Odd Lots - Why President Trump's Move Against Huawei Is Such A Big Deal

Episode Date: June 3, 2019

Earlier this month, President Trump escalated the trade tensions against China by limiting exports of U.S. technology to Huawei. But what is Huawei, and why is this such a big deal? On this week's episode, we speak to Dan Wang, a technology analyst at Gavekal Dragonomics, about the importance of Huawei to the Chinese tech industry, the specifics of what Trump just did, and the far-reaching fallout that we could see from this new phase of the trade war.See omnystudio.com/listener for privacy information.

Thanks for listening to Oddlots. Follow the show on Amazon Music for more future episodes or just ask Alexa, play the podcast, Oddlots on Amazon music. Hello and welcome to another episode of the Odd Lots podcast. I'm Joe Wisenthall. My co-host Tracy Alloway, she's off. She couldn't make today's episode. It's kind of an emergency last minute episode, though, because we wanted to do something very timely with just the right guest. Obviously, the trade tensions with China continuing to ratchet up. And it's really becoming less and less, I would say, about the trade deficit and some of these classical topics that we think of in a trade war. And much more about the sort of brewing technology cold war, as people are putting it. And the moves that the Trump administration has taken against some of China's big tech companies. today I'm going to be speaking on the subject with a previous Oddlott guest, going to be talking with Dan Wong. He's a technology analyst at Gavkal Dragonomics. He's also a Bloomberg opinion columnist, which is very cool.

You might recall we spoke to Dan a while ago about the China 2025 initiative, the endeavor on the part of the Chinese government to really sort of build its own domestic leadership and all these big. tech areas. So Dan is really the perfect person to discuss these new developments with, wanted to get him on, wanted to get his perspective on the latest development. So without further ado, I want to bring in Dan, Dan Wong, thank you very much for joining us. Thanks a lot, Joe. So obviously, pretty interesting moves we've seen over the last few weeks, a very serious ratcheting up in the trade war talks as President Trump has moved to really put the pressure on Huawei, a major Chinese tech giant. What do you describe to us to start? What is Huawei? What is their significance in the global or in the Chinese tech ecosystem? Where did they come from? How did they become so

important? So I think Huawei is the most important technology company in China, and it has a few major business lines. I think the two most important ones are its smartphone business and then its network equipment business. So as a matter of comparison, Huawei sold about as many smartphones as Apple did last year, although at much lower profits. But it is a major seller of smartphones around the world, not just in China, but also in Southeast Asia and now increasingly in Europe. The other major business line it has is network infrastructure equipment. So all of these things that make mobile calling possible and 4G or LTE possible, a lot of it, at least outside the U.S., is provided by Huawei.

And as the world is getting ready to transition to the next generation, the fifth generation of mobile network technologies or 5G, Huawei is a pretty major player in that ecosystem. How cutting edge are they? I mean, if you look at the companies, and I guess either on both lines, whether it's smartphones or networking equipment. Are they sort of a best-of-breed player in this stuff? I think the consensus is that Huawei is very competent on both the smartphone business and then also the network business.

So on the smartphones, I think people in the U.S. don't really get to see this, but a lot of the reason that Apple has been doing not so well in China is that basically Huawei and a few other players have made pretty good phones at quite a bit lower prices than Apple does. In fact, Samsung has been almost completely squeezed out of the China market because Huawei's phones are really good. And Huawei is giving a run for Samsung's money, basically, in many markets in the world. But, you know, plausibly, Huawei is a little bit behind or quite a lot behind Apple on the smartphone business. On the network equipment business, I think it is arguably really leading.

Everything I hear is that basically the network equipment business, not only is it selling as good or cutting-edge equipment, or even better equipment than its competitors, which are mostly Erickson and Nokia, it is also often significantly cheaper. Talk to us about the action that Trump took. Obviously, the companies that supply technology to Huawei, including many American companies, are now theoretically restricted from doing business with them. So how existential is this to Huawei's business, this move from the Trump administration? I think it is a pretty existential threat. Now, what the Trump administration did was about two weeks ago, it added Huawei to this list called the entity list. And what this is, effectively, is this export blacklist, which doesn't allow U.S. companies to export any equipment,

basically any components or any technologies over to Huawei. And I think this is a really big deal because Huawei depends very significantly on U.S. technology to make a lot of its own systems function. So on the smartphone side, it needs a lot of different types of chips. On the network equipment side, it also needs a lot of chips and then also some specialty laser products. Not only are the U.S. chips companies prevented from selling to Huawei, basically the U.S. is able to cut off Google's Android from supplying to Huawei as well. This is another big risk to the company. This is able to basically, I think there's a good chance that Huawei's smartphone sales overseas outside China could very well collapse this year because it doesn't have

access to Android. And there's just a lot of components that Huawei needs that are almost exclusively supplied by the US. There's a lot of these types of chips. If you have, if you lack even a single chip inside in a system, the entire thing may not work. And so I think this is a pretty big deal. And not only is the U.S. able to stop basically U.S. companies from supplying to Huawei, the U.S. has a little bit of an extraterritorial reach as well. So the U.S. Department of Commerce defines, has this de minimis 25% threshold standard. It takes a look at any foreign product sold by, let's say, a European or Japanese or Korean company. And if over 25% of the value was generated in the U.S., then the U.S. Department of Commerce asserts that to be a U.S. product.

So in this way, basically, it can deny non-U.S. firms from selling to the Chinese controlled entity, in this case, Huawei as well. And so from news reports, we've seen that basically Infinion, a German semiconductor firm, Arm, a UK semiconductor firm, and then also Panasonic, a Japanese firm, all have announced that they are going to stop supplying to Huawei. And as soon as this happened, the founder came out saying that, basically, this may not be too big of a deal. We have plenty of spare tires. I really don't. buy that argument. I think that it is very unlikely that Huawei can survive, basically being cut off from almost all of its foreign suppliers. So, I mean, that's exactly right. I mean,

there had been reports, and I guess Huawei itself saying that it had a stockpile of chips, maybe it anticipated a potential action like this. But ultimately, in your view, it just doesn't have many cards to play as long as this action by the Trump administration remains. in effect. That's right. It's really striking. Just hearing you describe the severity of this, and to think that a few months ago we were talking about China was going to increase its purchase of U.S. soybeans and that was going to help get a deal, you can just sense this is a very serious escalation. I think it is a very serious escalation that basically the U.S. has this ability to turn off one of China's most important companies, period, that this is a company that is really important

domestically in China as one of the few firms that really does have an international presence, selling smartphones all over the world outside of the U.S., then also selling network equipment all over the world, but again, outside the U.S. Just to illustrate a little bit of how important this company is, basically, you know, if you ignore the smartphones and focus on the network equipment business, it's becoming incredibly consolidated market. So Huawei's main competitors selling 4G and now, soon to be 5G equipment, are Erickson and Nokia. Basically, a lot of the U.S. position has pretty much vanished. These firms that used to be major U.S. phone technology, mobile telephony technology companies included

names like Motorola, Lucent, and then Canada-based Nortel. Basically, none of these are going independent concerns anymore. And Huawei Erickson has been. and Nokia are really the big players left in the game. You know, if you go, it's an incredibly consolidated market. And if the U.S. is able to knock out the biggest player in a consolidated market, bringing the number of players from three to two, basically the prices may not rise by only a few percentage points for service providers, let's say, like Deutsche Telecom or Vodafone or British Telecom,

prices can may well double because there's just so much less competition and there's just so much more collusion when you have the world being supplied by this Nordic duopoly. And so, you know, I think this is, the actions are of the US are having reverberations around the world, not just in the U.S. and China as well. Is there something about the telecom equipment industry that has naturally caused it to have so many major flameouts? I mean, I forgot, you know, all these names that you mentioned, like Motorola, Lucent, Nortel, all those companies like just sort of, I don't remember. exactly, I think, do you want a Motorola, like, sell to Google or something like that?

Yeah. All these companies sort of like evaporated as shells of their former selves. Why has this business been so brutal and gotten to the point where there's just a few oligalopolistic players, arguably? Well, arguably, I think that is a lot of the story with the, you know, general technology sector. I'm not so much talking about the internet companies here, although I know that's a big debate. Basically, if you look at something like chips, something really striking to me recently was that Apple had to settle very long-running litigations with Qualcomm, a firm that's been embroiled with in litigation for a really long time, mostly because a firm like Intel couldn't step up and be a credible supplier on something called modem chips. And so just generally, I think the story in this hardware space and technology is consolidation everywhere and limited players in basically every segment of hardware. hardware technologies.

Is it a situation where it's just really hard technologically to produce this at scale? And so even, you know, you mentioned a giant like Intel. I think they're still the biggest semiconductor company in the world. And they're unable to deliver these modem chips to Apple at scale. Is it just because it's hard stuff to get right and get good and do in high quantity? My understanding is that this is not one of the most difficult technologies that the world can produce. A lot of this is still fairly low margin, and that's one of the reasons why so many firms have exited the market. So one of the things I mentioned it in the intro, but obviously

last time you are on the podcast, we were talking about the China 2025 initiative and its efforts to become a world leader in all these different areas like aerospace and semiconductor and medical equipment and robotics and transportation, things like that. The fact that the U.S. can, in theory, still unilaterally deliver a death penalty to a major Chinese player, it can't do anything, I would imagine, except remind the Chinese leadership how important it is to build up their own domestic tech sector. I think that's exactly right. And I think in an area like semiconductors is where the U.S. power is clearest that basically a lot of the world has given up on semiconductors. A lot of the European firms that used to be big have gone away.

Same goes for Japan. And China's trying to work really hard to enter this technology space, in part because it is just so owned by the U.S. And I think that, you know, the Chinese response to a lot of these actions really has to be to try to double down on its efforts to develop all of these different technologies. Not only can it basically not count on U.S. supply, a lot of foreign supply may not be. be able to flow to China because of this de minimis threshold. And, you know, I think it is politically intolerable for the Chinese that the U.S. has this at-will ability to shut off a major technology company. This is not the first time over the last year that the U.S. has done this.

In fact, the U.S. has done this three times over the last 12 months. In April, last year, the U.S. said this as ZTE, which is kind of like a small Huawei with both smartphone presence and then also network equipment presence. It also did this to a company called Fu Jian Kwa, which is a memory chip maker in southeast China. And now the U.S. is doing this to Huawei. And so I think the Chinese leadership really feels that it needs to do a lot more to promote its own capabilities in these chips. So is this always where it was inevitably headed? Because when Donald Trump decided to really change the U.S. trading posture with China, at the start of his administration, the critique was that

you know, his complaints about the trade deficit and how much we import from China were off the mark or maybe not clear economic thinking, but that there really was some merit to this idea that on areas like technology and intellectual privacy, China really did pose some sort of threat. And it didn't play by the rules, arguably, according to some people we've spoken with. So these moves against the Chinese tech sector, is this sort of always what it was really about? I think that's a really fair assessment. And basically, if you look at the report that launched this trade war, I'm referring specifically to the U.S. Trade Representative Section 301 report, basically it lists a lot of these technology issues front and center, including basically the term that they use force technology transfer.

and it mentions made in China 2025, I believe over 100 times in the Section 301 report, basically that the U.S. feels challenged on a lot of these technology areas that it alleges that China doesn't play fair, trying to compete against the U.S. in a lot of these areas. And so it really has to maintain its technological edge over the Chinese. Now, as of right now, when we're recording this, I guess people are still holding out some hope for a deal. If you talk to investors and traders, they're like, oh, they'll come to something. There's an upcoming G20 meeting and Trump and Xi Jinping might meet and maybe they'll shake hands there and there will be a thaw. Do you see any possibility of a thaw in the tensions

here still at this point? Or have we sort of hit a point of no return in which the both sides are really going to be dug in for a while, and the relationship between these two countries is sort of permanently and irrevocably changed? I think it is a permanent change in many ways. Now, I think it is really difficult to predict whether there will be a deal. I think it is at least still plausible that you can read a lot of the actions in recent weeks, ever since the Trump tweets on tariffs on May 5th, to be basically this negotiating. you know, tactic to get the Chinese to concede on a little bit more, basically at the end of the process. Or, you know, maybe it is the case that both sides are basically walking away from a deal.

And if you had to push me, I would say it's a little bit of the latter. It is, you know, especially with this escalation on Huawei, I think it just makes it much more difficult for the, on the one hand, it, you know, ticking down with their major companies, it's really a big deal. And Chinese diplomats are not willing to see one of its major companies fail. On the other hand, you know, it just makes it much more difficult to come to a deal. But one core point that I want to make is that regardless of whether there will be a trade deal, I think a lot of these technology issues are permanently changed. Basically, by that I mean that while the White House was prosecuting this trade war,

Congress has handed a lot of tools to the rest of the bureaucracy to deal with the tech sector, not just in China, but also in the U.S. by passing various laws. Dan, actually, go into that further. I hadn't seen much or heard much about this. So what are these sort of these specific laws that Congress has passed to which you're referring? So I think this is the shows that the U.S. has a really wide toolbox to deal with the Chinese and then also to some extent the American tech sector. One recent legislative change is the foreign Investment Risk Review Modernization Act or Firma. So this is a bill that Congress passed last year that significantly strengthens this fairly obscure government body called SIFIUS, which is the

Committee for Foreign Investment into the United States. Previously, Sipheus was scrutinizing acquisitions of U.S. companies by foreigners for national security review. And, you know, if this interagency body, which is staffed mostly by Treasury, but also has representatives from Department of Defense and Department of Commerce and a few other places decides that a foreigner cannot own a U.S. asset, then it has the ability to block that acquisition. And what Ferma, the Legislative Act passed in August, did, was expand the civius power to scrutinize beyond acquisitions to into non-controlling investments. So basically, any deal now that involves a foreigner that is, that offers a foreigner,

are any information rights or decision-making rights has the chance to be rejected. And this applies mostly to technology companies, even unlisted ones. So I think the interesting news from last month was that Siphyas forced the divestment by a Chinese company of Grindr, which is, you know, I'm not sure if everybody on Bloomberg knows this, but it is a gay dating app. This was a gay dating app that had been acquired by a Chinese firm. The Sipheus body has decided. that this is a national security risk for the Chinese to own our gay dating apps, and therefore must be divested. And that's because of the data and the information that could be gleaned from that app? Presumably, but SIFIUS is not very often open about publishing these opinions, but I think

that is the right idea. What are there, are there any other tools that the U.S. has available? So you mentioned Sipheus. Obviously, we talked about export controls in the beginning. Are there any other tools in the administration's toolbox at this point to further apply pressure on Chinese investors or Chinese tech or Chinese companies. Another tool in the toolbox is criminal prosecutions from the Department of Justice. And there is a formal named initiative here. Basically, it is called the China Initiative. Right before Jeff Sessions, the previous attorney general departed from his post, he announced this China initiative, which is this political instruction on the rest of the bureaucracy to scrutinize Chinese actions a lot more closely. It includes a lot of things, but mostly ideas

like trade secret misappropriation. If a Chinese person or firm has done that, then the U.S. ought to really bring it to prosecution. One interesting thing to note about the China initiative is that it designates five U.S. attorneys as part of a working group to carry this out. One of the five U.S. attorneys is the U.S. attorney for the Eastern District of New York, who is the person who issued the arrest warrant for Meng Wenzhou, who is the CFO of Huawei. This is a very novel sort of prosecution, basically nabbing the CFO of a company alleged to have broken sanctions and then also committed financial fraud while she was in transit in Canada. And so this is creating basically a political issue as well.

But basically you can see how these types of fairly novel prosecutions are now permissible in this new political environment after something like the China Initiative has been announced. We just have a few minutes left. So let's talk about what we should be. watching for next. So from China's perspective, obviously the moves against Huawei will encourage them to, you know, double down on building their domestic tech sector. But, you know, that's an overnight thing. That's going to, it's a long-term project. You can't just snap your fingers and create domestic replacements for chip suppliers. So what else might we see from the Chinese, in your view,

to address the current tensions, both in terms of their own domestic needs and also from a retaliatory perspective? So we believe that the Chinese retaliatory toolbox is quite weak. Basically, you know, there's some news now that they may impose rare earth bans. I think that is a temporary sort of thing that will cause in pain. Our view is that it will not harass the U.S. companies too much, mostly because the, so Chinese companies are not very entwined in the U.S., but U.S. companies are very entwined in China. So Apple employs something like, you know, a few hundred thousand young Chinese men making iPhones through Foxcon. And basically, the Chinese government would like to see these people continue to be employed.

A similar story goes for major U.S. firms like GM or even Starbucks and McDonald's. It keeps a lot of people employed. So the Chinese, you know, harassment tool basically also hurts itself quite a lot. We really don't buy the idea that the Chinese will sell U.S. treasuries. It is not necessarily a very effective option. But basically what they can do is to permit the currency to depreciate, which is mostly a market-driven process, that if the U.S. imposes greater tariffs, then the currency should weaken.

And the People's Bank of China is not going to get in the way necessarily, unless it is quite a steep fall from basically allowing the currency to depreciate a little bit further. Real quickly, on the rare earth's question, And so it's literally just as of this morning when we're recording it. And this is, by the way, we're recording it on the 29th. There's a lot of rare earths talk today because of something that was published in People's Daily. Why is that people hear that? And they say rare earths. And apparently they're not even that rare, but they know that they're important for all kinds of advanced technologies and that currently about 80% of them come from China. Why is that threat not really as big

of a deal as maybe people might think it when they see the headlines? So as you point out, rare earths doesn't turn out to be all that rare. It seems like there are major deposits also in Australia, Japan, California. It's just going to take a little bit of time for that to come online. And actually, this is sort of a similar point with, you know, with U.S. export controls, China might export control rare earths. Well, in general, as economists, we believe that the supply curve slopes up. You know, at higher price points, there will be more supply to come,

supply this sort of thing. If the Chinese significantly raised the price, well, there will be more processing overseas to do something like this. And similarly, as the Americans raise the price of semiconductors, in some cases to infinity by totally banning them, while the Chinese also have more incentive to try to figure out a lot of the stuff as well, it's just going to take a lot more time for the Chinese to figure out most aspects of semiconductors than for most of the rest of the world to develop their reserves of rare earths. And then so what would you be watching for next from the U.S. perspective? Again, I would come to export controls. That export controls is really, I think, the most important tool in the U.S. toolbox to hurt China. I think we've seen them being used to

devastating effect with Chinese firms. The ones I mentioned were ZTE, Fulian Tinghua, and now with Huawei. And I want to preview a little bit that this is another legislative change that the U.S. is offered. Basically, concurrently with passing the bill on SIFIUS, the U.S. also passed the Export Control Reform Act in August of last year. And among several things, the Export Control Reform Act requires the Department of Commerce to come up with several lists of technologies. One is in emerging list of technologies, another is a foundational list of technologies. The emerging list is something we have a proposal of. It hasn't been finalized yet. The foundational list hasn't been finalized yet.

So we have a sense of what the emerging list looks like. it enumerates technologies like artificial intelligence, biotechnology, quantum computing. If you take a look at a lot of these items, smart dust is in there, quantum sensing, whatever that is, is in there. And these look like big science projects rather than major pillars of U.S. exports. But I think they really are quite material, mostly because the U.S. defines an export in extremely broad terms. It is not just the sale of a final good across borders. Any transfer of information to a foreign national is deemed an export. It is a deemed export. So Joe, let's say that, you and I are sitting in a cafe in Australia, and I am a U.S. national, and you are a French national or Iranian national or

Russian national, whatever. And if I'm just talking to you or if I'm sending you an email about a control technology, which right now is mostly things like munitions and weaponry, that is deemed an export, subject to control by the Department of Commerce. And if you think through the implications of that, plus the idea. that the U.S. might control as something as vague as artificial intelligence, AI, as a national security technology, then, you know, consider that U.S. firms in the U.S., like Microsoft, Amazon, Intel, Apple, Amazon, they employ substantial numbers of foreign nationals working on these technologies. And I spoke to people at these firms who say that, you know, they have to really

think about if they had to sequester or even terminate portions of their staff. Otherwise, would be in violation of U.S. export control laws. So I think that is possibly the next shooter drop, just depending on how this regulatory process goes. This is one of the risks that I think people ought to be watching out for. I think it's going to create basically a lot of havoc if the rawmaking process goes as the proposal, what it looks like. So people talk, I mean, you think about this term,

you hear a tech Cold War, so to speak, But that's really what this sounds like when you think of this idea that, you know, U.S. tech multinationals might not even be able to allow collaboration between their U.S.-based researchers and foreign nationals. You could really just sort of see how essentially disruptive to the way the world works, that would be. I think it could be really disruptive that potentially the U.S. might stop flows of knowledge between people. And I think the, you know, I am still not quite yet ready to call this a Cold War. I think that is a fairly extreme scenario. And in any case, basically, China is much more entwined with the U.S. than the U.S. was with the Soviet Union. So how this exactly shakes out, I don't even know if the previous Cold War might be a useful precedent.

But yes, I think you are getting into some interesting problems here. Industry has pushed back a lot against this deemed. exports idea. One of the industries has suggested that basically, you know, if you take this deemed exports very seriously, an inventor of a technology, if it is on the final list of control technologies might be prevented from possessing it. And so, you know, you get into these very odd situations where, you know, a lot of things can be shaken up. Well, Dan, on that note, I'm thinking we have to reschedule you again maybe every six months or something like that for the next several years because it feels like what you're describing and as you say it's not going away

and the the ramifications of these moves are bewildering and kind of almost extremely hard to comprehend how they will really play out but really appreciate your perspective of the perfect guest given the spate of news over the last few weeks so thank you very much for coming on well thank you job well here is where i would normally chat with tracy and talk about What a great conversation that was, and that one actually was really fantastic. But since she's not here, just going to wrap it up. And obviously, this has been another episode of the Odd Lots podcast. And I'm Joe Wisenthall.

You can follow me on Twitter at the stalwart. Even though she wasn't here, you should still follow Tracy on Twitter at Tracy Elway. Definitely follow our guest on Twitter, Dan Wong, at Dan W. Wong. And be sure to follow our producer, Laura Carlson. She's at Laura M. Carlson, as well as the Bloomberg head of podcast, Francesca Levy, at Francesca today. Thanks for listening.