The Dragon and the Tigers
Why the next move is in the currency, not the equity
You’re bullish AI. You bought TSMC back in ‘24, SK Hynix at the end of ‘25, on our nod. You’re up nicely. Felt good.
Then you sold too early. Like us.
Feels kinda icky.
Now what?
Maybe you want a way to stay long la révolution but you’re a little worried about piling chips on the equity table right now. Maybe you are worried about stocks if oil cracks $150, and you already have the latter trade on but can’t add more. Like us.
Well, maybe we’re both looking at it wrong, since what actually makes Taiwan the linchpin of the next twenty years isn’t just the chips. It’s the currency flows.
Today we go into the weird world of FX. Two points.
One, Taiwan is the most pivotal country in the world for the future of the dollar. $17-22 trillion of new East Asian savings (half of which from outside China btw) is going to land somewhere this decade. Whether the security architecture that funnels it into dollar assets survives is the most important question for the future of the reserve currency.
Long Taiwan and Korean FX, short Indian rupee. Equity markets have confirmed the regime change.
Meanwhile the FX hasn’t moved, at least not nearly in line.
Fifteen-year dislocation between the two markets for both TWD/INR and KRW/INR, never been wider.
Negative carry, positive convexity. Ideally in vol markets. We like it.
The friend’s question
A new friend asked me last week. Campbell, what does it matter if China gets Taiwan? Seems like it eventually happens anyway. Why should America care?
Reasonable question. We get it all the time. The map looks the way it looks.
As we put it in our ‘50-year peace plan for Taiwan,’ imagine a Soviet battle museum where the Statue of Liberty is.
Or as they call it: Kinmen Island.
And the neocons seem to care a lot. The average person notices that neocons getting upset about something is sometimes a tell that the thing isn’t worth getting upset about.
I get it.
The argument today isn’t politics, loyalty, honor, or duty. Even though personally those are the things I think we should stand firmest on. Today is material. Dollars and cents.
Because the future of the dollar runs through Taipei. And the dollar is the key to protecting your way of life. Whether you want to acknowledge it or not.
How the hegemon’s deal works
You don’t get to be the reserve currency for free. Country X sells TVs to the world and gets paid in dollars. If enough exporters keep enough dollars in USD assets, the dollar trades persistently rich. That richness gives you cheap imports and cheap capital, but it hollows out manufacturing and encourages too much leverage. All else equal, this is how reserve currencies die.
But all else isn’t equal. The center of the trade system also charges financial rents, gains sanction power over anyone who uses the currency, and uses the cheap capital to invest in the technological frontier. Today that’s AI. Two hundred years ago it was banking and insurance, run out of coffee houses in London.
The position also lets you cut a deal with your allies. They supply you. They recycle their surpluses into your currency. You backstop their security so they can invest in export industries instead of building militaries.
This worked for sterling. It works for the dollar. It also falls apart fast if you stop maintaining a world-class navy btw.
The AI revolution makes the surplus pile existential
The first time I sat down and tried to model the recycling architecture seriously was 2015. I thought the China-as-reserve-challenger thesis was 50/50.
I’m only convinced now they’re playing for keeps because I’ve watched them, for a decade, refuse to take the path that would resolve their problems domestically. The currency stays suppressed. The banks stay broken. The capital account stays closed. Every six months FinTwit says “this is the year of the great recap.” Every six months it isn’t.
But before we get to why they’re playing offense, deal with the peaceful version of the challenge.
The peaceful version doesn’t work
The optimistic case for China-as-reserve-challenger goes like this. China runs persistent surpluses. The world ends up holding RMB. Gravity does the rest. Reserve status follows surplus. No invasion needed.
This is the version Ray’s 1000-year cycle studies tend to gesture at.
The problem is that reserve currency status isn’t just trade gravity. It’s about whether holders of your surplus can do anything with the claims. They need to buy financial assets they actually want, exit when they need to, recycle into productive investments.
China fails this on every dimension. Capital account closed. Housing and A-shares overvalued or government-traumatized. Bond market dominated by state issuance with managed yields. There is no Chinese equivalent of the Treasury market that a foreign reserve manager can buy and sleep at night.
The peaceful thesis dies on the question “what do I do with my RMB once I have it?”
Ray’s framework misses this because it treats reserve status as a function of trade and military hegemony. It is. But it’s also a function of an asset market deep, liquid, and trustworthy enough to house the world’s savings for decades. Sterling had it. The dollar has it. China doesn’t, and there is no path to acquiring it without opening the capital account, which they can’t do because the banks would blow up.
What Ray also misses: the AI tigers
In the era of AI, the surpluses are no longer being generated by China. They’re being generated by the AI tigers — Taiwan, Korea, Japan — on higher-value products China can’t replicate.
Korean memory prices the past two months:
SSD prices doubled in ten days. NAND up 47% in a month. AI capex flowing through customs in real time.
Which is going to put upward pressure on already healthy current accounts:
Taiwan ran a $181B current account surplus in 2025. Twenty percent of GDP. Nobody runs that ratio. Korea ran $123B. Japan ran $204B. The trio is half a trillion a year and going vertical.
Setser’s Korea+Taiwan customs surplus is $400B trailing 3-month annualized, up from $100B two years ago. Quadrupled.
And here’s where it starts to get…interesting.
With the surge in export quantities and prices from the AI revolution, the AI Tigers are in shouting distance of outproducing the Dragon on surplus generation. On higher-margin products. With open capital accounts. With deep, liquid asset markets. With existing security relationships to the United States.
Taiwan does the heaviest lifting — 23 million people generating $1.2T to $4T of cumulative surplus. Korea is the second leg, $740B to $2.7T. Japan stopped being an export story a decade ago. Japan’s current account is now primary income on the $3.5T NIIP — interest, dividends, repatriated earnings on assets built up since the 1980s. That compounds whether AI booms or busts. Japan is the floor. ~$2.3T cumulative in any scenario.
This is the savings pile that is going to look for a home. Right now it lands in dollar assets by default, because the AI tigers sit inside the US security perimeter and there is no comparable alternative.
That default is what Beijing is trying to break.
The recycling channel quietly died
Here's the thing most Americans don't appreciate. The pipes changed.
Not because the surpluses are gone — they’re bigger than ever. What changed is who holds the dollar.
The Bank of Korea added basically zero reserves on a $123B surplus in 2025. Taiwan’s CBC added $20B against $181B. The central banks aren’t intervening because the private bid is doing the work. Korean lifers, Taiwanese insurers, Japanese pensions, and retail on the Toss app are absorbing the dollars to fund foreign-asset purchases. Setser nails this — Korea’s record surplus was offset by private outflows, not reserve accumulation.
Same surplus. Different holder. Different reaction function.
A central bank with $1T of Treasuries has a 30-year horizon and no career risk. A Korean lifer with $1T of Treasuries hedges FX quarter by quarter. If the hedge ratio rises 5%, that’s $50B of mechanical dollar selling.
That’s why TWD moved 5% intraday in May 2025 when the lifer hedge book wobbled. Five percent. On a major Asian currency. In one day. The surplus didn’t change. The hedger did.
The plumbing got fragile and we didn’t notice.
What China is actually doing
China's de-dollarization story is a press release.
Setser’s 2026 work shows what’s actually happening. SAFE’s official dollar share fell from 79% in 2005 to 55% by 2019, which made all the headlines. What the headlines missed is that SAFE stopped growing reserves at all. The new accumulation moved off SAFE’s books. State commercial banks hold roughly $1T in dollar assets abroad. Policy banks hold close to another $1T. CIC holds $450B, mostly dollars. Total Chinese state-sector dollar holdings now likely exceed $4T. More off the books than on.
China is the largest dollar accumulator in the world while running the loudest de-dollarization campaign. This isn’t a contradiction. It’s a holding pattern.
Beijing doesn’t have a better option yet. Letting RMB rip kills the export model. Opening the capital account exposes the banks. The banks themselves are the constraint. Rhodium’s recent work documents that 2025 write-offs were trivial compared to the scale of declining bank profits, suggesting the real recapitalization hasn’t even started. The hole is somewhere between $5T and $10T depending on whose estimate you trust. The banking system has about $5T of equity.
The solvency framing misses the point. This is a physics problem.
What holds it together is three forces. Capital controls. Consistent trade surpluses. And propaganda about the rise of China, aimed as much at the domestic audience as the Global South.
Tying the pieces together
Now ask yourself. Why does China keep the currency suppressed when raising it would boost consumption? Why not fix the banks? Why keep the capital account closed? Why the military build-up that exceeds ours on PPP terms? Why the proxy support for Russia, Iran, and North Korea?
One framework ties these pieces together better than the alternatives. Beijing is trying to convert manufacturing dominance into regional balance-sheet dominance.
Get Taiwan. Force the regional allies to price Beijing as the local risk-free authority. Use the captured savings to reallocate in CNY assets, and, in the process recapitalize the broken banks. You finally found a buyer to handle the offsetting inflows to domestic capital flight.
Then open the capital account. Then let the currency rise. Then let household consumption boom on the back of cheaper regional imports.
I can’t read Xi’s mind. But the framework explains the observable behavior better than the alternatives. And the timing works too neatly to ignore. They need roughly $8-10T to fix the banks. The AI Tigers surplus pile is tracking $4-11T over the decade depending on how wacky the AI acceleration goes. Which is about the same order of magnitude as a) the potential private capital flight, and b) the hole in the banking system.
Putting real stakes on Taiwan. It’s not about territory and ego. It’s about a regional balance sheet that can make all their problems go away and propel them to global reserve currency even when their banks are hosed.
Capital alone doesn’t get them there. The buildout needs physical capacity — chips, packaging, power. The very same constraints that gate the AI buildout gate the surplus accumulation in the take off scenarios:
The unwind doesn’t have to be loud
Most pushback on this thesis pushes back on the wrong picture. People imagine a fire sale. Trillion-dollar Treasury liquidations on a Tuesday morning. CNN chyron. Vol spike.
That’s not how it goes.
The first move is quieter. A Korean pension fund shortens duration. A Japanese insurer raises its hedge ratio. A Taiwanese lifer buys less agency paper this quarter and more gold. A reserve manager who never wanted RMB decides it needs a token allocation because Beijing has become the local weather system.
None of these are headlines. All of them happen in the marginal allocation meeting on Wednesday afternoon.
The stock doesn’t have to move. The flow only has to stop compounding in the old direction.
The choice
So when my friend asks why America should care if China gets Taiwan, the answer isn’t about Taiwan.
Taiwan is the credibility test for the balance-sheet regime that finances America.
Pay to defend it. Rebuild the manufacturing base. Generate AI’s energy domestically. Or take the cheaper path and let Taiwan go — in which case Beijing gets the keys to the regional balance sheet that has financed our fiscal model for forty years.
There is no clean version where Taiwan changes hands and the dollar keeps the same automatic claim on East Asian savings.
The dollar is the whole thing.
Come for it and you come for everything built on top of it.
That’s why America cares. Or at least why it should.
But you and I don’t get to control whether America cares. We control what we own. Let’s talk about how to position for the regime change already underway in the data, whether or not the policy response materializes.
The Trade
