Globalization and technology have been the two forces in recent decades driving economic growth and low inflation. The rise of China has been a major part of this process. With its sanctions on US tech exports to China and the passage of the so-called Chips Bill, the US has taken a sledge hammer to both globalization and technology.
The market has already adjusted semiconductor stock prices down in response to the announcement of these new sanctions. But these are short term reactions. The sanctions and deglobalization that lie ahead for this industry caste a long term negative over the entire stock market.
Tom Friedman of the NY Times has called computer technology the foundational technology of the information age. Massive non-linear increases in computer power– popularized by Moore’s Law– underly much of the overall economic progress of recent years. In other words, most of the economic progress of recent decades wouldn’t have happened without ever more powerful computers. Today’s mobile phones for example, which are high powered mobile computers, wouldn’t exist.
Historically, over time the US stock market has continued to rise. But there are bad periods when it didn’t. For example years like 1929-1953 and 1966-1981 when buy and hold US investors on average didn’t offer any capital appreciation. This destruction of the semiconductor ecosystem could be a long run negative that helps bring on one of those bad periods..
The computer industry had its origin in the United States but over the last decades has become a US-led marvel of international economic efficiency. David Ricardo, the author of comparative advantage, would be thrilled. Simplifying, the US designs the chips and Asia manufactures them. And increasingly, China is the number one customer. This arrangement is not a static one. If not interrupted by political interventions in the future as China gains expertise it will be more than just a customer. Especially in key areas like Artificial Intelligence (AI). This means more global competition. Human progress would take a great leap forward. An economist’s dream.
Unfortunately, the US with its China tech limits is now doing its best to destroy this idyllic Ricardian system. China should be kicked out and forced to resort to what economists call import substitution. In other words build its own computers. Import substitution is a time honored loser. China will have to settle for homegrown “Brand X” in computer technology.
Score one for the China haters. But the US will be a big loser as well. The sanctions mean billions of dollars in lost sales for US companies. Which in turn means huge cutbacks in research by US companies. So much for non-linear improvements in computer chips. And expect a slowdown in global economic progress.
Non-US semiconductor companies will of course attempt to replace US companies in the Chinese market. Although the US government is reportedly in the process of trying to bully them into not exporting to China. In other words cut your own throat for Uncle Sam. Otherwise Uncle Sam may cut your throat for you!
David Goldman of the Asia Times makes the following interesting points:
“US godfather makes a chip offer you can’t understand. New US chip bans on China show a thuggish ignorance of the targeted technologies and their military applications.”
Goldman argues that the US officials who issued the regulations didn’t understand the industry. This makes the situation worse. What in my opinion is motivating the US officials is a dislike of Chinese people and culture.
For US investor, the semiconductor sector will become a less interesting, less innovative place to invest. Subsidies from the US government to bring semiconductor foundries “home” will result in less efficient facilities on US shores. Morris Chang, the founder and now retired CEO of Taiwan Semiconductor, argued against TSMC succumbing to US pressure and handouts and building a foundry in the US. Unfortunately, his company didn’t listen. The “hero” for the US government will be Pat Gelsinger who is CEO of the once iconic but now mediocre Intel. Gelsinger never met a government subsidy he didn’t like and welcomes US protectionism against Chinese technology.
Industrial Policy Is Chinese Policy
Industrial policy has been defined as a government led program to support specific industries deemed to be of strategic importance. This contrasts with the free market approach where market forces based on expected risk and return determine capital allocation.
In China industrial policy is the policy and it is hardly a model of efficiency. The communist party and the state make the strategic decisions regarding capital allocation. In some ways this is an old story. China has a five thousand year history of top down rule by emperors where individuals and private property have no rights. The current draconian anti-virus lockdowns would not be possible in the West where individual rights are enshrined. (Though not always respected)
Much depends on the policies of the current emperor. Under Deng Xiaoping some room was allowed for the market. But the good old days of Deng Xiaoping’s “to be rich is glorious” have been replaced by Xi Jinping’s “common prosperity.” Billions of dollars have been lost in stock values by heretofore star companies such as Alibaba.
Xi Jinping claims to still be in favor of Chinese style capitalism and foreign investment in China but so far has shifted way left. At a recent exposition in China Xi said China offered “big opportunities for foreign investors.” Time will tell if he means it.
I believe China is investible. But investors—especially American investors– have two political risks. The first is that the Chinese government will swing further left. The second is that some yahoo in the American government will put the Chinese stock you own on one of the US’s many sh__t lists.
My positive attitude regarding Chinese stocks is fundamentally based on my admiration of the Chinese people who have higher than average IQs and unbeatable work ethics. The Chinese people make for an attractive investment opportunity despite their top down government. Chinese immigrants and their descendants dominate business in Southeast Asia. Economists don’t talk about these things because they don’t want to be called racist. But ask anybody in Southeast Asia.
In an earlier Dismal Optimist regarding Chinese stocks I wrote that investors should follow Barron Rothchild’s advice and buy when there was blood in the streets. There certainly was blood in the streets with Chinese stocks at that time. Unfortunately, the Barron was a little early. Xi has now assured his status with his endorsement by the communist party. Now may be the time for well informed and risk tolerant investors to start nibbling on Chinese stocks. Chinese stocks are certainly incredibly cheap compared to their Western equivalents.
Industrial Policy US Style
The US is shifting from a free market model to that of industrial policy. Imitate China should be the new slogan. Democrat politico and now US ambassador to Japan Rahm Emanuel in a Bloomberg interview summed up the new US industrial policy as it applies to international trade : “Cost and efficiency are no longer the driving forces.” The driving forces for international trade for Rahm are global power and political considerations. Rahm’s words are chilling for free market economists because he is right. This is the new reality. The politicians not the markets will allocate resources. And the US and the world will be the losers.
Any investment that requires a government subsidy is the product of industrial policy. That would include electric vehicles, green energy projects, now semiconductors and the halting of fossil fuel projects. The public has already seen how green energy and the halting of fossil fuel projects fall short with the spike in energy prices.
Regarding electric vehicles, auto manufacturers from Stuttgart to Seoul have been angered by Biden’s $430 billion “Inflation Reduction Act”, enacted in August and aimed at rolling back climate change and making Washington a world leader in the electric vehicle (EV) market. Suck up to Washington will rule in this case.
With regard to semiconductors, the entire global semiconductor complex may be the most successful ecosystem in our planet’s history. As mentioned, the US has taken a sledgehammer to this ecosystem. All these government handouts – and not just from the US—will probably bring overcapacity and a slower rate of innovation. And lower profits from the semiconductor companies. Other nations including Japan and South Korea have enacted their own chips handouts. In my opinion, the so called Chips Act, which allocates $52 billion to semiconductor foundries in the United States, will go down as a boondoggle.
Don’t expect miracles from semiconductor stocks.
The US Policy On Taiwan Is Contradictory
The leading semiconductor foundry in the world is Taiwan Semiconductor. And the island of Taiwan itself is burgeoning with high tech ventures. But what does the US want to do? It wants to vacuum the foundry business out of Taiwan and move it to the US. Thus damaging Taiwan’s economy. Meanwhile, Biden has said the US would defend Taiwan in the case of a Chinese attack.
Let’s see. American soldiers are supposed to risk their lives defending a place whose economy America is trying to damage!