China vs. USA – Tit for tat pt. II

Reality undermines the restrict strategy.

• China has resumed exports of Gallium and Germanium in another sign that unless one controls the reserves, restricting access to a mineral is a poor negotiating strategy.
• RFM Research and Alavan Independent are of the opinion that the USA’s strategy to slow China’s rise as a technological and geopolitical power by restricting semiconductors is reasonably effective.
• Although China can still make chips at leading-edge nodes, it is unable to do so at scale and profitably making this workaround ineffective in the long run.
• This leaves China in a position of needing to get access to foreign technology and we see three potential strategies in order to achieve this.
• First, recreate where China recreates the entire semiconductor value chain from scratch, second replicate where pieces of equipment are acquired and then reverse engineered and third, restrict where raw materials that China controls are subject to export bans in order to achieve negotiating leverage.
• Although China is actively trying to recreate the pieces of semiconductor technology that it no longer has access to, it has spent most of its retaliatory efforts on restriction.
• China produces the vast majority of different minerals such as rare earth metals, Germanium and Gallium all of which are used in semiconductor manufacturing or electronics manufacturing.
• However, while China produces the vast majority of these products, it does not control anything like a majority of the reserves, and this is where this strategy comes unstuck.
• Around 2010, China restricted the export of rare earth metals and while China produces over 70% of the finished product, it only controls around 40% of the reserves.
• China’s strategy has been to use its low cost of production to consolidate the production of these minerals in one place and thereby reduce costs even further to a point where no one else can compete.
• The net result in 2010 was a spike in the price of rare earth metals which made it economical for other countries to resume production using the reserves that they had in the ground.
• Consequently, the impact was a loss of market share for Chinese companies and slightly higher price of production for everyone else.
• This is why China dropped the export restrictions in 2015 and has not put them on again.
• The Gallium and Germanium ban has lasted for a full 2 months and resumed at a very low level in October with a large increase expected for the month of November.
• Furthermore, the price of both Gallium and Germanium has barely moved over the last two months underlining the market’s belief that it can get these minerals elsewhere if needed.
• Chinese exporters now have to get a licence and disclose to the Chinese state who the customer is and the user of the mineral, but it looks like the state of affairs is returning to normal.
• The world is now much more wary with regard to depending on China for raw materials and this event will have only served to ensure that back-up supply can be available if needed even if one has to pay slightly more for it.
• The lack of price action indicates that market participants thought that this was a storm in a teacup, and it looks like they have been proven right.
• Unless China can establish control of essentially all of the reserves of an essential mineral, the restrict strategy is unlikely to bear fruit as in this case.
• If the Chinese state is serious about proper retaliation, its most effective move would be to ban imports of all of Apple’s and Qualcomm’s products into China.
• While this would have a real impact on the USA, it would probably do more damage to Chinese companies as well as the state’s standing with the population.
• Hence, we see this is a very low risk although recent events have led us to think that the risk of an Apple ban is rising slightly.
• This continued rivalry means that the days of global standards are numbered and going forward we are likely to see one standard outside of China and another, competing, and non-compatible standard inside China.
• This is bad news for everyone as two incompatible networks will generate much less value than one global network.
• Consequently, long-term growth for the entire technology sector over the next 10 to 20 years will be lower than it otherwise would have been.