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US ‘decapitates’ China’s semiconductor industry: Should investors be concerned?

26 October 2022

New sanctions prevent US companies from supplying technology for advanced chips and ban American citizens from working in China’s semiconductor industry.

By Anthony Luzio,

Editor, Trustnet Magazine

Most of the media coverage around China is currently centred on the 20th Chinese Communist Party (CCP) congress, at which premier Xi Jinping announced he would turn the country away from the rapid growth of the past four decades and towards self-sufficiency.

Yet analysts warned this aim may have suddenly become more difficult after new sanctions introduced by the US drove an “industry-wide decapitation” of China’s semiconductor industry.

The rules prevent US companies from supplying technology for advanced chips in China and ban American citizens from working in the sector.

“Every American executive and engineer working in China’s semiconductor manufacturing industry resigned on [13 October], paralyzing Chinese manufacturing overnight,” wrote Rhodium Group analyst Jordan Schneider, translating from the original Chinese.

“One round of sanctions from Biden did more damage than all four years of performative sanctioning under Trump. This is what annihilation looks like: China’s semiconductor manufacturing industry was reduced to zero overnight. Complete collapse. No chance of survival.”

The sanctions will stifle China’s artificial intelligence and super-computing capabilities, which are predicted to become key areas in asserting military dominance in future.

But what about the impact on investors? China’s tech sector plummeted last year on heavy-handed state intervention, so could these sanctions deliver a further blow?

To begin with, most analysts admitted that China’s semiconductor industry may not be strong enough to survive such a significant headwind.

“Despite setting the development of a domestic semiconductor supply chain as a high strategic priority, China continues to lag severely in this regard and the new legislation will just serve to exacerbate this reality,” said Ewan Thompson (pictured), manager of the Liontrust Emerging Markets fund.

“China’s state-owned foundry national champion Semiconductor Manufacturing International Corporation (SMIC) will face huge issues moving forward into more advanced-level chips without access to extreme ultraviolet lithography equipment, which it currently imports. While it’s conceivable that China can make progress on chip design, catching up on the equipment side will be extremely challenging.”

William Warren, manager of the Artemis US Extended Alpha fund, accepted that China’s semiconductor industry was underdeveloped even before the sanctions hit. But on the plus side, he said this meant it had no strategic importance to the country’s infrastructure and so the impact of the sanctions on the economy would be limited.

“They weren't really making a huge amount of progress with the most advanced technologies to begin with,” he explained. “It's not like they will wake up tomorrow and say, ‘Oh, wow, we were so close. What now?’

“These latest sanctions do a lot more damage to that end goal of becoming a global exporter of competitive semiconductors than to the goal of self-sufficiency.”

Andy Rothman (pictured), an investment strategist at Matthews Asia, agreed with him.

“The vast majority of the chips consumed in China, the kinds of things that go into automobiles and appliances, are relatively low tech. This is not going to interfere with that,” he said.

“Talking to semiconductor engineers, the view I've heard is that this will make high-level computing in China take a little bit longer and consume a bit more power in the near term, but companies will be able to get by.”

Instead, he is more concerned about what the sanctions say about the direction in which the US/China relationship is heading.

“I think that the intention of the Biden administration is to try to slow down Chinese economic growth as part of its plan to better compete. I think it's unlikely to be successful in the long term,” he continued.

“China could retaliate by restricting access to rare earth metals or polysilicon which goes into solar panels, but that's not my expectation.

“I don't look at this as something that is going to derail an economic recovery once the Covid situation is resolved.”

Thompson said the elephant in the room is that both China and the US rely on a single Taiwanese company, TSMC, for “the very building blocks of modern society”: it is responsible for about 50% of the global foundry market, with Korea’s Samsung Electronics the next largest at 16%.

And, while the US is encouraging TSMC and Samsung to invest in facilities on the American continent, the manager said the economics of production outside of Taiwan are inferior, even after subsidies.

“This leaves TSMC as a vital strategic asset to both countries and a huge risk to either side if the geo-political situation deteriorated such that there were outright military hostilities over China’s claim on Taiwan,” he explained.

“Given this excessive reliance on Taiwan and TSMC, the US essentially has a huge national security risk to deal with and these recent moves to bolster domestic US semiconductor manufacturing capabilities – and curb China’s own technological advances – hope to address this, though in reality it will be a decades-long process.”

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