US sanctions backfire again. China is stronger as a result.

But there was an important second prong to America's semiconductor strategy—sanctioning China to hamstring their domestic chip manufacturing efforts.

In October 2022, sanctions caused the value of US-made chip and chipmaking equipment exports to China to fall significantly. pic.twitter.com/n1c50MAkgw

— Joey Politano 🏳️‍🌈 (@JosephPolitano) February 17, 2024

The largest source of rising Chinese semiconductor equipment imports comes from lithography machines used to print circuitry patterns onto silicon wafers, but purchases up and down the semiconductor manufacturing process have risen dramatically in 2023. pic.twitter.com/QV3vWC7JO5

— Joey Politano 🏳️‍🌈 (@JosephPolitano) February 17, 2024

America' did not just attempt to restrict Chinese imports of semiconductor equipment—it also tried to cut the PRC off from chips themselves, especially those used in AI and other advanced tech

Chinese chip imports have shrunk in response, though much of this is cyclical effects pic.twitter.com/UDq8TH4dEh

— Joey Politano 🏳️‍🌈 (@JosephPolitano) February 17, 2024

Thanks for making it to the end of this thread! Here's a link to the full article if you want to read more, and while you're there consider subscribing to my newsletter where I write all about economic data.https://t.co/3KD9eoXLrb

— Joey Politano 🏳️‍🌈 (@JosephPolitano) February 17, 2024

US-China Chip War Snips

The US makes up a significant portion of global manufacturing capacity for that semiconductor machinery, but it by no means has a stranglehold on the market—and in many areas, American firms still lag. That means DC is highly dependent on cooperation from its allies with key chipmaking equipment manufacturing centers for its sanctions policies to be successful—and the most important of those allies are the Netherlands and Japan.

The Netherlands is the headquarters and manufacturing home of ASML, the world’s leading semiconductor equipment giant and primary maker of key lithography equipment. In 2023, 29% of ASML’s total system sales were to China, up from only 14% in 2022, while the company’s net system sales rose more than 42%. That has shown up as a massive increase in chipmaking equipment exports from the Netherlands to China, which exceeded $5.8B in 2023. While none of those shipments represent the absolute-cutting-edge Extreme Ultraviolet Lithography (EUV) machines that ASML is famous for—the company has been effectively banned from shipping those to China for years—they do represent significant quantities of less-advanced lithography machinery that remain useful for a wide range of chip production. In 2023, the 176 machines bought from the Netherlands made up 85% of the dollar value of the PRC’s imports of “other apparatus used to project circuits.”

US imports of semiconductor equipment, while robust compared to pre-pandemic levels, are currently nowhere near the level or growth rate of Chinese imports. That’s in part thanks to significant delays among a wide range of CHIPS Act construction projects that now plan to open behind schedule.

The Chinese government and military have already been able to acquire some of the highly-coveted NVIDIA A100 and H100 chips American sanctions were designed to keep them from buying, and NVIDIA is rumored to be making more chips explicitly for the Chinese market with capabilities designed to come just under new US export restrictions. The US is continually playing whack-a-mole to wrangle the trading firms that enabled those acquisitions, as well as other possible methods of circumventing sanctions like via cloud computing services. America has also struggled to fully reign in foreign chip investment to China, with Korean chipmakers Samsung and SK Hynix alongside Taiwan’s TSMC negotiating essentially indefinite permission to import chipmaking equipment to their China-based factories. China’s leading domestic semiconductor manufacturer SMIC has already made an attention-grabbing breakthrough with the manufacture of 7nm chips used in new Huawei cell phones, and even though this was cobbled together using old foreign equipment and may not be ready for the limelight of long-term production it still represents a significant breakthrough that came much faster than observers expected. Plus, China is steadily reducing its reliance on imported chipmaking equipment, with domestic suppliers now eating into the market share once held by foreign firms.

The US-China trade war has only continually ratcheted upward over time, and the level of industrial policy spending and intensity of trade restrictions in place now would have been unthinkable even 10 years ago. Both countries are currently paying those costs, and it remains to be seen if either will be able to reap rewards from victory.

Trade Policy

The US is far ahead of China on technology, but China is gaining ground faster than anyone thought.

The US wanted to restrict China’s access to 7nm chips but now it appears China is making its own 5bn chips, and the smaller the better.

China Poised to Break 5nm Barrier

On December 8, Tom’s Hardware reported China Poised to Break 5nm Barrier

Chinese foundry SMIC may have broken the 5nm process barrier, as evidenced by a new Huawei laptop listed with an advanced chip with 5nm manufacturing tech — a feat previously thought impossible due to U.S sanctions.

When TSMC began to produce chips made on its N5 (5nm-class) fabrication technology in mass quantities in early Q2 2020, Huawei was not blacklisted by the U.S. Department of Commerce, and the foundry could still ship 5nm chips — which it did in huge volumes. Huawei formally introduced its TSMC N5-based Kirin 9000 SoC in late August 2020 and confirmed that the chip was made in Taiwan.

There are many similarities between the Kirin 9000 and the Kirin 9006C, which some might argue indicates Huawei is leveraging stock it obtained three years ago for its current PCs. While this could be true, keeping a massive quantity of premium processors (which were expensive to make on TSMC’s then leading-edge node) for three years doesn’t make a lot of sense, especially bearing in mind that the original Kirin 9000 featured a built-in 5G modem (something the Kirin 9006C presumably lacks) and could be used for a premium smartphone rather than for an inexpensive laptop. As such, it is possible that the company has turned to SMIC to create the processors.

It isn’t entirely surprising that SMIC could have broken through the 5nm barrier, as persistent industry chatter has indicated the foundry is close to further exceeding the limits imposed by US sanctions. “SMIC is preparing a 5nm process through DUV, and photomask usage is expected to increase further,” an expert in the semiconductor industry recently told The Elec.

Sanctions did not restrict China’s access to chips, Instead it forced China to make its own.

The US still has a big lead in the most advanced chips, but 5nm chips are quite good for most purposes.

On March 22, 2022 PC Mag reported Nvidia’s Latest GPU Boasts a 4-Nanometer Process From TSMC, PCIe Gen 5

2nm chips are on the horizon. But expect delays.

On September 24, 2023, Yahoo!Finance reported TSMC’s 2nm Chip Production Potentially Delayed Amid Global Semiconductor Slowdown.

Taiwan Semiconductor Manufacturing Company (TSMC), the world’s leading semiconductor foundry, may experience a delay in its planned 2nm chip production. Originally slated for 2025, the production could be postponed to 2026 due to a slowdown in the construction of a new plant in Hsinchu Baosha, Taiwan. The delay appears to be linked to a broader global deceleration in semiconductor demand.

The transition to 2nm technology is a significant step for TSMC as it will introduce Gate-all-around (GAA) transistors. These transistors, which will replace the existing FinFET transistors, utilize vertically stacked nanosheets that allow the gate to interact with the channel from all sides. This design innovation is expected to reduce energy consumption and current leakage while enhancing drive current.

Samsung (KS:005930) Foundry has already integrated this GAA technology into its 3nm node, but TSMC intends to debut this technology with its 2nm chips. However, TSMC has disputed reports suggesting a delay in their 2nm chip production, possibly due to competitive pressures. Samsung Foundry remains on schedule to launch its 2nm chips in 2025 and has plans to start 1.4nm production by 2027.

The Incentive to Break Sanctions

China lags the US in technology, but the direct result of sanctions is China now produces its own chips instead of buying them from the US.

As Politano notes “The US is continually playing whack-a-mole to wrangle the trading firms that enabled those acquisitions.”

And US imports of semiconductor equipment, despite the Inflation Reduction Act is behind China’s imports of semiconductor equipment.

How Russia Makes a Mockery of US Sanctions in One Picture

Unprecedented US and EU sanctions against Russia have had no impact on Russia’s oil exports or revenue. Who’s the beneficiary?

On December 29, 2023 I noted How Russia Makes a Mockery of US Sanctions in One Picture

On September 19, 2023, I commented Lesson of the Day: Sanctions Don’t Work Because They Create New Markets

Foreign Policy: “Since Russia’s invasion of Ukraine, Greece’s mighty shipping sector has continued to earn good money shipping Russian oil. But Greek shipowners have discovered an apparently even more lucrative source of revenue: selling the ships themselves to mysterious buyers linked to Russia. One publication has declared that a “Great Greek Tanker Sale” is taking place, and no price seems too high for a secondhand tanker. But the formerly Greek ships are entering a Hades-like shadow economy.”

Lesson Number Two

Countries, political leaders, and market makers act in their best interest.

It is in the best interest of Greek shippers to sell ships so they do. It is in the best interest of India and China to buy Russian oil and Greek ships so they do.

It is in the best interest of Dubai middlemen to make a market in ships so they do.

What this boils down to is simple: It is the best interest of middlemen in Greece, Russia, India, China, and Dubai to tell Biden to go to hell, so they do.

Why Sanctions Fail

• Someone always has an incentive to break sanctions.
• Sanctions create new markets.

This is how Russia sells oil and how China gets access to equipment and parts.

In the case of chips, the US has forced China into a path to self-sufficiency. Hooray?!

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