The US and China are fighting a trade war, contrary to my expectations, and to the consternation of equity markets, which on Monday had their worst day since January 3. The broad market gauges fell by 2.5%, and the tech sector fell by 3%, led by semiconductors.
In tweets Monday morning and again during a press briefing with visiting Hungarian President Viktor Orban, President Trump reiterated his view that China’s economy was weak while America’s economy was strong. He believes that tariffs will shift trade out of China and to some extent back to the United States.
President Trump wants to restore a past in which America dominated world manufacturing, and his negotiating strategy recalls the Parker Brothers game Monopoly, in which players attempt to extract rents. China is playing the ancient strategy game of Go, with the goal of technological supremacy.
Both sides have vulnerability and both will suffer lower growth in a trade war, as presidential economic adviser Larry Kudlow indicated in televised remarks on Sunday. But China hopes to come out of the trade war with an unchallengeable lead in semiconductor manufacturing and design. If it succeeds, it will become not only the dominant economic power but the dominant military power as well.
Monday’s losses on the equity market mirror America’s vulnerability.
The biggest loser was the chip design firm Nvidia, followed by Apple, Caterpillar, Texas Instruments and Boeing. Semiconductor firms were the sector hit worst by the trade war. Financials also plunged along with bond yields. Lower term yields cut into the profits of lenders, and financial stocks have moved inversely with yields.
The US has pursued both a trade war (over China’s trade surplus with the US, theft of intellectual property and barriers to foreign companies) and a tech war, the latter aimed at China’s premier telecom equipment maker Huawei.
Huawei is the spearhead of China’s Belt and Road Initiative, which employs mobile broadband as well as transportation infrastructure to remake developing countries on the Chinese model. Huawei is the clear leader in 5G broadband, and the US has tried to cajole and threaten its allies into excluding Huawei. Continental Europe, as well as the UK, have ignored American demands, and the exercise amounted to the worst humiliation for American diplomacy since the ignominious end to the Vietnam War.
It does not seem to have occurred to Washington that Huawei became the dominant player in telecom equipment with virtually no access to the American market. China’s nearly $500 billion of exports to the US consists mostly of consumer electronics assembled in China from imported components; America buys 5% of China’s manufacturing output, but the contribution to value added is low. The high-value-added industries that China is now fostering are sold to Asia and Europe. Huawei overtook Apple as a smartphone manufacturer during the first quarter although it sells almost none to the US.
By contrast, America’s flagship chip design firms are overwhelmingly dependent on the Asian market. Most of Nvidia’s and Qualcomm’s revenues stem from Asia, not the United States. These firms set the world standard for handset and data processing chips, until late last year, when Huawei released its Ascend chips for large-scale data crunching and smartphone handsets.
In early 2018, the US nearly shut down the smaller Chinese handset maker ZTE by banning the export of Qualcomm chips to ZTE. By the end of 2018, China was self-sufficient. An independent Japanese study rated Chinese semiconductors the equal or superior to Apple’s.
Semiconductor stocks crashed on Monday because investors fear a semiconductor price war. Huawei steamrolled the competition in telecommunications equipment by cutting prices and seizing market share, and is now in position to do the same thing to America’s most advanced chip designers.
America has very little chip fabrication capacity left (it shipped 25% of the world’s semiconductors in 2011 but only 10% in 2018), but until recently held an edge in design. America may lose that as well. China doesn’t have to use tariffs or other impediments to shut the American firms out of Asia. Huawei is in position to crush the competition on price.
President Trump is correct to argue, as he did, that manufacturing will shift from China to Vietnam and other countries on which the US does not impose tariffs, but that’s old news. Chinese firms have been shifting low-wage, low-value-added assembly industries to Vietnam for the past five years. In 2014 Vietnam’s exports to China were just an eighth of America’s exports to China, but today they are almost half as large.
If President Trump imposes 25% tariffs on the whole range of China’s exports to the United States, the Chinese economy will suffer some reduction in growth, and China will have to find ways to employ semi-skilled workers who now assemble consumer products for the American market. That will be uncomfortable, and China’s leadership clearly would prefer to avoid the problem. But if China believes that it is forced into a trade war, it will absorb the pain. Its trade war strategy will attempt to undermine key areas of American technological leadership.
America presently offers no competing product in the 5G broadband arena. It has urged its allies to work with Ericsson and Nokia, the main alternatives to Huawei. Sadly, Washington isn’t fooling anybody. Ericsson and Nokia offer products that cost more and offer less functionality than Huawei’s. They source their hardware in China (which means that if China wanted to plant “back doors” in their chips to steal data, it could do so as easily as with Chinese companies). They remain in business because Huawei prefers the appearance of competition and engages Ericsson and Nokia in consortia for major projects.
To my knowledge, there has been no discussion inside the Trump Administration of reviving semiconductor fabrication in the US, an industry that the United States invented and developed before it migrated to Asia. Asia, and particularly China, is poised to lead the design and production of 5G handset chips, the creation of national 5G networks, and the development of industrial as well as military applications.
The weakness of the dollar, as I pointed out last week (“The Dollar That Didn’t Bark”), is disturbing. Global Times editor Hu Xijin tweeted Monday that Chinese scholars are studying the possibility of dumping US Treasuries. They can study it all day, but they won’t do it; if China tried to start a run on the Treasury market, it would create so much havoc that demand for Treasuries would increase.
Nonetheless, the shift towards dollar alternatives, notably gold and the Japanese yen, is an unusual development. The dollar usually acts as a safe haven in times of stress, and the dollar’s weakness during the past several trading sessions points to American vulnerability.