The significance of the Huawei arrest

The economic cold war between the US and China is not about tariffs or trade deficits but about technology

Last Saturday, the CFO of Huawei was arrested at Vancouver airport, at the request of US authorities, on charges of supplying equipment to Iran and busting sanctions. Huawei is the Chinese national champion in telecom equipment and smartphone manufacturing and design. It is a $50-billion colossus, and the world’s largest telecom equipment company with a truly global footprint. It is also leading the Chinese charge to dominate the new 5G mobile standards. It is one of the few Chinese companies with the scale and resources to compete in the global technology hardware arena, and is a world leader in critical telecom equipment and technologies. It has always been suspected of having links with the Chinese armed forces, due to the military background of its founder.
 

The CFO, Meng Wanzhou, is the daughter of the founder of Huawei, Ren Zhengfei.

This arrest has potentially much more serious long-term consequences for investors, beyond the initial short-term market volatility already experienced. This is not a simple arrest of a senior corporate executive.

Illustration: Ajay Mohanty

First of all, it makes any deal on tariffs much harder and more complicated to complete. The Chinese authorities will undoubtedly demand the release of Meng as a precondition for any tariff deal. From the Chinese point of view, this arrest is undoubtedly a politically motivated action. The release of Meng will be complicated to negotiate, as unlike the action against telecom company ZTE, which was a civil action driven by the commerce department, the charges against Meng are criminal in nature and driven by the US justice department. They cannot be easily reversed at the trade negotiation table. At the minimum, this arrest has sent a shockwave through the Chinese establishment, showing a determination on the part of the US to play hardball. Stunned, China is already raising the stakes and threatening long-term economic consequences for Canada, if it does not release Meng and stop her extradition to the US. While both sides are incentivised to complete a trade deal and not allow a further escalation, Meng's arrest will slow down progress. It may even derail the whole trade war de-escalation, as to how can China sign a trade deal , and give the concessions US President Donald Trump needs to show, with Meng still in custody. It will be a tremendous loss of face. Yet the trade negotiators have no power over a justice department criminal investigation. We need to see how this disconnect gets resolved.

The second takeaway is that even if we get a deal on tariffs, there are many other weapons the US can use in its economic and technological cold war against the Middle Kingdom. A deal on tariffs does not in any way or fashion indicate a lull in the economic cold war between the US and China. The US is clearly determined to maintain its technological superiority at all costs. Just look at recent actions.

Beyond the arrest of Meng, we have the US trying to convince all its allies to forcibly stop their telecom carriers from buying Huawei 5G equipment on grounds of national security. America has significantly tightened the rules for Chinese venture capital investment into Silicon Valley, effectively blocking Chinese access to cutting-edge innovation in the Valley. Then we have the export controls imposed on ZTE, under which no US company could supply it components, which nearly drove the company to ruin, till Chinese President Xi Jinping personally intervened. We have also had export controls being imposed on Chinese chipmaker Fujian Jinhua Integrated Circuit, under which no American company can supply it any “commodity, technology or software". Deprived of American equipment to manufacture semiconductors, there is no way that Fujian Jinhua will be able to scale production of memory chips, as intended.

Export controls are a very lethal weapon in the American arsenal of tools in their economic cold war with China. The harsh reality is that China imports more semiconductors by value than it does oil. No Chinese technology manufacturing company can survive, if shut off from American semiconductors or semiconductor manufacturing equipment. For certain specialised high-end semiconductors or semiconductor manufacturing equipment, there is no alternative to American suppliers.

Even for Huawei, the pride of Chinese technology, if the company were to be hit with a ban on buying from US companies, it would be brought to its knees. Out of its top 90 suppliers, 33 are American companies, ranging from Intel and Qualcomm to Microsoft. If Washington were to stop these US companies from supplying to Huawei, it would severely cripple the Chinese telecom equipment giant. 

The economic cold war between the US and China is not about tariffs or trade deficits. It is really at its heart all about technology. America is determined to maintain its lead in critical technologies, most notably in semiconductors and artificial intelligence (AI). China is determined to catch up, at all costs. This friction is not going to go away, whether a trade deal is signed or not. While the markets may celebrate a reduction in tariffs, that rally is unlikely to sustain. The US has many more weapons, beyond tariffs to hurt China. Most notably export controls on US corporations. It is showing a growing willingness to use these alternative weapons. 

Be prepared for continued market volatility around these issues, and pressure on technology companies that are a part of these global supply chains. China will eventually build its own semiconductor industry, but that will take at least a decade. It has no microprocessor or GPU manufacturing capability, nor can it manufacture and design semiconductor capital equipment. It is vulnerable to American pressure till it can reduce its silicon dependence. Choppy times ahead, with continued headline risk. 

The writer is with Amansa Capital