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Re: Geopolitics/Demographics/Inflation - The Great Power Competition Between US & China.
On May 11, 2023, I chaired a private event discussing this globally important topic with a panel of experts. This is a synopsis of that event, with Chatham House Rules applied (Peter Zeihan excepted).
As a child of parents who fled from China to Taiwan in 1949 and then immigrated to the United States, you could say that I’ve been following the topic of US/China/Taiwan relations closely my entire personal and professional life. The global impact of this Great Power Competition on everything from global supply chains, energy flows, and even the prospect of kinetic escalation makes this topic front-and-center in today’s world. America has never faced a rival with the combination of economic, military and technological clout like China.
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On May 11, 2023, I chaired a private event entitled “The Impact of a US/China Cold War” to explore this topic with a panel of geopolitical experts. In addition, we had a number of resources from RAND, NATO, and various branches of the military in attendance for an incredible evening of learning and debate.
This is a synopsis of that event, with Chatham House Rules applied (Peter Zeihan excepted) along with some of my own observations and opinions.
Format / Speakers:
Peter Zeihan (Keynote Speaker), Geopolitical Strategist and Author
Colonel (Retired) Richard Lacquement, Professor/Ex-Dean at US Army War College
Oriana Skylar Mastro, Center Fellow at Freeman Spogli Institute, Stanford University
Derek Grossman, Senior Defense Analyst, RAND Corporation
I begin with a summary of the keynote address by Peter Zeihan.
The aftermath of WWII saw the establishment of NATO and Bretton Woods, both of which shaped the current US-led RBO (Rules Based Order). Following the collapse of the Soviet Union after years of US/Soviet Cold War, the US was left as a unipolar power with no serious challengers to its hegemony.
The US gradually turned its attention inward and, with the election of 5 increasingly populist Presidents leading up to and including Biden, began to question the economic merits of its subsidization of global security for the world.
China’s entry into the WTO in 2001 marked a sea change in global power dynamics, because it produced an economic/military/technologic adversary not interested in playing by the US-led RBO. There is a recurring school of thought that China will upset and perhaps even supplant the US-led RBO and that its currency may even compete with the USD as a major Global Reserve Currency (GRC).
Not so fast.
How Demographics Impact Capital Formation and Economic Growth
Let’s do a big digression into the Macroeconomic impacts of Demographics first.
Figure 1 compares the projected Demographic Distributions of the US, Mexico, Germany, and China.
The US Demographic Pyramid, while not perfect, is the healthiest in the Developed Market (DM) world (more on this later).
Mexico exhibits the quintessential “healthy” pyramid shape of many Emerging Market (EM) countries — large cohorts of young people relative to elderly cohorts.
Germany’s inverted pyramid tells you that this could be “Germany’s last decade as an industrial power,” according to Peter. There simply are not enough up-and-coming young workers to replenish the labor force.
Figure 1: Demographic Projections - 2025, Source: Zeihan On Geopolitics
Then we get to China. At first blush, it looks very similar to Germany — except 16-17x larger in absolute size. Or is it?
Consider this quote from Peter Zeihan’s article from earlier this year:
“A couple years ago, the Chinese started releasing bits and pieces from their 2020-decade census. And they came to the grudging—and public—conclusion that they had overcounted their population by in excess of 100 million people.
The worst part is that these missing 100 million people or so would have been aged forty or under. And as we saw above, that’s the most productive part of a population. They’re also the folks that have the kids.”
If this is true, it implies that the yellow bars in China’s pyramid (see Figure 1) don’t exist. Accordingly, Peter believes that China is already in the “advanced stages of national collapse — assuming nothing else goes wrong.”
Let’s return to the US Demographic Pyramid and dig deeper.
Figure 2: US Demographic Pyramid - 2025, Source: Zeihan On Geopolitics
First, keep in mind the general spending pattern of a typical US citizen: when you’re 45 and under, you’re generally spending; when you’re over 45 you’re preparing for retirement, pulling back on consumption and generating a lot of extra capital (with incomes high while consumption drops). All of that extra money from this Capital-Rich Stage comprises 70% of Private Capital.
I’ve referenced this Lifecycle Spending Pyramid before (Figure 3) in my own Tweets:
Figure 3: Lifecycle Spending Pyramid, Source: HS Dent
Back to Figure 2. The Boomers are still the largest generational cohort we’ve ever had. “From the 1990s through 2010s, the Boomers were in the Capital-Rich Stage, which is why capital was so abundant and interest rates were so low. That era is now ending.”
As of December, 2022, half of Boomers have already moved into retirement. “Capital will now be scarce until the Millennials move into their Capital-Rich Stage of their lives — in ~12 years during the 2030s.” It might take a while, but in the end, US Demographics will come to the rescue.
Incidentally, Demographics are likely also why Labor Inflation is so sticky and will remain high — until the Millennials’ kids (the Zoomers) enter the workforce in 20-25 years in the 2040s.
To build on this, I think that Demographics may explain not just the stickiness of Labor Inflation but also Shelter Inflation in Core CPI. Note the sheer number of Millennials in their prime homebuying age as well as the relative shortage of Gen X workers compounded by Boomer retirees:
Figure 4: Demographics Impacting Inflation? Source: Zeihan On Geopolitics
The Fragility of China’s Government-Led Investment Growth Model
The largely Boomer Consumption-fueled Private Capital growth in the US since 2000 looks like this:
Figure 5: Demographics Impacting Inflation? Source: Zeihan On Geopolitics
As Figure 5 shows, notwithstanding the credit contraction of GFC, our Private Capital Growth has gone up and to the right.
The US looks downright profligate — until you compare the US to the Rest of World (RoW) and especially China (Figure 6). Note the vertical scale for perspective, and now look at China’s Private Capital Growth by comparison:
Figure 6: Total Private Credit Comparison, Source: Zeihan On Geopolitics
Whereas Boomer Consumption primarily fueled US Private Credit growth, China’s exponential Private Credit Growth looks like it was powered by something else entirely.
Figure 7: Chinese Economic Concentrations, Source: Zeihan On Geopolitics
Figure 7 shows that Chinese economic growth has come almost exclusively from Government-led Investment as opposed to Private Consumption. Purple designates the only region where Private Consumption exceeds Investment; the US and Mexico would be Purple. Blue is the only region where Exports dominate growth; Germany and South Korea would be Blue. Green (Shanghai) is the only region where Private Consumption is balanced with Investment. In every other zone, growth has been dominated by Investment.
What makes things immeasurably worse for China is that the Chinese primarily grow their FOOD in the Orange zones.
Peter: “Not only is China the most over-levered economy in human history, the economic sector most exposed to this leverage is agriculture. China is already the least efficient agricultural sector in the world and uses 5x the global average of fertilizer per calorie produced.”
If/when this Government-led Investment Growth model fails, China will not only experience wholesale INDUSTRIAL COLLAPSE but also FAMINE.
Figure 8 illustrates how China’s lack of economically viable land (Beige and Brown) has crowded the population centers (Red) into tight clusters without any hinterlands acting as social/cultural/political “glue.” Only a top-down autocracy can effectively “hold the center” in this precarious dynamic, which is what led to China’s Government-led Investment Growth model in the first place.
Peter: “If/when that fails, the system shatters.”
Figure 8: Chinese Vulnerability, Source: Zeihan On Geopolitics
Maritime Power Balances: Green Water Superiority vs. Blue Water Superiority
I’ve talked for years on Twitter about the difference between the US Navy and the PLA Navy. Much is made about China’s much larger number of vessels, but people often ignore the difference in gross tonnage, which makes a world of difference for Force Projection capabilities:
A large flotilla of smaller ships means that China arguably has “Green Water Superiority” to patrol the coastal waters within the First Island Chain, in which Taiwan sits squarely in the middle.
By contrast, the US Navy possesses 11 of the 16 supercarriers in the entire world vs. China’s one. The UK has two, but with US commanders. Japan also has two, but with US planes.
China simply does not have experience on the waves, nor does it have the hardware to allow it to punch through the First Island Chain for an extended period of time. In fact, according to Peter, China has never in its history been able to sustainably Force Project out of the First Island Chain — except during this period of US-subsidized maritime security. Peter: “All it takes to destroy China’s industrial and economic position is the Americans going home. They cannot function without the US Navy in play.”
Figure 9 shows how the world looks to China — and why the CCP covets Taiwan as an “unsinkable aircraft carrier” to give it Force Projection capabilities beyond the First Island Chain.
Figure 9: China Hemmed In, Source: Zeihan On Geopolitics
Maritime Insecurity Leads To Energy Insecurity
Oil is the most important commodity in the world. It is also Russia’s biggest revenue source by far and China’s biggest insecurity by far.
A couple months after the Russian/Ukraine conflict began, there were many prognostications that Russia would easily circumvent Western sanctions on its Oil by simply diverting its flows eastward, straight into China.
Unfortunately, those predictions did not take geography into account, and I pointed this out at the time:
The reason is simple: Russian permafrost makes for very inhospitable geography and limits the ability to construct land-borne Oil routes between Russia and China (Figure 10a). According to Peter, “This area has the highest upkeep cost of any biome in the world.” Peter believes that everything being produced in this region will eventually go away. “If China & Russia wanted land-borne Oil pipelines in place now, they would have had to start construction back in 1985.”
Figure 10a: Russian Permafrost Zone, Source: Zeihan On Geopolitics
Figure 10b: Russian Transport Heatmap, Source: Zeihan On Geopolitics
Figure 10b is a heatmap of Russian transport of hydrocarbons. The blue circle is where ~75% of where Russia’s hydrocarbons are produced. Notice the absence of pipelines flowing eastward into China.
Figure 11 below shoes how China gets its Oil. Land-borne Oil pipelines are in green, and the yellow arrows represent Oil flows into China.
Figure 11: China’s Energy Gauntlet, Source: Zeihan On Geopolitics
The only pipeline of significance is ESPO (Eastern Siberia-Pacific Ocean) Oil pipeline, and it only has a capacity of 1.6 mmbpd, which accounts for <25% of Russia’s total Oil exports and <15% of China’s total Oil imports.
ESPO’s capacity was already nearly maxed out before the Russia/Ukraine war started, so everything else is seaborne, which means that the rest of China’s Oil imports literally needs to run a gauntlet from St. Petersburg and pass the Baltic Republics, Finland, Sweden, Poland, Denmark, UK, Italy, Spain, Turkey, India, Egypt, Vietnam, Indonesia, Malaysia, Singapore, Philippines, and Taiwan.
Essentially, ~85% of China’s Oil imports are seaborne and not only has to run this gauntlet past a literal ocean of “unfriendly’s” but must also squeeze through the narrow chokepoint called the Strait of Malacca between Malaysia and Indonesia. Peter: “This makes China the most energy insecure country on the planet.”
Figure 12 below illustrates starkly China’s “Malacca Dilemma.” The purple dotted line traces Oil routes from the Middle East to China during peacetime. This route is easy to disrupt from either side in a hot war, so the green dotted line likely becomes the wartime Oil route.
Figure 12: China’s “Malacca Dilemma,” Source: Zeihan On Geopolitics
China’s “Green Water Superiority” allows it to defend the First Island Chain (black dotted line) effectively. However, its lack of large vessels (like the supercarriers of the US) prevent it from breaking far outside of the First Island Chain. In a kinetic escalation, a carrier blockade of the Indian Ocean would effectively cut off China’s supply lines and cause an industrial capacity and famine in China within a year
Peter: “China has wholly committed its socioeconomic existence to the globalized order, but it lacks the capacity to take it over. That makes China the most fragile world power we have ever seen.”
Taiwan’s Importance Is Geopolitical And Economic
The last two sections illustrate why Taiwan is of paramount geopolitical importance for China’s ability to Force Project out of the First Island Chain and mitigate its energy insecurity given its “Malacca Dilemma.”
Taiwan is of utmost economic importance as well as it is also home to Taiwan Semiconductor (TSMC), which accounts for 90% of world high-end chip production.
In the world of semiconductors, China only dominates the low-end. China has no capabilities in the middle and high-end which collectively comprise 90% of the market.
If there’s one thing that unites this country politically, it is China’s threat to the US-led RBO. Biden has figured out how to hobble China in semiconductors by imposing strict export controls on foreign equipment, software, and US citizens. Peter: “It is already over (for China.)”
Does China have the military capability to take Taiwan? Probably, but there are 4 fallacious assumptions that people make.
“It will be easy.” No, Taiwan will be much harder to take militarily than Ukraine.
“Russian weapons are reliable.” No, China has major buyer’s remorse after witnessing Russia’s fiasco in Ukraine.
“No one will say a word because China is too important to international commerce.” No, the opposite is happening given the re-shoring trend.
“Sanctions won’t deter China.” But boycotts will. Companies like BP walked away from $27B of direct investment after Russia’s aggression. What will the world’s response be to another dictatorial aggressor?
Under normal circumstances, this stack of negatives would preclude any attempt at invasion, but the wildcard comes from Xi’s purging of his inner circle to hamper a well-functioning intelligence feedback loop.
Even if China did take over Taiwan, it could not run TSMC by itself unless the RoW sanctioned it. And if the RoW rises up against China and cuts off its energy routes, it would mean the end of Industrial China and its ability feed its population.
Structural Inflation Is Here
What are the ramifications of all of these factors on Inflation?
Figure 13 shows the Three Inflation Pulses since WWII:
Figure 13: Three Inflation Pulses, Source: Zeihan On Geopolitics
We’ve witnessed 3 big pulses of Inflation since WWII:
Post WWII Industrialization Demand-Driven Inflation
Peak Boomer Consumption Demand-Driven Inflation
End of Globalization / Cheap Labor Meets Peak Millennial Consumption Inflation
We are in Period 3 now, where a perfect storm of the end of the Post-Cold War Globalization Nirvana and the Cheap Chinese Labor Demographic Dividend is meeting Millennial Peak Consumption. The last 3 decades of little/no Inflation were simply the perfect storm the other way around.
If we are about to lose both China and Germany as world industrial powerhouses, we will need to double the size of the Industrial Plant; barring that, we could see 9-15% Structural Inflation over the next 5 years!
Inflation will be likely be sticky for a long time because of all of the aforementioned factors, but it will also result in a huge growth story for North America as we re-shore our Supply Chains to be resilient to geopolitical shocks as we come out of this period.
What follows are some bullet points that arose out of the ensuing panel discussions, with Chatham House Rules applied. Some of these points contradict one another and don’t represent my own views, but I felt it was important to relay them as is:
Panel Discussion Points
Be careful not to be the “taxi company comparing the size of its car fleet when facing the Uber threat.” Don’t assume US Blue Water Superiority is relevant from a “vessel vs. vessel” standpoint. We need to look at China’s defenses vs. our strengths. For example, although we clearly have superior air power, the Chinese have 39 combat-ready airbases in its theater vs. just 1 for the US, and China can simply bomb those runways, given its advanced cruise and ballistic missile program. This potentially nullifies any US Naval Superiority, because US Air Superiority is a prerequisite for bringing in a carrier group within the vicinity of the Taiwan Strait.
US forces in the Indo-Pacific are heavily reliant on Space assets, which China can disrupt. It’s not easy to threaten a high cost to that disruption either. China can rely on land-based systems in its theater, whereas the US would primarily be beholden to ship-based systems that rely on Space assets.
In a direct confrontation, the US would win a kinetic war in the South China Sea. But it takes us 4-6 weeks to deploy our forces from California to the Pacific theater. Some military estimates think China could take Taiwan in 2 weeks. Cutting off Oil supply lines via the Strait of Malacca sounds great, but it is only relevant in a protracted war. China knows this and will avoid a multi-year conflict.
“Fait Accompli” is the nightmare scenario where a quick takeover happens before the US can even respond. The US is woefully unprepared for Taiwan contingencies and only started prepping recently. At least the US spent 7 years training the Ukrainians. There is also some on-the-ground concern in Taiwan about the local population’s willingness and morale to fight China in the event of an invasion.
This is very similar to my Gray Rhino Bloodless Coup scenario in which the KMT-led officer corps of the Taiwanese military willingly lays down its arms and welcomes China in voluntarily, which would make it politically difficult to oppose (given the peaceful reunification) despite the geopolitical catastrophe for Indo-Pacific security and stability.
China believes it has everything under control and that it has checked the economic boxes in the region. All that remains is the military preparedness box. Xi’s purges also got rid of the opposition to the military reform. So if China believes it can win militarily, it could very well go in. This is scary.
The US has a strong hand and generally plays it well. There is a reason why the US has a lot of allies: our values and our institutions. We have an immigration crisis because people want to come here; it’s no surprise that China does not have an immigration problem. The same goes for USD hegemony — it is based on trust and rule of law. This is a key US advantage.
The military’s job is to deter war first and foremost. But if there is a war, we would rather have a Cold War than a Hot War. The Chinese should have the same incentives. We must convince China of the costs of escalation and of their relative fragilities.
We can pursue some small but targeted objectives to make sure taking Taiwan is not tempting for Xi by convincing him of the extremely high costs of escalation, but we need to back up those claims by having a credible Strategy of Denial. Although these are just delaying strategies which will invite counters, something is better than nothing:
Deploy missile capabilities in the Second Island Chain
Ensure adequate munitions stockpiles
Deploy Submarines/Bombers in Japan and Philippines (not something irrelevant without enough range)
The US military is competent in every sphere of warfare: Land, Sea, Air. But the character of war is changing, and we need to also consider Space and Cyber. One of our biggest strengths is Multi-Domain Expertise: how to pull together chaotic, competing services and make them work cohesively. This is where the US shines, and it creates dilemmas for our adversaries.
Another US advantage is its ability to leverage the diversity of its citizenry beyond just combat forces. For example, we had the best logistical backup in WWII as well as combat forces. Germany and Japan had great combat forces but had no logistical ability to sustain their forces over a protracted period of time.
The Chinese are untested in war and don’t trust their people like we do. Solving the “human trust” issue with AI and technology is possible but difficult to achieve in practice, because wars are messy and don’t play out exactly by the playbook usually. The US, by contrast, has had many successes, but has also learned from its failures in Vietnam, Iraq and Afghanistan.
Why has the “End of China” taken so long to play out and what would it look like?
Chinese growth since 2008 is absurd and suggests 75% of growth is Investment-driven. The diminishing returns to incremental Investments are evident in the spike in Private Credit growth. It’s hard to know when China’s Minsky Moment arrives, but it’s getting closer.
Demographic revisions are much worse than previously thought. China’s Consumption-led dreams are a “fantasy.” Investment-led Growth depends on RoW’s economies given China’s export dependencies. China’s Labor force that can access the wider world is now under-skilled relative to its price point.
Xi has no succession plan and is likely the last leader of his ilk. Post-Xi, one could see China fracturing into three parts: a North China neo-Marxist state, a Shanghai corridor that tries to go its own way, and a South China that will try to interface with RoW but with North China hampering those efforts.
Can AI overcome China’s Demographic problems? Economic structures must allow the convenience to have multiple children at scale. China doesn’t have that, but even if they figured out how to incentivize higher birthrates tomorrow, it takes decades to make adults that are ready to enter the Labor force. On the AI front, China is already cut off from pursuing cutting-edge chips given the current export controls. Even if they figure out this part of the equation, the other half of the equation is Consumption, and “robots don’t buy stuff.”
Xi is unable to deviate away from China’s Investment-led Growth model, and every time he’s tried to break away from it, he found that he could not and had to come back to it. Japan had the same problem and ultimately bit the bullet and stopped trying — but it had zero growth for decades. China’s system can’t survive that, so the implication is that it will be driven to stimulate ever more Investment-led Growth until it implodes.
What are some scenarios for a Taiwan takeover?
Quarantine/Blockade: While this could allow China to choke off Taiwan’s inputs for a period of time, Taiwan has enough supplies to last 35-45 days, and this is enough time to give the US time to marshal and deploy its forces which would be problematic for China. Therefore, a Blockade could be a limited harassment tactic but unlikely to comprise a real reunification campaign strategy given the riskiness to China.
Cyber/Space War: Could this be perceived as a “less-than-full kinetic escalation” that China will seek? Sure, but Taiwan will not give up its physical sovereignty unless under military threat.
Peaceful Reunification (Backed By Significant Military Force): This is the aforementioned “Fait Accompli” nightmare scenario, where China is able to convey a sense of “Resistance Is Futile” to the Taiwanese.
Bloodless Coup/Peaceful Reunification: Personally, this is the risk I worry most about, because there is no US policy or political will to oppose a peaceful reunification. Although the KMT is indeed embedded in the military, they supposedly still constitute a small minority, and only 7% of polled say they want reunification. That said, it is hard to share intelligence with Taiwan because of the KMT closeness to Beijing. Although our experts did not seem extremely concerned about this scenario, they admitted that if the KMT takes power next January, it could signal to China an opportune time to make a move. Some panelists believed that the US could possibly view peaceful reunification as a convenient resolution to the question of whether “Taiwan is worth fighting for” but also pointed out that South Korea was a clear example of something worth fighting for.
Military Invasion: This still seems like the most likely scenario to some of our panelists. The good news is that none of the telltale signs have yet occurred. These steps would take weeks, but the US POTUS would still be unlikely to marshal forces unless a war was already in place, simply because of the logistical problem of where to place those forces. Signs to watch for:
Massive propaganda campaign
Moving forces from central to eastern theater
Putting people on ships
Keep in mind that the US is a treaty ally with every other country within the First Island Chain and has already given Australia the launch capability to cut Chinese energy flows by themselves, so the idea that the US just abandons its allies and lets Taiwan go seems unlikely.
“The US has always been flexible until it’s not.” The US has the capability to smash the Chinese but hasn’t done so because the US has been the security guarantor since the Cold War. That is now changing, and the world doesn’t realize that the US perhaps no longer cares to shoulder that burden anymore.
China’s OBOR has been a disaster. The Kenyans just laughed at the idea of debt payback, and only Pakistan and Sri Lanka even attempted payback. However, to give China credit, they at least have an EM strategy, whereas the US has not focused at all on EM diplomacy.
How much does a charismatic leader like Zelinsky matter in such a conflict and does Taiwan have such a leader? Total wildcard. Even if Taiwan is lucky enough to have such a leader, whatever arms/munitions they have on day one of the conflict is “all they’re going to get for a while.” That must change.
Xi has said they will be ready to take Taiwan by 2026-2027. We need to get prepared early on and not react last-minute:
We cannot just send a token force and risk failure. This would be a worst-case scenario, and a failed defense would have severely negative repercussions in how the world perceives US strength.
We need to be ALL-IN, and yet there does not seem to be urgency right now.
One of the attendees of my conference was Lieutenant Commander Michael St. Pierre of the Royal Canadian Navy, with whom I collaborated and presented a paper at West Point in February. Our West Point Paper is entitled “USD Primacy In An Era of Economic Warfare” and goes into great detail about many of the power balances covered here but focuses instead on the importance of economic warfare vs. all of the kinetic options discussed at this event.
Because I think the economic dimension of geopolitical conflict is so rarely covered, I recently partnered with Grant Williams in starting a new podcast series entitled KAOS THEORY, dedicated to the intersection of Macroeconomics and Geopolitics.
I thought it was fitting that our first guest (of what I hope to be many) was none other than the aforementioned Michael St. Pierre. We discuss many germane topics: Taiwan, Economic Warfare, etc. in this debut episode:
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