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The London Brief - October 23rd, 2022

The London Brief

October 23rd, 2022

A sign outside the pub says, “Carpenters urgently required… Cabinet falling apart – apply to 10 Downing Street. No tools required; the building is full of them!” Meanwhile bond and share markets volatilely gravitate. One strategist remarked, "Investors are close to the point where all they want to be is hugged."

But while markets focus on inflation and whether the UK is the canary in the coalmine for Tolkeinesque battles between bondholders and sovereigns, a development that got less coverage were the new export control restrictions related to Chinese semiconductor companies.

The Nuclear Strike

The new restrictions impact logic devices at 16/14 nm or less, DRAM at design rules of 18 nm or less and NAND process at 128 layers or more. Jefferies calculates that of $18 billion of projected investments by Chinese companies in 2022, about $5 billion could be impacted.

However, more importantly, the nuclear strike is this language:

BIS is notifying U.S. persons that the prohibitions at EAR Section 744.6(b) are triggered by the provision of certain support related to semiconductor manufacturing in China. EAR Section 744.6(b) prohibits U.S. persons, absent licensing, from providing support for certain end uses and end users, including weapons of mass destruction-related end uses, even where the activity does not involve any items subject to the EAR. “U.S. persons” include U.S. legal entities and their non-U.S. branches; individual U.S. citizens, lawful permanent residents (“green-card” holders), and protected individuals as defined by 8 U.S.C. 1324b(a)(3), no matter where located or employed; and persons present in the United States.

The Advanced Computing and Semiconductors Rule informs U.S. persons that a license is required for the following activities, which “could involve ‘support’ for the weapons of mass destruction-related end uses” specified at Section 744.6(b):

  • Shipping, transmitting, or transferring, or facilitating such movement, to or within China, or servicing, any item not subject to the EAR with knowledge that the item will be used in the development or production of ICs at a fab in China that produces ICs meeting any of the following criteria:

    • Logic ICs using a non-planar transistor architecture or with a “production” technology node of 16/14 nm or less;

    • NOT AND (NAND) memory ICs with 128 layers or more; or

    • Dynamic random-access memory (DRAM) ICs using a “production” technology node of 18 nm half-pitch or less.

  • Shipping, transmitting, or transferring, or facilitating such movement, to or within China, or servicing, any item not subject to the EAR and meeting the parameters of any ECCN in Product Groups B, C, D, or E in Category 3 of the CCL with knowledge that the item will be used in the development or production of ICs at any fab in China where the U.S. person does not know whether the fab produces ICs meeting the criteria above.

  • Shipping, transmitting, or transferring, or facilitating such movement, to or within China, or servicing, any item not subject to the EAR and meeting the parameters of ECCN 3B090, 3D001 (for 3B090), or 3E001 (for 3B090) regardless of the end use or end user.

No license exceptions overcome these license requirements. However, in limited circumstances certain support may be provided by employees or contractors of a department or agency of the U.S. government without prior licensing. License applications will be subject to a presumption of denial, except for end users in China that are headquartered in the United States or a country in Country Groups A:5 or A:6, which will be considered on a case-by-case basis.

According to my Beijing counsel, there are over 1,000 Chinese Americans on the sites of Chinese fabs or are embedded in the industry that hold green cards or are citizens of the U.S. Renouncing U.S. citizenship is possible, but it takes four or five years, so they would be breaking U.S. law if they stayed employed. Others have family or assets in the U.S. and will quit. Unless the BIS relaxes the restrictions, Chinese sources say this would practically kill China’s advanced chip-making and compromise many lower technology fabs.

Control Risks said, “The technology is nothing without the people there to make it work.” The Wall Street Journal said there are 43 senior executives working with 16 publicly listed Chinese companies who are American citizens, working in C-suite roles. These executives will now have to choose between U.S. status and their jobs. Gerald Yin, founder of Advanced Micro-Fabrication Equipment, is a competitor to Lam Research and Applied Materials. He is focused on creating etching machines. He and six other executives are U.S. citizens having worked at Intel and Applied Materials. GigaDevice Semiconductor designs flash chips used in automobiles and personal computers; the top two executives hold U.S. passports. KingSemi, which produces the most advanced coating and development equipment, has an executive director with a green card. KLA and Lam Research have suspended the work of engineers and other less senior staffers in China. Yangtze Memory has a Santa Clara office with more than a dozen U.S. employees. Apple has said they will not source memory chips from Yangtze now. TSMC suspended the production of advanced silicon for Chinese start-up Biren Technologies. UMC’s founder, Robert Tsao, poured money and technology into China two decades ago and renounced his Taiwan identity card for Singapore. Today, he has taken back his identify card and donated $100 million to train 3.3 million “civilian warriors”. My sources also say that Korea, Japan and Europe are considering similar export controls on chips on growing concern on an attack on Taiwan, and China’s support of Russia in the Ukraine conflict.

China imported $466 billion semiconductors in 2021. China can only manufacture a quarter of the chips it needs and much of it comes from foreign-owned fabs. China has 170 supercomputers powered by Intel CPUs, except for one, which is an AMD CPU. Gavekal Group suggests that the limits would cause China to lose the capability to make chips beyond a technology level dating to 2014.

In his party speech, Xi twice mentioned the need for “self-reliance” in technology. China must be prepared for “strong winds and high waves and even dangerous storms.” Hu Weiwu, founder of Chinese chip design firm, Loongson Technology Corp., and one of the delegates at the Communist Party Congress said, “If China does not have its own industrial information technology system, it’s just like growing crops on someone else’s land. The control is entirely in their hands.” He advocates for the development of the country’s own industrial information technology system independent from the widely adopted Intel-Windows and Android-Arm structures. “Some products are like raising pigs, and they can be sold in one year. Some products are like raising cattle, and they can work in the fields after raising them for three years. But some products are like raising children. Building CPUS is like raising a child. It takes 30 years to see a child make real achievement.” (Must be tough being a child in his house). “I was like Don Quixote that held a long lance named Loongson tilting at two windmills, Intel and Arm”. Weiwu is advocating against a “copy it” strategy and going alone. An excellent new book called Chip War: The Fight for the World’s Most Critical Technology by Chris Miller suggested that because of its “copy it” strategy, the Soviet Union was constantly behind the U.S. in transistor technology. A popular book in China is called The Three Body Problem by Liu Cixin. This a science fiction book where the Trisolarans try to stunt Earth’s development by limiting its access to technology, a metaphor to U.S. chip dominance.

However, the Soviets had other issues besides copying. First, Western allies established an organization that prohibited the transfer of many advanced technologies including semiconductor components. As a result, Soviet facilities had to work with less sophisticated machines and materials that were less pure, producing far fewer working chips as a result. Today, ASML has 100% market share in extreme ultraviolet lithography machines (a product of a U.S. acquisition). Replicating its equipment is a herculean task. Second, Soviet foreign exchange students could become smart physicists, but only Silicon Valley engineers knew at what temperature certain chemicals needed to be heated, or how long photoresists can be exposed to light. Every step of chipmaking involved specialized knowledge that was rarely shared outside of a specific company. The “know-how” was not written down anywhere. China would have to do countless experiments to figure this out. Finally, in Silicon Valley people job-hopped and gained practical “on the floor” experiences. Getting rich and entrepreneurial activity was key to the creativity and drive that went into chip development. In Russia, on the other hand, a politically influential bureaucrat called the shots from a desk. Career advancement required becoming a better bureaucrat. Many Russian scientists were frustrated by the politics and had little motivation to take risks.

China starts at a much better place, having used its economy to extract knowledge and attract talent, but it will be harder from here.

Loyalty Over Capability

Cynthia Lau, a Goldman strategist, used tea leaf analysis to suggest that Xi’s power may be curtailed. Boy was she wrong. Instead, we have gone “Maximum Xi”.

Xi and his allies swept all the Politburo Standing Committee positions. This increases the probability of poor policymaking and bad decisions particularly as none of the appointees have economic experience or believe in liberal economics.

Xi Jinping stays as General Secretary. The ranking order of the CCP Politburo Standing Committee after Xi are Li Qiang, Zhao Lefi, Wang Huning, Cai Qi, Ding Xuexiang and Li Xi. Li Qiang was promoted to premier. His “accomplishment” is locking down Shanghai for two months under zero-COVID which prompted food shortages and clashes between people and health workers. But he implemented Xi’s decrees loyally, which is all that mattered. Li overlapped with Xi in Zhejiang. He spent his entire career there until Xi promoted him in 2016 to head Jiangsu Province. The old premier, Li Keqiang, was booted. Zhao Leji is from Xi’s ancestral homeland in Shaanxi Province and accounts are that his father was a friend of Xi. He became the youngest provincial governor in 2000. In 2012 he was chosen to head the organizational department where he helped promote Xi supporters to top positions in Beijing and Chongqing. Wang Huning is an ideology czar famous for drafting the “Three Represents” under Jiang Zemin, “Scientific Outlook on Development” for Hu Jintao and Xi Jinping’s “Chinese Dream”. His idea is that authority must be concentrated at the top to promote reform, Xi’s political ideology. Beijing Party Chief Cai Qi worked under Xi in Fujian and Zhejiang. In 2014, he moved to Beijing to work at the CCP National Security Commission, started by Xi. Ding Xuexiang is one of Xi’s key aides. He accompanied Xi on trips to Hong Kong and Xinjiang and worked under Xi in Shanghai in 2007. Li Xi got to know Xi when he would accompany provincial party Chief Li Ziqi to visit Xi’s father in Beijing and Shenzhen. He impressed Xi by trying to make Liangjiahe, the village where Xi spent his youth, a “sacred place”.

Vice Premier Hu Chunhua, or “Little Hu” was dropped from the Politburo, a sign of demotion. He was well-regarded by analysts and foreign executives who saw him as an advocate of relatively liberal economic policies. His patron, Hu Jintao, seems to have been forcibly removed at the end of the meeting, reportedly for health reasons. Eurasia, a political strategy service, noted these events are well coordinated so it was unlikely he was removed forcibly. However, in a dinner I had with Matt Pottinger, former National Security Advisor in charge of China affairs, he noted that Xi dislikes Hu Jintao and the China Youth Federation. These members are not sons and daughters of the original revolutionaries. Pottinger’s view is that Xi and the other princelings believe they are the proper rulers of China and that Hu Jintao’s rise was an affront to the natural order. The facial expressions of people while the incident was taking place do not indicate people were worried about Hu’s health. Li Zhanshu, who sat next to him, stood up to help or assist, but his colleague pulled him back down. As Hu passed Li Keqiang, the former Premier, he touched him on the shoulder, and Li looked like a zombie had attacked him. We’ll probably never know the truth. Two other rivals, Jiang Zemin and Zhu Rongji, were notably absent from the event.

Xi twice mentioned the need to “balance development with security.” He also emphasized “dual circulation” goals driving growth through domestic demand, a nod to concerns about decoupling from the West and building the “resilience and security” of supply chains. “We will focus on national strategic needs, gather strength to carry out indigenous and leading scientific and technological research, and resolutely win the battle in key core technologies.”

The WSJ in an October 13th article cited people familiar with Xi’s thinking that he sees a showdown with the West as increasingly likely. Xi has invoked an aphorism of Mao: “Don’t fight unsure wars, and don’t fight unprepared battles.” He has installed trusted lieutenants at every level of the ruling Communist Party and has weeded out foreign influences in Xinjiang and Hong Kong. He has reorganized the People’s Liberation Army, doubled its budget, and begun to enhance China’s nuclear arsenal. He launched a society-wide campaign to promote toughness, punish criticisms of the military and prevented young men from wasting their time playing video games. This is so China can be combat-ready for Taiwan in case it declares independence.

Hui Feng who co-wrote The Rise of the People’s Bank of China, said, “One-man rule is now complete. Even who will become premier is not that relevant anymore. Economic policies will be less of technocratic policymaking and succumb to political statecraft. China is indeed in a new era.” There are now fewer voices to question zero-COVID, tighter control over the private sector and more assertive foreign policy like going after Taiwan. Not one woman was chosen for the Politburo.

Xi Jinping said, “Taiwan is China’s Taiwan. Resolving the Taiwan question is a matter for the Chinese, a matter that must be resolved by the Chinese. We will continue to strive for peaceful reunification with the greatest sincerity and the utmost effort, but we will never promise to renounce the use of force, and we reserve the option of taking all measure necessary… External attempts to suppress and contain China may escalate at any time.”

American companies are rethinking their investment plans in China. Eswar Prasad, a Chinese expert at Cornell said, “I see some dark days ahead as Xi now turns to rallying the country behind his muscular foreign policy vision.” Norio Nakajima, head of Japanese electronic component maker Murata Manufacturing, summed up his concerns over the U.S. curbs in an interview with Nikkei Asia: "The world is decoupling at a faster pace than I had feared."

End Note

Liz Truss is now Britain’s shortest ruling prime minister losing to a cabbage in longevity. A loss for the Conservative Party, but a victory to farmers and the improving half-life of vegetables. The aubergine has been chosen in the event Boris Johnson is reinstalled as Prime Minister.

Omar Sayed

Cobham, Surrey

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