Date: 10/08/2021
Author: Mr. X
President Joe Biden’s withdrawal from Afghanistan, most would agree, did not go well. You can blame former president Donald Trump’s agreement with the Taliban, you can blame the military, you can blame the president, or can say it was simply unavoidable. However, the spectacle of the United States retreating in confusion was humiliating.
Yet it doesn’t seemed to have lingered in the public memory. Domestic public opinion has already moved on to debates over vaccine mandates and infrastructure spending, issues where President Biden has the public on his side. A poll in August 2021, taken when feelings of shame and rage were still fresh, found that most Americans did not think the Afghanistan war was worth fighting. The Taliban, yesterday’s insurgents, now finds itself fighting a mini-insurgency within Afghanistan from the Islamic State, which has used bombings against the new de facto government.
The United States itself has reoriented its defense policy towards containing China. From this perspective, President Biden’s decision was a painful but necessary move to extricate Americans from a quagmire with no end in sight in order to prepare for a possible fight with far higher stakes. American military and diplomatic moves show that the Pacific is now the primary interest for strategists in Washington.
The American people also know what’s truly important. A survey released yesterday by the Chicago Council on Global Affairs found that a plurality of Americans think China is a stronger economic power than the United States. That’s a sharp reversal from just two years ago. A survey from the same group found that a majority of Americans support military action to defend Taiwan from a Chinese invasion.
A small United States special-operations unit has been in Taiwan for more than a year, helping to train the island’s military forces. They are accompanied by a contingent of United States Marines. These forces could be compared to the small American units in Berlin during the Cold War, a “tripware” that would dissuade the Soviet Union from taking direct military action.
China, which regards Taiwan as merely a “rogue province,” has said that it will do whatever is necessary to protect its “sovereignty and territorial integrity.” China has been repeatedly violating Taiwan’s air defense identification zone, breaking records day-by-day by sending ever greater numbers of warplanes. Taiwanese Defense Minister Chiu Kuo-cheng said that the situation is “the most serious” in 40 years. White House Press Secretary Jen Psaki also said America’s defense commitment to Taiwan is “rock solid.”
Even some of America’s missteps inadvertently show that the United States is taking this new commitment seriously. Currently, there’s rather embarrassing news coverage about an American nuclear-powered submarine that struck an object in the Pacific, reportedly injuring several sailors. It’s noteworthy that American subs are patrolling this area.
The United States also infuriated France by forming a new defense agreement with the United Kingdom and Australia (AUKUS). That agreement led to Australia canceling an agreement to buy submarines from France, and renewed talk about an independent European (or even French) defense policy, especially now that the United Kingdom is out of the EU. While American policymakers may have underestimated French anger at the move, they almost certainly expected some reaction. They simply prioritized a defense agreement in the Pacific over maintaining strong relations with European allies.
America’s other Pacific allies are also becoming more bellicose. Earlier this year, Japanese forces participated in war games with naval forces from the United States, the United Kingdom, Canada, New Zealand, and the Netherlands. A recent poll found almost 75% of the Japanese favor engagement in the Taiwan Strait to secure “peace and stability.” While it is hardly a return to pre-war Japanese militarism, Japanese isolationism and anti-military feeling is fading fast.
The Philippines has chosen the United States over China after months of wavering between the two powers. On July 29, President Rodrigo Duterte said he would continue the Visiting Forces Agreement with the United States, the country’s former colonial master. President Duterte had repeatedly threatened to scrap the agreement, but his frustration with a lack of Chinese aid and repeated challenges to Filipino sovereignty over some Pacific islands appear to have settled his mind.
China’s ally North Korea might be more of a hindrance than a help in any serious military confrontation. Though China and Russia have been strengthening their strategic partnership, it would be a mistake to assume the two giants’ interests are identical.
For example, last year, a clash between Indian and Chinese forces left dozens dead. Media reports featured lurid tales of soldiers from the two countries fighting each other even as they plunged off cliffs in the Himalayan border region. Yet Russia is selling military equipment to India and India is even willing to risk American sanctions to get a Russian S-400 missile defense system. President Vladimir Putin is also surely aware about the possible Chinese threat to Russia’s eastern territories that could someday emerge. It’s Russia’s interest to have a strong China challenge the United States, but it’s certainly not Russia’s interest to face a Chinese hegemon.
The situation in the Pacific is complex and ever-shifting. On paper, both the United States and China seem to have a firm position. China claims Taiwan is part of its territory. It punishes businesses and individuals who say otherwise. China would regard an outright declaration of independence as a cause for war. The United States is orienting its defense policy towards deterring China, even at the cost of angering our oldest ally (France), and already has troops in harm’s way.
Yet in reality, there’s still a great deal of maneuvering room that allows both sides to posture. Since President Richard Nixon’s visit to China, the United States has agreed to a certain ambiguity about Taiwan’s political status, whereas it once recognized the Republic of China (Taiwan) as the “real” Chinese government. Meanwhile, China has agreed not to invade the island, though it has never and will never repudiate its territorial claims. China’s recent moves towards Taiwan are also less frightening than they might appear. While China is challenging Taiwan’s air defense identification zone, it’s not actually flying warplanes over Taiwan itself.
This does not mean there is no danger. There could easily be an accident as military units train and exercise in relatively close proximity to each other. There is also a major unknown – the true extent of the economic danger facing China.
The Evergrande debt crisis could potentially cause massive damage to China’s already overvalued real estate market. A missed payment by Fantasia Holdings Group this week shows that the problem is bigger than any one company. Considering the Chinese government’s recent moves to consolidate control over pop culture, corporate leadership, and information in the country, we can’t rule out the possibility that the situation is far worse than we think.
If faced with a catastrophic economic situation that could endanger its power, it would be entirely rational for the Chinese Communist Party to rally the masses against a foreign enemy. It’s worth noting that the number one movie in the world right now isn’t anything from Disney or Netflix, but the Chinese patriotic epic “Battle at Lake Changjin,” which celebrates a Chinese defeat of American forces during the Korean War. It should top $500 million by this weekend, a major accomplishment in an age when most studios make movies for a global audience and try to avoid taking a stand on any historical issue.
All that said, we shouldn’t get paranoid or carried away. Though there might be a move against a particular island or an especially large military exercise, it’s doubtful China even has the capacity to successfully invade Taiwan, though Taiwan’s own defense establishment warns that might be possible by 2025. It’s more likely that both powers are preparing for an economic, diplomatic, and military competition, a second Cold War.
This has the potential to shape the next few decades, particularly as the United States is suffering from catastrophic supply chain difficulties because of the strains COVID-19 has imposed on the global economy. America may rediscover the benefits of being able to produce its own goods and being reliant only on its own companies.
It will also need control over sensitive information. This is no small thing – industrial espionage has been a major tool exploited by the Chinese government. “The greatest long-term threat to our nation’s information and intellectual property, and to our economic vitality, is the counterintelligence and economic espionage threat from China,” warned FBI Director Christopher Wray in 2020. “It’s a threat to our economic security–and by extension, to our national security.”
What should investors do to prepare for this potential long-term showdown? Three companies in particular seem promising.
First, there is Raytheon Technologies [RTX], now a giant after last year’s merger between Raytheon Company and United Technologies Corporation. In May 2021, Raytheon won a $228 million contract from the United States Space Force for the follow-on control system for the GPS satellite constellation. In July 2021, RTX won a potential $2 billion contract for a new nuclear cruise missile. Raytheon was also selected by the Army to develop a laser energy weapon for the Stryker A1 vehicle and by the Air Force and Marines for air defense. Most intriguingly, RTX is working with the Air Force to study how distributed ledgers (blockchain) could help make command-and-control centers less vulnerable to attack. Raytheon stands to benefit from a long-term investment by the United States government in crypto and anti-missile technology and equipment that would be needed for a Great Power conflict.
Another forward looking company is Palantir [PLTR], a firm I’ve praised before. PLTR recently beat Raytheon to create a new version of its Distributed Common Ground System-Army (DGCS-A). It’s worth $876 million over 10 years. Yesterday, Palantir also announced it had won a $90 million, four-year contract with the U.S. Department of Veterans Affairs.
Palantir has some vulnerability because its reliance on government contracts could potentially make it a political target. However, Palantir has something that sets it apart from many other big technology and data management companies. It won’t work with China. “I’m very proud that Palantir is sticking to working with America and America’s interests,” said co-founder Jon Lonsdale in 2020. Much like it was only Richard Nixon who could go to China, perhaps it was only Joe Biden (sometimes criticized by Republicans for being “soft” on China) who could reorient American defense policies against China and who could work with companies that take sides in geopolitical competition.
Finally, there’s Kratos Defense & Security Solutions [KTOS]. This has been something of a “meme stock” for retail traders. It’s undervalued compared to the consensus developed by most analysts, but investors are right to be cautious. Almost 34,000 shares were sold by insiders at the company last month, all at prices above its current value at $22 a share.
However, if KTOS is caught in a general market selloff and dips below $20, investors might want to take a second look. Kratos is developing the XQ-58A Valkyrie combat drone. Chinese experts have reportedly downplayed the dangers it poses, noting the relatively modest gravity “pull” the combat drone can endure. Yet as National Interest reported on September 20, the Valkyrie is not meant to be a dogfighter, but to be a kind of “wingman” that will help manned fifth-generation fighters accomplish their own missions. Perhaps more importantly, Valkyrie enjoys a certain autonomy from centralized command and control. It’s also cheap (for military equipment anyway.) Finally, it’s part of a long range program that won’t even be fully unveiled until 2023.
I find these characteristics impressive because they meet some of the challenges American forces face in the Pacific. Despite advanced anti-missile systems, American carrier groups could be potentially vulnerable to drone swarms or missile attacks. Centralized and expensive vehicles and command systems could be outmatched by autonomous systems that operate along decentralized lines. Valkyrie shows that the United States military recognizes these vulnerabilities and isn’t just taking a defensive approach, but playing offense.
RTX could stand to benefit from the large-scale weapons contracts that will be arriving as Great Power competition really takes off. PLTR’s patriotic stance gives it a unique selling point for a government which must now worry about Chinese infiltration of its research and scientific centers. Finally, KTOS is developing a weapons system that seems custom made for the challenges American forces will face near Taiwan – though investors must be wary about buying stock in a company that so recently has experienced sales by insiders.
Remember, investing is just warfare by other means.
Mr. X is an investment analyst working in the Washington DC area who specializes in the intersection of business and public policy. After fifteen years working in politics, he writes on a classified basis for RogueInvesting.com three times a week to bring you news on what those with power are debating, planning, and doing.
