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China Semiconductors, ZTE 5G, Trump Trade: CEO Daily for April 6, 2019

Good morning. Eamon Barrett filling in for Clay who is taking a well-earned vacation.

On Wednesday the U.S. Semiconductor Industry Association (SIA), an industry group that includes Intel, Micron Technology and Nvidia among its members, released a report no doubt designed to capture the imagination of President Donald Trump. It came out a day before the president met with China Vice Premier Liu He to discuss trade and was called “Winning the Future”—a very Trumpian sentiment.

The report sets out the challenge of securing America’s leadership in the semiconductor space—where the U.S. has dominated ever since the industry was created.

Semiconductors are vital to all the next great tech advances, including 5G, AI, and quantum computing. However, as the report explains, Silicon Valley’s supremacy is “under threat from [foreign] government policies that seek to localize supply chains and build state-backed national champions to compete abroad.”

In case it isn’t obvious: they’re talking about China.

We’ve mentioned before how last year’s blockade on U.S. companies exporting microchips to Chinese telecom manufacturer ZTE was a wake-up call for Beijing, demonstrating how many of China’s tech champions are dangerously dependent on supplies from the U.S.

In fact, Beijing became wary of China’s crippling silicon addiction years before. The government released the National Guideline for the Development of the Semiconductor Industry in 2014 and established a $22 billion fund, nicknamed the Big Fund, to invest in domestic chip makers. The incident with ZTE only made Beijing realize it had to double-down its efforts.

China’s private tech companies have promptly answered the call. Baidu released its smart chip, Kunlun, last July; Huawei unveiled the world’s first 7nm microchip in August; Alibaba launched its semiconductor division Pingtouge last September; and this week smart phone maker Xiaomi announced it will reorganize its microprocessor subsidiary as part of a $1.5 billion AI strategy.

It’s the age of AI that might give China a chance to excel in the semiconductor business. AI chips are a different class from semiconductors of old so China is starting (relatively) fresh, rather than playing catch up. China’s huge data pools also give it an advantage when it comes to testing and improving AI chipsets.

The problem for China, and the saving grace for the U.S., is that Chinese companies are designing chips too sophisticated for domestic foundries to manufacture. For example, Huawei had to outsource the manufacturing of its groundbreaking 7nm chip to the Taiwan Semiconductor Manufacturer Company (TSMC).

But that won’t be the case forever. Chinese foundries currently meet 30% of domestic demand. Beijing wants to boost that number to 40% by next year and is flooding the sector with subsidies to do so.

To keep an American hand in the lucrative silicon trade, the SIA recommends the government does three things: first, triple federal funding for industry research to $5 billion a year; second, scrap immigration caps on qualified STEM candidates; and third, protect intellectual property.

That last point is something the U.S. has a real chance to do now, as Chinese negotiators engaged in discussions on forced tech transfers last week for the first time since the Trade war began nearly a year ago. Hopefully, negotiators will be able to keep focus on this space and away from less important objectives, such as reducing the trade deficit and increasing sales of soy.

Enjoy the weekend!

Eamon Barrett
@eamonbarrett49
eamon.barrett@fortune.com

Economy and Trade

Wars don’t just end. President Trump met with China’s economic tsar Liu He this week to continue negotiations on a trade deal. Trump said a deal could be signed in four weeks, but reports say China might be given until 2025 to implement any agreed upon conditions, stretching out the tentative peace both sides have submitted to for another six years. CNBC

Silk Road Summit. The White House won’t send top-level officials to China’s upcoming summit on the Belt and Road Initiative (BRI), to be held in Beijing later this month. Broadly, the BRI finances large scale international infrastructure projects. The U.S. is a staunch opponent of the scheme, which it views as a vehicle to spread Chinese influence overseas. Last month, Italy became the first G7 nation to endorse the BRI. Reuters

Raise a glass. Kweichow Moutai, China’s most prestigious baijiu distillery, is tipped to become the first Chinese stock to pass Rmb1,000 ($149) per share. Moutai’s share price has rallied 47% this year and four analysts predict it could reach the Rmb1,000 mark within 12 months. Moutai, named after the village where the liquor is made, was included on Fortune’s list of 50 companies best positioned for growth last year. Bloomberg

Innovation and Tech

The nine-to-nine grind. Employees of Chinese tech firms are protesting the so-called “996” culture pervasive in the industry. The digits refer to the expectation that engineers work from 9 a.m. to 9 p.m. six days a week. The protest emerged as a post on software code sharing site Github where a user highlighted how 996 culture violates China’s labor laws and advocated for better protection of worker rights. Roughly 30,000 users have saved the post. Mysteriously, web browsers operated by some of China’s biggest tech players have since blocked access to the thread. South China Morning Post

5G and EU. ZTE, the Chinese telecom manufacturer brought to its knees by a U.S. embargo last year, has carried out Europe’s first call over a 5G network. Local service operator Orange claimed to have conducted the call in Valencia, Spain, using 5G equipment provided by ZTE. Unlike Chinese telco Huawei, which been under intense scrutiny for its alleged ties to Beijing, ZTE is a public company with known state-owned shareholders. TechNode

Running out of Luckin. Luckin Coffee, the start-up that threatened to topple Starbucks in China, has offered $6.7 million in assets as collateral against a loan, suggesting all is not well at the feisty young brewer. Luckin was founded in 2017 and aims to outgrow Starbucks in store numbers by the end of this year. Starbucks China currently operates over 3,600 coffee shops, so Luckin is targeting exceptional growth. Rapid expansion has been the downfall of many a Chinese startup but also the success of a few. TechNode

In Case You Missed It

Uber, but for Xi Jinping NYT

Bolton builds anti-China campaign at the U.N. FP

MIT cuts funding ties with Huawei and ZTE citing US investigations SCMP

What’s going on with Mar-a-Lago and Chinese spies, explained Vox

Politics and Policy

Warmer climes. The China Meteorological Administration released a “Blue Book” report on the effects, and causes, of climate change in China. The Blue Book found that sea levels in China were rising faster than the global average, and Chinese glaciers were melting at their fastest rate to date. China, the world’s largest source of greenhouse gases, has struggled to rein in emissions. Sixth Tone

Duty Bund. The American Chamber of Commerce in Shanghai released a report claiming the cosmopolitan city won’t meet its target of becoming an international finance center by 2020 due to strict government controls on capital flows. The report says Shanghai is struggling to balance between being loyal to the Party and offering a safe haven to global capitalists. South China Morning Post