heavy hand of the vision of the anointed have been making poor choices since the labor law changes in 2008.
However, it is not a foregone conclusion that trends will move in a straight line, that China will decouple. Things may improve. And for many companies the relative strength of China in the geopolitical Olympics just does not matter to their bottom line. Regardless, the next twenty-four months will reveal who is in control and if we are going backwards or forwards.
What seems evident at this junction, however, is that China will implement a massive stimulus, the currency will depreciate and perhaps with a little luck the US and China will find some path to détente or at least rationale civility. If China could solve its energy problem, they might throw Russia under the bus. Trump might pull a Nixon.
Yes, long shots they all are. But we believe that the odds of these outcomes are as good or better than the doomsday narratives that fill the airwaves. In sum, it is time to rethink China, both in terms of supply and demand, but not like Chicken Littles . We need to heed the calls of methodical informed analysis not hyperventilating performers profiteering on doom.