As President Trump lays the groundwork for the next round of tariffs on China which can be imposed no earlier than the 24th of June, it’s time to examine the wider landscape in what is moving beyond a trade war and into a technology cold war which is one of the major facets driving the trade hostilities between the two countries.
It’s worth keeping in mind that the trade war is the end result of a long term building of tension between the US and China. Although many people have been critical of Trump’s reasoning for firing the starting gun on the current situation (the dollar imbalance between imports and exports has always been a rather meaningless measure given the ultimate accrual of much of the value chain of technology to US companies), both Republicans and Democrats have long held major concerns around Chinese trade practices.
The Real Problem – China Forced Technology Transfer and the Search for Geopolitical Dominance
There are numerous genuine problems which do exist with Chinese economic and trade policy however and these are the point of what is going on now. China has made a big deal about snazzy programs, particularly the Made in China 2025 plan which aims to reduce the country’s reliance on foreign technology by promoting home-grown tech, along with the Belt and Road Initiative which aims to build up the developing world with major infrastructure projects to promote economic ties in a modern day Silk Road promoting Chinese goods and trade.
These schemes formalise much of the issue which the west has with Chinese economic practices, particularly that companies which seek access to Chinese markets and consumers must typically form joint ventures with local firms aimed at unofficially promoting technology transfer of valuable intellectual property. China now has its own companies which can produce x86, ARM and other processing units along with pretty much owning the supercomputing top 500 list with 229 of the systems being Chinese (the US is in second place with 108 as of November 2018 although it does currently hold both first and second place).
Where we are now – Escalating Tensions and Chinese Corporate Targets
The high profile topics are obviously tariffs, however it’s also clear that the trade war has moved beyond simply escalating these on each-other. Last year, the US targeted ZTE after finding it guilty of breaching sanctions against Iran and North Korea, effectively banning US companies from doing business with the firm. The obvious and immediate result was effectively the short term death of ZTE until it was thrown on to the table as a bargaining chip in the trade war between the two companies with the US accepting a fine and corporate reorganisation as acceptable to allow the firm to start its business again.
Having been successful here, it’s clear now that the US is pursuing a similar strategy with its latest targeting of Huawei, the undisputed jewel in the crown of Chinese technology firms. However Huawei has apparently not been standing idly by since it saw what happened to ZTE last year and has been both stockpiling chips as well as working to reduce its reliance on US software and hardware with its own HiSilicon chip unit working to design its own Kirin SoCs to further reduce its reliance on US hardware.
The difficulty is that the US placing Huawei on its entity list has resulted in some non-US companies such as ARM (now owned by SoftBank TYO:9984) also stopping working with Huawei and its subsidiaries like HiSilicon. It’s worth noting here though that although these companies may stop working with Huawei and other Chinese companies the US names, the ultimate objective of China was that it wouldn’t need these companies anyway.
Clearly however, China would rather have been in a position to just stop using foreign technology when it decided it no longer needed it rather than have access to foreign technology be forcibly removed from it and it remains to be seen whether Huawei and other Chinese companies are ready for a protracted trade war which sees critical technology no longer accessible. Even if the Made in China 2025 plan was successful, there is still another 6 years to go until it was supposed to come to fruition so it is likely that the withdrawal of foreign technology will result in some pain for China.
It’s not just silicon we’re looking at here though. It’s worth noting that this forced intellectual property transfer is happening in China across industries with the notable example being automotive and most major international car manufacturers of importance having some joint venture with a Chinese car company including all the majors such as Volkswagen, Ford, GM, Toyota, Mercedes, Jaguar Land Rover, Peugeot and others all attempting not to hand over the critical secrets to their Chinese “partners” which allow them access to sell to Chinese consumers.
Now we have a US tech startup CNEX claiming that Huawei has been stealing its trade secrets in what is likely to become one of numerous lawsuits against the company to test the waters as to how difficult it will be to prove the transfer of intellectual property against Chinese firms. For its part, Huawei is also suing CNEX claiming IP theft. The US obviously has a judiciary which is designed to be independent of the other arms of government and although the firm is small, the lawsuits will be interesting to follow with the trial for both cases set to kick off on the 3rd of June.
Where Next? Deals, Lawsuits, WTO and Rare Earths?
It’s worth keeping in mind, although the US can cut off businesses from working with Chinese entities it doesn’t like, this is a legal mechanism, not a technical one. So although ARM may not speak to HiSilicon anymore or licence its newer designs to the firm for use, this doesn’t stop HiSilicon from continuing to design its own chips. It simply stops them from licencing ARM designs and getting support from them in doing so. This does mean that the time may come when HiSilicon faces lawsuits of its own for using ARM technology without a licence for doing so, the difficulty will be in actually using a lawsuit to make Huawei or any of its units stop doing what it’s doing and it’s an important distinction to make. For his part, President Trump has made it clear that the situation with Huawei is now up for negotiation as part of a wider trade deal. Whether this gets taken up or not probably depends at least in part on how self-reliant Huawei can really be.
Realistically, if China wishes to continue pursuing its current course, there is no way that the US can stop it in the short term other than by making life very difficult for the Chinese and hoping that the populace in China becomes disgruntled enough with its leadership as to stop it pursuing the current course of action. President Xi’s recent stirring of nationalistic feelings with calls for a new long march in the face of American aggression are seen by many as testing the waters for pushing its populace to stand firm with it and support Chinese companies and products while the trade war gets worked out of the US’ political landscape, although there is bipartisan support on the surface for the current action against China, the Democrats may look to capitalise on any economic weakness which results from the trade war.
President Trump is right to note that the Chinese may be hoping to negotiate terms with a President that comes after him (potentially a Democrat) who may be not as aggressive on the terms of a deal. Trump of course has a maximum of 6 years or so left in the White House. There will unquestionably be a burden put on the Chinese economy if the current escalations continue, however China is not without cards of its own to play although it has mostly played its minor cards and the ones remaining are potentially unpalatable for several reasons.
Tariffs on the US are the minor cards in question, it’s fair to say that these are reaching a point where it can’t do much more since the US obviously imports more from China than vice versa, the US can continue to impose tariffs on additional goods long after the Chinese have run out of things to do the same on. However the latest proposal for tariffs the US may impose in June does contain a notable omission and unsurprisingly, this is rare earths.
As we covered in our exclusive piece regarding decoupling the Western tech industry from China in December (here), China holds the largest reserves of rare earths in the world. As well as having the largest reserves, it’s also the largest producer and estimates put its production at anywhere between 80% and 95% of global supply. Although some may argue that this isn’t a big deal, because rare earths simply aren’t that rare, this misunderstands the problem.
As with oil, the difficulty with rare earths isn’t that they’re running out, the difficulty is that CHEAP oil is running out (environmental concerns aside). While it is certainly possible that given enough time to absorb a short term supply shock, the world would adapt and be able to ramp up production in locations other than China, operations which mine and refine hundreds of thousands of tonnes per year don’t spring up overnight and when they do they tend to cost more since we can safely assume that market efficiencies have driven the production to China in the first place due to it being the cheapest place to reliably produce them. As such, yes it doesn’t mean that we won’t have electronics products anymore which rely on rare earths to make them, however it is likely that the cost of those products would go up if they were to be tariffed or subjected to export controls on a large scale, leading to higher production costs, lower profit margins and therefore worse corporate performance, translating into a deteriorating stock market.
The prospect of this has been raised after a visit by President Xi to a Chinese rare-earth facility last week which was widely seen as a nod to the fact that this is a card China could theoretically play at some point if the trade war escalates further.
Additionally, some are now starting to speculate that China could also begin retaliatory actions against some US companies. The spectre of major western companies losing access to China’s almost 1.4 billion consumers isn’t a pretty one to contemplate. As the trade war ramped up last year, technology stocks suffered in a big way. Since then, reassurance from the US in the shape of what is being referred to as the “Trump put” has prevailed to allow the market to recover most of its Q4 2018 losses. The Trump put refers to the fact that the President will always act to support the stock market and if necessary, wheel out administration bigwigs to calm the markets and keep things on an even keel. However concerned statements in recent earnings reports from major technology companies such as Apple (NASDAQ:AAPL), NVIDIA (NASDAQ:NVDA) and others as to softening demand for their products in China has seen investor appetite for companies deemed to have large exposure to the trade war falling away.
China remains cautious thus far to target western companies directly in the way which the US has done to Chinese companies like ZTE and now Huawei but there is no doubt that if China were to close off access to its markets to some of these companies, it would signify a major escalation in the trade war and the stock market would suffer. The likelihood is the President would lay the blame for this at the door of his beleaguered Fed Chair Jerome Powell for raising interest rates, but in the event it happens, it would probably be a combination of both of these things along with other factors.
The other card which China holds is its massive holdings of US government debt. Currently sitting at over $1.2 trillion, concerns were stoked this month when data showed that China sold about $20 billion of them in March, leading to concerns that China could attempt to weaponise the holding. Something which would cause the US a reasonable degree of economic discomfort no doubt, but also an unappealing possibility for Beijing.
Wrapping Up
The difficulty with China’s cards is that if it plays them, they will hurt China too. The US cards being played are no different in that they do hurt Americans in the form of higher costs for some consumer goods, lower revenues for some industries that rely on China and inflation but these are incremental changes which aren’t going to slap consumers in the face like if China banned Apple from doing business there anymore and you simply weren’t able to buy a new iPhone. The cost of an iPhone going up in the US will mean consumers have less money to spend on other items or they’ll perhaps upgrade less frequently but the product itself would still be available.
Similarly, China earns a lot of money from its rare earths production. Banning the export wholesale could prove problematic for the Chinese economy, as well as drive up costs and generate short to medium term supply headaches for western firms in need of them.
As for weaponising US government bonds? Well, the Chinese holding is currently worth $1.2 trillion. Dumping them on the market would absolutely hurt the US economy but at the same time, the value of the holding would collapse while the sale was going on. You can’t simply dump a trillion dollars in T-notes on the market and expect people to just buy it all at the current price.
So what we’re left with is a semi-limbo state while China tries to figure out how best to respond. Given Trump’s insistence that any deal will not result in the immediate lifting of tariffs until China changes its laws in the way the US is looking for and ensures compliance with the terms of the deal, it may simply be in China’s best interests to just tone things down and play a waiting game. The stock market is definitely slowing down as we would expect this late in the economic cycle.
Government and central bank firepower to keep the party going is almost exhausted with tax cuts running out, interest rates still at global record lows and central bank balance sheets stuffed full of quantitative easing positions it’s difficult to see what more the global economy can do to keep the party going. Tech stocks with China/US trade war exposure have suffered, not just the headline names but also the likes of smaller but still important suppliers such as Skyworks (NASDAQ:SWKS), Qorvo (NASDAQ:QRVO), Broadcom (NASDAQ:AVGO), Lumentum (NASDAQ:LITE)and others have shed as much as 25% of their market cap since tensions increased with the latest round of tariffs. Chinese publicly listed companies are also suffering such as Tencent (HKG:0700).
Overall however, it is felt that the likelihood is the US and the West has stronger economies than China and although they will absolutely bear some of the brunt of a trade war, they will also reap some benefits with likely greater trade between Western countries the result. What most models predicting this don’t take into account however is that this could be the trigger for a global economic downturn since both the US and China maintain large economies which drive much global consumer demand.
This much said, a recession is likely overdue given that we are currently in the midst of the longest bull market in history. It is difficult to see how either side can climb down from the current state of the trade war with what has currently been set out, for our part, we’ll continue to discuss the state of the technology market with an increasing focus on some of the tech coming out of China as the trade war plays out in the coming years.
https://wccftech.com/new-tariffs-on-300bn-of-chinese-goods-inbound-huawei-and-rare-earths-in-play/
2019-05-25 16:24:14Z
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