Hurt China — Is That Trump’s Real Goal?

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ZTE vs US Department of Commerce
ZTE vs US Department of Commerce

I hope what I’m about to say turns out to be too pessimistic and very wrong. But as an alternative scenario it must be considered.

Right now, the smart money says a trade war with China Is not going to happen. Accordingly, Trump is just bargaining for a China more open to American business and exports and an elimination of Chinese IP theft. In the end, according to White House respected free market economic advisor Larry Kudlow, we will all live happily ever after. I hope the smart money is right.

But a darker view just may describe what really will happen. The intentional destruction of Chinese telecommunications firm ZTE (763:HK) by the United States is ominous. Trump may be following a HURT CHINA policy, as outlined very clearly in the book of his other economic advisor, Peter Navarro. Chinese technological progress must be stopped in its tracks. No matter how many American tech firms are harmed in the process. Just collateral damage. Embargos on American tech exports — tariffs on imports will play a lesser role — will be America’s “nuclear’ weapon. China’s resumption of its historical role as East Asian hegemon must be halted. Yes this is a war but it’s not really a trade war — it’s a HURT CHINA war, especially in tech. The term “trade war” is just a disguise, a cover.

Needless to say under this darker scenario, the stocks of American firms whose businesses are significantly involved in one way or another with China — and that includes a majority of major tech firms — will get trashed. Stocks like Qualcomm (QCOM), Nvidia (NVDA), Intel (INTC), and Apple (AAPL) will be heading down. The American tech sector will be the loser as will the global economy in general. Trump cannot tear down the integrated network of global business that has evolved in the post WWII period without serious negative consequences.

Another victim in this HURT CHINA scenario may be Chinese President Xi Jinping. At Trump’s urging, Xi has helped push North Korean head Kim Jong-un to the bargaining table. Xi may expect something in return from Trump and certainly not a HURT CHINA program. But if rumors from Trump’s real estate days are correct, the Chinese President wouldn’t be the first stiffed by The Donald in a negotiation.

Round One in the HURT CHINA Campaign — Destroy ZTE

Last week, the Department of Commerce’s Bureau of Industry and Security (BIS) imposed what’s known as a denial of export privileges against ZTE. This means that U.S. firms cannot provide components or software to the Chinese giant. ZTE is dependent on a number of US products including semiconductor chips used in smartphones from Qualcomm, and the Android operating system and Android App Store from Google (GOOG).

ZTE is one of two global Chinese telecommunications firms, the other being Huawei. ZTE is a publicly traded company, with shares trading on the Hong Kong and Shenzhen Exchanges. It is in telecommunications infrastructure and smartphones, among other things. It shipped 46 million smartphones in 2017. In March 2017, ZTE was fined a total of US$1.19 billion by the U.S. Department of Commerce for exporting U.S. technology to Iran and North Korea in violation of sanctions. It is the largest-ever U.S. fine for export control violations. ZTE paid the fine and insists that it has complied with the other requirements associated with the settlement with the Commerce Department. The Commerce Department thought otherwise and essentially is putting ZTE, if not out of business, into dire straits. ZTE strongly disagrees that it was not in compliance.

In my opinion, and that of many observers around the world, even for a moment assuming ZTE was not in compliance with what seem like minor parts of its agreement with the Commerce Department, putting ZTE out of business is a punishment that far exceeds the crime. The political aspect of this Commerce ruling is quite clear. This is Round One of HURT CHINA. It is the kind of ruling that one expects from a lawless third world country, not one from the United States where the rule of law supposedly prevails. It sends a message to users of US products around the world — “Obey American rules or you will be punished.” (In the banking sector that message has been around for years but that’s another story.) That’s a rule that may have counted in the past but in a future of multiple powerful states that may not fly.

It would seem at this moment that Huawei, the world’s leading company involved with 5G, would have a target on its back. 5G of course is the new global wireless standard being developed by the major global telecommunications companies, including Huawei and ZTE. It is regarded as essential for the growth of such things as the internet of things, driverless cars and the cloud.

The US, without presenting any evidence on national security grounds, has banned the sale of Huawei products in the United States. Huawei is an employee-owned Chinese firm. One might ask, is the US looking for some flimsy excuse to impose a ban on exports to Huawei similar to that placed on ZTE?

Semiconductor chips are definitely a weak point in Chinese technology. Under the Chinese plan Made in China 2025, the Chinese will be devoting over $150 billion to this project. But money isn’t enough. The Western companies have years of experience, skilled engineering personnel and a wall of patents. Building semiconductor chips has a much higher degree of difficulty than making, say, sneakers. The Chinese may try to shift to non-US suppliers but there the supply may be limited and not as good as US sources. And there is no replacement for the widely used Android operating system in the mobile sector. Apple’s operating system is only for Apple.

It is odd that the Trump Administration wants to reduce the US trade deficit while embargoing US exports to a major Chinese customer. Admittedly so, many US chip manufactures are fabless and have their chips made in places like Taiwan, not the US. So under balance of payments accounting, chips made outside the US don’t count as US exports. But that would probably not be true in all cases.

It seems highly possible that under the umbrella of a HURT CHINA program that the real Trump Administration objective is to prevent the emergence of a global 5G standard in which the Chinese would have a major input. What the US may want is two 5G standards, one for the US and one for China. The rest of the world would have to choose (and who knows, they might choose the Chinese standard!) Even worse, the Trump Administration may try to revive the much discredited idea of the US government running the US 5G network. The same people who run the Post Office, the Veterans Administration and the Air Traffic Control systems! If all that transpires, a less efficient 5G and one that is a long way off are in the US future. And probably in China’s as well.

The upshot of all this is that the US can only hurt China by hurting itself. The US tech sector has thrived on expanding global demand including China’s and, yes, cheaper labor from places like China. Tech companies including those from China cooperate and compete with each other on a global basis. They, including ZTE, had been cooperating on 5G. Ironically, the major players in 5G are largely non-American, i.e., Nokia (NOK), Ericsson (ERIC), Huawei and ZTE. Only one US company, Qualcomm, is considered a major global player in 5G.

The Trump Administration has now “screwed” Qualcomm shareholders three times, (1) once by blocking Qualcomm’s acquisition by Broadcom on unsupported national security grounds, (2) last week by banning sales of Qualcomm chips to ZTE, a major Qualcomm customer, and (3) finally by turning Qualcomm’s proposed acquisition of NXP (NXPI) a hostage to China’s approval which might not be given in the current environment. Qualcomm has been cited in some media sources as the American national champion of wireless standards. With champions treated like this, America is in trouble.

A Bad Suggestion for China

I’m told the terrible idea that I’m about to propose has already been bandied about on the Chinese internet by irate Chinese citizens. The HURT CHINA program — a program of economic destruction — will inspire its own responses of economic destruction. China is economically and technologically weaker than the US but it is by no means helpless.

So here’s my terrible proposal for China that hopefully will never be implemented: Shut down the production of Apple phones in China. All Apple phones are reportedly assembled in China, with components that come from over 200 firms in a number of countries. The phones are assembled in China by Taiwanese firms Foxconn (2317:TW) and Pegatron (4938:TW). So it’s very simple. China can just shut them down for whatever reason. For example, Westerners have complained that conditions in these plants are unsatisfactory for the workers. So all China has to do is find some pretext — unsanitary bathrooms might suffice — and no more Apple phones.

Such an idea, if implemented, is about as economically destructive as you could imagine. Probably a half-million or more Chinese would suddenly be unemployed and the world would suddenly be deprived of one of the greatest consumer products. Apple’s stock would collapse. Plus, China would ruin its reputation as a reliable place to set up a manufacturing plant. And the great progress the world has been making on the technology front will be disrupted.

But China may feel that it must do something stupid and that the destruction of ZTE cannot go unanswered. Chinese are known for their sensitivities regarding losing face.

Let’s hope that the ZTE situation can be resolved quickly and that there is no such thing as a HURT CHINA program. And that Larry Kudlow, not Peter Navarro, will prevail. Otherwise, it will be one piece of bad news after the other.

Hurt China — Is That Trump’s Real Goal?