US Blockades China's Semiconductor Market

Semiconductor Wars.

We are in uneasy times. While Europe is witnessing its biggest kinetic war in decades, the global technology war is also seeing new chapters. The latest move by the United States is a massive offensive with global reach and global consequences. The Americans, using semiconductors, have hit China's high-tech sector and the scale of this strike eclipses anything we've seen before.

The Axis of Mankind's Development

Microchips are the heart of the 21st-century’s technological bloodstream. Without them, we would regress in development by at least several decades. Beginning with everyday appliances such as washing machines, refrigerators, and vacuum cleaners, continuing to smartphones, computers, and modern cars, and then on to satellites, fighter jets, drones, hypersonic missiles, and finally artificial intelligence - the field of their application is quite endless. Semiconductor sales in 2021 reached nearly $600 billion and the industry is planning capital spending of one third of that amount – that is $200 billion. By comparison, the global automotive industry has earmarked a similar amount for capital spending, even though auto sales are five times higher. Putting up a state-of-the-art chip factory costs $20-30 billion dollars and it will become obsolete within a few years. The manufacturing process is impossibly complicated and uses machines with a system of mirrors produced by only one Dutch company, ASML. In a word, semiconductors define mankind’s current state of development.

Therefore, whoever holds the key to their design and production, in effect, holds the keys to this development. Despite the fact that the global semiconductor market is fragmented, the Americans believe that they own the keys and, with their help, have decided to essentially close the door on the development of advanced technologies in China.

Of course, as in everything that has a global dimension and involves cutting-edge technology, we operate on an extraordinary degree of complexity and number of connections. In spite of this, let's try to find the essence.

The microchip ecosystem is highly globalized. It touches East Asia, Europe, and of course, America. Only 10% of semiconductor manufacturing is in the United States. The most is in East Asia and that's primarily the now legendary TSMC, or Taiwan Semiconductor Manufacturing Company. Korea's Samsung and Japan are also essential, and then there’s China: the world's 3rd largest chipmaker. However, it must be noted that China produces, almost exclusively, the lowest-complexity semiconductors.

Nevertheless, it’s one level. In order to manufacture an integrated circuit, suitable, extremely complex machines are needed. This is where Europe and, above all, the aforementioned Dutch ASML, come into play. Again. Japan is important as are American companies, such as LAM Research or Applied Materials.

Finally, we descend to the level of designing the most advanced chips and the software needed for this purpose - this is almost entirely the US. Moreover, American technology is an almost inseparable component of the previous two levels. In a nutshell, the United States holds a dominant position in many areas of the semiconductor ecosystem, and so there is no advanced semiconductor center in the world that is not fundamentally dependent on American technology. This dependence is usually not through one-time purchases, but through licensing, ongoing maintenance, repair, and troubleshooting.

Greatly simplifying, we can divide semiconductors into 3 categories. The most advanced ones go into satellites, cruise missiles, or smartphones. The mid-range into, among others, aerospace and automotive systems that have been on the market longer and don't require constant changes, such as ABS. Finally, the simplest ones are installed in washing machines, refrigerators, or electronic calculators.

Lethal Addiction

Outside of the simplest semiconductors, where China is indeed essential, the Middle Kingdom's participation in medium and the most advanced integrated circuits is limited solely to imports of products, machinery, and knowledge. This dependence gives the US an unusual advantage in granting or denying access to technological development.

Let's briefly illustrate the technological gap. In 2014, the American company, Intel, mastered the 14nm process and began production. However, China's SIMC didn't reach that level until 2019 with mass production only beginning this year! Meanwhile, Samsung and TSMC are working now at the 3nm level. This difference of 5 to 8 years in development in the semiconductor market isn’t just a gap – it’s a gulf.

With this in mind, it becomes easier to understand the scale of the latest American move. But what exactly has the Biden administration done?

According to a new directive announced on Friday, October 7, semiconductors made directly or indirectly with US technology for use in artificial intelligence or high performance cannot be sold to China. While manufacturers can seek an export license – one that Intel, TSMC, Samsung and SK Hynix have been granted on a case-by-case and temporary basis – it will be unattainable for most.

Still, many companies have halted exports to China before their legal departments analyze the new regulations to make decisions about the future of cooperation with China.

Following the US narrative, the restrictions are motivated by limiting development in China's military sector, which will inevitably happen. In practice, however, their application has much broader repercussions and will inevitably affect not only China's overall high-tech development, but also the global semiconductor market.

China's most ambitious plans – the space program, landing on the moon, development of artificial intelligence, machine learning, hypersonic weapons, as well as 5th and 6th generation fighters – all require powerful computing power, which is only made possible by supercomputers, and these cannot be created without the most advanced integrated circuits.

Therefore, Washington's move is the biggest yet escalation in the technological rivalry between the two powers. According to some, we have crossed the so-called "point of no return."

The Americans previously made a similar move by banning the sale of advanced chips to Chinese telecom giant Huawei. The result? Huawei lost 80% of its global market share and sold its smartphone division. Now, the Americans plan corresponding moves against most of China’s high-tech companies.

Is that all? No. Washington didn't stop there.

As we have already pointed out - China is a major player in the entire chain, but primarily as an end consumer and manufacturer of the simplest chips. Beijing's pursuit of technological dominance has forced the Chinese to import semiconductors extensively, which in turn were designed and manufactured in other parts of the world. This has made and continues to make China extremely dependent on foreign countries in this niche. The Chinese Communist Party is not indifferent to this problem and so in order to drive domestic technological development and achieve the desired independence, it threw trillions of yuan at the sector.

This has yielded some results, including laying the groundwork for its own semiconductor industry. China's share of semiconductor production increased from 9% in 2011 up to 16% in 2021 making China the third largest producer after Taiwan and South Korea. Still, Chinese production is focused almost exclusively on the oldest types of chips (in the 28nm standard). However, even these smaller successes didn’t come from thin air. The Chinese tempted Western engineers and managers with lavish salaries in order to create a domestic and independent semiconductor market. As it happens these people were very often US citizens.

5 days after the first wave of restrictions, Washington delivered a second blow.

"This is what annihilation looks like: China’s semiconductor manufacturing industry was reduced to zero overnight. Lots of people don’t know what happened yesterday. To put it simply, Biden has forced all Americans working in China to pick between quitting their jobs or losing American citizenship. Every American executive and engineer working in China’s semiconductor manufacturing industry resigned yesterday, paralyzing Chinese manufacturing overnight. One round of sanctions from Biden did more damage than all four years of performative sanctioning under Trump,” a Chinese entrepreneur who tweets under the name Lidang wrote in a thread translated by Jordan Schneider, a senior analyst at Rhodium Group.

This figurative description needs little commentary. The US administration has ordered all US citizens to break off cooperation in the semiconductor field with Chinese entities under threat of losing their US citizenship.

As a result, China's chip market experienced a mass of immediate resignations of employees holding key positions and forced companies to immediately transfer entire divisions out of China.

The Netherlands-based ASML wrote in an internal message to its US employees: “ASML US employees must refrain — either directly or indirectly — from servicing, shipping or providing support to any customers in China until further notice.”

"To put it mildly, Chinese companies are, in practice, going back to the Stone Age," stated Sheho Ng, Managing Director of China Renaissance. "This is an even bigger bombshell than the import ban," an anonymous human resources manager at a Chinese semiconductor plant told the Financial Times. For example, six of the seven key R&D executives at China's leading semiconductor equipment maker, Piotech Inc. are American citizens. Many of Piotech's top executives, including its managing director and CEO, are also Americans.

To put a more systematic spin on what happened, it would be useful to refer to a report by Gregory C. Allen for Center for Strategic and International Studies, or CSIS. Allen confirms that the Americans are trying to regain control of the chokepoints of the global semiconductor system with this move, which includes:

• Designing the most advanced chips
• Design automation software
• Semiconductor manufacturing machines
• Essential components

The Biden administration's move is designed to take advantage of US dominance in these four areas. The effect of these actions is expected to be strategic and to stifle China's artificial intelligence sector by denying access to the semiconductors that are essential to its development. Secondly, on stifling China's potential to design new chips by limiting access to US design software. Further on undermining Chinese semiconductor production by limiting access to production machines built under American licenses or with American components. As the report was written a day before the latest salvo of restrictions, it can be added that the stifling of each of the areas mentioned is amplified by cutting off access to American human resources and know-how.

In Allen's view, these actions show an unprecedented degree of intervention by the US government to not only retain control of semiconductor hotspots but also to launch a new US policy of actively throttling large segments of China's technology industry – throttling with the intent to kill, the author points out. The Americans want to maintain their position in which they are two technological levels and 5 to 8 years ahead of the Chinese.

The timing of the offensive is no coincidence either. The strike came just days before the 20th Congress of the Chinese Communist Party at which Xi Jinping was to be elected for an unprecedented 3rd term. One might suspect that the choice of such an attack date was primarily intended to undermine Xi’s own power and secondly to paralyze decision-making. With the entire state apparatus focused on the congress and Xi Jinping devoting all attention to consolidating his power and eliminating opponents, a swift and decisive response to the Americans' move will be impossible. And indeed, at the time of this writing, two weeks after the introduction of the new regulations, apart from a few dry statements, the silence from Beijing is deafening.

Money or Security?

Of course, with such a complex issue, nothing is black and white. The White House's decision hits not only China, but it also ricochets hard toward US companies.

Just think of one of the most important US players in the market, Nvidia, whose valuation nearly tripled in a year. Washington has already banned Nvidia from selling to China during the first wave of the offensive. The company has, unsurprisingly, commented critically on the decision. As Nvidia accounted for a whopping 95% of sales of artificial intelligence chips in China – the high end ones. Allen of CSIS summarizes Nvidia’s and other producers’ criticism as follows:

1. Chinese manufacturers wouldn't have won an audience in China anyway because their products can't compare with those from Nvidia or AMD
2. Due to the lack of consumers, Chinese manufacturers have not been able to grow as fast as US companies
3. The new regulations will ensure that profits that previously went to US-based companies will stay in China, providing the basis for domestic industry growth
4. In the short term, the new rules will hurt the Chinese, but in the long term it is good news for China, as it will allow it to develop its domestic semiconductor industry

Leaving aside the manufacturers’ motivations whose primary concern is to grow their own business, one cannot deny their logic. They are echoed by Asia Times columnist David P. Goldman.

Goldman criticized Biden's decision saying that the world as a whole derives most of its profits from cooperation with China. In good times, major chipmakers such as Nvidia were making $20 billion in profit from $30 billion in sales. To cut off China is to cut off 26% of this revenue. For the aforementioned Dutch ASML, it’s 15% of profits; for the US LAM Research, 35%, all the while Washington offers nothing extraordinary in return. Although a so-called CHIPS Act worth $50 billion was announced earlier this year, Goldman says this is far too little to make up for the vacuum created by cutting off China.

He believes Washington is not investing enough in the development of semiconductor technology while Beijing is throwing a sea of money at the problem by creating a $221 billion sovereign fund. This, combined with the buying up of Taiwanese and Korean specialists, as well as a large supply of its own engineers – recall that China creates 7 times more STEM engineers annually than the US – will lead to, in the author's view, the creation of a separate Chinese semiconductor industry. This will result in years of global overcapacity, which will spell financial trouble for non-Chinese companies that depend on high margins to maintain capital expenditures and R&D. China will try to cushion its massive semiconductor subsidies by flooding the global market with cheaper products to put Western companies out of business.

Moreover, the American decision, although consulted with allies beforehand, was essentially unilateral. The Americans tried to convince allies, including the Dutch, Japanese, Koreans, Israelis, and British to implement the restrictions jointly. To no avail… so they decided to attack alone.

The Taiwanese government signaled that it would comply with the American directives but indicated that Europe, Japan, and Korea also needed to comply for the regulations to be effective. However, the Japanese have expressed concerns, and the Dutch have outright criticized the Americans' decisions.

Apparently, the US administration, as well as other analysts including Peter Zeihan, are betting that not everything can be bought, and the hard-to-estimate financial value of the US advantage is much greater than China's $221 billion fund. Either way, we are dealing with an event that bears very serious consequences. The Americans have gone on the offensive on two fronts – first, after Russia, and now a second one has been opened at China.

Time will tell to what extent the new restrictions will hit the Middle Kingdom, but in the short term, there are many indications of a multi-level paralysis of China's high-tech sector. The key from Washington's perspective will be the extent to which the Americans succeed in convincing the other poles of the semiconductor world to cooperate in restricting China's access to high-tech chips. Although they are often the closest allies of the US – after all, we are talking about Taiwan, South Korea, the Netherlands, and Japan – their reaction to Washington's move is not unanimous. This should come as no surprise, for when it comes to the clash of economic interests and the security sphere, friction is inevitable, as can also be seen within the United States itself.

Deglobalization is in full swing, and the formation of a new world order is taking new and increasingly aggressive phases. Americans are using all the pre-kinetic instruments of their arsenal to hold back China's growth, and the result will, in one way or another, affect all of us as well.

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