SinoInsight 1
May 15 saw several developments that concern the Sino-U.S. tech war and “cold war”:
1. The U.S. Department of Commerce unveiled a new rule that required global chip suppliers to obtain licenses to sell Huawei semiconductors manufactured abroad with U.S. technology. The ruling went into effect immediately with a 120-grace period.
The Department’s ruling affects Taiwan Semiconductor Manufacturing Co Ltd (TSMC), the biggest contract chipmaker and a key supplier to Huawei. According to international news reports, Keith Krach, U.S. undersecretary for economic growth, energy and the environment, said that “there’s no assurance whatsoever” that TSMC will be granted a license to sell to Huawei. “I think roughly around 10-12 percent of TMSC’s business is China, and I think that is in essence almost primarily Huawei. So they will be restricted unless they’re granted a license, and there’s no assurances on that and we don’t anticipate that,” Krach said.
In what appeared to be a response to the U.S. move, Hu Xijin, the editor-in-chief of the nationalistic CCP media outlet Global Times, tweeted, “Based on what I know, if the U.S. further blocks key technology supply to Huawei, China will activate the “unreliable entity list,” restrict or investigate US companies such as Qualcomm, Cisco and Apple, and suspend the purchase of Boeing airplanes.”
2. The U.S. Department of Commerce announced that it was extending temporary general licenses for Huawei and its non-U.S. affiliates on the entity list for 90 days. The Department also noted that the terms in the license could be revised or possibly eliminated after Aug. 13, 2020.
3. TSMC announced that it will build a $12 billion semiconductor factory in Arizona that will produce the latest 5-nanometer chips.
In a statement, U.S. Secretary of State Mike Pompeo said, “TSMC’s announcement comes at a critical juncture, when China is competing to dominate cutting-edge technology and control critical industries. The TSMC facility in Arizona will increase U.S. economic independence, bolster our safety and competitiveness, and strengthen our leadership in high-tech manufacturing. This historic deal also strengthens our relationship with Taiwan, a vibrant democracy and force for good in the world.”
4. The PRC unveiled 11 measures, which it describes as “incentives,” aimed at helping Taiwanese businesses operate in mainland China.
OUR TAKE
1. TSMC’s decision to build a semiconductor factory in America is almost certainly shaped by political and security considerations. While operating and wage costs are much higher in America as compared to Taiwan and mainland China, TSMC would be far less exposed to intellectual property theft, a serious epidemic outbreak, and other CCP-related problems in the United States. TSMC would also be minimizing its exposure to political and geopolitical risks brought about by the Sino-U.S. “new cold war” and de-globalization in the post-pandemic world.
The Trump administration has cheered on TSMC’s announcement because it means increased national security, the creation of more jobs (1,600, according to news reports), and the shifting of critical supply chains to the United States. Secretary Pompeo’s statement also suggests that the U.S. is viewing TSMC’s move as a part of a broader strengthening of U.S.-Taiwan ties.
TSMC has not placed all its eggs in one basket. The $12 billion factory in Arizona is considered a small chip factory and is set to produce about 20,000 chips per month, or about a fifth of what the largest Taiwan-based factories are producing. The factory will also not produce the latest chips when it is up and running in 2024 since TSMC is expected to roll out in volume its 3-nanometer chips by the second half of 2022. The Wall Street Journal cited an analyst as saying that TSMC’s “Arizona facility will be a ‘margin drag’ unless government incentives or higher prices can make up the difference.”
TSMC’s move, however, is by no means insignificant. The company now has leverage to bargain with the PRC, especially in a climate where the U.S. is threatening to cut Huawei and other Chinese telecommunications firms’ access to U.S. technology; this creates more headaches for the CCP and curbs its tech domination agenda (see point 3). Other Taiwanese and even global companies could even follow TSMC’s lead and invest in the U.S. to mitigate political and geopolitical risks as the Sino-U.S. “cold war” unfolds. And the CCP will find it much harder to compromise U.S. national security and military with critical high-tech chips being “Made in America.” All this poses a threat to the CCP regime.
2. In the May 11 edition of this newsletter, we wrote that the CCP could announce “benefits for Taiwanese akin to the so-called ‘31 measures’ and ‘26 measures’ at the upcoming Two Sessions.” The recently unveiled “11 measures” are likely part of the CCP’s larger strategy of attempting to win over Taiwan using a mix of carrot-and-stick measures. The CCP could yet roll out more “incentives” for Taiwan at the Two Sessions.
3. Several news outlets reported in May 2019 that Huawei had stockpiled up to a year’s worth of crucial components ahead of the U.S. ban. However, an Oct. 7, 2019 report by The Washington Post cited analysts as observing that Huawei’s supplies were running low then. Huawei running out of parts, the full enforcement of the U.S. ban on Huawei, and global chip makers like TSMC becoming more “beholden” to the U.S. would be disastrous for Huawei and the CCP’s global 5G push; Huawei’s 5G and other products would be much less attractive to buyers if it is forced to use its less advanced in-house chips and software exclusively.
We believe that Sino-U.S. tensions are set to further escalate before September over the tech war, especially if the U.S. does not extend any more temporary licenses to Huawei and its non-U.S. based entities when the current extension ends on Aug. 13.
The tech war, however, will be just one of the CCP’s many concerns. As we wrote in July 2019, “the current Sino-U.S. conflict is not just a trade war or a tech war, but a critical battle of ideology, value systems, and morality.” Businesses, investors, and governments must account for political risk in China, including tracking developments in the CCP factional struggle, to avoid being blindsided by Black Swan events and discover hidden opportunities ahead of tremendous change in China.
SinoInsight 2
Many countries have responded to the coronavirus pandemic with unprecedented stimulus measures. Meanwhile, PRC academics and government officials have recently been vigorously debating whether or not China should embark on “debt monetization” to stimulate the economy.
Popular arguments being floated include:
- Quantity theory of money is “outdated” and the PRC should look into pursuing “debt monetization” by issuing special government bonds.
- The PRC currently lacks preconditions to carry out “debt monetization.” If “debt monetization” is allowed, then there is a real risk that the PRC government would lack discipline, expand government debt limitlessly, and end up being bankrupt.
- The central bank would be breaking the law if it directly purchases government bonds. Article 29 of the PRC law on the People’s Bank of China states that the central bank “may not provide loans to local governments or governmental departments at all levels, or to financial institutions other than banks, other organizations or individuals.”
OUR TAKE
1. The fact that PRC academics and officials are talking about “debt monetization” now is a clear indication that the Chinese economy is in pretty bad shape. The Sino-U.S. trade war and the coronavirus pandemic has sharply worsened many of the PRC’s existing economic and financial problems, including revenue shortages, debt crises, and a property bubble. The coronavirus in particular has resulted in China seeing negative GDP growth, as well as declining consumer spending power coming in tandem with rising consumer prices.
2. The recent debates over “debt monetization” appears to be a “trial balloon” of sorts by the CCP to signal it is preparing to go ahead with “unlimited quantitative easing.” By describing the process as “debt monetization,” PRC scholars are priming the people to accept the central bank’s plan of “unlimited quantitative easing.” The scholars, however, are concerned that “unlimited quantitative easing” will lead to hyperinflation and the collapse of the Chinese economy.
3. The current debate on “debt monetization” indicates that the CCP could be releasing between 5 trillion yuan to 10 trillion yuan worth of stimulus in 2020. The CCP, however, will unlikely succeed in its plan to print its way out of trouble given Party characteristics and the contradictions of its autocratic system:
a) The PRC government’s debt-to-GDP ratio (explicit debt only) is around 60 percent, and could be as high as the 90 percent range after counting implicit debt. In recent years, PRC officials have noted that no local government wants to pay off their debts and instead are hoping for the central government to step in. With this mentality, the central bank will not be able to stop the printing presses, and hyperinflation is almost guaranteed.
b) The PRC government rolled out a 4 trillion yuan stimulus package in 2008 to bail China out of the financial crisis. Should the CCP go ahead with “debt monetization,” it would likely release more than 4 trillion yuan worth of stimulus. Such stimulus measures, however, could prove to be much less effective in 2020 as compared to 2008 when China is facing markedly different economic and financial conditions.
In 2008, China had 47.5 trillion yuan of broad M2 money supply, 20.7 trillion yuan in central bank assets, and a money multiplier of 2.29. The PRC government’s 4 trillion yuan stimulus package spurred 10 trillion yuan of private capital investments, and had a positive effect in driving the real economy.
In March 2020, China had 208.1 trillion yuan of M2, 36.5 trillion yuan in central bank assets, and a money multiplier of 5.7. With the money multiplier close to its theoretical limit, the PRC authorities have lost room to make monetary policy adjustments. And with an M2 of 208.1 trillion yuan, the PRC authorities have to roll out over 20 trillion yuan of stimulus for there to be an effect. China’s monetary system is bound to collapse if the PRC does release over 20 trillion yuan in stimulus.
c) China faces stagflation and the CCP needs a solution. Historically, stagflation was resolved through increased privatization and deregulation, which created the conditions that led to technological revolution and new demands in society. Privatization and deregulation, however, are closed to the CCP because its authoritarian system demands greater control over society during crises. Also, technological revolution is virtually impossible in the CCP’s ideologically rigid environment and its inability to enact political reform.
