The geopolitical risks to the market of Taiwan tensions explained by ex U.S. diplomat Bill Klein

In this episode of Live with Lizzi Lee, Bill Klein, career U.S. diplomat and currently consulting partner at FGS Global explains the significance of China’s third white paper on Taiwan. Notably, the document has no mention of Beijing’s prior promise of not sending troops or administrators to Taiwan after unification. How has U.S. House Speaker Nancy Pelosi’s visit changed Beijing’s Taiwan calculus? How should investors assess the geopolitical risks associated with the Chinese market? 

Below is a transcript of the video:

Lizzi: Joining me today is Mr. Bill Klein, currently a consulting partner with FTG Global. Prior to that, Mr. Klein dedicated most of his diplomatic career to leadership roles at the heart of the US-China relationship. Mr. Klein served as acting deputy chief mission chargé d’affaires ad interim and minister counselor for political affairs at the US Embassy in Beijing from 2016 to 2021. Mr. Klein will help us understand the current state of bilateral relationship as well as the geopolitical risks associated with the Chinese equity market. 

Thank you so much, Mr. Klein, for being here with me. 

Bill Klein: You’re welcome, Lizzi. It’s my honor. 

Lizzi: So, Mr. Klein, China just published its first white paper on Taiwan since Xi Jinping came to power. The document has no mention of Beijing’s prior promise of sending no troops or administrators to Taiwan after reunification. Does that signal a change in the one country two systems model? More generally, how has Speaker Pelosi’s visit changed Beijing’s Taiwan calculus? 

Bill Klein: Well, Lizzi, I think that those changes that you mentioned will certainly continue to generate a lot of discussions, not only outside of China, but also among Chinese commentators in the coming days and weeks. I think this is a very important document. 

It is indeed the first Xí Jìnpíng 习近平 came to power following two white papers that China published with respect to Taiwan in 1993 and in the year 2000, I believe.  One can ask themselves, why is this paper being published now? I think that if you look at the paper, it’s obvious that it required a lot of preparation. So, it was certainly not something that was published hastily after the Pelosi visit. 

And I suspect that this paper was prepared for the upcoming Congress of the Communist Party, that its goal tends to embed the Communist Party’s Taiwan policy under the leadership of Xi Jinping in a very explicit manner, and that its publication date was moved forward in response to the Pelosi visit. 

Indeed, commentators are already poring over this document and comparing it with statements with two earlier documents, as well as with other key statements that Chinese leaders have said with respect to Taiwan over the past few years. Having said that, I think that this paper also demonstrates a lot of consistency and most importantly, remains very, very consistent about what China’s ultimate objectives are with respect to Taiwan. China intends to obtain de facto and de jure sovereignty over Taiwan.  And this document makes it very, very clear that as in the past, there is no change to these aspirations and that if anything, China is doubling and tripling down in its goals with respect to the one country, two systems question. 

I think it’s important to point out that one country, two systems never enjoyed a lot of popular support in Taiwan. Across the political spectrum, all of the democratic parties in Taiwan have rejected the concept of one country, two systems. Even former KMT president, Ma Ying-Jeou (馬英九 Mǎ Yīngjiǔ), who is credited with having a policy aimed at bringing Taiwan closer to China, was also very, very explicit over the years of his rejection of this concept. 

I think that as China has formulated this concept, given all the events in Hong Kong over the past several years, this has further devalued this concept in the eyes of people in Taiwan. China has a very, very big challenge if indeed its goal remains to win over the hearts and minds of the people in Taiwan and for peaceful unification. This paper will not help China’s case in Taiwan. 

With respect to Nancy Pelosi’s visit and what its meaning actually is for the bilateral relationship, there’s this old adage that there’s never a good time for things like this in US-China relations, but also sometimes are worse than others.  And I think from a Chinese perspective, this was seen as a particularly the timing of this visit was seen as particularly provocative, given the party Congress coming up. I also think that it is important to see this visit in the context of the US-China relationship as relations have worsened, as China has ascribed the intention to intentions to the United States of trying to contain China or try to thwart China’s modernization aspirations.  They view this visit in that context, and they see this visit as a further attempt to internalize the separation between Taiwan and China and to make even more difficult on China’s ultimate aspirations for Taiwan. 

I do not believe that this was the intention of the visit, but this is, I think, how China perceives it is this change in China’s calculus. I do think that the visit created a new status quo. I think that some of the military activity that we have been seeing around Taiwan will probably be normalized and become more frequent moving forward. Just exactly what that looks like I think it’s too early to tell. Only time will tell. 

Lizzi: Speaking of Taiwan’s position in the global supply chain, TSMC chair Mark Liu recently told CNN in our interview that the company’s advanced chip factory would become inoperable in the event of a PRC invasion. Has the world become too reliant on TMSC? 

Bill Klein: I think that COVID demonstrated the brittleness of many of the supply chains that we have taken for granted over the years. And we’re already seeing that companies around the world are taking a very, very good, hard look at their supply chains, and at the reliability and dependability of their supply chains. We are also seeing that partially in response to COVID, but also certainly in response to a growing competition between the United States and China. 

And here, from a European perspective, against a backdrop of increasing European concerns about China’s intentions, governments are also taking a very, very hard look at supply chains from a perspective of economic and national security, and we have already seen a wide range of measures being taken to address the issue of supply chain dependability. 

Obviously, this is not restricted only to issues such as pharmaceutical inputs, personal protective gear, battery, electric battery components, etc., but also and very importantly, our semiconductors and whether it’s China, whether it’s the United States, whether it is the European Union, all of these sides are now taking very proactive efforts to incentivize companies to either onshore their research and development and their manufacturing or to reshore it or to friend-shore it, as we’re seeing in these US led efforts to create a common interest with respect to other manufacturing locations on the Pacific Rim 

And of course, at TSMC and others, they realize this. They too understand the need to diversify not only their production and research and development, but also, they understand that their clients need to diversify, diversify their sources of semiconductors. We also see that companies like TSMC are proactively taking advantage of incentives offered by government, and we’ll continue to see this as part of their efforts to diversify. 

Having said that, a company like TSMC, even under these rapidly evolving circumstances, will remain a decisive player in the global chip markets moving forward, and that Taiwan, as a location for research, development and manufacturing of semiconductors, will also remain a key location moving forward. 

Lizzi:  And given the rift over Taiwan further complicates the outlook of Chinese equities, which have already had several major flashpoints due to the trade wars, the fear of delisting from the U.S. stock market, what’s your view on valuations of Chinese equities, both in the short term and the long term? How should investors assess the geopolitical risks associated with the Chinese market at this point? 

Bill Klein: As China continues to modernize and grow, of course, growth rates are going to go down. You’re not going to see the growth rates of 10%, 8%, perhaps even six or 5% that we have seen in earlier phases of China’s modernization and economic growth. 

And much of the factors driving China’s model of economic growth moving forward in the past have run their course, whether that is the debt and credit-driven growth, whether that is infrastructure driven growth, etc. The headwinds facing China’s economy are very well known. Outsiders like to reference China’s demographic challenges and the debt challenges that China faces. China is aware of these, of course, within China. A lot of focus is now on how China can move up the value-added chain. How can China increase innovation and productivity to avoid the middle-income trap? But other issues such as the rich-poor divide are big issues within China are shaping perspectives of the economy here. Of course, geopolitical uncertainties between the United States and China are also casting a further shadow on the market and then decisions. 

Response to COVID, actions against high tech companies, actions on education platforms and against the real estate market from last year have also cast a certain amount of uncertainty among investors with respect to China’s market. 

Having said that, China is roughly one fifth of global GDP. China plays a very, very important leading role in global economic growth and will continue to do. So, moving forward, given the sheer size of the economy… And, it’s very, very important to emphasize that knowledge and knowledge transfer is no longer a one-way street, that in important areas China is also becoming a center of innovation. Companies know this. And companies know that they have to be in China to participate in this innovation, not only in order to compete with China in China, but also in their home markets and in third markets around the world. And the same thing has to be true with some portfolio investors. 

Yes. Uncertainties, geopolitical risks will continue to shape the environment. Investors need to understand that. If investors understand the risks, the uncertainties, and they have a keen awareness of their investment horizons and their risk preference, there will continue to be a place for Chinese equities in the portfolios of international investors. 

Lizzi: We know you played a very important diplomatic leadership role in the US embassy in Beijing from 2016 to 2021, as we mentioned at the top of the program. That was an especially tumultuous period in the US-China relationship. So how would you compare the situation of US-China relations now versus then? 

Bill Klein: Oh, they have changed dramatically, Lizzi, as we all know. So, you know, I arrived in Beijing in the summer of 2016 in the run-up to the G20 summit in Hangzhou.  I was in Hangzhou to support President Obama’s engagement there with Xi Jinping, and already then suspicions, mistrust about strategic competition was playing a greater role in the bilateral relationship. And, you know, the Chinese view that the United States wants to contain China, or at least for China’s modernization drive and was already well-established within China’s strategic thinking. 

I did see and experience firsthand during the Trump administration that this became a mainstream, if not a near consensus view in China of U.S. intentions. And then, of course, views have only hardened under President Biden. 

So what does that mean as a US diplomat? Well, living in Beijing has always been very pleasant and the people are gracious and welcoming so that, let’s put it that way. That didn’t change, obviously, as COVID came in. The uncertainties and restrictions related to China’s COVID response has made life more difficult, I think, for foreigners, for all people in China, but also specific challenges for foreigners and for diplomats. 

And what we did see is that the communication between the two sides became more difficult and the channels of communication became more difficult and many of them atrophied over this period. I think that is very bad. I think that it is very, very important that the two sides maintain open channels of communication. And that’s very important to understand the other side’s intentions and to explain to the other side what one’s intentions are and to understand what the other side’s red lines are, to delineate where the own red lines are. 

And then through these types of conversations, to understand what the other side’s priorities are, where they are inflexible, and where they may be flexible with respect to the things that one wants out of the relationship, particularly as strategic competition and mistrust drive the relationship, this type of communication is very, very important so that the two sides can reduce the risk of misjudgment, risk, reduce the risk of bad decisions that can actually intensify the strategic competition and the distrust at the heart of the relationship. 

So having said that, it did not become easier in those five years, but I still remain hopeful that the two sides have a common interest in ensuring that their strategic competition and their distrust does not descend into conflict and confrontation.