The elephant in the room: Brewing cold war and huge risks facing tech firms

Strong signals for broadening tech export restrictions to China  
Although earnings season is upon us and this one should prove particularly tricky, the latest geopolitical developments are just too important not to address this week. President Biden’s pledge to protect Taiwan if it came under attack by China, live on CNN, has huge implications that we think takes us a step closer to a second cold war. This policy change could prove highly disruptive to global trade, especially in the technology field where the battle lines have already been drawn.

Although the White House spokesman later clarified that there has been no official change in policy outlined by Taiwan Relation Act of 1979, the message to China was still fairly clear and it leaves Japan at centre stage of the new Eastern front. This will give Japan much leverage in its trade and currency policies with its Western allies but that’s another subject for later publications. The Biden Administration also named a respected China hawk, Nicholas Burns for its Beijing envoy. Burns has strong bipartisan congressional support and has praised Trump’s government for QUAD and other initiatives to wake up the establishment to China’s growing threat.

Interestingly, the US Commerce data released by the House Foreign Affairs Committee’s lead Republican last week unveiled that the Commerce Department issued more than $100bn worth of export licenses for semiconductors and others to suppliers of Huawei and SMIC between November 2020 and April 2021. As we have also noted previously, China now accounts for 30% or more of SPE order books among the Japanese companies which we follow. This latest US data clearly shows that even those Chinese firms named as a major security risk by the US have continued to have access to American (and Japanese) semiconductor production equipment and materials which are advanced enough to churn out chips for defence applications.

This could also explain why we have seen this major hoarding and front-loading of capital goods budgets, particularly in semiconductors-related and automation fields by the Chinese. We think this is a likely human behaviour when fear of supplies being cut off becomes a key consideration for survival. But even here, we are seeing evidence of a slowdown which could prove more painful if there has been over-ordering which could have greatly distorted the market in the near term. 

We think these lax US export laws are coming under closer scrutiny as pressures mount to slow China’s technological advance. Indeed, the latest Weekend FT reports that US intelligence officials have already launched a campaign to warn US firms about risks of dealing with Chinese buyers in critical industries such as AI, quantum computing, biotechnology, semiconductors and autonomous systems. These developments are clear warning signals to investors that broadening of export restrictions of technology to China seems a highly realistic and probable risk that is not at all priced into earnings estimates of major semiconductor firms.