Small Powers Caught in the US–China Chips Competition

China-U.S. Relations

Summary:

There was a time when government spending to support particular industries was widely deplored as wasteful interference in free markets. No longer. China, the United States and the European Union have vastly increased government subsidies to industries, frequently supporting the development of advanced technologies. These subsidies are sometimes complemented by policies designed to deny technological innovations to competitor economies.

A report by Global Trade Alert reveals that the three economic superpowers introduced 18,000 industry subsidy programs in the years following the 2008 financial crisis, roughly split evenly. Now in the order of US$361 billion a year, the industry subsidy programs of the big three are collectively bigger than the GDP of four-fifths of the world’s nations. As the international institutions argued, these huge programs pose a particular problem for smaller economies, which cannot begin to match them.

In contrast to earlier protectionist programs for import-competing domestic industries, today’s subsidies are more likely to support industries focused on a global market — particularly high-technology businesses.

Increasingly, subsidy programs are entangled in national security concerns, often justified by a declared requirement to maintain a lead against rival countries or achieve independence from them in new technologies.

While WTO agreements discipline certain subsidies where a harmful effect on competitors can be demonstrated, the new subsidies are often beyond the reach of international agreements.

The most expensive and spectacular example of the new subsidies is the intense battle between the United States and China over advanced chips. Beijing has long been determined to catch up in chip technology, while Washington strives to stay ahead. Both China and the United States now lavishly support the development and production of advanced chips, though neither produces leading-edge chips on their own territory in commercial quantities.

Under programs announced in October 2022, the United States has adopted twin policies of subsidising advanced chip production at home, while arranging with security allies to deny China access to advanced chips and advanced chip-making machinery.

Since the United States does not currently make leading-edge chips or the machinery to produce them, it relies on Taiwan to refuse to make advanced chips for Chinese businesses and the Netherlands to refuse to supply them with advanced chip-making equipment. At the same time, Washington is paying billions of dollars to the Taiwan Semiconductor Manufacturing Company and South Korea’s Samsung to establish advanced chip-making foundries in the United States.

China currently produces 16 per cent of the world’s chips, more than the United States. But it cannot yet produce in quantity the advanced chips the United States is seeking to deny it.

While presented as a denial of one of a ‘narrow set of sensitive technologies’ in the 20 May 2023 G7 communique, it is widely understood that the US objective is to block China’s progress in artificial intelligence technologies. These technologies are already widely used in military applications such as eavesdropping and self-guided drones but, more importantly, hold the possibility of large-scale commercial transformation. As CSIS expert Greg Allen explained in 2022, the US strategy has shifted from slowing the pace of China’s advance to actively seeking to reverse it.

China is not far behind the United States in the number and quality of research publications in artificial intelligence. But Chinese businesses are encountering serious difficulty training large language models of the quality being developed by their US counterparts due to the shortage of advanced chips.

While it is commonly said China is 10 years behind in chip production, there are plausible signs that Chinese businesses can now design advanced chips. Despite having a somewhat smaller economy than the United States, China’s manufacturing value-add is roughly the same size as that of the United States, Germany, Japan and South Korea put together.

The new intensity and lavish scale of industry subsidisation among the economic superpowers, coupled with the entanglement of these programs in national security rationales, pose issues for smaller powers. Australia, for example, cannot begin to match the new levels of industry subsidisation. There is also the considerable risk of being drawn into what is essentially a commercial competition on the US side, to the detriment of Australia’s far bigger economic relationship with China.

There are signs of that already in the Australia–United States minerals pact, signed in May 2023. There are thousands of research cooperation agreements between China and Australia, some of which are at risk, especially if the United States extends its chip denials to other frontier technology areas, as foreshadowed by the Biden administration.

Once dominated by business interests and economic bureaucrats, large areas of industrial policy are now shifting into the realm of national security. The director-general of Australia’s Office of National Intelligence, Andrew Shearer, noted in March 2022 that technology is ‘the centre of gravity in this new geopolitical contest’.

The policymaking apparatus in Canberra has been rearranged to bring a national security lens to bear on what were customarily economic policy decisions. This is evident in departments such as the Treasury, Foreign Investment Review Board and Department of Foreign Affairs and Trade, the enhanced importance of the Office of National Intelligence and the Department of Home Affairs, and the changing focus of the Five Eyes intelligence-sharing group.

Source: eastasiaforum.org

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Alex

Central Bank

Australia's central bank on Tuesday held interest rates steady saying it wanted more time to assess the impact of past hikes, but reiterated its warning that further tightening might be needed to bring inflation to heel.

Wrapping up its July policy meeting, the Reserve Bank of Australia (RBA) kept its cash rate at an 11-year high of 4.10%, having lifted rates by 400 basis points since May last year, in its most aggressive tightening cycle in modern history to tame inflation.

Markets had been leaning towards a pause, but economists were split on the outcome, with 16 out of 31 polled by Reuters expecting a hike and the rest forecasting the bank to stand pat.

The Australian dollar dipped 0.4% to $0.6647, but has since recouped all the losses to trade at $0.6682 as traders expect at least one more hike in the current cycle. The market YIB: has now shifted to imply around a 50-50 chance of a hike to 4.35% in August, while scaling back the risk of a further move to 4.6%.

Australia's Central Bank Holds Rates, Signals More Hikes Might Be Required_1

In Tuesday's policy statement, RBA Governor Philip Lowe said that higher interest rates are working to establish a more sustainable balance between supply and demand in the economy.

"In light of this and the uncertainty surrounding the economic outlook, the Board decided to hold interest rates steady this month."

The RBA chief pointed to uncertainties about the outlook for household consumption and regarding the global economy.

However, Lowe repeated previous warnings that some further tightening of monetary policy might be required as "inflation is still too high and will remain so for some time yet."

"Today's decision to pause rate hikes shows the RBA has realised the economy is on a knife's edge and that it must pivot to achieve its goal of threading a 'narrow path' through current economic conditions," said Stephen Smith, Deloitte Access Economics partner.

The RBA first paused in April and then surprised markets by resuming its hikes both in May and June, a hawkish tilt that led many economists to see a higher chance of a recession this year given anaemic economic growth.

Economic data over the past month have been mixed. A sharp cooling in a volatile monthly inflation reading argued for a pause, but a blockbuster jobs report and strong retail sales point to some work to be done by the RBA.

Sustained gains in housing prices, improving housing finance and a strong rebound in building approvals suggest financial conditions might have not been as tight as desired.

HIKE IN AUG?

Indeed, many economists see a decent chance of a hike in August after the release of the second-quarter inflation figures in late July, which is likely to reveal inflation remained sticky.

"With the labour market still very tight, house prices rebounding strongly and unit labour costs surging, another 25bp rate hike in August still looks likely and we suspect the Bank will follow that up with another one in September," said Marcel Thieliant, a senior economist at Capital Economics.

The central bank currently forecasts headline inflation - which was running at 7% in the first quarter - to return to the top of its target range of 2-3% by mid-2025.

Global policymakers are still grappling with relatively high inflation despite sweeping rate increases for more than a year. Both the Federal Reserve and the European Central Bank are almost certain to hike by a quarter-point this month, which could pressure an already soft Australian dollar.

Australia's Central Bank Holds Rates, Signals More Hikes Might Be Required_2

Lowe is also set to find out this month whether he would be reappointed for a second term. The governor, a four-decade veteran at the bank, has been under a cloud since repeatedly saying in 2021 that interest rates would not rise until 2024, only to reverse course and hike in mid-2022 when inflation unexpectedly surged.

Source: Reuters

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Kevin Du

Economic

• Permission will be required for exports of some gallium and germanium compounds starting Aug.1, China’s commerce ministry said in a statement late Monday.

• This move is part of an intensifying global battle for technological supremacy — with China as the world’s largest source of both metals, according to a European Union study on critical raw materials this year.

China is restricting the exports of two metals key to the manufacturing of semiconductors, its commerce ministry said late Monday, escalating a technological trade war with Europe and the United States over access to microchips.

These new regulations — imposed on grounds of national security — will require exporters to seek a license to ship some gallium and germanium compounds starting Aug. 1, China’s commerce ministry said. Applications for these export licenses must identify importers and end users and stipulate how these metals will be used.

This move is part of an intensifying global battle for technological supremacy — with China as the world’s largest source of both metals, according to a European Union study on critical raw materials this year.

Shares of Chinese germanium producers soared on Tuesday. At the midday trading break, Yunnan Lincang Xinyuan Germanium Industrial surged by the 10% limit in Shenzhen, while Yunnan Chihong Zinc & Germanium pared earlier gains but was still 7.5% higher. Both are outperforming the 0.1% gain for the CSI 300 index of China’s largest A-share listings.

In October, the U.S. launched sweeping rules aimed at cutting off exports of key chips and semiconductor tools to China. The measures are believed to have the potential to cripple China’s ambitions to boost its domestic technology industries. The U.S. has also lobbied key chipmaking nations and allies, like the Netherlands and Japan, to introduce export restrictions of their own.

The Netherlands responded Friday with new export restrictions on advanced semiconductor equipment. This will effectively bar ASML from exporting to China. But these latest Dutch curbs do not specifically target ASML, one of the most important semiconductor companies in the world.

Some countries are also trying to secure their own supply chains and build up their domestic chip industries, focusing on areas where they are traditionally strong. Last week, a fund backed by the Japanese government proposed a 903.9 billion yen ($6.3 billion) acquisition of semiconductor materials giant JSR.

Semiconductors are some of the most important technology products. They go into everything from smartphones to cars and refrigerators, and are also seen as key to military applications and advancing artificial intelligence.

Source: CNBC

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Cohen

Commodity

Oil prices held steady early on Tuesday as markets weighed supply woes from cuts for August by top exporters Saudi Arabia and Russia against mixed analyst views on economic data that could hint at weak crude demand.

Brent crude futures LCOc1 rose by 43 cents, or 0.58%, at $75.08 a barrel by 0322 GMT. U.S. West Texas Intermediate crude CLc1 were at $70.22 a barrel, up by 43 cents, or 0.62%.

"Fundamentals are not having as much influence on price direction as one would expect. Instead, the uncertain macro outlook is what the market is focused on," ING analysts said in a client note.

"It is difficult seeing this pattern changing significantly in the short term, though the additional cuts do put a stronger floor in place for Brent at around US$70/bbl," ING analysts added.

U.S. markets will be closed on Tuesday for the nation's Independence Day holiday. Oil benchmarks had settled down about 1% in the previous session.

Saudi Arabia on Monday said it would extend its voluntary cut of 1 million barrels per day (bpd) from output to August, the kingdom's state news agency reported. Russia will also reduce its oil exports by 500,000 bpd in August, Deputy Prime Minister Alexander Novak said.

The cuts amount to 1.5% of global supply and bring the total pledged by OPEC+ oil producers to 5.16 million bpd as Riyadh and Moscow look to prop up prices. OPEC+ includes members of the Organisation of the Petroleum Exporting Countries and allies.

U.S. crude inventories were expected to fall by about 1.8 million barrels in the week to June 30, a third straight week of declines. Industry data on inventories will be published on Wednesday and official data on Thursday, both delayed by a day due to the U.S. holiday.

On the macro front, analysts' forward expectations were mixed after business surveys showed a slump in global factory activity because of sluggish demand in China and in Europe and U.S. manufacturing also fell further in June - reaching levels last seen in the initial wave of the COVID-19 pandemic.

Although GDP gains have been drifting lower in recent weeks due to second quarter downgrades in China and the Europe region, neither the U.S. nor global economies is at imminent risk of falling into recession, amid a strong services sector, waning U.S. goods sector drags and a broad easing of global financial conditions, JP Morgan analysts said in a note.

However, the weaker economic growth demand still suggests demand for merchandise remains weak, which would weigh on distillates consumption, ANZ analysts said in a client note.

Source: Reuters

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Samantha Luan

Political

The Biden administration's climate agenda is facing an unexpected challenge in drought-prone Corpus Christi, Texas, where a proposed clean hydrogen hub would require the installation of energy-intensive, expensive and potentially environmentally damaging seawater desalination plants.

The Gulf Coast port is in the running for up to $1 billion available under President Joe Biden's 2021 Infrastructure Investment and Jobs Act to create a regional hub to produce hydrogen, a low-emissions fuel made by electrolyzing water that can help decarbonize heavy-emitting industries and transportation.

A hydrogen hub would require access to millions of gallons of water – a challenge in Corpus Christi which is experiencing a multi-year drought. While local officials say they can provide that water by constructing a seawater desalination plant, environmental groups and some local residents and lawmakers are lining up to oppose desalination sites.

"It makes no sense to create a purported clean energy source that in turn destroys an entire ecosystem, threatens other economies reliant upon a healthy bay system, and usurps the water supply for residents," the Coastal Alliance to Protect the Environment, a Corpus Christi activist group, wrote in a letter to U.S. Energy Secretary Jennifer Granholm, shared with Reuters.

Reuters interviewed six researchers who study hydrogen as green power and had exclusive access to an analysis by Rystad Energy consultancy that showed that the Biden administration's vision of low-carbon hydrogen may run into a challenge that is itself exacerbated by climate change: water scarcity.

Producing hydrogen requires enormous amounts of fresh water in a world increasingly affected by climate-driven drought.

Nine of the 33 projects on the Department of Energy shortlist for the hydrogen hubs are in highly water-stressed regions, according to Rystad data.

Those locations include Southern California, Colorado, Kansas and New Mexico as well as Texas. Globally, the picture is even worse, with more than 70% of proposed green hydrogen projects located in water-stressed regions like the Middle East.

"Most of the world's planned green hydrogen projects are to be located in water-stressed regions," said Minh Khoi Le, renewable energy analyst at Rystad, adding that this would create demand for more desalination plants.

The Biden administration is offering companies up to $100 billion in tax credits and regions up to $7 billion in grants to build out hydrogen hubs to help reach a target of producing 50 million metric tons of clean hydrogen fuel by 2050.

The DOE will announce the hubs in September.

The DOE declined to comment on the Corpus Christi or other hydrogen hub applications, but pointed Reuters to the agency's funding announcement, which "acknowledges that water consumption for H2Hubs could place additional stress on regional water resources."

The U.S. Environmental Protection Agency's Assistant Administrator for Water Radhika Fox told Reuters that "more water systems are considering desalination as source water becomes scarcer and treatment technology improves" but did not comment directly about Corpus Christi.

Peter Zanoni, the city manager for Corpus Christi, said the hydrogen project, if approved, all but requires the adoption of seawater desalination.

Even with around 100 million gallons of groundwater supply per day, the city is experiencing drought conditions and limiting the use of sprinklers and irrigation to once a week, according to its drought contingency plan.

The city is contracted to supply up to 25 million gallons of water per day to major industrial users ExxonMobil and Saudi Arabia's Basic Industries Corporation, Zanoni said, and anticipates hosting at least a half dozen green hydrogen producers at the hub, each which would need around 3 to 4 million gallons of fresh water per day.

He said the city plans to add at least 70 million gallons of water per day of capacity, including at least 30 million from the proposed seawater desalination plant. "That drought-proof source is really appealing to us," Zanoni said.

WATER WARS

While the United States has hundreds of desalination plants scattered across the country to treat mildly brackish inland sources of water, transforming ultra-salty ocean water into fresh water carries higher risk, some water experts say.

Pumping the briny byproduct of desalination into Corpus Christi Bay could cost the fishing industry around $6 million per year by killing off seafood species like shrimp and Atlantic croaker, according to Texas A&M University-Corpus Christi's Paul Montagna, an endowed chair at the Harte Research Institute for Gulf of Mexico Studies.

And seawater desalination plants are energy intensive and expensive to build and maintain, energy experts say. The Poseidon plant near San Diego, California - the largest seawater desalination plant in the Western Hemisphere - cost over $1 billion to build and requires nearly $275 million in upgrades to meet updated state rules to protect marine life that can get sucked into the intake pipes or are affected by the briny discharge from the plant.

In March, the EPA stepped in with a $170 million loan to offset the price spikes for local consumers.

Corpus Christi first proposed seawater desalination in 2017 to supply its rapidly growing energy and petrochemicals industries.

The city has struggled to secure federal environmental permits and local support.

The EPA in January said it will not recognize a state-issued pollutant discharge permit for one of the proposed desalination plants on Harbor Island until Texas regulators conduct a more thorough environmental impact review of groundwater use and conservation efforts.

In a letter to the Texas Commission on Environmental Quality in September, the EPA said it "continues to have concerns regarding reporting and monitoring requirements for total dissolved solids, chlorides, and sulfates."

In October, a local residents' association from the Hillcrest neighborhood, a majority black area that is already home to refineries, filed a Civil Rights Act complaint saying the proposed Inner Harbor desalination plant would worsen pollution.

The city is seeking regulatory approval for three other desalination sites.

Errol Summerlin, founder of local environmental group CAPE, said the environmental costs of seawater desalination were too high, even if it is in support of a low-carbon fuel.

"This plan would destroy an ecosystem to create an unproven solution to the world's climate crisis," he told Reuters.

Brandon Marks, a regional campaigner for the Texas Campaign for the Environment, said heavy industrial users, not residents, have the most to gain from the proposed desalination plants.

A report released in November by consultancy Autocase Economic Advisory said that over the last decade, nearly 70% of the increase in water use in the Corpus Christi area came from industrial users compared to just under 6% from households, commercial uses, fire protection, public recreation, and sanitation.

"The whole reason they are pursuing this water is to enable unfettered growth, which would not only harm the bay but harm communities of the bay area," Marks said.

Charles Zahn, chairman of the Port of Corpus Christi and a major proponent of desalination, said desalination plants could be a boon for the region, even offering the opportunity to sell water to the city of San Antonio, if there was a surplus.

"We need desalination to bring in industry that brings us jobs and increases our tax base," he said. "I think water is probably the number one issue in Texas and we have the ability to help Texas."

Source: Reuters

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Cohen

Economic

• European PMIs shows downturn deepened.

• China's June Caixin PMI expands marginally.

• Factory activity slumps in Japan, South Korea.

• Surveys highlight gloom spreading from weak China growth.

Global factory activity slumped in June, business surveys showed on Monday, as sluggish demand in China and in Europe clouded the outlook for exporters.

Across the euro zone manufacturing contracted faster than initially thought, as persistent policy tightening by the European Central Bank squeezed finances, and in Britain the pace of decline steepened as optimism faded.

In Asia, while factory activity expanded marginally in China, it contracted in Japan and South Korea as Asia's economic recovery struggled to maintain momentum.

"There are no real signs we are going to get any rebound in the manufacturing sector this year. On the whole we are still talking about a negative assessment," said Rory Fennessy, European economist at Oxford Economics on the euro zone release.

Compiled by S&P Global, HCOB's final euro zone manufacturing Purchasing Managers' Index (PMI) fell to 43.4 from May's 44.8, its lowest since the COVID pandemic was cementing its grip on the world, below a preliminary reading and further from the 50 mark separating growth from contraction.

June's downturn was broad-based with surveys published earlier on Monday showing factory activity in all four of the euro zone's biggest economies contracted last month.

The S&P Global/CIPS UK Manufacturing PMI fell to 46.5 from 47.1 in May, its lowest reading this year and one of the weakest since the 2008-09 financial crisis.

ASIAN PAIN

Asia's surveys underscore the toll China's weaker-than-expected rebound from COVID lockdowns is inflicting on the region, where manufacturers are also bracing for the fallout from aggressive U.S. and European interest rate hikes.

"The worst may have passed for Asian factories but activity lacks momentum because of diminishing prospects for a strong recovery in China's economy," said Toru Nishihama, chief emerging market economist at Dai-ichi Life Research Institute.

"China is dragging its feet in delivering stimulus. The U.S. economy will likely feel the pain from big rate hikes. These factors all make Asian manufacturers gloomy about the outlook."

China's Caixin/S&P Global manufacturing PMI eased to 50.5 in June from 50.9 in May, the private survey showed.

The figure, combined with Friday's official survey that showed factory activity extending declines, adds to evidence the world's No. 2 economy lost steam in the second quarter.

Global Factory Output Slumps as Weak Demand Weighs_1

The impact is being felt in Japan where the final au Jibun Bank PMI fell to 49.8 in June, returning to a contraction after expanding in May for the first time in seven months.

New orders from overseas customers decreased at the fastest rate in four months reflecting feeble demand from China.

South Korea's PMI fell to 47.8 in June, extending its downturn to a record 12th consecutive month on weak demand in Asia and Europe.

Factory activity also contracted in Taiwan, Vietnam and Malaysia, the PMI surveys showed.

There were bright patches among the economic indicators with India's manufacturing industry bucking the trend and expanding at a brisk pace in June, albeit slightly slower than in May, supported by robust demand.

The Bank of Japan's closely watched tankan survey also showed Japanese business sentiment improving in the second quarter as raw material costs peaked and the removal of pandemic curbs lifted consumption.

Asia is heavily reliant on the strength of China's economy, which saw growth rebound in the first quarter but subsequently fell short of expectations.

The fate of Asia's economy, including China's, will have a huge impact on the rest of the world with aggressive monetary tightening also expected to weigh on U.S. and European growth.

In forecasts released in May, the International Monetary Fund said it expects Asia's economy to expand 4.6% this year after a 3.8% gain in 2022, contributing around 70% of global growth.

But it cut next year's Asian growth forecast to 4.4% and warned of risks to the outlook such as stickier-than-expected inflation and slowing global demand.

Source: Reuters

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Thomas

Economic

• Huge processing vessel undocks as a chorus of calls and suggestions flag energy security pitfalls and call for Beijing to take action.

• Russia’s invasion of Ukraine has pushed up global energy prices and raised fears in China about securing enough oil and gas.

China undocked the world’s largest crude-oil-processing vessel by tonnage and storage at the weekend, as energy security has taking centre stage in policymakers’ risk-preventing playbook.

The floating production storage and offloading (FPSO) vessel, designed by Qidong Cosco Marine Engineering Co in east China’s Jiangsu province, will be capable of processing 180,000 barrels of oil per day and handling 12 million cubic metres of gas, according to state-backed Yangtze Evening Post.

The FPSO came at a time when Beijing is trying to shore up its energy supplies, especially with Russia’s invasion of Ukraine having pushed up global energy prices and brought huge uncertainties. FPSOs are used by the offshore oil and gas industry to produce and process hydrocarbons, and for oil storage.

China is the world’s largest crude-oil buyer. It imported 508 million metric tonnes of crude oil, mainly through Saudi Arabia and Russia, last year, which represents more than 70 per cent of its crude requirements.

The new vessel is 335.31 metres long, 60 metres wide, and 33.51 metres deep. It has a maximum storage capacity of 1.4 million barrels of crude oil, according to the report.

The National Development and Reform Commission (NDRC), which oversees the country’s strategic oil reserve, on Saturday called for greater attention to energy-resource security and for deeper promotion of the energy revolution.

The top economic planner listed energy security as one of the major risks, along with food security, supply chains and industry chain security, plus data protection.

“[We] should push forward the energy revolution, accelerate the planning and construction of the new energy system, and strengthen the construction of the energy production, supply, storage and marketing system,” according to an article by its chairman, Zheng Shanjie.

Zheng also called for greater exploration of China’s resources, strengthening the country’s energy reserve system, and improving the layout of reserves and the network of facilities.

The world’s second-largest economy is seeing its energy security tested amid higher external dependence on oil and gas, pushing Beijing to take steps to ensure China has sufficient energy to meet its needs.

Over the past few years, China has imported more than 70 per cent of its crude oil and more than 40 per cent of its natural gas, according to Post calculations based on data from China Customs and the National Bureau of Statistics.

Russia was China’s second-largest source of oil last year, accounting for 16.9 per cent of total imports, up 1.4 percentage points from 2021, according to a review of customs data.

During the “China Energy Security Summit Dialogue” in Chengdu on June 29, Sichuan University and the Chengdu municipal government released a “White Paper on China’s Energy Security 2023”.

The paper said China’s energy security is facing major challenges, including low per capita, unbalanced regional distribution, weak enterprise power, high oil and gas reliance and low international bargaining power.

China’s oil and gas resources per capita are only about 1/15th of the world average, and its coal and hydro resources per capita possession is equivalent to 50 per cent of the world average, according to the paper.

The paper also called on the government to accelerate the replacement of traditional oil and gas energy with new energy sources and to speed up breakthroughs in key technologies for oil and gas extraction and storage.