Poking the Chinese Bear

If you think a war with Russia is all we have to worry about, think again.

The US just pulled the most significant provocation of war since the Cold War.

On October 7, Washington banned the US and its allies from exporting microchips and their technology to China —a severe escalation that we predicted back in July. 

But what the media reported is just the “official” tip of the iceberg. 

What happened off the record, in effect, paralyzed all of China’s chip sector and potentially slowed its development by a decade. Overnight. 

With his back to the wall, China’s Xi Jinping – who just secured his third term – may now have no choice but to respond.

But how?

We’ll try to answer that today, but first, let’s talk about the semiconductor trade war.

China’s crippling chip industry 

On October 7, the US Department of Commerce slapped an all-out embargo on all China-bound chips.

In short, the new rules prohibit American chip makers from selling chips and their manufacturing equipment to China. Even allies that make chips using American technology in their assembly line will have to obtain licenses to ship to China.

In fact, ASML—the world’s only company that manufactures the Extreme Ultra Violet (EUV) machines used to produce the most advanced chips—has stopped providing services to its Chinese clients:

These ASML-made EUV machines are required to produce all of today’s modern chipsets. And by many estimates, ASML will have a complete monopoly over them for at least five years.

This is why the US has long been pressuring ASML to stop trading with China. 

In 2019, Trump banned the Dutch government from selling these machines to mainland China.

And now Biden has compelled the company to cut all support and services. 

The justification for this protectionism is that China will use these advanced chips to make AI weapons and surveillance technology.

Via US Department of Commerce:

“The PRC has poured resources into developing supercomputing capabilities and seeks to become a world leader in artificial intelligence by 2030. It is using these capabilities to monitor, track, and surveil their own citizens, and fuel its military modernization,” said Assistant Secretary of Commerce for Export Administration Thea D. Rozman Kendler. “Our actions will protect US national security and foreign policy interests while also sending a clear message that US technological leadership is about values as well as innovation.”

In other words, fearing that China will beat the US in the AI game, the Biden administration has effectively bound all American companies and its foreign partners to collectively embargo China.

And those are just the “official” measures. 

In a Twitter thread translated from a Chinese tech insider, Jordan Schneider, a closely followed China analyst, revealed the real scale of Biden’s initiated trade war with China.

Long story short, all American citizens who worked in the Chinese chip industry received the order to quit immediately or lose their American citizenship. 

And just like that, the entire American staff in China resigned almost overnight.

As a result, since October 7, China’s semiconductor industry has been paralyzed.

As Schneider tweeted, “China’s semiconductor manufacturing industry was reduced to zero overnight. Complete collapse. No chance of survival.”

Why chips are so important for China?

A few decades ago, chips were just this niche, high-tech thing. But that technology has now “computerized” almost every gadget in our lives and have become a staple commodity. 

Even things as mundane as kettles and lightbulbs have microchips in them.

Now, if you want to make a kettle that displays the water temperature on an LCD, you need a microchip. But for something so simple, you can use microchip technology that has been around for decades. 

But if you want to build gadgets with more computing power, you have to use chips built using the 10nm (or less) process. 

For example, Apple’s new iPhone 13 is powered by TSMC-made 5nm class chips. 

But even the smallest chip in an iPhone isn’t enough to fully power next-gen technologies like AI or quantum computing. By many estimates, the 5nm process is the bare minimum to tap into these technologies. 

This has vast military implications.

AI-driven missiles, artillery, autonomous combat machines, and even robo-infantry are the future of warfare. And all of these future weapons will run on 5nm or smaller chips.

Losing access to these chips today is like running out of steel during WWII. No matter how far ahead you were in weapon innovation, if you didn’t have plate steel to piece together combat machines, you couldn’t fire a single shot. 

China is emerging as the global leader in AI, and XI Jinping wants to use its tech superiority to modernize its arsenal. But just because he can innovate, it doesn’t mean he can produce that technology at scale.

And that’s China’s Achilles’ heel. 

As I wrote in “A Battlefront for the New Global Order”:

“Last year, Alibaba designed its most advanced 5nm Yitian 710 chip. Baidu, China’s Google, released a 7nm chip called Kunlun 2. And Oppo, the Apple of China, is reportedly working on a revolutionary 3nm circuitry.

But while China can design chips, it doesn’t have leading-edge foundries to produce them at scale. So all they can do is contract TSMC and a few other makers to manufacture their designs.

Industry experts think it will probably take a decade or so for China’s chip foundries to catch up to TSMC – and by then, there may be even better technologies, making China always a few steps behind.”

That’s right. 

It might take China a decade to build a self-reliant domestic chip industry. In the meantime, it has to source chips from elsewhere…peacefully or possibly by force. 

Will China invade Taiwan for chips?

EUV foundries are the next battlefield in the West-China confrontation.

And the world’s biggest EUV foundry sits on the west coast of Taiwan—China’s long-sought invasion target. 

As we mentioned in July, Taiwan is home to the world’s most important company and largest semiconductor maker, TSMC. It prints over half of all chips globally for tech giants like Apple and Samsung.

So naturally, all the pundits jumped to the conclusion that China would invade Taiwan and take over TSMC foundries. 

But the thing is, China’s solution to chip dependency isn’t as simple as invading Taiwan. 

For starters, being on the western coast, TSMC probably falls within China’s artillery range. And if China sets out to fully invade Taiwan, not just spook it, TSMC could become collateral damage. 

Even if China invaded Taiwan without blowing up TSCM, it couldn’t make use of it for long. 

While TSMC has the world’s biggest chip production facilities, it still sources most of its manufacturing equipment from the West, including the Netherlands’ ALMC. And without the West’s supplies, TSMC would lose its capacity, let alone have the ability to scale.

Via Bloomberg

“Chen Ming-tong, director-general of Taiwan’s National Security Bureau, told lawmakers on Wednesday that it would be useless to take over facilities from Taiwan Semiconductor Manufacturing Co. if Beijing took control of the island. TSMC is highly integrated with the global supply chain, including suppliers such as ASML Holding NV of the Netherlands, so the US and other countries would be able to choke off its production without getting rid of its plants, he said.”

In the worst case, if China ever took over Taiwan, the US could destroy TSMC with ballistic missiles. In fact, some US officials have suggested explicitly warning China that if it invades Taiwan, the first thing the US will do is destroy TSMC. And while this will be a major blow to both economies, this will undoubtedly will hurt China more than it would hurt the US.

So contrary to what the mainstream media claims, China likely won’t go head-on into war with Taiwan because of the chips.

But that doesn’t mean Xi Jinping can’t respond—if for no other reason than his long-term vision.

So then, how will China respond?

If it came down to it, we would not be surprised to see China retaliate by cutting off supply chains.

China currently controls 80% of the global supply chain of rare earth elements necessary to build high-tech components. That means many of our technologies (including iPhones) require metals from China.

China exports also represents a significant portion of cheap goods to Americans. For example, it is estimated that 70-80% of all products from America’s largest retailer, Walmart, are made in China. And during a time of already high inflation, China could raise the cost of these goods significantly.

While shutting either of these supply chain off would be a major blow to China, it would also be a major blow to the US. But as the saying goes, “If I go down, I am taking you with me.”

In other words, China’s quiet-to-no response to the recent chip ban likely means it already has something prepared.

It’s hard to predict what will happen in the short term, but consider the following.

China is an autocratic regime whose policy is predicated on the whims of one dictator, not the collective interest. As such, war-gaming as to what would make the most sense for China won’t cut it. 

History shows that China’s dictators have a long record of making seemingly illogical short-term sacrifices to save communist rule.

But in the long run, Xi isn’t as unpredictable. 

In fact, he has a well-defined mission of going down in history with what he calls the “great rejuvenation of the Chinese nation.”

Imperialistic buzzwords aside, he wants to counterweight the West and become the world’s number 1. 

In his 2017 once-in-five-years address to the National Congress, he laid out a clear timeline for his grand vision.

Via Warontherocks:

“By the Party Centenary in 2021, China should “finish building a moderately prosperous society in all respects.” By 2035, China should be much stronger economically and technologically, have become a “global leader in innovation,” and have completed its military modernization. By the People’s Republic of China Centenary in 2049, China should have “[r]esolv[ed] the Taiwan question” and be a “strong country” with “world-class forces.” 

And in his address a few weeks ago, he explicitly reiterated his unconditional devotion to this vision.

He promised to achieve supremacy in key technologies, which obviously included chips: “We must speed up technological progress and self-reliance. We must pool our resources and focus on key areas to achieve breakthroughs, so that we can win the race in core technologies critical to our national strategy,” he said.

And he vowed to reunify the Chinese nation:

“We will continue to strive for peaceful reunification with the greatest sincerely and the upmost effort, but we will never promise to renounce the use of force, and we reserve the option of taking all measures necessary. The wheels of history are rolling on towards China’s reunification and the rejuvenation of the Chinese nation. The complete reunification of our country must be realized and it can without a doubt be realized.”

Poking the bear 

Can China pull the trigger anytime soon?

On the one hand, Xi Jinping has proven himself as someone willing to play the long game. And he knows his export-driven economy is now too weak to bear the West’s sanctions.

It isn’t a coincidence Xi set China’s reunification (meaning Taiwan’s invasion) as his last milestone so far out in 2049 only when China will be a “strong country” with “world-class forces.” 

On the other hand, America’s chip embargo strikes at the heart of Xi’s grand vision because losing access to the most crucial tech commodity puts his regime at risk of falling behind once again.

And I’m not sure how long this bear will stand being poked before it starts swinging its claws.