Pentagon Moves To Finally Cut Off Sales Of American Chips To Huawei

The Pentagon has followed through with threats to drop its opposition to tighter sales restrictions involving American-made components, the WSJ reports, signaling that the Trump Administration is adopting a policy of no mercy as Germany's legislature prepares to make an important decision that will govern Huawei's access to the German market.

Here's a brief summary in case you haven't been following the simmering beef between Washington and Huawei, which has played out over the past 18 months in a bevy of attacks on the US side.

In December 2018, Canadian police arrested Huawei's CFO Meng Wanzhou, who is also the daughter of the company's widely-beloved father. Since then, the Commerce Department has added Huawei to its 'entities list' - essentially a 'black list' that requires companies to get special permission from the Department if it wants to sell American made goods to Huawei (it applies to products with even a relatively modest percentage of American-made components).

Though the signing of the 'Phase 1' trade deal temporarily eased tensions (Washington quietly exempted Huawei from the strictures of the blacklist), now that the trade deal has essentially collapsed thanks to China's economic woes, and now that Boris Johnson has defied Washington and allowed Huawei to work on ''con-core" components of Britain's 5G network, Washington is realizing that maybe it shouldn't have been so gentle. Now, the Pentagon is sending a clear message: 'We're done playing games.'

Earlier in the week, Pentagon officials issued a trial balloon: A leaked report in the WSJ claiming they had discussed reinstating Commerce Department restrictions that would essentially ban Huawei from buying American-made products. It's unclear whether that had any impact on German legislators' thinking, or Johnson's. And as part of the continuing effort to hamstring Huawei, the DoJ added a "Racketeering" charge in its case against the company, which is playing out between prosecutors in at least two federal districts.

One of the reasons Washington initially hesitated to move ahead with a complete ban was the American semi-conductor industry, which would have been badly hurt by the measure (Huawei being a major customer of American chips).

Huawei is scrambling to stockpile up to a year's worth of foreign supplies for its core telecoms equipment business ahead of a widely-expected toughening of U.S. technology sanctions that may come as soon as next month, Nikkei explained.

Could Huawei - which the Nikkei notes had also stockpiled foreign supplies ahead of that move - possibly be the catalyst behind the tremendous chip rally over the past year? Think of this way: a company will pay virtually anything (especially since the money comes from Beijing) and on a very truncated timeline, which means vendors can demand any price and Huawei will have no choice but to pay it. The result: an exponential surge in the SOX index (as shown in the chart above).

That said, this frenetic purchasing spree has a deadline, and if the Nikkei is correct, it could come as soon as next month: "Although there are no details about the scope or timing of the widely rumored tightening of sanctions, two sources close to Huawei said the company anticipates it could happen next month."

Others agree. Harry Clark, a Washington-based lawyer and chair of Orrick international trade and compliance group, told Nikkei he was aware that "the U.S. government may soon adjust these rules to expand the scope of items that are subject to Export Administration Regulation, at least with respect to transfers to export-sanctioned Huawei entities."

Clark added that: "We understand that the U.S. government is [also] considering expanding the types of microelectronics hardware, including production equipment ... to be covered by EAR controls."

If and when an expanded ban hits Huawei, watch out below, as the it would impact a far wider array of U.S. companies such as Corning, which supplies glass to Huawei for its smartphones, as well as Asian suppliers such as Sony, liquid crystal display maker Japan Display, South Korea's LG Display and Samsung, as well as Taiwanese contract chip makers TSMC and United Microelectronics Corp.

Apparently, that's no longer as big of a consideration for the Pentagon. Which means it's only a matter of time before American semi-conductor stocks start really feeling the pain, since Huawei has helped badly inflate that bubble.

And American investors are going to need to figure out what this 'kicking the Chinese economy while it's down' is going to mean for future trade negotiations.