The Investor April 2021

Posted on


ShareFinder’s prediction for Wall Street for the next 12 months:


The State of Play

By Richard Cluver                                      April 2021

US Treasury secretary, Janet Yellen made her debut policy speech this month with a call for international cooperation on a new minimum corporate tax. Currently the US corporate rate is 21 percent but the Biden administration wants to raise it to 28 percent against a global average of less than 24 percent.

Furthermore, based on past experience of corporate tax increases that led in turn to some of America’s most iconic companies jumping ship for more favourable tax dispensations, Ms Yellen is hoping to persuade the rest of the world to increase their taxes in line with hers.

Under a coordinated international tax proposal that Yellen pressed at this month’s virtual IMF and World Bank meetings, multinational firms would face the same minimum rate regardless of where they park their HQ.

The issue is a big one in an era when it has become increasingly possible to headquarter your company in countries like the 15 listed on the right which do not levy any corporate taxation. Such countries get the same revenue results by taxing employees of the international companies that are attracted to their shores because of their corporate tax approach. It was an idea that worked splendidly for countries like Ireland which were suffering from high unemployment.

By offering low and, in some cases zero corporate taxes, such countries have seen employment rates benefit while the personal taxes levied upon these newly employed workers have adequately compensated such governments for their loss of corporate tax income.

It was a win win solution for countries like Canada which welcomed Burger king to cross the border from the US in order to avoid some $275-million in taxes, Budweiser to move to Belgium, Medtronic moved to Ireland translating a US corporate rate then of 39.6 percent to Ireland’s 12.5 percent.

Dozens of others like pet food giant Purina merged with Nestle’ effecting a headquarters move to Switzerland, construction giant McDermott moved to Panama, computer icon Seagate moved from California to the Cayman Islands, Frigidaire, inventor of electric refrigerators, moved to Sweden, Actavis (Pfizer) moved to Ireland, Lucky Strike to Britain…and so the list goes on

And, if you do not fancy any of these destinations I have listed, then there are another 18 that levy corporate taxes of less than 12.5 percent. And that is a real problem for governments elsewhere which have increasingly seen their corporates migrating elsewhere.

Worst affected are the following 20 countries whose corporate tax rates of over 32 percent have been a distinct disincentive for businesses located there. If, however, you consider the following list, it must be fairly obvious that most are small island countries which have never attracted much business. But do note that there are a few notable exceptions like France and Brazil whose tax regime is driving away business:

So, it should not surprise South African readers at all that at his latest budget, Finance Minister Tito Mboweni lowered corporate tax to 27 percent from April next year.

In order to compete to attract business investment, he will have to do a whole lot better because Britain only levies a 19 percent corporate tax, Switzerland 18 percent, Portugal 21 percent, Norway 22 percent, the European Union 20.9 percent while France has just lowered its corporate rate to 32.02 percent and hopes to progressively reduce it to 25.83 percent next year. In the Netherlands, Covid 19 has prevented a planned reduction to 22.55 while Sweden will cut the statutory corporate tax rate from 21.4 percent to 20.6 percent this year.

Tito has a very long way to go if he is to match the global average percentage of total available revenue that governments extract out of their economies to finance ALL of their spending. At 33.44 percent, South Africa takes one of the biggest slices of domestic cash flow. The 2019 average expenditure of 151 countries as a percentage of national GDP was a mere 15.75 percent while the world’s highest percentage was Lesotho with 39.61 percent and the lowest Chad with 3.59 percent.

The South African Government has, moreover demonstrated an ever-growing hunger for a bigger share of GDP. Back in 1920 the government took just 18.53 percent of GDP and that rate remained below 20 percent for half a century until 1970 when it reached 20.05 percent. After a 1990 rate of 28.7 percent, it fell back to 25.86 when Trevor Manuel, then Minister of Finance saw the need to attract foreign companies to locate here to mop up our rising unemployment rate. Sadly, like so many other priorities, low corporate taxes went out of the window during the Zuma years when the rate rose to 32.99 percent and, more recently to 33.44 percent currently.

But, if corporate taxes have been declining worldwide because business has found how easy it is to migrate in the Internet era, individuals are beginning to do the same. After all, why pay the South African Government 45 percent of your salary if you can move to Bermuda, the Cayman Islands or the Bahamas and pay nothing while you sip Pina Coladas on a sub-tropical coral beach, or pay only 15 percent in Mauritius and the Seychelles, 20 percent in the Isle of Man or 25 percent in Botswana. You could move to Kenya and pay 30 percent, Swaziland and pay 33 percent, Malta and pay 35 percent, the United States and pay 37 percent or New Zealand and pay 39 percent.

For folk who have labored all their working lives to build up investment portfolios that offer them a comfortable lifestyle in retirement, soaring dividend taxes have become a means of punishing the elderly for a lifetime of frugality but there is nothing more irksome than Capital Gains taxation which effectively prevents them from selling underperforming shares in order to re-invest in better performers for the not unreasonable objective of protecting the capital value of their nest egg.

For those in South Africa who hold investment portfolios via a family trust in order to ensure that their heirs might inherit the benefit without the Government claiming the bulk of it in death duties, CGT is now an aggressive 40 percent. But there are literally dozens of countries which offer us infinitely better rates in both respects. I have listed only the top 24 on the right:

While Ms Yellen might have found some enthusiastic listening ears at this month’s IMF meetings among representatives of left-leaning governments whose hunger for an ever-larger slice of the earnings of their citizens is matched only by the rapid expansion of the size of their civil service, the reality is that the world is moving in the opposite direction.

Increasingly, governments are learning that raising taxes deters economic growth leading to shrinking state revenue and simultaneously to ever-growing public demands for state benefits like free medical care and the dole. Enlightened governments are growing their economies by cutting taxation and pursuing business-friendly policies.

Looking towards a utopian future, however, progressive governments everywhere are realising that VAT is the only tax that is cheap to collect and easy to police.

Meanwhile, the latest Biden tax proposals that are filling US residents with gloom are to raise the top 37% rate on wages and other ordinary income to 39.6%. He also plans to raise the tax rates on capital gains, calling for a 39.6% top capital-gains rate on income over $1 million, including that extra 3.8% tax in the total rate.

Dirty powership blunder – solar, wind, and batteries are cheaper and better

Reproduced from My Broadband

The government’s decision to include three liquid natural gas powerships from Karpowership SA for emergency power is a mistake which will cost South Africa dearly in the long run. This is the view of energy expert Chris Yelland, who was speaking to the SABC about the procurement of emergency power by the Department of Energy.

Yelland said there is growing opposition to the Risk Mitigation IPP Procurement Programme (RMIPPPP) process and the decisions which arose from this process. Two-thirds of the new emergency risk mitigation power programme – 1,220MW of the 1,845MW – went to a single company, Karpowership SA.

This decision is facing severe criticism from energy experts who highlighted problems with powerships, like the lack of local gas resources, high costs, and the negative impact on the environment. To put the cost in perspective, the CSIR estimated that Karpowership SA can get as much as R218bn from the 20-year deal. Yelland explained that all the liquid gas will need to be imported which carries a lot of financial risk for the country.

The fuel cost is linked to the US Dollar price for liquefied natural gas which means the USD/ZAR exchange rate can significantly influence the future cost. It is also linked to carbon tax. “It is currently very low, but this can increase in future,” Yelland said. He added that South Africa will never own the powerships. Instead, it is rented from Karpowership SA. “It is not a South African asset, and all the money goes abroad to the Turkish Karadeniz Energy Group,” Yelland said. So, while the bid price from Karpowership SA may look competitive now, it has a significant risk that will fall on South African consumers. Yelland said solar and wind power, in combination with battery storage, provide a better and more sustainable solution.

Clyde Mallinson, director at Virtual Energy and Power, echoed Yelland’s views in a briefing note on a systems approach to South Africa’s electricity supply crisis. Mallinson warned that the Karpowership SA deal will lock the country into “dirty and expensive energy for the next 20 years”. He proposed an alternative emergency procurement programme that will make “full use of available system assets” in South Africa. The plan is to significantly overbuild on wind and solar power plants and back this up with large battery energy storage facilities. This approach, Mallinson said, allows for 30TWh per year to be procured at an estimated tariff of R0.61 per kWh. This is 39% of the weighted average tariff of R1.58 per kWh of the winning bids in the RMIPPPP. He added that his solution guarantees a dispatchable supply of 2,000MW from 05h00 to 21h30 every day of the year.

In short, South Africa will get far more power for far cheaper than from Karpowership SA’s liquid natural gas powerships. “This alternative way of procuring emergency power could deliver electricity at less than half the price and meet fully the requirement of dispatchable power,” Yelland said. He added that Mallinson’s proposal will also deliver far more power than the government programme. Commenting on the speed at which the solar and wind power could be delivered, Yelland said there are no concerns in this regard. “There is no question that wind, solar, and battery power can meet the delivery requirements,” he said. “We should take Mallinson’s analysis very seriously. It is a sound analysis, backed up by facts using scientific data.” Considering these facts, the Department of Energy and Minister Gwede Mantashe got it wrong, Yelland said.

No Growth without property rights

By BRIAN KANTOR

I once asked a meeting of law students if they knew why we have the laws that protect our wealth and enforce the sanctity of contracts. They appeared to have little idea, other than that it is morally wrong to steal or perpetrate fraud, or not to be true to your word.

Nobody had told them that protecting rights to wealth is essential if wealth is to be created in the first instance. That if you saved and invested in a home, farm, mine or business enterprise and somebody who is stronger than you can simply take it away, there would be no reason to save and invest in productive, long-lasting assets. Protection of wealth to encourage wealth creation is essential if any community is to become more productive and escape deprivation.

https://lh3.googleusercontent.com/KAWPTCZKvetnVbs8g24enwLZHFtdhUsBNfAgZ5-OsfWA3Q7cgklrNJfDHoEWdC8eEWopHLL20URd3btvJVa_20oA3LtbziyYKXgBpafcuHdP=s750 The power of any government to take what might be yours, gained fairly in exchange, is one of the obvious dangers to be averted in the public interest of more saving and more capital expenditure. While there might be good cause for a compulsory purchase to advance a broad public interest, it should be facilitated by offering the market value of the asset as compensation. No compulsory expropriation without compensation is enshrined in our constitution and legal practice — for good income-enhancing reasons.

Having to offer full compensation to owners is a deterrent to exercising compulsory purchase orders. The taxpayer will have to pay up for the assets, and they have political influence resented by those whose ambitions to change the world for the better are frustrated by want of the means. Just pay for what you wish to take is a principle to be defended and honoured.

South Africans are not only reluctant taxpayers, we are reluctant savers and maintain an unsatisfactory rate of capital accumulation. We have to rely on foreign savings on a big scale. We are dependent on capital that can be freely invested anywhere. And that capital is easily frightened off by threats of being taken away, by expropriation or changes to regulations that will affect its market value.

The mere hint of expropriation of land and real estate, without compensation, makes foreign capital more expensive. Foreign investors demand high expected returns to compensate for https://lh3.googleusercontent.com/KPtTRn_-zoIqFeoTZfbFlmb_ZDmTtrPbLMmDRBWRoPr2Ll5yIzUOT5xuSrhVytqpl92fz0HiRqLmsN4WZbeS49UxqLTjURQtUheH2QWHhTjBJXI=s750 the risk of our taking away or interfering with their capital. Hence our low rate of capital formation.

To justify any addition to its plant and equipment, an average-risk JSE-listed company would have to expect an annual return of more than 15%, or at least a real 9% after expected inflation of about 6%. That is a return few companies can confidently budget for. Hence they are investing less, and saving less, by paying out more of their earnings in dividends. The ratio of JSE earnings to dividends has halved since 2010. Companies are retaining less because they are investing less in capex, for understandable reasons.

https://lh3.googleusercontent.com/WalkkodPadY8t37giKdkRjOlUU3ufbtKrcRWOhxFfNVwwHWAVGxxSQT5ZCk0LiEm2HI6KsEqxZ00MwEAygzOkAQgCTLYrw9jQuwumXcBuel_cw=s750It has taken Covid-19 to bring the low rate at which SA saves above the dismal rate at which we are adding to plant and equipment — only 12% of GDP in 2020. Accordingly, we have become a net lender to the world rather than a borrower, temporarily it is to be hoped.

Reducing the risks of investing in SA will encourage more capex and more savings in the form of earnings retained by business. We could then attract the necessary foreign capital at a lower cost than we are paying now. Reducing risks means sensibly reducing the threat of taking — not adding to it.


Some Thoughts on Inflation

John Mauldin

By John Mauldin

Considering the effects of inflation on mortgage rates. I have noted before that the comparisons from one year ago beginning in March/April will make “headline inflation” appear to be soaring in the next few months.

That is because we had very low inflation this time last year, and prices are rising on many items across the board.

https://ggc-mauldin-images.s3.amazonaws.com/uploads/newsletters/Image_10_20210410_TFTF.png
Source: MBS Highway

Note that annual core inflation was just 1.3% a few months ago. Inflation is roughly rising 0.2% a month, which is a reasonable base assumption. If that is the case, we should see 1.5% inflation in March (reported in April). But it will quickly rise to 2.1% and then 2.4% in April and May, at that relatively benign 0.2% assumption.

I have smart and talented friends who believe the base assumption should be higher for the next six months. I would not be surprised to see a 3% inflation number. Jerome Powell and other Federal Reserve officials will tell us the number is transitory, and I would generally agree. As we go back to normal, as supply chains actually get fixed, I expect the inflation numbers to go down. Further, one year from now the comparisons will be from a much higher base so it is likely that inflation will once again be below 2%.

For whatever reason, and I think it’s a silly reason, the Federal Reserve wants to keep rates low until we get back to 3.5% unemployment. That is a number we have only seen twice in the past 60 years, once during the Vietnam War when we had half a million soldiers out of the workforce and again at the end of 2019. Try as I might, I cannot see the linkage between financial repression with low rates and the unemployment rate again reaching an all-time low. I would much rather have stable pricing and some actual coupon return on my bond investments.

The standard 60/40 (stocks to bonds) portfolio is broken because bonds are broken. Look at this chart from Ray Dalio courtesy of my friend Steve Blumenthal of CMG. We literally have negative real rates in the bond markets and many institutional bond funds. The bond part of the 60/40 strategy was supposed to reduce volatility and provide income. When rates are rising it’s actually costing you money. If you own a 10-year Treasury fund, you are down about 6% this year. At a 1.7% yield, it will take the over three years just to get back to breakeven and that’s assuming that yields don’t rise even more. Bonds are not providing either the income nor the volatility hedge. Traditional passive 60/40 investing is dead.

There are places you can find income in the private markets, but those don’t show up in ETFs or mutual funds. There are reasonably good funds with trading strategies that produce bond-like characteristics. Again, not the traditional choice for most investment advisors.

The Federal Reserve is forcing investors to move out the risk curve to generate income from their portfolios that they spent decades accumulating, hoping for enough to live on. For Boomers and people looking to retire in the next 10 years, this is an absolutely insane policy.

The Exponential Ride

The last year brought exponential growth in, among other things, use of the word “exponential.” It is now the go-to term when you want to say something is “growing super-fast.”

As humans, we tend to think in terms of linear growth—whatever is happening immediately around us in shorter time periods. Accelerating, exponential growth is harder to grasp. Exponential growth means the rate of growth increases with time, just like a car goes faster the more you press the gas pedal.

“Exponential” has become popular recently to describe the way a virus spreads, if nothing stops it. When one person infects two others, each of whom infects two others, who each infect two others and so on, the numbers can quickly get out of hand. Exponentially so.

But exponential growth isn’t always scary. Compound interest is exponential and we all enjoy it (when we’re the lender, at least). Moore’s Law, which says the number of transistors on integrated circuits doubles approximately every two years, is another example of extremely useful exponential growth.

The number of transistors on a microchip “only” doubles every two years. But that took it from 1,000 transistors to 50 billion in 50 years. Literally, 50 million times more powerful.

But it’s even better. If you go back to the late 1940s when transistors were first being developed, having 1,000 transistors on something called a microchip was barely a dream. But with time and literally tens of thousands of patents and innovations, etc., we got to 50 billion. People have been proclaiming the end of Moore’s law for decades. I’ll take the other side of that bet and we are just exploring the edges of quantum computing.

Read a little about the chip industry’s growth and you’ll see words like “surprise” and “accidental” discoveries. You’ll also see that it didn’t happen in one place at one time but was literally exploding all over.

But the exponential growth of the microchip would not have been possible without the exponential growth of all sorts of technologies and innovations developed over the previous 100 years. That’s the amazing thing about innovation. Or, more broadly, we could just call it “progress.”

Humanity is constantly learning and improving. These improvements build on themselves in an exponential process. That’s why daily life changed far more in the last 200 years than it did in the prior 20,000 years. The rate of growth accelerated. And that’s why we will see more change in the next 20 years than we have seen in the last 200.

Today we enjoy living standards far higher than even royalty did not so long ago. Yes, we have problems, serious ones, but we also have advantages. We know we can make the world better because it is getting better. And it’s getting better all the time, at least over time.

Occasionally I devote a letter to highlighting good news—positive things that are happening all around us, often unnoticed or unappreciated. The last one was in January 2020, just before the pandemic consumed our attention (see Looking on the Bright Side). We’ll get back to the problems of the day later, but today I want us to appreciate the positive. There’s a lot of it out there. And any serious investor should pay attention because technological innovation is where the real financial upside is (along with, admittedly, a lot of dead-end alleys).

Before we begin, I’m very happy to report that our second all-virtual Strategic Investment Conference is shaping up to be one of the most star-studded SICs we’ve ever had. We have confirmed close to 40 speakers now, and many are celebrities in their respective fields. And yes, we will be devoting some time to some of the technological innovations that are just now appearing, with some of the people who are making them appear.

We haven’t unveiled the full list of speakers yet but for more details, I invite you to watch a short personal video message I recorded a few days ago. On the same page, you can also pre-order your SIC 2021 Pass at a 50% discount (or more, if you are one of our Alpha Society members). I hope to see you in May!

Pandemic Pluses

This year’s top good news, by far, is the COVID-19 vaccines. It was a mind-boggling scientific, manufacturing, and distribution achievement. To have a vaccine at all is amazing; to have several of them only a year after the virus was identified is unprecedented. This kind of work once took decades. Operation Warp Speed was indeed a triumph of human work, cooperation between the private and public sectors, effort, and ingenuity.

This happened in part because scientists had been working on the underlying methods and technologies for a long time, not knowing they would be useful in a pandemic. You can read the whole gripping story in The Atlantic by Derek Thompson.

Briefly, “messenger RNA” (ribonucleic acid) is a genetic substance that tells your cells which proteins to make. Researchers in various places realized long ago that manipulating RNA could be quite useful, but exactly how to do it was elusive.

It turns out that Hungarian scientist Katalin Karikó discovered mRNA back in 1978. She eventually ended up at the premier epidemiological university in the United States, the University of Pennsylvania, where she worked on her discovery with other scientists. Eventually in 2000 they began to see some success. (I have probably walked past what was once her office on my tours of the facility.)

Private companies began working on mRNA products, with Moderna in the US and BioNTech in Germany eventually cracking the code. US pharmaceutical giant Pfizer had made a deal with BioNTech in 2018 to develop an mRNA flu vaccine. When SARS-CoV-2 struck, they pivoted quickly. The result went into my arm a month ago and again this week (and I hope yours as well). The technology they developed may well lead to other life-saving medicines, like a malaria vaccine (with a variation of mRNA technology) and individually tailored cancer treatments.

I want to focus a little bit on how incredibly successful the actual vaccine is, and to highlight some of the misinterpretations of statistics by the public. I get a long email from Justin Stebbing every day discussing the massive amounts of research on COVID that came out in just the recent few days. This crossed my desk this week:

So, with a 50% effective vaccine, we have a 50% chance of contracting COVID-19, and with a 95% effective vaccine, we have a 5% chance… right?

Actually, the news is much better. Consider what that “95% effective” statistic actually means. As The New York Times’ Katie Thomas explained, the Pfizer/BioNTech clinical trial engaged nearly 44,000 people, half of whom received its vaccine, and half a placebo. The results? “Out of 170 cases of COVID-19, 162 were in the placebo group, and eight were in the vaccine group.” So, there was a 162 to 8 (95% to 5%) ratio by which those contracting the virus were unvaccinated (albeit with the infected numbers surely rising in the post-study months). Therein lies the “95% effective” news we’ve all read about. Or the 90% real world stuff I sent round yesterday.

So, if you receive the Pfizer or equally effective Moderna vaccine, do you have a 5% chance of catching the virus? No. That chance is far, far smaller: Of those vaccinated in the Pfizer trial, only 8 of nearly 22,000 people, less than 1/10th of one percent (not 5%), were found to have contracted the virus during the study period. And of the 32,000 people who received either the Moderna or Pfizer vaccine, how many experienced severe symptoms? The grand total, noted David Leonhardt in a follow-up New York Times report: one.

[German Scientist] Gigerenzer says that his nation suffers from the same underappreciation of vaccine efficacy. “I have pointed this misinterpretation out in the German media,” he notes, “and gotten quite a few letters from directors of clinics who did not even seem to understand what’s wrong.” “Be assured that YOU ARE SAFE after vaccine from what matters—disease and spreading,” tweeted Dr. Monica Gandhi of the University of California, San Francisco.

Of 74,000+ participants in one of the five vaccine trials, the number of vaccinated people who then died of COVID was zero. The number hospitalized with COVID was also zero:

https://ggc-mauldin-images.s3.amazonaws.com/uploads/newsletters/Image_2a_20210402_TFTF.png

This is simply mind-boggling, in terms of not just the speed at which the vaccines were developed but also their efficacy. But just like the 442,000 Teraflop per second computer (the world’s fastest computer now in Japan), the successful vaccine would not have been possible without the multiple decades of work developing it, let alone the even longer period of research prior to the discovery of mRNA. Moderna literally had a working vaccine model within 48 hours after learning the DNA sequence. Six weeks later, it shipped its first vaccine batches to laboratories in Maryland to begin human trials. The summary from The Atlantic article mentioned above?

The triumph of mRNA, from backwater research to breakthrough technology, is not a hero’s journey, but a heroes’ journey. Without Katalin Karikó’s grueling efforts to make mRNA technology work [in 1978], the world would have no Moderna or BioNTech. Without government funding and philanthropy, both companies might have gone bankrupt before their 2020 vaccines. Without the failures in HIV-vaccine research forcing scientists to trailblaze in strange new fields, we might still be in the dark about how to make the technology work. Without an international team of scientists unlocking the secrets of the coronavirus’s spike protein several years ago, we might not have known enough about this pathogen to design a vaccine to defeat it last year. mRNA technology was born of many seeds.

The vaccines may be what gets us out of the pandemic, but the experience drove some other unintentional innovation, too. One was remarkably simple: Remote doctor visits. Many medical issues can be handled with a simple conversation, but (at least in the US) it rarely happened for legal, liability, and insurance reasons. The pandemic compelled all the players to cut through those barriers. I don’t think we will be going back.

This also illustrates the exponential growth principle. Now that remote medicine is allowed and people (both providers and patients) are getting comfortable with it, we will expand the range of services delivered that way. Technology will be the key—or rather, a bunch of technologies working together. Virtual reality cameras and visors, 5G bandwidth, haptic sensors to convey “touch” without being there—all will speed up the process and should lead to better outcomes.

But even as the pandemic unfolded, other innovation continued. Let’s look at some more examples.

Food Future

The last year also gave many of us a new relationship with our food. With restaurants closed or limited, we did more of our own cooking.

In fact, our food habits and methods are always changing. Many plants we eat simply didn’t exist in their current form even a century ago. They have been cross-bred and manipulated into what we know now. That process is continuing as several companies now offer plant-based meat substitutes. As often happens with new technologies, prices are falling and people are finding new uses for the products.

My friend Professor Jesse Ausubel at Rockefeller University wrote to me last week about a joint venture between US and Chinese companies making a new “single-cell protein” substance called FeedKind. It is manufactured by fermenting natural gas with naturally occurring bacteria. The resulting pellets are used to feed fish. Used instead of soy, it will free up huge quantities of land and fresh water.

Material Factors

Some of the most amazing breakthroughs are also the most basic: the materials we use to build everything else. Hydrogen, for instance, is the most abundant element in the universe yet we have long struggled to isolate and make use of it. This is changing.

The current process for producing hydrogen consumes a lot of energy itself, and also emits large amounts of greenhouse gases. Another method called electrolysis is simpler and cleaner. All you need is water and electricity. The electricity can come from renewable sources. That means hydrogen can (in theory) be produced almost anywhere, reducing the need to haul fossil fuels around the world.

Beyond hydrogen, other materials science breakthroughs are brewing everywhere. My friend Peter Diamandis recently talked about graphene, which is basically a sheet of carbon just one atom thick, nearly weightless but 200 times stronger than steel. He calls it a “super-material” for obvious reasons. The applications are endless.

He also wrote about nanotechnology—manipulating matter at super-microscopic levels. This is a bit unbelievable so I’m just going to quote him directly.

Progress has been surprisingly swift in the nano-world, with a bevy of nano-products now on the market.

Never want to fold clothes again? Nanoscale additives to fabrics help them resist wrinkling and staining.

Don’t do windows? Not a problem! Nano-films make windows self-cleaning, anti-reflective, and capable of conducting electricity.

Want to add solar to your house? We’ve got nano-coatings that capture the sun’s energy.

Nanomaterials make lighter automobiles, airplanes, baseball bats, helmets, bicycles, luggage, power tools—the list goes on.

Researchers at Harvard built a nanoscale 3D printer capable of producing miniature batteries less than one millimeter wide.

And if you don’t like those bulky VR goggles, researchers are now using nanotech to create smart contact lenses with a resolution six times greater than that of today’s smartphones.

And even more is coming. Right now, in medicine, drug delivery nanobots are proving especially useful in fighting cancer. Computing is a stranger story, as a bioengineer at Harvard recently stored 700 terabytes of data in a single gram of DNA.

The applications are endless. And coming fast. Over the next decade, the impact of the very, very small is about to get very, very large.

Again, all this is coming now. And as I described above, the real impact is exponential. Using nanotechnology to solve these problems will free up the productivity currently being applied to them, so it can be multiplicatively used for something else. What would that be? Probably things we can’t presently imagine.

While we are approaching the limits of lithium-ion batteries, there are literally scores of new technologies being developed which will far surpass current technology. The ultimate green energy, fusion energy, is fast becoming more than a pipe dream. There is a revolution in agricultural production (I am somewhat involved with it) that will completely disrupt current production cycles over the next 20 years. A little slower than Moore’s Law, but just as powerful.

You may have missed that last year Brown University scientists began wirelessly connecting the human brain in quadriplegics. An electrode array is attached to the brain’s motor cortex and then high-speed networks allow the patient to communicate. We are not all that far from the day when, if you choose, you will be able to “talk” directly to your computer simply by thinking.

Entrepreneurial Shifts

Our most important natural resource, by far, is the human mind. Any one of them has astonishing potential all by itself. When we put them together, true magic happens.

As you know (because I and others have lamented it), this pandemic/recession has destroyed hundreds of thousands of small businesses all over the world. But it didn’t destroy the entrepreneurs who founded them. I believe many will do what comes naturally to them and start more businesses—hopefully better than those they lost.

Transitions are hard but often lead to a better place. I believe some wonderful new ideas—and very successful businesses—will emerge from this time. I can’t wait to see what they are.

We literally live in one of the most exciting periods in all of human history. Oh, did I not mention the possibility that we might live a great deal longer than previous generations? Maybe in the next positive letter…

Tsunami Warning

By John Mauldin

A tsunami is a wall of water that wipes out everything in its path, typically caused by earthquakes. But first, the water actually disappears from the usual shoreline, leaving land where there should be sea.

If you are on the shore and see that happen, the correct response is to run for high ground. Tragically, though, people often rush toward this new and unusual sight. It’s hard to blame them; we humans are drawn to the unknown. This impulse explains much of our progress, but it has costs, too.

Right now, the stock market is in the land-where-there-should-be-sea phase. What we don’t know is when the wave is coming. Maybe there’s time to venture out and see what treasure was hidden beneath the waves… or maybe not. Prudence would suggest that we go searching for treasure on higher ground.

This is an age-old investor conundrum. How do you balance risk and reward? You have clues, but you can’t be certain of what is coming, or when it will arrive, or what it will look like. You know you need positive returns, but you also need to avoid major losses. The answers are never easy. You take your chances, no matter what you do. Today we’ll see what some of my favorite market wizards see on the horizon.

When Every Lot Is Odd

One sign the water may soon rush out of stocks, indicating tsunami, is the amount of money rushing in. My friend Doug Kass recently shared this staggering chart. It shows the inflows to stock funds since November exceed the total inflows of the last 12 years. Doug helpfully pointed out that one of the legendary Bob Farrell’s rules is that “individuals buy most of the top and buy the least at the bottom.”

https://ggc-mauldin-images.s3.amazonaws.com/uploads/newsletters/Image_1_20210416_TFTF.png

Source: CNBC

Note also, this is just stock funds. It doesn’t include individual trading accounts, and I suspect the amount entering the market via those is equally staggering.

Where is the money coming from? The obvious answer is from the Federal Reserve and government stimulus. But Danielle DiMartino Booth gives us a visual chart to understand just how completely out of historical context the current levels are (from Quill Intelligence):

https://ggc-mauldin-images.s3.amazonaws.com/uploads/newsletters/Image_2A_20210416_TFTF.pngYes, some of this is showing up in retail sales (which were gonzo last week), but clearly some of it is showing up in stock purchases (see some reasons why below). We see well over three times the normal tax refund and stimulus number (pushing $700 billion), and I assume this doesn’t even include state unemployment and other indirect stimulus. Also, notice the tiny blip on income tax deposits. The differential is even more stark.

When markets change, as they clearly have in the last two years, you want to ask if something else changed that might explain it. Federal Reserve activity and COVID stimulus payments are obvious factors, but I think something else is contributing. Some history may clarify it.

Way back in ancient times, which some of us can remember, stocks traded in 100-share “round lots.” If the share price was $30, you had to invest $3,000, or $6,000, or some other multiple. You could trade in smaller increments but brokers frowned on it and some charged higher commissions, which back then were already extremely high compared to today. And odd lot orders often got executed at inferior prices, too.

(I have a friend who once ran serious money for a family office, focused entirely on buying bonds in odd lots. He didn’t need to find odd lots, as they had plenty of money. He could simply get 1 to 2% more yield for the little bit of extra work.)

Over time, “odd lot” trading became a sign of amateur activity, to the point some used it as a contrary indicator. More odd lot activity meant uninformed people were entering the market and a top was approaching.

By the 1990s, back office technology had made the whole round lot preference obsolete. Brokers stopped caring how many shares you traded. In effect, a “round lot” became one share. But now it is even less. Robinhood and many other trading platforms let users trade fractional shares, as little as 1/1,000,000 of a share. I believe this may be more consequential than is generally recognized.

Look at the share prices for of some of today’s top companies: Apple (AAPL) is around $130. In the old round-lot world, you would have needed $13,000 to trade it efficiently. Now you need less than a penny. This vastly expands the universe of people who can trade Apple shares. And Apple is low-priced compared to some other popular names like Tesla (TSLA) around $750, or Amazon (AMZN), which is over $3,000 per share.

https://ggc-mauldin-images.s3.amazonaws.com/uploads/newsletters/Image_3_20210416_TFTF.pngWe have, without really noticing, severed the connection between share price and liquidity. This matters in ways I think we may not fully understand. Combine it with game-like mobile apps that let people buy and sell in individually tiny amounts that add up to the big numbers once reserved for giant institutions. And without any kind of institutional decision-making process to constrain rash moves. Source: Rosenberg Research

Further add trillions in government cash payments, often to people with time on their hands because they are unemployed, and who need ways to generate income. Of course, some turn to stock trading. It’s an attractive “side hustle” for a time when Uber driving is less attractive. If all you have is $100, that’s okay.

We have raised a generation playing adrenaline-charged video games. For a relatively small stimulus check, they get to play in a game where Dave Portnoy assures them that stocks only go up, or they can “stick it to the man” in GameStop. Sigh….

In the bigger picture, all those small accounts add up to enormous sums of hair-trigger money. Some of it has much higher risk tolerance. The app users don’t see it as a nest egg to preserve. In their minds, it’s more like buying gas to get to work—something you have to burn. The whole concept of a stock being overvalued or undervalued doesn’t apply. They just want it to move.

Where all this leads is uncertain but I suspect it won’t be good.

A Key Difference

One of the first rules my mentors taught me: All it takes to create a bull market is for buyers to show up. All it takes to create a bear market is for the buyers to disappear. Just reading the zeitgeist, I don’t think they’re going to disappear for a while.

Dave Rosenberg at Rosenberg Research has also been following these inflows, and finds them problematic. He added another perspective in his latest monthly chartbook. The line in this chart shows current equity exposure in the AAII Asset Allocation Survey going back to 2002.

As you can see, equity exposure dropped in early 2020 as the coronavirus struck, climbed sharply and is now far stronger than it was when the last bull market began in 2009. I’m not sure the AAII survey captures the individuals (it’s hard to call them “investors”) trading small amounts on Robinhood and other apps. But their inclusion would only make the point stronger. A bull market needs fuel and this one has already burned a lot of it.

This is important also because we are talking about percentages, which include whatever money people may have received from the various stimulus programs. That money is already in the woodpile and being burned along with pre-existing cash.

https://ggc-mauldin-images.s3.amazonaws.com/uploads/newsletters/Image_4_20210416_TFTF.pngDave has another chart showing the result. Comparing S&P 500 gains in the last four recessions, this one is stronger than the others were.

This market recovery has actually tracked the 2009 one pretty closely. But remember the previous chart: In 2009, investors had pulled out and then spent months furiously reinvesting. The current recovery happened with people closer to fully invested. That means it is even stronger than the price action shows.

None of this means the bull will tire in the near future. Major market trends often persist far longer than we think possible. Precedent is reliable until something unprecedented happens. It is certainly plausible to think the economy will bounce once the pandemic is out of the way, which we all hope will be soon. I’ve noted how crises often generate growth-sparking innovations. Good things may be coming. The question is whether they will both justify today’s valuations and even higher future valuations that justify further price gains.

Let’s think about this. The Fed is adding QE at an ~$1.5 trillion annual pace. They say interest rates won’t rise until 2023 at the earliest. The US government (by my latest count) has thrown, or soon will, $5 trillion of stimulus money, almost 25% of annual GDP, into the economy. Yes, not all of it goes directly to individuals, but it will eventually find a home, creating new jobs or programs.

At some point the government stimulus simply has to stop. Job openings are plentiful and the economy is opening up. Employers are having to pay much higher wages to get someone to come to work. When you can make $20-$30,000 a year staying at home, $10-$12 an hour just isn’t appealing. Ironically, the unemployment checks are actually creating wage inflation.

While we may get a massive infrastructure bill later this year, it will be spread out over a decade. I don’t think we are going to see anything like the current free-for-all, multi-trillion-dollar injections like the last 12 months.

The Contest of Supply Versus Value

Central banks and governments worldwide are supplying massive amounts of rocket fuel for supercharged markets. The yields on high-yield bonds (junk bonds) are close to the recent all-time lows. Investors are desperate for yield and the only place that seems to offer return, if you’re only paying attention to price momentum, is the stock market. So Baby Boomers and retirees, along with their Millennial children, are taking more risk than they can possibly imagine.

The stock market is trading at more than three standard deviations above its 50-day moving average (courtesy Doug Kass).

https://ggc-mauldin-images.s3.amazonaws.com/uploads/newsletters/Image_5_20210416_TFTF.pngSource: Doug Kass

Our friend Lance Roberts at Real Investment Advice offered these two charts:

I don’t know of a time when valuations and markets were more stretched than they are right now. I also don’t remember a time when monetary and fiscal stimulus was more than it is right now. I would not be surprised to see the market rise considerably more from here. That being said, let me repeat what I said last week. I do not want to play the stock market or bond market game. There are other, more profitable games with much less risk. I am not bearish. I am 100% invested and as aggressive as I have ever been in my life. Just not in index funds.

https://ggc-mauldin-images.s3.amazonaws.com/uploads/newsletters/Image_6_20210416_TFTF.pngSource: Real Investment Advice


CPI inflation has a real chance of approaching 3% and maybe 4% this year. Something could easily become the tipping point (it literally doesn’t matter what it is) that makes the market roll over 20% or more.





https://ggc-mauldin-images.s3.amazonaws.com/uploads/newsletters/Image_7_20210416_TFTF.pngIn that scenario, I will bet you a dollar to 47 doughnuts the Federal Reserve steps in, and in giant size. QE increases another $50 billion per month? Or Whatever It Takes! If that’s not enough, then some clever lawyer will find a loophole to allow the Federal Reserve to enter the stock market through the back door. Or Janet Yellen walks over to her friend Nancy Pelosi and says we need a bill letting the Fed be more aggressive. It won’t be Hank Paulson on his knees to Pelosi this next time. Literally nothing—I truly mean nothing—will be off the table. When you are in the middle of a crisis, you channel your inner Mario Draghi and do whatever it takes.

Will it work? Who knows? I truly don’t know what will happen. We are exploring brand-new territory this decade. The new era we are entering can bring challenges as well as opportunities. Time to think about changing your game if you are still playing the old one.

Why a Chinese invasion of Taiwan would be a catastrophe for China and the world

If they, do it, it won’t be for the microchips

By Jon Stokes

https://cdn.substack.com/image/fetch/w_90,h_90,c_fill,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fbucketeer-e05bbc84-baa3-437e-9518-adb32be77984.s3.amazonaws.com%2Fpublic%2Fimages%2Fee38d799-c7d2-4804-b23d-c2080a4510f4_400x400.png

Worries are increasing that China may invade Taiwan, amid a combination of Chinese military saber-rattling and US military warnings that the PRC’s timeline for “reunification” has moved up and may happen any time within the next few years.

Most coverage of a possible Chinese invasion of Taiwan focuses on the area as a potential flashpoint for a US vs. China war, but I haven’t found any detailed coverage of what such an invasion would mean in practical terms beyond generic talk of nuclear escalation risks and widespread damage to the global economy.

In an effort to think through the impact of such an event on the technology sector, along with potential ripple effects elsewhere in the global supply chain, I talked to David Kanter, Executive Director of ML Commons. David’s an old friend of mine who’s spent many years covering semiconductors as an analyst and journalist, and he helped me update my slightly out-of-date semi knowledge and better understand how the current market is structured.

In short, the market for advanced microchips fits together like this:

The equipment and tooling for making leading-edge chip fabrication plants comes from the US and Europe

The two leading-edge fab makers, who have the proprietary know-how to turn that equipment and tooling into fabs that turn out chips more advanced than anyone else’s, are in Taiwan’s TSMC and South Korea’s Samsung. (There actually sort of two-and-a-half leading-edge fab makers, with Intel being the half. They’ve stumbled but will recover and join the other two, soon.)

The customers for the outputs of those leading-edge fabs are global, including in the US and Europe.

Porting a chip design from one company’s fab process to another is costly and painful. It’s not like you send an email with some files to a different address and a few days later identical chips come off a new production line in a different factory. No, customers are tied to specific companies’ fabs, and suddenly losing access to that fab means suddenly no more chips until you complete a lengthy, costly re-targeting process.

So fab equipment goes from the west into Taiwan, where TSMC puts all the parts together into fabs that can turn raw materials into advanced chips, and the chips then go back out to the west and rest of the world.

Thus the semiconductor market in 2021 is a fully baked cake. You can’t just swap some ingredients out in response to a one-off military invasion, and then keep trucking along. No, we’ll have to bake a whole new cake if TSMC goes bye-bye. And that will be painful for everyone, everywhere.

To unpack all this in a bit more detail:

The world’s largest, most valuable tech companies are dependent either directly or indirectly on the steady output of TSMC’s fabs. If those fabs went offline or became unavailable in the west because they were controlled by PRC, it would immediately devastate the global economy. An unknowable number of large companies just wouldn’t be able to refill their inventories for an indeterminately long time.

TSMC’s status as a leading-edge semiconductor powerhouse depends critically on inputs — tooling, equipment, software — from the US and Europe. So if China did seize TSMC and could keep it running (a big “if,” and probably unlikely), it would be stuck and unable to advance the state-of-the-art. It will not realize its tech leadership dreams through military adventures.

More likely is that China would not even be able to take over TSMC’s fabs and talent via military means and keep it all running, status quo. They’d take over disabled fabs that had been damaged either by the invasion or by the Taiwanese (in an effort to protect customer IP), and wouldn’t be able to locate and/or keep critical talent.

The world economy would likely go into crisis if TSMC suddenly stopped working, but in the long-term, the US is already in the process of decoupling from dependence on Asia and is on-shoring more of the semiconductor value chain. So the US would eventually recover in a few years, and companies outside China would eventually re-target their designs for other fabs.

China is a lot further behind the US in its national semiconductor sovereignty efforts and would suffer more in the medium- and long term.

Given that an invasion of Taiwan would not magically give China leadership in the global semiconductor market, and would in fact set back its timeline for being an advanced semiconductor superpower by probably decades, then if such an invasion does happen then it’s not because they want TSMC.

TSMC’s lone $12B fab in Arizona is a nice gesture, but it is not relevant to any part of this wargaming. It will only make a tiny slice of TSMC’s global output when it comes online in a few years and will be trailing-edge at that point. It would generally be pretty useless without the rest of TSMC in existence.

The decapitation strike

TSMC operates a foundry business that takes chip designs from its clients — like NVIDA’s GPU designs, or the designs for the ARM chips that power Apple devices — and manufactures them on its advanced processes. All told, TSMC has over half the global foundry market (55 percent), and even more of the foundry market for the most advanced microchips.

So if the PRC invades Taiwan and seizes TSMC, it will be something like a decapitation strike on the global semiconductor market — a big chunk of the world’s most advanced, powerful chips made on the world’s most advanced manufacturing process will instantly stop being available during whatever invasion and transition period. This alone will upend markets and global supply chains while it plays out.

Assuming China can get TSMC is up and running again after an invasion — this is a really big assumption — all of TSMC’s clients in the west will have a painful choice to make:

Drop TSMC immediately, so that there are just no new products — no new iPhones, no new NVIDIA GPUs, no new who-knows-what other kinds of advanced products that rely on TSMC chips either in the product itself or in the production process — for two or three years until everyone can find replacement foundry capacity at a comparable level of sophistication somewhere else and then complete the costly work of porting their chips over to that foundry’s process.

Try to keep existing product lines at TSMC while making plans to migrate new product lines to other foundries as those catch up with TSMC in capability and capacity.

There are three options that are actually not on the table, and later in this piece, I’ll explain why for people who don’t know the industry and who may mistakenly think either of these is viable:

Keep on doing business-as-usual with TSMC, but under de facto, Huawei-style PRC ownership and control.

Shift existing TSMC order volume to a rival like Samsung, which shares process leadership with TSMC, or to trailing-edge fabs owned by Global Foundries, Intel, or the like.

Just move advanced chip manufacturing to the US and/or Europe. After all, TSMC is working on a new fab in Arizona, and Intel is building new fabs in the US. So imagine a kind of Project Warp Speed, but for advanced chip fabrication.

There may be some other options I haven’t thought of, but these are the possibilities that come to mind.

It’ll go through these in the rest of this article, including the last three that are not likely to happen. My main goals here are to do a little bit of scenario planning, and a lot of educating and debunking.

Dropping TSMC like a hot potato

My first option above — everyone outside China drops TSMC immediately — would immediately halt the flow of iPhones, GPUs, parts for fighter jets and supercomputers, and many other complex electronics that make up the global economy.

It’s really difficult to say how widespread the carnage would be because it’s hard to say where TSMC’s chips are sprinkled throughout the global supply chain. But my guess is it would be very grim.

As more products, from cars to home appliances, have begun to rely on more advanced logic for features like voice recognition, image processing, complex user interfaces, and the like, our markets have become more reliant on high-end semiconductors. I really don’t have a good sense of the number of consumer products that are using high-end chips from TSMC, much less the prevalence of these chips in military, manufacturing, shipping and logistics, and other critical points in the supply chain. But I wouldn’t be surprised at literally anything going out-of-stock for a few years if this happens.

As for why this worst-case scenario might happen, it’s not at all clear that China could just step in after a military invasion and send everyone at TSMC right back to work in their old jobs. Some of the fabs may well be damaged from conventional weapons or a cyberattack, employees could be dead or missing, and many key employees would have expatriated.

Furthermore, there’s a lot of critical IP at TSMC headquarters that either TSMC itself or western powers would probably destroy to keep China from getting their hands on it. The masks for things like iPhone CPUs or the proprietary TPUs that power Google’s AI efforts may not be usable on the day the PRC tries to turn the lights back on at TSMC.

(Update: I got some smart feedback to the effect that Applied Materials and other US-based suppliers to TSMC could close down the company quickly by just cutting them off from the ongoing flow of critical materials and other inputs. So the US effectively has a kill switch on TSMC, and even if China were to take it intact with all the critical personnel willing to keep working, the US could shut it down by ordering its domestic suppliers to drop it.)

All of this means it’s very possible, maybe even likely, that the day after an invasion China would have a non-functional mess on its hands, and there would just be no more TSMC production for a very long time, if ever.

Phased migration from TSMC

Assuming TSMC is still intact after a Chinese invasion and that China can get it all running again, then some consumer product makers like Apple might be willing and able to keep the iPhones and new Macbooks flowing from PRC-controlled fabs while looking for an alternate supplier.

Big tech mega-platforms, like Google and Amazon, that are using some TSMC silicon in their clouds or other efforts, might likewise be suck up the likely IP theft in order to continue to source existing products from “Chinese Taipei” while making plans to migrate the next versions of all their chips to other foundries.

However, companies that sell chips to the US government will run into problems. These companies will be barred by law and other forms of pressure from selling chips made in PRC-controlled fabs to the government. So a lot of NVIDIA GPUs that go into our government supercomputers and the Xilinx chips that go into our F-35’s would suddenly have to find other buyers the moment the PRC takes over Taiwan.

Some firms would survive this sudden loss of revenue while they solve their foundry problem, while others would not.

I should note that already something like the beginnings of a phased migration away from TSMC is probably already in the works, in light of all the military activity around Taiwan at the moment. Every entity with a dependence on TSMC is right now in meetings trying to figure how to decrease that dependence so that if anything happens to TSMC they’re able to survive it. I’m sure Samsung’s phone is ringing off the hook.

Chip fab basics

Now let’s take a look at the options for dealing with a Chinese-occupied Taiwan that are not viable. To understand why certain things are off the table, you have to know a bit about how the global semiconductor market works.

Key points:

How advanced, high-performance, and power-efficient a microprocessor is depends mainly on the manufacturing process used to make it — i.e. how small a feature size that process is capable of producing.

Smaller feature sizes are better and more advanced, and whoever has the smallest feature size at any given moment is winning the technology race. (Right now, that’s TSMC at 5nm.)

Every transition to a smaller feature size is built on highly proprietary, secret know-how that the chipmaker learned from all the previous transitions.

There’s no way to magically jump the line by throwing money at the problem. The Gulf nations tried this by throwing $20 billion at Global Foundries, largely to no avail. You can’t just buy the know-how to make a leading-edge fab. You have to build that know-how before you can build the fab.

The secret know-how for fab building resides meaningfully in the parent company, not in the fab itself. So if you somehow had a super-advanced fab in one location — let’s just say Arizona, for instance — you couldn’t take all the employees and equipment at that fab and just clone it all a couple of times by throwing money at it if the parent company didn’t cooperate. It’s like in Breaking Bad, how the cartel couldn’t just buy a state-of-the-art meth lab and expect to compete with Walter White — they actually needed Walter White there to run it.

There are only three companies that have the know-how to make fabs at the leading edge: Samsung (South Korea), and TSMC (Taiwan), and Intel (US). (Update: Originally I said “only two companies…” but this isn’t fair enough to Intel. Intel has the know-how, they’re just still getting their execution sorted.)

TSMC can’t keep making new, advanced fabs without critical inputs from the US and Europe. So the US can basically stop TSMC’s ability to advance the state-of-the-art dead in its tracks, and will undoubtedly do so if PRC controls the company.

The first thing to know about microprocessors is that performance improvements are largely driven by innovation in our ability to make the fabrication plants (“fabs” for short) that make the chips. Yes, clever chip design matters and innovation does happen there, but innovation in the manufacturing process trumps everything else for most of the attributes we care about, like application performance and power efficiency.

https://cdn.substack.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fbucketeer-e05bbc84-baa3-437e-9518-adb32be77984.s3.amazonaws.com%2Fpublic%2Fimages%2Fa82de059-f4e7-4879-9d73-6fd875a005f6_700x298.jpegThe chart is a recap of Intel’s improvements to its manufacturing process over a 15-year span. Each of the columns — 90 nm, 65 nm, etc. — is a feature size (i.e. a measurement of a critical part of a transistor), and each feature size shrink involves a massive amount of engineering effort that builds on all the knowledge gained from the previous feature size shrink.

So Intel used its proprietary learnings from the 90 nm to 65 nm transition to design the 65 nm to 45 nm transition, it used its learnings from that transition to design the next one, and so on for each transition down to the latest 7 nm transition. (Intel actually stalled out at 7 nm and is just now starting to move ahead again. More on that in the next section.)

This constant shrinking of feature sizes is the engine behind Moore’s Law, and staying on track to keep delivering regular feature shrinks is how you stay on the leading edge.

The other important thing to know is that when a new semiconductor manufacturing process is first brought online, there are a lot of imperfections and other issues in the finished product. The result is that relatively few of the chips that get produced actually work to spec — you have to throw all the bad ones out.

As you run the process for a while, you start to work the kinks out. Eventually, your yield rises, and enough of the chips you’re making are sellable that you can actually run the fab profitably. Until you really get the process dialed in, though, you’re taking a loss on every production run.

My point is that it takes at least two years and tens of billions to build a modern fab, and then it takes another year or so to work the kinks out and get the yields up. Lost fab capacity will not be replaced quickly.

America’s leverage

Given the above realities of how the semi market works, you can see how the US and the world are extremely dependent on TSMC for advanced processors. But this dependency is a two-way street — TSMC is dependent on the US and Europe for critical inputs to its fab building efforts. Without the west, TSMC couldn’t advance the state-of-the-art and would become frozen in time.

The technical secret to getting features smaller than 7 nm is extreme ultraviolet (EUV) lithography, an advanced process that only Samsung and TSMC have mastered.

As for US semiconductor giant Intel, Kanter tells me that their “EUV is 15 years late and 10X over budget. It’s so horrifically complicated there’s no way to get it aside from ASML, and trying to recreate it would take you a decade.”

ASML is a Dutch fab equipment maker, and the US has successfully pressured it not to sell EUV equipment to China, effectively locking PRC’s entire semiconductor sector out of the feature size race. (They can sell older equipment to China, just not the good stuff.)

If PRC controlled TSMC, then suddenly ASML would find itself in a bind — either anger the Americans by continuing to supply TSMC with EUV tech or cut off one of its two main customers for bleeding-edge fab equipment.

Furthermore, there are many other fab equipment suppliers and semiconductor design tooling makers that are based in the US, and who are directly subject to US export controls. None of these would have the option of keeping TSMC as a customer.

Simply put, a PRC-controlled TSMC would be a dead man walking, in terms of its ability to participate in the march of Moore’s Law. It would be frozen at whatever its smallest feature size is at the time of a Chinese takeover, and it wouldn’t progress further until China could replace all the US-based fab equipment and toolchain inputs with domestic equivalents. That would take a very long time if it’s even possible.

China is actually trying and failing to break this dependency on the west and to gather all the inputs to the chip fabrication industry on its soil. It’s planning to throw over $100 billion at the problem over the next decade, and it’s way behind schedule. Again, this is just not the kind of problem you can solve by throwing money at it or with a national mobilization; if it were, China would already be winning at it.

To make its silicon sovereignty dreams a reality, China needs TSMC’s cooperation and know-how. It seems unlikely to secure that by military means, which is a good reason to think that if China does invade Taiwan, it’s not because they’re trying to take TSMC by force.

Why certain options are off the table

Now that we know more about the chip market, let’s revisit the options I said were off the table, and explain why they won’t work. This is repeats of stuff I said above, but now I’m just putting the pieces together to summarize.

Keep on doing business-as-usual with TSMC:

TSMC won’t be able to innovate without access to tooling and equipment from the west. So business-as-usual won’t be possible, and any company that stays with TSMC is planning to leave the leading edge and live in the past.

Many companies will be barred by the US from getting chips from a PRC-controlled fab.

TSMC probably won’t meaningfully exist after a military invasion of Taiwan, anyway.

Shift existing TSMC order volume to a rival like Samsung:

TSMC is 55% of the foundry market, so Samsung can’t instantly absorb all that, nor can the rest of the market.

You can’t immediately make the same chips on a different foundry’s process. Re-targeting a design for a new process is expensive and time-consuming.

Just move advanced chip manufacturing to the US and/or Europe:

It will take another few years for Intel to ramp production at 5nm and to catch up on future processes.

You can’t just throw money at the problem of having a leading-edge semi fab on your own soil, because if you could then the Gulf states and China would’ve already done it. Talent and institutional experience are critical and non-fungible assets in this race.

TSMC’s Arizona fab is a few years from being online, will be a small percentage of global 5nm production when it is online, and is not something anyone will use if the parent company is out of the picture. So it doesn’t matter for this discussion.

An alternate scenario

Speculating about the why’s and wherefore of a Chinese invasion of Taiwan is a bit above my pay grade, but I want to toss something out there that occurred to me as I read this great Steve Blank piece on the geopolitics of semiconductors. Specifically, this part stood out to me:

Alternatively, Beijing may seek to negotiate with or coerce Taipei (or both) in order to allow China sole access to TSMC and block chip exports to the United States, thereby securing China’s own supply while crippling American industry.

If China were looking to strangle TSMC’s western business, so that the chipmaker would have to turn to the mainland for customers, then I’d say it’s probably doing a really good job of exactly that with all the military activity around Taiwan.

The prospect of an invasion is spooking every one of TSMC’s non-Chinese customers, and in the coming weeks and months we’re going to start seeing more announcements like Tesla’s recent decision to backtrack on plans to use TSMC, and instead go with Samsung for some critical chips.

If China can scare Apple and the rest away from TSMC with a bunch of bomber flyovers and maritime shenanigans, then TSMC might go back to making chips for Huawei and other Chinese firms. I don’t know how plausible this is as a rationale for what we’re seeing in and around Taiwanese airspace, but it’s a less stressful thought than an all-out invasion and a crash of the global economy.

Nuclear weapons, AI and political entrepreneurs

Oxford University’s Future of Humanity Institute (FHI) has an excellent new paper that looks what we can learn from the early days of nuclear weapons about how to govern potentially destabilising future technologies, such as AI. I’m a big fan of this historical approach. We previously discussed what the history of general purpose technologies can tell us about the future of AI with Jade Leung (formerly of FHI) on the TiB podcast and in TiB 149.

The paper identifies several key themes: the window of opportunity for radical solutions; the contrasting roles of secret and open discourse; and the need for technical experts to be politically savvy, among others. Particularly interesting is the importance of “political entrepreneurs” – politicians who can react to an exogenous shock that reveals the inadequacy of existing intellectual frameworks and introduce new ones into the political sphere (see this piece for more; the canonical examples are Reagan/Thatcher as political entrepreneurs for monetarism).

It’s interesting to think about how this might apply to AI. First, what event or milestone in its development might constitute a sufficient “shock” to change the political or ideological landscape, domestically or internationally? Second, who stands ready to play the role of political entrepreneur? My sense is that today we lack both leaders with sufficient interest in the space and a platform of policy ideas for them to adopt. Both feel like important gaps if you believe that AI’s impact is only going to accelerate.

Anti-portfolios in philanthropy

One useful idea in venture capital is the “anti-portfolio” – the set of now-successful companies that a venture firm could have invested in, but passed on. Bessemer Venture Partners famously post theirs – which includes Apple, Google and Airbnb – complete with self-deprecating commentary on their web site (Admittedly it is easier to do this when you’ve invested in 130 startups that have IPO’d…)

This week the always-interesting Michael Nielsen suggested that a similar concept might be useful in research funding and philanthropy. This was prompted by the remarkable story of Kati Kariko, whose work on mRNA proved critical to the development of the Pfizer and Moderna COVID vaccines, but was shunned and failed to attract funding for decades. The idea is that funders who go through the exercise might identify weaknesses in their processes (Apparently the Gates Foundation does just this).

As Alexander Berger points out, funders have different incentives from VCs: VCs care who gets the upside from a big company; philanthropists (should) care only whether the world gets the benefit – and by definition a philanthropic anti-portfolio contains only projects that someone funded. But I suspect the exercise is still useful: the factors that cause a funder to miss an important project are likely similar across those that do and don’t find money elsewhere. We discussed in TiB 127 the challenges of applying VC to philanthropy, but this feels like low hanging fruit.

Ripple effects in science

We’ve talked before about the challenge of bad incentives in science. In particular, it seems likely that scientists are incentivised to pursue lower risk, incremental research, rather than riskier but more fundamental work (see TiB 103 for more on this). This might be especially damaging if such improvements in fundamental science have indirect but compounding benefits in terms of the other science and technology they enable.

One model for thinking about this is Jerry Neumann’s excellent argument, which we discussed in TiB 113, that “radical” and “normal” science are in fact the same process – it’s just that the former is more “upstream” and so its ripples are felt further. Matt Clancy – who is an absolute must-follow if you’re interested in the economics of innovation – has an excellent new post on this topic, which provides some empirical evidence for this idea.

Clancy cites this interesting paper, which uses chains of citations from patents to identify upstream (i.e. more fundamental) and downstream technologies. The authors find that patent growth in upstream fields predicts future patent activity in downstream fields. Another study shows that the technologies most directly influenced by new science are more likely to be these upstream fields. Taking these findings together, we can trace a causal chain from scientific progress to more innovation. Clancy concludes that these indirect benefits are at least as valuable as the direct ones (which he discusses in another very good post) – which underlines the importance of finding ways to fix the incentive problem.

Quick links



Leave a Reply