Taiwan

Taiwan will need to make painful tradeoffs to ensure its continued security, Richard Bush argues in a new book.

When Japanese Prime Minister Yoshihide Suga came to Washington last week to meet with President Joe Biden, there were great expectations that some sort of agreement was to be announced on Taiwan.  The Joint Statement issued after their meeting did include mention of the island nation, but instead of a new and more combative reference, Suga and Biden chose to reuse language that had long been part of the U.S.-Japan vernacular.  “We underscore the importance of peace and stability across the Taiwan Strait and encourage the peaceful resolution of cross-Strait issues.”  It was a low key expression of shared interest, but what does it mean? First, some historical context might help frame the import. To be sure, this was the first reference to Taiwan in a leaders’ meeting since the now well-known 1969 joint communique issued by then Prime Minister Eisaku Sato and President Richard Nixon.   The President and the Prime Minister shared the hope that Communist China would adopt a more cooperative and constructive attitude in its external relations. The President referred to the treaty obligations of his country to the Republic of China which the United States would uphold. The Prime Minister said that the maintenance of peace and security in the Taiwan area was also a most important factor for the security of Japan.  The communique came when the Nixon Administration was trying to end the Vietnam War, a war that prompted candidate Nixon to claim that the United States would fight no more ground wars in Asia. But it was also a crucial statement by Japan’s prime minister about the utility of American bases in Japan.  Sato was hoping to conclude the Okinawa reversion agreement, and wanted to reassure the United States, and especially its military, that the Japanese government understood the importance of American bases in Japan for missions in the region.  Returning Okinawa to Japanese sovereignty, in other words, would not compromise America’s ability to act if necessary in Korea or Taiwan.  Prime Minister Sato noted that the security of the Republic of Korea “was essential to Japan’s own security…..[and] that the maintenance of peace and security in the Taiwan area was also a most important factor for the security of Japan.”  This was the first time a Japanese leader had explicitly linked these two Cold War flashpoints to Japan’s own security.  Second, the choice of language in the Biden-Suga Joint Statement is also important.  Rather than identify a new aim, the two leaders’ emphasis on the “peaceful resolution of issues across the Taiwan Strait” echoed decades-old language used by the United States and Japan independently to reference their interest in cross Straits relations.  In 1996, Beijing’s saber rattling over Taiwan’s elections after a new political party flirted with a declaration of independence provoked the Clinton Administration into demonstrating continued United States interests in peace across the Straits. Two carrier battle groups were dispatched. As Northeast Asia remained unsettled in subsequent years, the United States and Japan announced in 2005 their Common Strategic Objectives, a first for Tokyo and Washington. High on that list was their concern over the growing North Korea threat, but also included was this:  “In the region, common strategic objectives include… encourag[ing] the peaceful resolution of issues concerning the Taiwan Strait through dialogue.” Third, mention of Taiwan inevitably draws a reaction from Beijing. There were no diplomatic ties between either the United States or Japan with the PRC in 1969, so there is little public commentary on the Sato-Nixon communique to be found.  Beijing did speak out, however,  in 2005. The Chinese embassy in the United States expressed “grave concern” about the U.S.-Japan statement. But this year, Beijing responded to the U.S.-Japan summit meeting last week far more harshly.  Xinhua cautioned:  “stop interfering in China's internal affairs and stop forming ‘small cliques’ targeting China,” and the more obstreperous Global Times went further:  “The joint statement demonstrates the hypocrisy of the US and Japan… Japan has to rethink any consequences that may result from its actions.” So what does this mean for the U.S.-Japan alliance?   It means two things. First, the growing activities of the Chinese military in and around Taiwan worry Washington and Tokyo.  The intrusions of PLAAF into Taiwan’s Air Defense Identification Zone (ADIZ) since last fall have been increasing in number and in size, with twenty-five Chinese military aircraft flying through on April 12. The United States has already identified China as its primary concern in its National Defense Strategy, as has Japan in its 2018 National Defense Program Guidelines.  American military leaders have been blunt about how American capabilities are being challenged by China’s increasingly large and more capable forces.  As such, Chinese behavior towards Taiwan coupled with its increased military advantage have some commanders believing that military action against Taiwan might be on the horizon.  Indo-Pacific Commander Admiral Philip Davidson’s testimony that the Chinese could possibly use force against Taiwan within the next six years thus drew headlines across the globe, unnerving many in Japan.  If China has no intention of using military force against Taiwan, then its activities should demonstrate that intention. Second, Japan’s proximity to Taiwan amplifies Tokyo’s defense concerns.  Taiwan sits 111 kilometers from Japan’s southernmost island of Yonaguni, and 509 kilometers* from the main Okinawa island where the bulk of the Self Defense Forces are deployed in southwestern Japan.  Any military activities in and around Taiwan therefore are immediately noted by the SDF.  Of course, Chinese military presence has grown considerably over the past two decades in the East China Sea and the South China Sea. China’s challenge to Japan’s sovereignty over the Senkaku Islands has upped Japan-China tensions. Both countries’ Coast Guards now patrol around these uninhabited islands, and their navies are not far away. Moreover, China has more than once teamed up with Russian forces to demonstrate their maritime prowess in the East China Sea, as well as transiting through Japan’s straits between its southwestern islands.  On April 3, China’s Liaoning aircraft carrier went through the Miyako Strait accompanied by five ships, a repeat demonstration of Chinese power in close proximity to Japan’s territory. The Biden-Suga summit, meanwhile, has drawn considerable attention in Japan.  The Japanese media was particularly focused on their prime minister’s visit to Washington and specifically on the Taiwan issue. The conservative Sankei criticized Suga for being the "only country in the G7 to not impose sanctions on China," while the left-leaning Asahi thought Japan’s prime minister should not be so easily swayed by the United States, arguing that Japan should draw up “its own proactive strategy.” Both the Yomiuri and the Nikkei were more muted, emphasizing the importance of strengthening the U.S.-Japan alliance when dealing with China. The Prime Minister was subjected to considerable questioning in the Diet, and tried to reassure his colleagues that in the joint statement he had simply expressed Japan’s desire for peaceful relations between Taiwan and China. Like in the United States, Japanese defense policymakers are increasingly voicing concern about how to understand and possibly respond to the Chinese military behavior in and around Taiwan.  Defense Minister Kishi Nobuo, former prime minister Abe Shinzo’s younger brother, chairs the LDP’s Japan-Taiwan Parliamentarian’s League and has long been interested in Japan’s policy towards Taiwan.  While Prime Minister Suga was in Washington, DC, Kishi took the opportunity to visit Yonaguni Island. He pointed out on his Twitter page that on a clear day you could see Taiwan, but during his visit it was shrouded in clouds.  Similarly, his parliamentary vice minister, Yasuhide Nakayama, was widely quoted in the press for calling on the United States to declare a red-line on Taiwan and to clarify its plans should a conflict erupt so that Japan would know what to do.  Anxiety is growing in Japan, to be sure, and for some politicians, emotions seem to be running high.  But the United States and Japanese governments got it right in the Joint Statement. Encouraging peaceful relations across the Taiwan Straits should be our highest priority. Our militaries exercise regularly in and around Japanese waters and increasingly beyond, and will undoubtedly discuss in detail what is happening in the region and how to respond. Our governments need to consult and coordinate closely to sustain Japanese defenses and to deter aggression – against Japan and against others in the region.  In this sense, the Biden-Suga statement on Taiwan simply reminds us of what Nixon and Sato made plain:  Japan’s security is tied to peace in the region, as is ours.  On the eve of the U.S.-Japan Summit, an American delegation visited Taiwan at President Biden’s request.  Led by former Senator Chris Dodd, the delegation included two former deputy secretaries of state, Richard Armitage and James Steinberg.  In their meeting with President Tsai Ing-Wen, Taiwan’s president stated that “We are very willing to work with like-minded countries, including the United States, to jointly safeguard the peace and stability of the Indo-Pacific and deter adventurous manoeuvres and provocations.”  Clearly, Chinese behavior towards Taiwan will require a concerted and collective response.  Japan and the United States along with other Indo-Pacific partners will undoubtedly have more to say should militarily tensions in and around Taiwan continue.    *In the original version of this blog, the distances between Taiwan and Yonaguni Island, and between Taiwan and the main Okinawa Island were incorrectly reported. This has now been corrected in the main body of the text.

Many prominent analysts believe that a crisis over Taiwan is brewing and that the chances of a war between China and Taiwan, which has the potential to involve the United States, over the next year is not insignificant. The continued deterioration of cross-Strait relations is a critical factor leading analysts to make this conclusion. While the trajectory of cross-Strait relations is worrying, the coming year is unlikely to produce a crisis over Taiwan because China will remain preoccupied with more pressing challenges, Taiwan will continue to refrain from starting an escalatory dynamic, and the new administration in the United States will bolster stability in the Taiwan Strait. Since Tsai Ing-wen’s inauguration as Taiwan’s president in 2016, cross-Strait relations have been at an impasse, marked by a lack of official exchanges, dialogue, and activity. Beijing blames Tsai, arguing her refusal to endorse the “92 consensus,” a one-China framework endorsed by her predecessor, precludes official dialogue. From China’s perspective, Tsai is salami slicing toward independence, and therefore it should not reward her by opening up communications. Chinese officials would point to Taiwan’s revision of textbooks that separate Taiwanese history from Chinese history, its introduction of a new passport that minimizes the “Republic of China” while emphasizing “Taiwan,” and the recent call to replace the island’s national symbol. Tsai, however, would probably counter that she went far enough in her first inaugural address when she sought to reassure Beijing that cross-Strait relations would be conducted “in accordance with the Republic of China Constitution, the Act Governing Relations Between the People of Taiwan Area and the Mainland Area, and other relevant legislation.” This was a creative nod to “one-China” that she likely believed Beijing would accept, but instead she was told she had handed in an “incomplete test paper.” Beijing’s actions, in particular its undermining of Hong Kong’s autonomy, have eroded support on Taiwan for closer cross-Strait ties. Xi Jinping still insists that Taiwan must unify with the mainland on the basis of “one country, two systems,” but Hong Kong’s fate reveals that formulation’s fatal flaws. As a result, Tsai felt bold enough to formally reject “one country, two systems,” and her reticence toward the mainland was rewarded with a landslide reelection victory. Taiwanese identity is now at an all-time high, fueled in large part by disaffection with China. In sum, leaders in both Beijing and Taipei are not happy with one another, believe they are reacting to moves made by the other side, and are not inclined to make a conciliatory gesture to jumpstart cross-Strait dialogue. While some might conclude that cross-Strait relations will continue to deteriorate and could spark a crisis, instead this period of tension will persist without boiling over. While China has escalated its coercion of Taiwan, primarily by increasing the frequency and scale of bomber flights over the median line and into Taiwan’s air defense identification zone, Taiwan has not responded in kind. Tsai has avoided creating an escalatory dynamic. She has also demonstrated an ability to improve Taiwan’s relationship with the United States while not pushing for changes that would provoke a harsh response from Beijing. Tsai is thus unlikely to trigger a crisis. Although Beijing is displeased with Tsai and has increased its coercion of Taiwan, it is preoccupied with multiple challenges and does not want to add a crisis over Taiwan to its inbox. It is looking to reset relations with the United States (albeit on its own terms), bring its economy back to its pre-COVID level, and maintain a positive atmosphere throughout the year, which marks the 100th anniversary of the Chinese Communist Party’s founding. A confrontation over Taiwan would complicate China’s ability to accomplish these tasks. The United States is the other principal actor, and while the Biden administration has indicated it will continue to strengthen U.S.-Taiwan relations, it will probably do so in a way that does not test Beijing’s red lines. The Trump administration, although it should be commended for bolstering U.S.-Taiwan relations, often prioritized symbolism over substance and unnecessarily publicized certain developments that in turn prompted a forceful Chinese response. The Biden administration can be expected to take a lower key approach that China will feel less compelled to publicly react to. In addition, the Biden administration has sent useful signals that it would respond to further Chinese coercion against Taiwan. While President Trump allegedly likened Taiwan to the tip of a sharpie, and his desk to China, undermining deterrence by communicating that Taiwan was not defendable, senior Biden administration officials have stated that the United States should be “crystal clear” about its commitments to Taiwan. While 2021 is unlikely to see cross-Strait tensions spill over into open confrontation, there are a few ways that cross-Strait relations can be put on a firmer footing to minimize the chance of conflict. First, while the Trump administration did not make it a priority to encourage cross-Strait dialogue, the Biden administration can publicly and privately urge both sides to resume official communications and press one side when it believes it is acting in bad faith. In a positive sign, the State Department urged Beijing to “engage in meaningful dialogue with Taiwan’s democratically elected representatives” in its first statement on cross-Strait relations under the Biden administration. Such messaging should continue, and it should be repeated privately at the highest levels. Second, the United States can reinforce deterrence by publicly and privately highlighting its commitment to Taiwan and allocating the resources necessary to back up that rhetoric. This would involve developing a credible denial strategy for Taiwan, shifting additional military assets to Asia and dispersing them throughout the region, procuring long-range munitions and stationing them in the region, coordinating with Japan on contingency planning, and working more closely with Taiwan’s military to improve Taiwan’s ability to defend itself. By making clear it has the will and the capacity to come to Taiwan’s defense, the United States would reduce the chances of a cross-Strait conflagration. Finally, Taiwan and China can seek to cooperate on practical matters even without agreement on the framework for cross-Strait relations. For instance, they can attempt to establish an exchange of medical information to ease travel during the pandemic. In addition, they can look to resume scholarly exchanges, virtually for the time being. Either of these steps would help build trust and place a floor on cross-Strait relations. While some are predicting that the deterioration of cross-Strait relations will trigger a conflict between China and Taiwan over the next year, Taiwan’s reluctance to escalate, China’s preoccupation with multiple challenges, and the change in administration in the United States make such a scenario unlikely. Over the next year, cross-Strait relations will remain fraught, but China and Taiwan will avoid a direct confrontation.

Following Joe Biden’s election as the forty-sixth president of the United States, many people in Taiwan feared that U.S.-Taiwan relations would suffer. According to one poll conducted prior to the presidential election, Taiwan was the only place in Asia surveyed where the population favored President Trump’s reelection. The Trump administration had bolstered U.S. ties with Taipei, dispatching high-level envoys to the island, selling over $18 billion in arms to Taiwan (compared with $14 billion during the eight years of the Obama administration), removing all restrictions on contacts with Taiwan officials, working to shore up Taiwan’s relationships with its remaining diplomatic allies, and explicitly including Taiwan as part of its Indo-Pacific strategy. A significant share of the Taiwan public was apprehensive that the Biden administration would be a continuation of the Obama administration, which they believed had prioritized Chinese cooperation on global issues such as climate change over building stronger ties with Taiwan. So far, however, these fears appear to be misplaced. The Biden administration has signaled that it will largely pick up where the Trump administration left off. Those who now serve in senior roles in the Biden administration signaled their support for Taiwan prior to joining the administration. Writing in Foreign Affairs, Jake Sullivan, Biden’s national security adviser, and Kurt Campbell, the NSC coordinator for the Indo-Pacific, called for the United States to invest in capabilities that would bolster deterrence in the Taiwan Strait and for the United States and China to maintain their “tacit commitment not to unilaterally alter the status quo.” Both Secretary of State Antony Blinken and Secretary of Defense Lloyd Austin underscored their support for Taiwan during their confirmation hearings. Blinken stated the U.S. commitment to providing Taiwan with the capabilities it needs to defend itself “will absolutely endure in a Biden administration,” noted he “would also like to see Taiwan playing a greater role around the world,” and alluded to reexamining U.S. regulations for interacting with Taiwan with an eye toward liberalizing them. He concluded, “the commitment to Taiwan is something that we hold to very strongly.” Austin emphasized U.S. “support to Taiwan has been rock solid over the years” and he would “make sure that we’re living up to our commitments to support Taiwan's ability to defend itself.” The Biden administration sent an important signal of its support for Taiwan when it chose to invite Taiwan’s representative in the United States, Bi-khim Hsiao, to President Biden’s inauguration. This marked the first time since the United States severed diplomatic relations with Taiwan in 1979 that Taipei’s representative in the United States was formally invited to a presidential inauguration. The strongest indication that U.S.-Taiwan ties will continue to be strengthened came in official statements that were issued after China flew fighter jets into Taiwan’s air defense identification zone just days after Biden took office. The People’s Liberation Army sees operational value in conducting these missions, and it could have also been motivated by a desire to test the Biden administration’s response. The spokeswoman for the National Security Council responded by underlining the U.S. commitment to Taiwan is “rock-solid.” The State Department issued its own statement that is worth quoting in full: The United States notes with concern the pattern of ongoing PRC attempts to intimidate its neighbors, including Taiwan. We urge Beijing to cease its military, diplomatic, and economic pressure against Taiwan and instead engage in meaningful dialogue with Taiwan’s democratically elected representatives. We will stand with friends and allies to advance our shared prosperity, security, and values in the Indo-Pacific region—and that includes deepening our ties with democratic Taiwan. The United States will continue to support a peaceful resolution of cross-strait issues, consistent with the wishes and best interests of the people on Taiwan. The United States maintains its longstanding commitments as outlined in the Three Communiqués, the Taiwan Relations Act, and the Six Assurances. We will continue to assist Taiwan in maintaining a sufficient self-defense capability. Our commitment to Taiwan is rock-solid and contributes to the maintenance of peace and stability across the Taiwan Strait and within the region. The statement clearly puts the onus on Beijing for raising tensions, elevates the Six Assurances to holding the same weight as the three joint communiqués, affirms a U.S. intention to deepen ties with Taiwan, and again notes a “rock-solid” commitment to Taiwan. The Biden administration passed its first test with flying colors. Taken together, these signals indicate that the Biden administration is likely to continue to forge a closer relationship with Taiwan. This reflects a growing sense among U.S. policymakers that as Chinese foreign policy grows more assertive and military deterrence in the Taiwan Strait continues to erode, China could be tempted to try to coerce Taiwan. As a result, the United States has to more clearly signal to China its commitment to Taiwan and work with Taiwan to bolster deterrence. It also reflects a growing consensus in the U.S. policymaking community that Taiwan is a reliable partner for the United States on a host of issues. It is possible that the Biden administration will choose to strengthen this relationship out of the public eye, as the media attention makes a Chinese response more likely, and Taiwan often bears the brunt of that response. Thus, the next four years may see fewer high-level visits to Taipei, but one should expect that senior U.S. officials will continue to meet with their Taiwanese counterparts in private in an effort to build this partnership. Nonetheless, the Biden administration has sent strong signals during its first week in office that it will continue to nurture U.S.-Taiwan relations. The next four years are likely to have more continuity than discontinuity.

Yun Sun is a senior fellow, codirector of the East Asia program, and director of the China program at the Stimson Center. 2020 witnessed tension across the Taiwan Strait unseen since the 1996 missile crisis. Feeling challenged by the popular Democratic Progressive Party (DPP) government and the Trump administration’s measures to enhance ties with Taiwan, the mainland China escalated its military posturing and coercive approach significantly. “Unification by force” became a buzzword among the Chinese public, and the public sentiment strengthens Beijing’s justification for intensified military actions. Although China may not seek a preemptive military campaign for unification, it is increasingly tolerant, or even neutral toward the military risk over Taiwan.    While people appear to believe that the Biden administration will strive to avoid acute crisis with China over Taiwan, U.S. policy toward Taiwan only reflects half of the story. The other, and more important half is from China. At least three factors contribute to China’s increasingly destabilizing stance: the belief that DPP is seeking “Taiwan independence”; the indispensability of unification for China’s rise and for Xi’s glory. In this sense, the trajectory of China’s coercion will only intensify rather than subside.   China prefers peaceful unification over use of force. However, in the Chinese lexicon, coercion is not unpeaceful. China’s confidence in unification lies the belief that there will be a day that the United States is exhausted by the security commitment to an island so far away as power balance continues to tilt in China’s favor, therefore, for Beijing, when and only when the United States withdraws, will Taiwan’s political will to negotiate peaceful unification with China begin to emerge. The calculation dictates that China must respond militarily to Taiwan’s “moves” toward independence before that day comes. The growing confidence in the shifting power balance also fosters growing Chinese tolerance, or even neutrality toward military risk.   China’s calculations pose serious danger for miscalculation and inadvertent escalation of tension with the United States. Neither side seems to believe the other side wants a conflict, and consequently could put themselves in a game of chicken and collision course given the stakes at hand. Regardless of who prevails, both will suffer tremendous human and financial costs, and Taiwan will be the first to bear the dire result of such a war. To avoid such a scenario will require the United States to balance its adamant support of Taiwan with a clear strategy for conflict prevention and to find the optimal combination of military deterrence and smart diplomatic strategies. View the full results of the Preventive Priorities Survey to see which other contingencies were deemed top tier priorities for 2021.

The rapid spread of COVID-19 in Southeast Asia, where the pandemic recently has hit Indonesia, Malaysia, and the Philippines (as well as other regional states like Singapore) hard, has not stopped jockeying over the South China Sea. In fact, while handing out COVID-19 aid to Southeast Asian states—and many other countries—Beijing reportedly has upped its pressure on other claimant states in the South China Sea. It has sailed the survey ship Haiyang Dizhi 8 off the Malaysian coast, to closely shadow a Malaysian ship exploring for state oil giant Petronas, in waters near areas claimed by both Malaysia and Vietnam. The actions by the Haiyang Dizhi 8, which previously shadowed Vietnamese ships in waters claimed by Vietnam, are hardly China’s only sign that it is stepping up its pressure in the South China Sea. The New York Times reports that last weekend Beijing “announced that it had formally established two new districts in the South China Sea that include dozens of contested islets and reefs.” In recent months, Chinese vessels and forces also have conducted new exercises in the Sea, made incursions into waters claimed by Indonesia and near the Natuna Islands, and, according to Hanoi, rammed and sunk a Vietnamese ship, among other steps. To some extent, Beijing may be trying to gain advantage at a time when the locus of the pandemic has shifted to other countries and away from China. It is doing so even if this attempt undercuts China’s efforts to gain regional and global goodwill through aid to neighboring states and promoting China’s cooperation with other countries in the fight against COVID-19.   At the least, Beijing may be wanting to demonstrate that COVID-19 has not incapacitated its increasingly powerful naval, coast guard, and air forces. Outside of the South China Sea, Beijing is appearing to demonstrate force too: In recent months, Chinese military aircraft also have flown close enough to Taiwan to lead Taiwanese forces to intercept them. As Richard Heydarian notes, many Southeast Asian civilian and military leaders are basically incapacitated, sick themselves or in self-isolation, leaving countries like the Philippines—which already was tilting toward Beijing and has little ability to protect its South China Sea claims anyway—with even less ability to defend itself. (Philippine army chief Felimon Santos Jr. has been diagnosed with COVID-19.) Even if Southeast Asian leaders themselves are not isolating, many of their senior military staff are, and civilian leaders are focused on the pandemic, creating a distraction that has become a potential opportunity for China. Or, the continued assertiveness in the South China Sea shows the bottom line, indeed, is that no crisis, no matter how large, will stop Beijing from advancing its regional agenda. Malaysia, Indonesia, and the Philippines—all increasingly dependent on Chinese investment and infrastructural aid—have mostly tried to stay mum about China’s assertive actions, even as some military leaders in these countries want to push back harder. At this point, it seems unlikely that U.S. forces can deter Beijing, despite the Trump administration’s intensive pushback in the South China Sea, which recently has included sending the U.S. ships America and Bunker Hill (along with Australian vessels) into waters near Malaysia.

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Asia’s life insurers likely hold somewhere between $1.5 trillion and $2 trillion of foreign currency denominated bonds as part of their portfolio—mostly dollar denominated, but some in euros. Japanese lifers report 10 trillion yen (~ $900b) in foreign securities (25 percent of their portfolio). Taiwan’s lifers, counting their holdings of ETFs that are listed in Taiwan but invest abroad, are heading toward $600 billion in foreign bonds (the latest data shows $555 billion in foreign securities holdings, and the insurers also have around $30b billion in indirect exposure through the bond ETFs; this is roughly 60 percent of their portfolio). Korea’s insurers have done something similar, but on a smaller scale. There was a reach for yield on a massive scale, as their “home” markets weren’t generating the returns they had promised savers. This poses a problem right now—especially as a large portion of this book, over 60 percent, typically needs to be hedged against FX risk in the market (some is balanced by domestic foreign currency policies) more or less continuously. But it is in my view a solvable problem. There are at least three potential issues— 1) The insurers have traditionally needed to hedge (through foreign exchange or cross currency swaps, see this blog) a portion of this exposure with the banking system to limit their currency mismatch (having invested abroad, they are exposed should their “home” currency appreciate, reducing the value of their investments abroad). Those hedges are typically done on a short-term rolling basis, as the insurers assumed they could roll over maturing swaps every 3 months or so. Hedging long-term investments with short-term hedges was a central element of this strategy. 2) A portion of their investments are in corporate bonds—whether the traditional investment grade bonds Japanese insurers bought, or the more adventurous bonds (dollar callables, ultra-long dated bonds, dollar bonds issued by non-U.S. firms) that the Taiwanese favored. Many of these bonds have lost value recently (safer Treasury and Agency portfolios have held up better). 3) In some case, a portion of the portfolio has been farmed out to third party asset managers who themselves face constraints as they may use leverage and may have promised to stay currency hedged. Big sovereign pensions funds with an allocation to “credit” often have done the same. The first two problems are solvable in my view, with cooperation between the “home” country central bank and the regulators. The key countries have either very ample reserves, or ample reserves and access to the Fed’s swaplines. In normal times, I believe in strong prudential regulation—and I have criticized the Taiwanese for letting their lifers run a bit wild. But in the face of a pandemic, it can make sense to loosen regulatory constraints—this is the time to make use of regulatory flexibility and existing buffers. And similarly, in normal times, it is risky for the government to enable these trades by providing the insurers with low cost hedges (the newly disclosed $100 billion swap book of Taiwan’s central bank, the CBC, is a case in point). But in times of crisis, the direct provision of hedges to regulated insurers who are in a bit of a pickle is a sensible use of reserves—and I believe the Japanese should be considering ways to facilitate the provision of swap financing to their regulated insurers (whether directly, or through a dedicated window used by a bank intermediary that basically acts as a pass through). The broad idea is the financial equivalent of sheltering-in-place—insurers have long-term liabilities, so they need not be forced sellers, or even forced hedgers. They can use their balance sheet to absorb short-run volatility—and if needed, they can draw on their capital (and potentially new capital from their home governments) to absorb losses, as their home governments effectively provide a form of portfolio insurance. Let’s start with the currency hedging need. The risk of an open position in this case comes when the “home” currency appreciates against the dollar. Japanese insurers would lose money if the yen went to 90 (a rise in the yen’s value vs. the dollar; it takes fewer yen to buy a dollar, and in this case, dollar assets are then worth fewer yen). Taiwanese insurers would feel a bit of pain the Taiwanese dollar appreciated through say 28 or 29… So far the currency market moves haven’t hurt these portfolios, even the unhedged bits, as the dollar has generally strengthened (and the yen depreciated). And should market conditions change, in all probability the Japanese government and the Taiwanese government would act to limit a disorderly appreciation. Remember, there is no limit to how much you can intervene to block appreciation. So even an open position is ultimately a manageable short-term risk, so in my view existing open books don’t now suddenly need to be closed to “derisk.” (Trying to do so would generate demand for dollars to borrow, as closing the book in this case means borrowing a dollar and then selling the dollar to buy your home currency—e.g. reversing the currency leg of the initial use of your home currency to purchase foreign bonds.) If firms are worried about this, their home governments can directly provide portfolio insurance against extremely large FX moves (guaranteeing that the insurers wouldn’t lose money from a move bigger than a certain defined amount) while regulators relax prudential regulations and allow the lifers to temporarily run bigger open positions. Alternatively, the government can directly step in and provide the hedge. One unexpected advantage of Taiwan’s decision to disclose that it already has a substantial swaps book is that it provides a model here—not a model of good behavior in normal times, but a model of the options available to those countries with substantial reserves and private sector dollar exposure in a crisis. I don’t know if the lifers directly hedge with the CBC, or, more likely, do so through the banking systems (most of the lifers are part of bigger financial conglomerates).* In some sense it doesn’t matter—the CBC has long used a portion of its reserves to provide FX funding or hedging for the lifers (the CBC swaps FX for TWD, the lifers swap TWD for FX which they then invest abroad). And it can increase the provision of these hedges. Absent disclosure, this would have meant reserves would “disappear” from the CBCs balance sheet. But now that the CBC is disclosing its forward book, it could show both a fall in reported reserves, and increased provision of swap funding to local financial institutions. With over $450 billion in reported reserves and close to $600 billion in foreign currency assets the CBC isn't financially constrained.** Japan also has a substantial pool of dollar reserves—and the ability to borrow more from the Fed. Korea the same. So between the regulatory forbearance for open positions, government insurance against losses from big FX moves and the direct provision of hedges, the underlying currency mismatch among the big Asian insurers can be addressed. And it can be done in ways that put minimal stress on bank balance sheets. Alas, the currency mismatch is an easier problem to solve than the fall in the value of the corporate bonds that Asian insurers were increasingly buying (as hedging cost rose, the insurers reached for credit risk). The lower market value of investment grade bonds may reflect an overshoot, as there have been a lot of forced sellers in the market. Or it may reflect a real shock that really has reduced the expected return over time on these bonds. It depends on the individual company. But let’s assume there are real losses. And let’s further assume that some bonds will be downgraded and fall out of the subset of bonds that regulated insurers normally can buy. Those real losses can be absorbed by the equity capital of the life insurers. And if, over time, the losses exceed the insurers’ equity capital, the policy holders—who have been promised a fixed payoff over time—can be bailed out by a government capital injection. The long-term “home” currency liability structure of the lifers allows them to be patient (they need to rollover their hedges, but hold the long-term bonds against their long-term liabilities). In normal times a regulator would worry if the insurer’s capital fell, and likely encourage the insurer to sell its riskier assets and/or raise capital (and regulators do need to worry about the possibility that undercapitalized insurers would gamble for redemption by taking big new risks once the situation stabilizes). But at a time when those who can shelter in place should, the regulators can simply allow the insurers to operate with less capital (or inject government capital if they want) while they hold on to their existing portfolio (This no doubt will require relaxing some regulatory restrictions as portfolio quality falls). That portfolio may well be a long-term problem. It doesn’t have to be a short-term problem. The regulators can take steps to make sure the insurers aren’t forced sellers. Note here that Taiwan’s insurers are more thinly capitalized than the Japanese insurers, so Taiwan’s government may need to be thinking seriously about government equity injections relatively quickly (see the IMF’s Global Financial Stability Report). Finally, a brief word on third party managers—in a sense, these pose the most difficulties, as they typically have to invest to achieve a certain mandate and thus don’t have the flexibility of in house portfolios. It may make sense though to bring some of those portfolios back in house (when possible), or to give the third party manager flexibility to essentially maintain a static portfolio even if it breaches some contractually agreed risk and volatility thresholds. One basic truism of a market is not everyone can sell at the same time. My point is simple: think creatively of ways long-term money can ride out a crisis that by its nature will be relatively short-term. Some strategies that worked in normal times may not work now. And the kind of prudential regulation that is absolutely essential to build buffers in normal times now needs to be turned on its head. In good times, you build buffers. In the face of an unexpected shock, you draw down on those buffers. Finally, I no doubt have gotten some things wrong here.  This is offered in the spirit of putting forward ideas that help, even if they haven't been fully stress-tested.   * Very, very roughly—and this is a way of simplifying things to make the math easy that intentionally is not precise—a quarter of the $600 billion foreign bond book of Taiwan is hedged vs. domestic foreign currency policies, a quarter isn’t hedged (this can vary a bit, a quarter may be high), a quarter is hedged at home (vis a vis the domestic financial system and the CBC), and a quarter is hedged through proxies and in the offshore NDF market). In my view, the CBC could easily provide another $150 billion in hedges out of its $450 billion in on balance sheet reserves ($300 billion would still be 50 percent of Taiwan’s GDP). ** There is a longer-term issue here as well. The lifers accounted for over three quarters of the net portfolio outflow that balanced Taiwan’s 10 percent of GDP current account surplus—so a likely slowdown in new foreign bond purchases would potentially generate pressure on the Taiwan dollar to rise. I thus expect the CBC to resume buying foreign exchange if global trade starts to normalize. Normally that would worry me—Taiwan’s dollar should be stronger in a normal world. But right now there are more important fights.