What would a war with China mean for the economy?

A U.S. war with China over the democratic sovereignty of Taiwan would come with terrible consequences. After the loss of life, the economic effects would be a preeminent concern.

War with China would lead to collapse in financial markets. Equity markets would be roiled. The great housing recession of 2007-2009 resulted in a 50% fall in U.S. equity markets. War with China could lead to an even sharper fall in equity prices. The market capitalization of the S&P 500 is about $34 trillion. A 50% drop would wipe out $17 trillion in wealth, or an amount equal to 66% of current GDP. The market in U.S. Treasurys would experience a true black swan event. International investors hold up to 30% or $7.5 trillion of U.S. debt Treasurys. Global and national wealth would be destroyed, consumer confidence would collapse, and business investment would stop. The effects on GDP would likely be highly significant. Because of COVID-19, for example, U.S. economic output fell by 9% of GDP for one quarter.

A 10% decline in GDP would entail a $2.5 trillion subtraction to annual economic output. Mass layoffs would result. Consumption, which accounts for 70% of U.S. output, would take a nosedive. The government would respond with massive economic stimulus. The federal deficit, already at 100% of GDP, would expand rapidly. At a minimum, the debt burden on future generations would become even more intolerable. Economic trade among the U.S., China, and Taiwan exceeds $700 billion annually.

In an all-out economic war, semiconductors would be the first casualty. The world economy runs on semiconductors. The semiconductor fabrication facilities of Taiwan are a global treasure. They are the modern equivalent of the oil fields of the Middle East. Neither the U.S. nor China could allow control of the semiconductor manufacturing facilities to be seized by one country or the other. Destruction of the facilities would be probable in the event of total conflict.

Taiwan produces 92% of the world’s most advanced chips as well as up to 50% of commodity chips. As the Rhodium Group notes
, “By some estimates, Taiwan’s leading chip foundry TSMC produces 35% of the world’s automotive microcontrollers and 70% of the world’s smartphone chipsets. It also dominates in the production of chips for high-end graphics processing units in PCs and servers. A rough, conservative estimate of dependence on Taiwanese chips suggests that companies in these industries could be forced to forgo as much as $1.6 trillion in revenue annually in the event of a blockade.”

In the event of a total economic war with China, global supply chains would have to be reconfigured. The order of magnitude of supply chain restructuring would exceed that resulting from COVID-19. The supply chain for Apple products, including iPhones, would have to be relocated. Imagine life without a smartphone.

Companies as diverse as Caterpillar, GM, Ford, and Starbucks would be severely affected. Each company derives more than 25% of its revenues from China. Chip companies with the most to lose from a war with China include Qualcomm, Broadcom, and Texas Instruments. The U.S. also relies on China for clothes, shoes, electronics, furniture, and other essentials of daily life, and consumer giants such as Nike and Procter and Gamble source from China.

Top line: China’s production is embedded in the U.S. economy. It would take years to resource the supply chains for such products. In the meantime, many retailers which sell goods imported from China would collapse both from sourcing problems and also from the collapse in consumer consumption. Walmart would not go bankrupt, but it would suffer serious economic damage since up to 80% of its products are sourced from China.

The ripples from a deep recession caused by a total conflict with China would become a tsunami for the global economy. The negative supply chain effects from the conflict in Ukraine would be relatively inconsequential compared to the global economic effects of a total economic war with China. A global depression would be inevitable.

So what should be done?

The U.S. should take economic steps to prepare for war. But, by definition, economic resources are limited. U.S. labor markets are tight. The U.S. possesses neither the physical nor human resources necessary to prepare for war with China and to fight climate change or to pursue other progressive policies. Moreover, the administration is criminally negligent in conditioning financial support to the domestic semiconductor sector on social issues such as child care and prevailing union wages. The U.S. should immediately institute a semiconductor “Manhattan Project” to increase exponentially domestic semiconductor fabrication capacity. In times of imminent crisis, economic and social eggs must be cracked.

Redundancy must be built into U.S. financial systems. Markets must be prepared for the immediate sale and repurchase of physical and financial assets invested by China in the U.S. Such financial and physical assets exceed $1 trillion. Resilience must be built into domestic supply chains. International supply chains must be reconfigured for trade with countries such as India, Vietnam, and Mexico and not with China.

But Americans should be under no illusions: War with China would entail military and economic costs unprecedented since World War II.

Continue Reading at The Washington Examiner.