When President Trump lays the groundwork for the next round of tariffs in China, which can not be imposed before June 24, it is time to examine the larger picture in what is moving beyond a trade war and towards a cold war of technology that is one of them. of the main facets that drive commercial hostilities between the two countries.
It is worth bearing in mind that the trade war is the end result of a long-term increase in tension between the United States and China. Although many people have criticized Trump's reasoning to shoot the starter gun in the current situation (the imbalance of the dollar between imports and exports has always been a pointless measure given the final accumulation of much of the value chain of technology for American companies), both Republicans and Democrats have long had great concerns about Chinese business practices.
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The real problem: China's forced technology transfer and the search for geopolitical dominance
However, there are numerous genuine problems that exist with China's economic and trade policy and this is the point of what is happening now. China has achieved great agreement with the elegant programs, in particular the Made in China 2025 plan, which aims to reduce the country's dependence on foreign technology by promoting local technology, together with the Belt and Road Initiative that aims to strengthen the developing world with major infrastructure projects to promote economic ties in a modern Silk Road that promotes Chinese products and trade.
These schemes formalize much of the West's problem with Chinese economic practices, in particular that companies seeking access to Chinese markets and consumers should normally form joint ventures with local firms with the aim of unofficially promoting the transfer of proprietary technology. valuable intellectual. China now has its own companies that can produce x86, ARM and other processing units, in addition to having virtually the top 500 supercomputing list with 229 of the Chinese systems (US ranked second with 108 in November). 2018, although currently maintaining both the first and second place).
Where we are now: the growing tensions and the Chinese corporate objectives
The high profile issues are, obviously, tariffs, however, it is also clear that the trade war has moved beyond simply escalating these ones over others. Last year, the USA UU They focused on ZTE after declaring him guilty of violating sanctions against Iran and North Korea, which prohibited 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 to the table as a bargaining chip in the trade war between the two companies with the United States accepting a fine and a corporate reorganization as acceptable for Allow the company to start. your business again.
Having succeeded here, it is now clear that EE. UU It is following a similar strategy with its ultimate goal of Huawei, the undisputed jewel in the crown of Chinese technology companies. However, apparently Huawei has not been idle since he saw what happened to ZTE last year and has been accumulating chips and working to reduce its dependence on EE software and hardware. UU With its own HiSilicon chip unit working to design its own Kirin SoC to further reduce its dependence on US hardware.
The difficulty is that the EE. UU Placing Huawei on its list of entities has led some non-US companies, such as ARM (now owned by SoftBank TYO: 9984), to also stop working with Huawei and its subsidiaries such as HiSilicon. However, it is worth noting that although these companies may stop working with Huawei and other Chinese companies that are named in the United States, the ultimate goal of China was that they would not need these companies anyway.
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However, it is clear that China would prefer to have stopped using foreign technology when it decided that it no longer needed it, instead of forcibly removing access to foreign technology and it remains to be seen if Huawei and other Chinese companies are. . ready for a prolonged commercial war that sees that critical technology is no longer accessible. Even if the Made in China 2025 plan succeeded, there are still six more years to go to fruition, so the withdrawal of foreign technology is likely to be a pain for China.
However, it's not just the silicon we're seeing here. It is worth noting that this forced transfer of intellectual property is taking place in China in all industries, with the notable example being automobiles and most of the major international major car manufacturers that have a joint venture with a Chinese car company, including all the main ones like Volkswagen, Ford, GM, Toyota, Mercedes, Jaguar Land Rover, Peugeot and others tried not to deliver the critical secrets to their Chinese "partners" that allow them to access to sell to Chinese consumers.
Now we have a US technology company. US, CNEX, which claims that Huawei has been stealing its trade secrets in what is likely to become one of the numerous lawsuits against the company to test the waters as to how difficult it will be to prove the transfer of intellectual property against China. the companies For its part, Huawei is also suing CNEX for the theft of IP. Obviously, the USA UU They have a judicial power designed to be independent of the other branches of government and, although the signature is small, it will be interesting to continue with the trials in both cases that will begin on June 3.
Where next Offers, Trials, WTO and Rare Earth?
It is worth taking into account, although EE. UU It can prevent companies from working with Chinese entities that they do not like, this is a legal, not a technical mechanism. Therefore, although ARM can no longer talk to HiSilicon or license its newest designs to the firm for use, this does not prevent HiSilicon from continuing to design its own chips. It simply prevents them from licensing ARM designs and getting support from them to do so. This means that the time may come when HiSilicon will face its own demands for the use of ARM technology without a license to do so, the difficulty will be to use a demand for Huawei or any of its units to stop doing what they are doing and It is an important distinction to make. For his part, President Trump has made it clear that the situation with Huawei is now under negotiation as part of a broader trade agreement. If this is retaken or not, it probably depends, at least in part, on what Huawei really can be.
Realistically, if China wishes to continue with its current course, there is no way that the United States can stop it in the short term rather than making life difficult for Chinese people and waiting for the population in China to become sufficiently dissatisfied with their leadership as Stop following the current course of action. The recent upheaval of President Xi's nationalist sentiments with the call for a new long march in the face of US aggression is seen by many as a test of the waters to pressure its population to stand firm and support the companies and products Chinese while the trade war is resolved From the political panorama of the USA. Although there is bipartisan support on the surface for current action against China, the Democrats can seek to capitalize on any economic weakness resulting from the trade war.
President Trump is right to point out that the Chinese can expect to negotiate the terms with a president who comes after him (potentially a Democrat) who may not be as aggressive with the terms of an agreement. Trump, of course, has a maximum of about 6 years in the White House. Undoubtedly, there will be a burden for the Chinese economy if the current escalation continues, however, China is not without its own cards to play, although it has mostly played its smaller cards and the rest are potentially unpleasant for several reasons.
The tariffs in the USA UU They are the secondary cards in question, it is fair to say that they are reaching a point where they can not do much more, since the USA. UU Obviously they matter more from China than vice versa, the USA. UU They can continue imposing additional tariffs. Merchandise long after the Chinese have run out of things to do the same. However, the last tariff proposal that the United States can impose in June contains a notable omission and, as expected, is rare earths.
As we covered in our exclusive article on the decoupling of China's western technology industry in December (here), China has the largest rare earth reserves in the world. In addition to having the largest reserves, it is also the largest producer and estimates put its production between 80% and 95% of the world's supply. Although some may argue that this is not a big problem, because rare earths are simply not so rare, this misinterprets the problem.
As with oil, the difficulty with rare earths is not that they are running low, the difficulty is that CHEAP oil is running low (apart from environmental concerns). While it is possible that given enough time to absorb a supply shock in the short term, the world adapts and is able to increase production in places other than China, the operations that extract and refine hundreds of thousands of tons per year are not are produced. overnight, and when they do, they tend to cost more, since we can safely badume that market efficiencies have brought production to China in the first place because it is the cheapest place to produce them reliably . As such, yes, it does not mean that we no longer have electronic products that depend on rare earths to manufacture them, however, it is likely that the cost of those products will rise if they were tariff or subject to export. Large-scale controls, which lead to higher production costs, lower profit margins and, therefore, worse corporate results, translate into a deterioration of the 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 seen as a gesture of approval to the fact that this is a letter that China could play at some point if the commercial war intensifies. .
In addition, some are now beginning to speculate that China could also initiate retaliatory actions against some US companies. The spectrum of major Western companies that lose access to China's nearly 1.4 billion consumers is not a nice thing to contemplate. As the trade war increased last year, technology stocks suffered considerably. Since then, the security of the USA. UU In the form of what is known as the "Trump Put" has prevailed to allow the market to recover most of its losses in the fourth quarter of 2018. Trump's goal refers to the fact that the president will always act to support the stock market and, if necessary, expel the big shots from the administration to calm the markets and keep things calm. However, the worrying statements in the recent earnings reports of major technology companies such as Apple (NASDAQ: AAPL), NVIDIA (NASDAQ: NVDA) and others on reducing the demand for their products in China have seen the appetite of the investors by the companies considered as exposed to the market. falling commercial war.
China remains cautious so far to target Western companies directly from the way the United States has done with Chinese companies such as ZTE and now Huawei, but there is no doubt that if China closed the access to its markets to some of these companies , I would. it would mean a great escalation in the commercial war and the stock market would suffer. Most likely, the president blames this on the door of his beleaguered Federal Reserve chairman, Jerome Powell, for raising interest rates, but if that happens, it's probably a combination of both, along with other factors. .
The other card that China has is its large amount of debt from the government of the United States. Currently, with more than $ 1.2 trillion, worries were moved this month when data showed that China sold about $ 20 billion in March, raising concerns that China might try to build possession. Something that would cause the United States a reasonable degree of economic discomfort, no doubt, but also an unattractive possibility for Beijing.
The difficulty with China's cards is that if you play them, they will also harm China. The US cards that are played are no different, as they hurt Americans in the form of higher costs for some consumer goods, lower incomes for some industries that depend on China, and inflation, but these are changes Incrementals that are not going to slap the consumers. the face is as if China were forbidding Apple to do business there and you simply could not buy a new iPhone. The cost of an iPhone in the US UU It will mean that consumers will have less money to spend on other items or perhaps they will update less often, but the product itself would still be available.
In the same way, China earns a lot of money from its production of rare earths. Prohibiting wholesale export could be problematic for the Chinese economy, as well as raising costs and generating headaches in the short or medium term for Western companies that need them.
As to arm the bonds of the government of the United States? Well, the Chinese holding is currently worth $ 1.2 billion. Leaving them on the market would absolutely damage the economy of the United States, but at the same time, the value of participation would collapse while the sale continued. You can not just throw a trillion dollars in T-notes in the market and expect people to simply buy it at the current price.
So, what we have left is a semi-limbo state, while China tries to find the best way to respond. Given Trump's insistence that any agreement will not result in the immediate lifting of tariffs until China modifies its laws in the way that the United States is seeking and guarantees compliance with the terms of the agreement, it can simply be the best China's interest simply tone things up. Down and play a waiting game. The stock market is definitely slowing down, as expected in this late stage of the economic cycle.
The firepower of the government and the central bank to maintain the party is almost exhausted because the tax cuts are running out, interest rates are still at historic lows and central bank balance sheets filled with quantitative easing positions is difficult to see what else the global economy can do to keep the party going Technological actions with exposure to the trade war between China and the US UU They have suffered, not only the names of owners but also similar but more important providers, such as Skyworks (NASDAQ: SWKS), Qorvo (NASDAQ: QRVO), Broadcom (NASDAQ: AVGO), Lumentum (NASDAQ: LITE) and others have eliminated up to 25% of its market capitalization, as tensions increased with the last round of tariffs. Chinese companies that are publicly traded are also suffering, such as Tencent (HKG: 0700).
However, in general, it is considered that the United States and the West are likely to have stronger economies than China and, although they will bear most of a trade war, they will also gain some benefits with increased trade among Western countries. . However, what most of the models that predict this do not take into account is that this could be the trigger of a global economic recession, since both EE. UU As China they maintain large economies that drive much of the demand of consumers.
That said, there is likely to be a backward recession given that we are currently in the middle of the longest bull market in history. It is difficult to see how any of the parties can descend from the current state of the trade war with what has been established now, for our part, we will continue to discuss the state of the technological market with a growing focus on some of the technologies that come out of China while the commercial war develops in the coming years.