Taiwan in Trouble

I have been fairly well convinced by Robin Hanson and Bryan Caplan that prediction markets are a good way to get informed information about the likelihood that something will happen.  Basically, prediction markets combine the so called miracle of aggregation or “wisdom of crowds” with the idea that the more someone is sure something will happen the more money he will be willing to wager on it.

The converse of trusting prediction markets is that when I disagree with them, I have to justify why I don’t agree, or maybe what I know that other people don’t.  I find this market on the likelihood of a Chinese attack on Taiwan by December 2010 worrying.  It has enough volume (>4000) to be accurate, and is trading at twenty five dollars a share.  This implies that there is a twenty five percent chance that an attack will happen.

This is far higher than I would put the likelihood of a mainland operation.  I would put it down around three or four percent.  In my opinion, the only likely situation in which an attack might happen is that the Chinese economy goes through a steep downturn, the current Communist administration falls, and the military takes over.  Chinese can be very nationalistic, so the military might view an attack on Taiwan as a way to consolidate power.

But in the absence of such a catastrophic turn of events, I can see many reasons why the Communist leadership of China would not want to attack:

-The new Taiwanese president, Ma Yingjiu, favors closer relations with the mainland.  Why attack when the winds of unification are blowing in the right direction anyway.

-An attack on Taiwan would alienate just about every foreign country.  China would face military action from at least the United States, and heavy sanctions from others.

-Any sort of military operation would cause instability within China’s economy.  Foreign exports and imports would certainly be affected in the short run.   Since the Communist party has no electoral mandate, it is in a much weaker position than many assume.

-The long run economic effects would be disastrous for China.  In the medium term exchange with most developed countries would certainly be curtailed.

-Even if the Taiwanese army had no foreign help, it would be a difficult force to defeat with its advanced American firepower.  In the event of an attack, there would be foreign help.  The Chinese can’t count on an easy victory.

My guess is that the disconnect between the market and me is caused by my knowledge of Chinese and recent experience in China.  I think foreign China experts tend to view the Communist party as being stronger than it is, and also reading too much into saber rattling headlines in mainland Chinese newspapers.

Maybe I should short some shares…

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