USA vs. China – Tit for tat

The USA still has the upper hand.

• In the face of further restrictions on its ability to develop AI algorithms, China is threatening to restrict the export of graphite in a move that is likely to be as ineffective as the restrictions it put on rare-earth metals 10 years ago.
• In what is now likely to be an annual update, the US Department of Commerce has updated its restrictions on what chips can and cannot be exported to China as well as what chips can be manufactured on behalf of Chinese customers using US equipment.
• The biggest problem for Chinese companies is that their own in-house designs for AI training chips now fall foul of the updated regulations.
• Baidu and Alibaba have in-house AI training chip designs the latest of which will be impacted by these expanded regulations.
• This means that non-Chinese manufacturers like TSMC, UMC, Samsung and Global Foundries will have to apply for a licence to continue making these chips for their customers.
• Unlike the Japanese regime, the US regime is based on a presumption of denial, meaning that everyone who makes these chips for Chinese customers will very soon have to cease manufacturing them entirely.
• Nvidia and AMD will also be unable to sell all of their recent chips to China which will force Chinese companies who are training AI algorithms to use silicon with specifications that were cutting edge in 2017.
• In effect, this means that China will be forced to use the equivalent of Nvidia’s V100 series which has now been discontinued and where the cost to train an algorithm will be at least double what it costs to use the latest H100 series.
• This will slow China’s ability to develop cutting-edge AI algorithms which is precisely what the US Department of Commerce aims to achieve with its new regulations.
• China’s response to this has been to impose restrictions on the export of graphite which is an essential material for EV batteries and where China controls over 70% of global production.
• However, China only controls 16% of global reserves meaning that other countries will be able to increase their production although this will take some time.
• Furthermore, graphite can be manufactured from petrochemicals meaning that the routes to replace China are plentiful although it will take time to ramp production back up and it will be more expensive.
• This is a very similar situation that exists with rare earth metals, gallium and germanium which are all substances where China has restricted or threatened to restrict export in the past.
• While China’s restrictions on rare earth metals in 2010 did increase prices, they did not have the desired effect as production restarted elsewhere leading to Chinese companies losing market share and the reversal of these restrictions in 2015.
• The situation for gallium, germanium and graphite is very similar as China dominates production following a consolidation of production in China and then being able to produce far cheaper than anyone else.
• The only way that this “restrict” strategy will work is if China also controls the reserves of these materials such that its production capacity can not be replaced, but this is not the case for any of these materials.
• Hence restrictions on graphite, germanium and gallium will cause prices and insecurity of supply to rise, ensuring that production restarts in in locations away from China’s sphere of influence.
• The restrictions will cause short-term problems and it is these that I think that China will attempt to leverage in negotiations to try and get some of the semiconductor restrictions lifted.
• I am not convinced that these will be very successful, and so I do not expect to see a relaxation of the restrictions in any meaningful way.
• As a result, China’s AI ambitions will take a hit which will only serve to increase its determination to achieve technology independence from the USA.
• This means that the days of global standards are numbered and going forward we are likely to see one standard outside of China and another, competing, and non-compatible standard inside China.
• This is bad news for everyone as two incompatible networks will generate much less value than one global network.
• Consequently, long-term growth for the entire technology sector over the next 10 to 20 years will be lower than it otherwise would have been.