Trade war month 55 and Biden levels up with chip bans

Image: Onurhan Keskin

Biden bans tech pick and shovel supply to China

You might recall that in March 2018 Trump pulled out his MAGA baseball bat and whacked China with steel and aluminium tariffs.

That move catalysed a populist trade war between the U.S. and China that’s now in its 55th month.

Following tariffs, reactionary tariffs and the EU, India, Mexico and even Australia joining in the slugathon, President Xi’s soft power Belt and Road Initiative was challenged by Van Der Leyen’s Global Gateway and the G7’s Build Back Better World.

And then it got nasty. Russia, in its quest to rebuild the USSR invaded Ukraine and held Europe to energy ransom, setting off a chain of energy, fertiliser, food and commodity supply shocks.

And now we have the latest swing of the trade war bat. It’s an interesting one because it goes to the ‘picks and shovels’ of technology and innovation which amongst other things is hugely important to China as it continues to build its military (see below).

This time the White House has issued orders to ban the sale of artificial intelligence and other high-performance chips (or semiconductors and circuits, including memory) to China.

Specifically, the U.S. Bureau of Industry and Security has implemented export controls on certain advanced computing semiconductor chips (chips, advanced computing chips, integrated circuits, or ICs), transactions for supercomputer end-uses, and transactions involving certain entities (28 of them) on the Entity List.

Additional controls will be adopted for certain semiconductor manufacturing items and on transactions for certain IC end use.

Why? Biden says that the ways in which China has mobilised vast resources to support its defence modernisation, including the implementation of its military-civil fusion development strategy, are contrary to U.S. national security and foreign policy interests.

Biden is referring to the billions seeded into investment funds by Beijing to stimulate defence R&D. These funds were part of the Made in China 2025 plan and contain around $100 billion for semi-conductors and an unknown amount for military and defence R&D. Anecdotal evidence from two sources I’ve looked at suggest at least $70 billion in sub-funds and one source had predicted multiples of that.

Rules are effective as of 7 October, and you can read the unpublished version of the document (which will be published on 13 October), here.

Potential consequences

While the probability of China invading or in some way taking over Taiwan (and exerting more influence over world leading IC fabricator Taiwan Semiconductor Company (TSM) which has a circa 80% global market share) has been increasing for some time, this is potentially the biggest catalyst so far.

China needs to control more picks and shovels if it is to overtake the U.S. technologically, and in this regard we should think about China’s appetite for ICs as no different to its appetite for mineral and food commodities.

But will the Party risk sanctions and opposition from the U.S. and other forces if it was to physically invade Taiwan in order to protect its supply chain? Could it even pull this off?

We don’t know, yet.

And at home, Biden’s new swing of the bat follows his CHIPS Act which was passed in July and provides for $52 billion in funding support to build IC fabrication in the U.S. and up to $170 billion for IC research.

So far, the Act has enabled Intel and Micron to commit to new plants.

These fabs have been estimated to take between 3 and 5 years to build, so in the meantime there is still no certainty of chip supply and there is the prospect of revenue declining materially from decreasing exports of finished product to China.

The Chips Act certainly looks like it was a partial down payment to the domestic industry for the just released Chip ban.

Still, the precise effect on the semis industry (which will be negative) is yet to quantified.

Aside from Nvidia and AMD who are clearly in the frame, most companies are yet to come out to address the effect to their businesses going forward.

On Friday, chip stocks were down between 2% and 5%.

Also, there seems to be an exception under the ban for certain ICs that can and would be supplied by other countries if the U.S. was to withdraw its supply in that category, i.e., why give away a market that’s only going to be filled by a competitor, right?

Nonetheless, tariffs, sanctions and bans create losses for both counterparties. Users of steel and aluminium as well as farmers felt this after the original Trump tariffs backfired (as did his failed Phase One trade deal).

And while the new demand/supply lines for these chips are yet to be sketched out, the effect of sanctions and bans is likely to be similar for the semis industry.

Now what?

No one really wins blunt instrument trade wars. They are politically sharp and economically blunt.

In time, alternative supply chains or substituted products are found.

But what’s for sure is that the U.S. and the EU are locked into a geo-political game of whack-a-mole with Russia, China and OPEC (again).

It’s an ideological war that’s been accelerated by COVID/Putin and heavily supported and extended by liquidity saturated monetary policies, ageing demographics and Dollar Vader.

This war is terraforming the global economy and moving us all to a massive deglobalisation event. Whether it’s going to be net inflationary or deflationary over time is impossible to tell due to second and third derivative effects, and it will depend on how much of this war expresses itself in economic versus military terms.

But back to the chip ban. This development in ‘technology creating commodities’ and how that interplays with the Party’s view on Taiwan will no doubt have to be responded to ideally before, or at this year’s National Congress which starts on Sunday.

And unlike all predecessors since before Deng Xiao Ping, President Xi presides over a super politicised, militarised, and debt-ridden country which needs to deleverage, or face economic stagnation. It’s a Dragon with indebted scales which makes it hard to fly but no one really knows how to get rid of those scales (rip up the debt?) when the Party is all about extracting social and economic taxes from corporations.

This suggests to me that President Xi’s response to the chip ban is likely to be multi-phase and highly political and it’s sure to interplay with his long-range Taiwan strategy, with lesser regard to the very short-term economic effects.

In closing, it’s game on mole with China, again. China demand is likely to remain weak. China is over-levered when you add the SOE balance sheets to the government balance sheet. China is focussing on military growth, not necessarily economic growth. Either way, Biden’s chip ban will not help. The USD remains elevated. Most commodity prices remain weak. No sign of expanded or new swap lines yet. And with one or two interest rate increases up the Fed’s sleeve still in play (unless yields untether, U.S. bonds break, and the Fed is forced to intervene) the higher dollar/lower commodity prices scenario is likely to continue for some time unless something else breaks.

See you in the market.

Mike

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Next Level Corporate Advisory is a leading M&A and capital markets advisor with a 20 year track record of delivering the highest quality of independent financial advice as well as strategic transactions to help companies of all sizes level-up, in and out of Australia.

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