As we have made clear on this blog and in our recent public discussions on the trade war, the real economic threat posed by the US-China trade war is not tariffs. The real threat has always been the U.S. government prohibiting sales of products to China or purchases of products from China. Focus on the tariff issue is missing the real risk. As we wrote in Who Pays the Tariffs on China Imports? there are various things companies can do to deal with the tariffs that allow them to continue conducting their business without major dislocation. But when an absolute ban is imposed the impact is usually much more direct and much more severe.
My predictions on this issue have come true. The trade negotiations broke down on a Friday and by Wednesday of last week — right when I was giving a talk on the risks of unilateral bans from the U.S., the U.S. government did exactly what I had been predicting. The U.S. announced two related sales/purchase bans on telecommunications product. The bans are focused on Huawei, the largest telecommunications manufacturer in the world and the largest private manufacturing company in China and yet these bans could easily extend beyond Huawei to cover every high-tech company in China and at some point relatively soon they probably will. It is a serious issue that has been mostly missed or downplayed by the U.S. media, at least so far. But as I will show below, these product ban issues impact virtually every country in the world. It is not just a spat between the U.S. and a single Chinese company.
There are two separate but related actions. I will discuss the sales ban in this post and then discuss the purchase ban in a later post. As the first step in its attack on Huawei, the U.S. imposed a general ban on selling U.S. high-tech products to Huawei. This ban was imposed by the Department of Commerce Bureau of Industry and Security. This is the powerful BIS that I referred to in my earlier post. BIS imposed the ban by placing Huawei and 68 Huawei subsidiaries on the notorious Entity List. This ban will go into effect on May 21, when the notice is scheduled for publication in the Federal Register. You can check out the preliminary notice here.
If your company is placed on the Entity List it can no longer purchase any U.S. made product listed on the Department of Commerce Commodities Control List (CCL). The CCL covers far more than semiconductor chips. It covers a huge list of equipment, materials, software and “technology” and essentially includes virtually any technical product or service you would want to sell to Huawei or any of its 68 subsidiaries. You can take a look at the CCL here. The CCL covers the following ten product categories:
0 Nuclear & Miscellaneous
1 Materials, Chemicals, Microorganisms and Toxins
2 Materials Processing
5 Telecommunications and Information Security
6 Sensors and Lasers
7 Navigation and Avionics
9 Aerospace and Propulsion
So if you want to sell children’s books to a Huawei daycare center, that’s OK. If you want to sell paper napkins to a Huawei employee cafeteria, that’s OK. But if you want to sell ANY FORM of technical product or service to Huawei, you are banned.
I have set out this list of products to make a point. If you look at the list, you will see it includes virtually every product from the U.S. where the U.S. has a competitive advantage. Consider this: The U.S. complains about its trade imbalance with China, yet we ban the sale of virtually every product for which the U.S. has a comparative advantage. If Chinese companies do not purchase from this product list, about all they can purchase are raw materials and agricultural products. Every company in China can see that it is at risk of suffering under a similar ban. So every company in China is strongly motivated to ensure that it is not dependent on high-tech products from the U.S. By this action, the U.S. is forcing Chinese companies to decouple. China is the second largest economy in the world so if it does decouple from doing business with the United States we can expect to see other high-tech companies from all over the world follow.
It is important to note that this Huawei action is an absolute ban. The technical language states that an exporter requires a license but the BIS notice states that all such licenses are presumptively denied. In other words, don’t bother applying. Note also that the ban applies to any foreign entity that purchases the banned product. So it will not work to sell the product to a manufacturer in Malaysia who then resells the banned product to Huawei or to a Huawei subsidiary. This applies to situations where the banned product is incorporated as a even a small component in a more general product.
For example, right out of the gate, Google has announced it will cease licensing its proprietary Android software to Huwei. This will likely mean owners of Huawei phones and tablets will not receive Android OS updates from Google. Huawei will probably fight back by providing its own Android updates and by in the future providing its own operating software for its phones and tablets. But let’s face it, if Huawei had been able to develop its own operating software remotely as capable as Android, it would have done so long ago. So its now being cut off from Android will almost certainly lead to the overally quality of its phones and tablets declining and an eventual lowering of its prices and its sales. Will this lead to increased sales of Google Pixel phones and iPhones in China? Difficult to say. Will this lead to increased sales of Google PIxel and iPhones and Samsung phones around the world, at the expense of Chinese-branded phones and tablets? Very likely.
This ban on sales to Huawei had an immediate negative impact on U.S. chip manufacturers. Media reports state that on Thursday, the day after the notice, Qualcomm was down 4%, Micron was nearly 3% lower, and semiconductor firms Qorvo and Skyworks were respectively down 7% and 6%.
The impact of the disruption on the supply chain is already being felt. One issue that has already arisen is that many U.S. rural telecoms depend on inexpensive Huawei equipment. If Huawei cannot purchase U.S. semiconductors, it cannot provide this equipment. Though this is the intent of the ban, these rural telecoms are a strong support base for President Trump. In response to their concerns, the U.S. Department of Commerce has already indicated that it might provide an exception to the ban solely for the purpose of manufacturing for this U.S. rural telecom sector.
The Department of Commerce’s announcement of a possible exeption for rural telecomes makes little sense. It is unlikely Huawei would even be interested in a carve-out designed solely to benefit President Tump’s supporters. More important, the U.S. is planning to ban all imports of Huawei telecom products into the U.S. and this ban will go into effect in no less than 150 days. So any reprieve for the rural telecoms would likely be short lived. Moreover, Huawei is reported to have enough semiconductors in inventory so that production will not be interrupted during this 150 day period, so the short term impact on the rural telecoms will be zero. The issue for the rural telecoms is much more significant. An absolute ban is coming and there is no solution. Period. None.
But now consider the deeper issue. Virtually every country linked to China in the Belt and Road Initiative depends on Huawei for its core telecom and network infrastructure. Many or most of the countries in the world developing 5G networks depend on Huawei for their 5G infrastructure. These same countries also depend on other Huawei products, such as cell phones and related networking equipment. If the ban on sales of high-tech products shuts down Huawei, it also shuts down the telecom infrastructure development for many countries.
If the U.S. rural telecoms are concerned about the impact of the Huawei ban on their own systems, we must assume all the other countries and systems involved have similar concerns. What this means is that this U.S. decision will have impacts far beyond the relationship between the United States and China/Huawei.
It is not clear what the immediate impact will be on Huawei. Huawei is a private company, so there is no stock price we can monitor to measure an immediate impact. Press reports suggest Huawei has inventoried a large stock of essential semiconductor chips. Some analysts estimate Huawei may be able to continue production for another nine months without purchases from the U.S. During this period, Huawei has the following two possibilities for a reprieve:
First, during this nine month period, the U.S. and China will finally reach an acceptable trade agreement. A requirement of this agreement would then be that Huawei and other Chinese companies (ZTE) are freed from the risk of further sanction. We do not expect this.
Second, the stated reason for the ban on Huawei is that Huawei violated U.S. sanctions against Iran. This is the same basis for the earlier sales ban imposed on ZTE. If the trade agreement does not get Huawei off the hook, Huawei may be able to enter into an agreement with the U.S. that removes the sanctions in exchange for a major fine and other measures. We do not expect this either.
Both these two possibilities rest on an assumption that the U.S. will be willing to allow Huawei to escape the impact of the sales ban. If the United States’ goal is to shut down Huawei, neither of these possibilities is realistic. If Huawei cannot find another supplier of technology not dependent on U.S. companies, Huawei is probably doomed.
It is then essential to consider the implications of all this. An action of this magnitude will require the Chinese government to respond. Some facets of its response will focus on “tit-for-tat” sales and purchase bans, tariffs and other economic and trade measures. But for China, the response could also result in non-rational emotional actions, such as those we saw recently when China lashed out at Korea, France, Norway, and Japan and, even more recently, against Canada. This might mean boycotts and other attacks against U.S. owned companies and detentions and other police harassment directed against American individuals.
U.S. companies and individuals operating in China need to take great care during this year as the disputes get worked out. The day before President Trump tweeted out his most recent 25% tariffs against Chinese products, my co-blogger, Dan Harris, wrote about how “Winter is Coming” for US-China relations. From my view on the front lines, I would revise that to say that this Huawei action means winter has mostly arrived. Put on your overcoats and be prepared for a long winter. Let’s hope it is not a new Ice Age.
May 21 UPDATE: As we predicted in this post, the sales ban did result in immediate negative impacts on U.S. companies and purchasers of Huawei products: Google shut down Android and U.S. rural telecoms were shut off from Huawei product they had already purchased. In response to these issues, the United States Department of Commerce on Monday modified the Entities List ban to provide for a 90 day general license for export to Huawei. This license allows Google to provide Android updates and it allows for chip sales solely for maintaining existing networks. The text of the limited license has been posted on the Federal Register. In response, Google has said it will provide updates for 90 days but will go back to shut down mode at the end of that period. Huawei’s reponse has essentially been, So What? The damage has been done and a 90 day reprieve designed to help U.S. companies and consumers is of no interest to Huawei.