USA – China: The Chilly War

05/20/20_As you probably know, the term Cold War is usually referring to the period of geopolitical tension between the Soviet Union and the US and their respective allies, the Eastern bloc and the Western Bloc after WWII. The term “cold” was used because there was no large-scale fighting directly between these two superpowers, but they each supported major regional conflicts known as proxy wars. The overall conflict was an ideological and geopolitical struggle for global influence, forcing other countries and parties to choose sides…

Cold war definitions

Cold war has also been defined as an “intense economic, political, military, and ideological rivalry between nations, short of military conflict; sustained hostile political policies and an atmosphere of strain between opposed countries, a continuing state of resentful antagonism between two parties short of open hostility or violence”. Or alternatively in a more narrow and short definition as “a state of political hostility between countries characterized by threats, propaganda, and other measures short of open warfare”.

In mijngroeve.nl the socalled US-China trade conflict was termed a geopolitical technology war early on (refer f.e https://www.mijngroeve.nl/history/america-first-vs-china-first/ ), i.e. as a fight for geopolitical technical hegemony, in particular in the field of 5G. The background to the conflict and how it sucked in other countries, such as Taiwan and the Netherlands, companies and entities (see f.e https://www.mijngroeve.nl/history/taiwan-and-holland-sandwiched-in-the-geopolitical-technology-war/ and Ajax see f.e. https://www.mijngroeve.nl/sport-en/ajax-huawei-contract-extension/ ) was highlighted several times.

In one of the most recent posts issued just after the signing of the Phase 1 trade agreement but still pre-Corona pandemic I wrote: “Could in other words the trade agreement ultimately mark the official starting point of a gradual decoupling of the two economies? Food for thought…” Several of my posts last year also indicated more stringent American export control rules regarding strategic goods, incl. high-tech products, were being contemplated which would seriously affect Western and Taiwanese companies using American technology/content to fabricate products for the China market….

American interim final rule on chip supply to Huawei

Well, on May 15, 2020, the US Department of Commerce, Bureau of Industry and Security (“BIS”) announced an “interim final rule” that will further restrict the use by non-US persons/entities of certain US technology, software and equipment in the design, development and production abroad of semiconductors for Huawei and 114 of its affiliates around the world. The new rule, which went into effect last Friday but has a 120-day grace period, on the one hand targets Huawei’s own ability to access tools for the design and manufacture of their chips, especially via its major design branch Hi-Silicon. But on the other hand it also means even non-US chip manufacturers using American chip making technologies, equipment and software will have to apply for licences before shipping their chips to Huawei or its subsidiaries…

In an effort to mitigate the immediate harm to companies that are involved in Huawei’s semiconductor supply chain, BIS will exempt certain items subject to the new controls and implement a wind-down period for companies that have initiated shipment or production for items based on Huawei design specifications as of the effective date. In a separate announcement, the Commerce Department also said it will extend for the last time the temporary general licence that allows US tech companies to make certain transactions with Huawei for another 90 days. This licence, which was due to expire last Friday, allows American companies to sell to Chinese companies products deemed non-critical.

As you may remember, already back in May 2019 US officials put Huawei on an export black list in order to cut it off from some US chip makers, incl. Qualcomm and Intel. Huawei is viewed as a serious threat to American national security, across bi-partisan lines. The American decision gave foreign chip manufacturers the opportunity to fill the void, as the original rule didn’t apply to them. But with the new American ruling, the US is effectively taking control of Huawei’s complete (advanced) chips’ supply chain: whether a license to export to Huawei will be granted will be in the hands of the US government because almost all digital chips and anything made in leading edge process nodes are using American equipment, software or EDA tools…

TSMC

While the Corona news has obviously overshadowed this latest American decision, it nonetheless has received some attention in the media. In particular TSMC, the undisputed #1 pureplay foundry in the world, is seen as suffering major collateral damage by this latest US ruling. Hi-Silicon contributes ~15% of its annual revenue and is a major customer in the <=7nm process node. TSMC is partially relying on American knowhow and equipment in its fabs to manufacture the wafers/chips for Hi-Silicon. Yet while the Taiwanese company is likely to suffer in the short term, its worldwide customer base and undisputed foundry & technology leadership is big and strong enough to compensate for the loss of any Hi-Silicon revenue, I reckon.

The media are correct, though, in depicting Huawei/Hi-Silicon as the biggest victim: these companies just won’t be able to quickly find an alternative for TSMC. There is no substitute in the PRC: the Chinese foundries such as SMIC are far less advanced and can’t provide the most advanced chips Huawei requires. The telecom company has built up stock of advanced chips, but its business will inevitably be heavily affected if this ruling remains unchanged. It would be almost impossible to find a foundry or fabrication plant, or fab, that could still work with Huawei as US machines are used by ~40% of the world’s chipmakers, especially for advanced nodes.

SMIC

It would even put SMIC, China’s #1 foundry, in a very awkward situation: the Chinese fab could have to choose or be forced by the communist leadership to stand with China by taking over a small part of TSMC’s business with HiSilicon in 14nm. But this could land the foundry on Washington’s blacklist as well, blocking the road to its fabs’ modernization as demanded in Xi Jinping’s ambitious chip industry expansion vision. SMIC relies on American and Dutch (ASML EUV see https://www.mijngroeve.nl/history/export-stop-asml-euv-steppers-who-will-be-the-next-target-in-the-usa-prc-geopolitical-technology-war/ …) equipment vendors for its fabs’ upgrades…

TSMC is desperately trying to avoid to have to make a choice between the US and China. The American ruling “coincided” with an announcement by the Taiwanese foundry that it intends to invest US$12 billion, to be spread over 2021-2029, to build a chip factory in Arizona. This news should have come as no surprize to those who have followed this blog since the begin of last year. American political and military circles do find the growing American technical reliance (including for the production of chips for America’s defense industry) on TSMC’s fabs in Taiwan, located in the volatile South China Sea region, too risky. Let’s not forget China considers the island to be an undeniable part of the PRC, and the communist government under Xi has been increasingly assertive in displaying its power in the area.

The US would certainly benefit from having TSMC setting up a new fab in the USA…It’s worth to note, however, there are signs TSMC’s investment plan is provisional; it’s for sure subject to change, or delay – or even cancellation. Moreover, the size of the investment and planned fab seems relatively small compared to the mega-fabs it has in Taiwan. In short, it’s doubtful this intention declaration by TSMC will be good enough to get in return the export licenses to maintain at least some shipments to Hi-Silicon….But it served its political purposes, i guess, and could be presented as another big achievement by Trump, as a “renaissance in American manufacturing”. By the way, Nikkei in Japan reported yesterday TSMC has immediately stopped taking any new orders from Hi-Silicon…

Taiwan

Strikingly even this TSMC investment announcement has been immediately politicized in the toxic climate on Capitol Hill: Democrats have urged more transparency about the deal and asked the government to consider “companies that already have built a significant presence in the U.S.”, citing Micron, GlobalFoundries and Cree. “We have serious questions as to how this project takes into consideration national security requirements and how it aligns with a broader strategy for building a diverse U.S. semiconductor manufacturing supply chain,” they said of the TSMC plan…

At the same time America’s (continued) reliance on TSMC in Taiwan offers the Taiwanese government extra leverage to secure America’s continued military protection of the island. If that dependency would be greatly reduced , Taiwan might worry America’s commitment to protect Taiwan might consequentially be less firm in the future…Meanwhile President Tsai Ing-wen, just confirmed for her second term, has clearly stated Taiwan will and can never accept to become part of China under the latter’s “one country, two systems” offer of autonomy, strongly rejecting China’s sovereignty claims and setting the stage for a further worsening of ties with the PRC. As China is unlikely to make any concessions to Taiwan, there’s little chance for the cross-strait relationship to improve in the foreseeable future…

European silence

European governments and chip manufacturers have been remarkably silent about the latest moves by the American government. It’s not just because they are still busily dealing with the fall-out of the Corona-crisis. These American rulings should not have come as a big surprize, though the timing of the announcement right in the midst of the corona- and economic disasters is curious. It just underlines the fact that even these crises have not distracted the US government and political establishment in its determination and mission to block the further rise of Huawei and de-couple from China, at least in terms of technology. Some in those circles even clearly seem to aim for the complete destruction of the Chinese telecom company. The Trump administration’s latest approach to Huawei brings to memory how it singlemindedly crushed the Iran deal, which rattled European governments and companies….In a similar fashion European governments and enterprises are probably again struggling to find an answer to the May 15th announcement by the US government.

European chip makers like STMicroelectronics, NXP and IFX who all have supplier relationships and joint projects with Huawei could be impacted. While most of their business is not in advanced technology and possibly could be considered non-critical, they do often rely on American software too. Or their supply could be perceived as usable for dual-purposes (civilian & military), triggering anew concerns of the US government. For all these European companies Huawei is still an important customer…

It’s also hard to imagine the Dutch government will be willing to incur the wrath of the Trump administration and grant ASML an export license to ship its EUV-equipment to SMIC any time soon. In short, more than ever before, European governments and companies -just like TSMC and Taiwan- are being pushed into a direction they don’t like, i.e. of making a choice between China and the USA….

Huawei survival at stake

The Wall Street Journal recently reported that Huawei’s handset shipments outside of China dropped by 35%, threatening its position as the world’s second-biggest handset maker. It’s still the dominant player in the China-market of course, but the loss of the support by Google Apps is killing its international appeal. Yet a far bigger problem for Huawei looms in the telecoms network business which helped it grow into a global technology giant and which still accounts for >35% of its revenue. The new American restrictions will impact the expansion, maintenance, and continuous operations of networks worth hundreds of billions of dollars that Huawei has rolled out in more than 170 countries.

American chip suppliers power Huawei’s telecoms base stations, alternative suppliers won’t be quickly available. The created inventories by Huawei and Hi-Silicon are not infinite, the supply shortage could eventually impact (future) orders for 5G equipment by f.e. European and other telecom operators around the world…

In other words, the message from Washington seems to be: “if Europe doesn’t want to side with the US in our Huawei ban, we will make sure Huawei won’t be able to deliver/service its 5G equipment to Europe….”

A milder version of a Cold War

Add to the above the American complaints over China’s cover up of the origins and scale of the Corona-virus problem, the American campaign against WHO/China, the growing military tensions in the South China Sea, the constant propaganda activities on both sides, the combative Chinese ambassadors and increasingly ugly nationalistic & ideological rhetoric….it pretty much starts to fit the above short definition of a Cold War, doesn’t it?

Ooh, and what about that “fantastic” Phase 1 trade-deal? The targets never seemed realistic anyhow; they were probably just numbers meant to impress. Hasn’t the Corona pandemic made the unrealistic the completely impossible? U.S. exports of goods to China in the first quarter of 2020 were down 10% from the same period in 2019…. By contrast, the trade deal forecasted a rise in goods exports of 36.6% this year…Q1 doesn’t bode well for the rest of the year, a big shortfall in the $200 billion deal is very likely.

And forget about a Phase 2 deal. As I wrote on January 14th after the Phase 1 deal was closed, all the signs suggest that “the competition and rivalry between Beijing and Washington is being viewed as long term in American political and military circles…. I wouldn’t be too surprized if the top of the Chinese communist party is actually holding the same view irrespective of any Phase 1 trade agreement…”

While Europe is gradually recovering from the Corona-pandemic, we’d better wake up to the next nightmare…… Luckily enough no proxy wars in sight yet, but the situation in Hong Kong and the China – Taiwan (independence) issue remain very tense. And countries worldwide will be facing more and more pressure to choose sides in this American – Chinese conflict, no matter how reluctantly.

Yes, I am fully aware things could still turn around for the better. Trump apparently still holds a soft spot for Xi Jinping, and he might truly believe the Chinese Chairman does the same for him. Both leaders do share a complete lack of empathy, that’s what they do have in common. Personally I am more of the belief Xi’s trust in Trump is extremely limited as the American President tried to bypass Xi in his own backyard, that is in building direct ties with the North Korean leadership and in addressing the nuclear problem without Beijing’s involvement. Xi must have also noticed international agreements do mean little to the Trump administration, as proven in the Iran and Paris climate agreement cases.

Yes, I also realize a new American President could perhaps return to multilateralism, free-trade and diplomacy to counter Chinese influence, by building an united Western diplomatic front and creating systems to address the new challenges—in digital trade, advanced dual-use technologies, investment, and competition policy—for which the world currently lacks even the most basic institutions to govern. Or perhaps even Xi Jinping could get a moment of enlightment, toning down his rhetoric and ambitions and fully embracing such multilateralism not just by mouth. Yet for the time being his diplomats are mostly extolling the virtues of the authoritarian state model in the combat against Corona….And the American Democrats are in no mood to give in much to China either.

The Chilly War

China will be a major topic in the coming American Presidential elections, no candidate wants to be seen as soft on China. Both Democrats and Republicans are united in their anti-China stance, the only topic in fact which has united them in Congress over the past 3 years. And in the aftermath of the pandemic in a lot of European capitals including Brussels strong concerns have arisen over China’s behavior and the overdependency on the China market. China’s economic importance is undeniable and the attraction of the huge market won’t fade. Yet the growing lack of trust among the European political establishment as painted in my blog over the past 1.5 year can no longer be denied either. The political atmosphere is far less favourable and forgiving to China than it has been for over the past 30 years….

While we are heading towards summer, the US-Chinese relationship has gotten very… uhh, chilly?

So welcome to the US-China Chilly War…If not treated in time, this chill could grow into a serious cold or even worse… a new worldwide pandemic, called Cold War.