Semiconductors are now fundamental to our lives. They are ‘the brain’ in every electronic device imaginable, from cars, cameras, LED bulbs, mobile phones, refrigerators, televisions through to washing machines. And more uses are coming online every day. For example, you can now buy a robot dog, Unitree Go1, from US$2,700 to carry your bottle of water and run up to 17 kilometres an hour alongside you.

However, there’s a problem. The world’s supply of computer chips has been beset with challenges since the start of the coronavirus contagion

While the pandemic-promoted factory shutdowns have ceased, a series of unrelated incidents is still hampering supply. Examples include a fire at the Japanese Nittobo factory in July 2020, which stopped its supplies of special fiberglass used for printed circuit boards. And readers will be aware that the Trump administration started tightly regulating the sale of chips to Chinese firms, including Huawei, in January 2021, to which the companies responded by stockpiling the chips they need for production. Additionally, the global freight industry continues to face problems delivering semiconductors due to a concurrent shortage in shipping containers, while reduced passenger air travel means air freight capacity is also lower given about 50% of air freight typically travels in the bellies of passenger aircraft.

At the same time, changing consumer behaviour has fuelled fresh demand. The industry can’t keep up. It is estimated that at least 169 industries have already been impacted by the supply shortage, with the technology sector one of the worst hit.

Apple buys about US$58 billion of semiconductors a year, but had to postpone the launch of the iPhone 12 by two months. More worrying for some is Samsung’s statement that it too is facing production delays given the company is the world’s second largest supplier of chips, selling US$56 billion of semiconductors to others and consuming another US$36 billion of them itself.

In turn, issues at an industry level affect the economic performance of countries. The US, amongst others, is already hurting and the problems are set to continue. Production lines typically needed lead times of at least nine months. Now, some lead times have increased to over a year. The shortage is set to continue into 2022 at the earliest and you can’t quickly build your way out of the shortage – it takes between two and five years to get a complex semiconductor factory up and running.

But what does this have to do with democracy?

At the same time, the standoff between China and the US has become increasingly tense.

Many believed that Biden would pour oil on troubled waters when he took over from Trump. Instead, he has further antagonized the Chinese. Instead of repealing the sanctions Trump imposed on the world’s second largest economy, Biden’s administration has modestly expanded and fine-tuned them. In his June trip to Europe, meanwhile, Biden’s diplomatic efforts led to joint statements about concerns over China being released from the G-7 meeting, NATO, and (somewhat unexpectedly) the European Union (EU)-US summit.

The statements focused on human rights, security and the rule of law. And while they stopped short of reiterating the accusation of Uyghur Muslim genocide that Biden and his secretary of state have levelled against the Beijing-based authorities, they did reference China’s behaviour in the Taiwan Strait. In particular, the EU-US statement cites a consensus to “strongly oppose any unilateral attempts to change the status quo and increase tensions”.

This calls out conduct that China deems to be internal politics. In the same way that China baulks at any international criticism of its handling of Hong Kong, it is keen to ensure that its view of Taiwan as “an inalienable part” of its territory continues unopposed. The statements may, however, lead to action and force an end to the ambiguity created by the US publicly acknowledging the “one country, two governments” and doing all it could to ensure that Taiwan remained independent.

Japan too is embroiled. As recently as 28 June, the reference by Japan’s deputy defense minister, Yasuhide Nakayama, to Taiwan as a “country” was slammed by China’s foreign ministry as an “erroneous and a serious violation”. Japan, meanwhile, is increasingly concerned by the view that China may seek to take Taiwan by force. This action – in the minds of the Japanese leaders – represents a “survival-threatening situation” given it envisages Chinese aggression shifting to focus on its claims on a group of Japanese-controlled islets in the East China Sea. The uninhabited isles are called the Senkaku in Japan, while China calls them the Diaoyu Isles, and lie off the country’s southern island of Okinawa and north of its Ryukyu Islands. Japan has also not ruled out that “Okinawa could be the next”.

But it was the UK that linked the balancing act between wanting to do trade with China and condemning many of its political actions to democracy as it hosted the G7 meeting.

And pineapples?

Earlier this year, tensions between China, Japan and Taiwan also hit the headlines when Japan became the biggest importer of Taiwanese pineapples after China imposed a ban on the fruit stating that previous imports had been contaminated by pests. The resultant #FreedomPineapples social media campaign went viral as the Taiwanese President, Tsai Ing-wen, encouraged everyone to “eat Taiwan’s pineapples until you burst” and its international allies got involved too.

In helping Taiwan and encouraging allies to stand up to China, the US is also protecting itself economically. Taiwan is a clear leader in the global semiconductor industry, with its biggest company, Taiwan Semiconductor Manufacturing Company (TSMC), alone producing more than 50% of the global market. TSMC also produces 84% of the world’s advanced chips, including those the US needs for its military hardware, which can’t be produced at home. It is estimated that TSMC is a decade ahead of its peers in terms of its know-how and technology.

And although Taiwan has always maintained a neutral stance between China and the US, its electorate has voted in governments that are increasingly vocal in stressing self-rule. Taiwan has stopped short of declaring independence so far, but its politicians will come under pressure as China continues to escalate its military might and as a result of the Mainland’s treatment of Hong Kong. The management of the former British colony under the “one country, two systems” rule was supposed to showcase a route by which China would win over the hearts of the Taiwanese people and auger peaceful unification.

On 1 July, on the occasion of the 100th birthday of China’s Communist Party, President Xi Jinping stated the country remained “committed to promoting peace, development, cooperation, and mutual benefit, to an independent foreign policy of peace”.

More worrying to ‘Old China Hands’ was his perceived desire to channel his predecessor, Mao Zedong. Xi’s grey buttoned suit looked identical to the one Mao wore in the picture hanging beneath the Tiananmen rostrum. At the end of his 65-minute speech, Xi raised his right hand – a gesture that replicates the stance of Mao statues across the country.

He also used the speech to reiterate his commitment to “resolving the Taiwan question and realising China’s complete reunification” calling it “a historic mission and an unshakable commitment of the Communist Party of China”.

Only time will tell whether Xi sees the reunification of the Mainland and the “Renegade Province” as his chance to stamp a permanent mark on China. We won’t know until the autumn whether he is content with his job title as president, or wants to become party chairman – a title previously only bestowed on Mao.

The speech also served to highlight that the debate about capitalism versus communism is over. Instead, it’s a battle – however it’s fought – between democratic capitalism and one-party capitalism.

So what does all this mean for investors?

First of all, the hurdles facing manufacturers who rely on semiconductors will mean higher consumer prices for these goods – at least in the next 18 months to two years. Chip manufacturers have significantly raised prices in less than a year and other costs, such as shipping, have also risen. And the delays to production lines mean that storage costs increase for the other materials that were delivered on time. This is not what authorities want to hear at a time when other price increases are causing inflationary concerns.

And although the debate has focused the minds of governments around the world on the strategic importance of the chip sector, no concrete action has been taken. While Boris Johnson has asked his national security adviser to look into the acquisition of Newport Wafer Fab by Dutch-based Nexperia – a company in which China’s Wingtech has a controlling stake – the deal is already done as far as the Chinese are concerned.

This is a medium to long-term risk that we are aware of in portfolios, but which does not cause us to shift our positioning in the short term. An invasion and suppression of Taiwan by China would have high profile ramifications – not least on trade. In time though, this scenario could become more likely.

This is the advantage that our global, multi-asset class approach gives us: we have the ability to tap into the best opportunities in the world – access that has recently been bolstered by the move to use regional over global passive investments. While we are keenly aware of risks, such as those presented by China, the semiconductor shortage and the ongoing battle against COVID-19, we believe that these can be mitigated through the huge level of diversification we deliver to clients.