China Made a Chip Breakthrough That Shocked the World

23:38Then they're going to have their own domestic NAND. Then they're going to have their own domestic DRAM. And then all of a sudden, you just like look at it. And that's the entire semiconductor tool chain. Like, you know, so this is this is and so yeah, is it capital efficient? Hell no. Like Big Fun 2, for example, has allegations of massive amounts of fraud. And that definitely is happening. And there's hundreds and hundreds of companies that have started probably this year to to take advantage of the subsidies for semiconductors. And yes, there are lots of misses. But in terms of being able to get the talent there, and then also bring them all up the learning experience, I think that that's a huge thing.

24:13And I think that's also a conversation that is completely missed about this as well, is that like, Dylan and I, we go to, you know, trade shows in Japan or Taiwan or Korea, and like, the amount of young people there versus the amount of young people in the West that are making chips is just drastically different. And I think that you fast forward that same equation. And yes, maybe they don't have EV tools, but there are a lot of ways to make better phones using packaging or other clever engineering tricks. And so what's going to happen is that not only do they have the technological know how, they also have the talent too.

24:45And we could be talking about in 10, 20 years that America's chip dominance is very backwards looking. And I think people need to watch this closer. The rate of change has just constantly shocked me, at least, and I'm sure Dylan, but the progress is staggering.

25:16Support for the show comes from public.com. You're thoughtful about where your money goes. You've got your core holdings, some recurring crypto buys, maybe even a few strategic option plays on the side. The point is you're engaged with your investments and public gets that. That's why they built an investing platform for those who take it seriously. On public, you can put together a multi-asset portfolio for the long haul. Stocks, bonds, options, crypto, it's all there. Plus an industry leading 3.6 % APY, high yield cash account. Switch to the platform built for those who take investing seriously.

25:49Go to public.com slash market and earn an uncapped 1 % bonus when you transfer your portfolio. That's public.com slash market. Paid for by Public Investing. All investing involves the risk of loss, including loss of principal. Brokered services for U.S.-listed registered securities, options, and bonds in a self-directed account are offered by Public Investing, Inc., member FINRA, and SIPC. Crypto trading provided by ZeroHash. Complete disclosures available at public.com slash disclosures. Introducing the all-new Adobe Acrobat Studio, now with AI-powered PDF spaces. Do more with PDFs than you ever thought possible.

26:24Need AI to turn 100 pages of market research into five insights with a click? Do that with Acrobat. Need templates for a sales proposal that'll close that deal? Do that with Acrobat. Need an AI specialist to tailor the tone of your market report to sound real smart in real time? Do that with the all-new Adobe Acrobat Studio. Learn more at adobe.com slash do that with Acrobat. This kind of gets me to, I don't know if it's a strange question or a theoretical question, but when it comes to semiconductors, you hear a lot about the importance of the overall supply chain. So, you know, people will say that NVIDIA is really good at managing its own supply chain and that's been part of its success story.

27:05If China is now manufacturing more and more of its own chips on a domestic basis, I guess like maybe it'll take them longer to develop some things. But does that in the end kind of lead to a more resilient or reliable supply chain for that technology? How do you see those two things interacting? You know, it depends. In capital intensive industries, what you tend to see is a very big sort of winner takes all vibe, which is why in prior, you know, sort of technologies, if you will, right? Solar, for example. Hey, Germany and the U.S. invented all of it. And they were great until China dumped way more capital in a very capital inefficient way, put way more people at work at it, right?

27:52Smart engineers working on it. And all of a sudden, you know, hey, 90 plus percent of solar cells come from China. Right. And likewise, you know, U.S. companies were the first to do electric vehicles. Right. Like GM initially, then Tesla. But hey, China makes like three times as many electric vehicles as the West does now. And so, you know, sort of you see these technology curves and there is a significant amount of winner takes all. Right. You know, if you look at Latin American markets, I mean, even even Europe had to put up tariffs recently. Chinese EVs are killing it. Right. The U.S. has had to put up massive tariffs and then has had the sort of the Inflation Reduction Act with the huge subsidies for battery production and cathodes and anodes and all these sorts of things.

28:30There is a big winner-takes-all sort of element of capital-intensive industries, and the semiconductor industry is not different. In fact, it is even more tilted that way. Every single vertical you look in, and there's hundreds of verticals, people think, oh, this is such a complex supply chain. Every single spot where you zone in, there's two, maybe three competitors in any specific technology in any specific chip and many times one. And everyone makes good profit and it's a very strong industry. But what happens when someone comes with breakthrough innovation and now all of a sudden it's capital intensive and those players start to fall off or they exit markets?

29:06That's something that happens, right? And the winner does take all. And so it's not just necessarily a, hey, it's a domestic supply chain. It's, hey, well, what about all of the vehicles that are being shipped out of China into Latam, Southeast Asia, and maybe even Europe if they don't have tariffs, or the US already blocks Chinese vehicles mostly. Or how about solar, right? Like solar inverters to convert the power from sort of the solar panels to what's acceptable for your home or for the grid, that's going to become a Chinese supply chain. Why wouldn't it, right? They already have the solar panels.

29:35So it's not just like, hey, domestic versus not. It's actually, there's a very strong element of, hey, this is going to be a Chinese supply chain, or this is going to be a Japanese supply chain, or this is going to be a Korean supply chain, which is already the case in sort of semiconductors, right? Or a US supply chain. Yeah. And I think there's also like an important thing to note there, at least, I don't think this will happen in the United States, but Europe is where this is happening the hardest is so we've been talking about the leading edge, which they put out this new Huawei phone, really amazing technology, but there's problems with ramping, there's problems with yield, we have some cutoffs.

30:08But like, you know, China at the same time is also pressing their foot to the gas in the lagging edge. And we've been talking about automotive. And I think that that's probably where it's scariest, frankly. So if you are European automotive OEM, and you are trying to sell more EVs as everyone is, and you're buying your semiconductors from other semiconductor companies, and then you're buying the battery, and then you're putting it all together. And you're trying to have this margin, you know, it's like a it's a single digit or, you know, maybe double digit margin. It's a it's a very low dollar value added industry.

30:38And then you're trying to compete against BYD who and BYD in this conversation is making their own batteries. They're buying their own ships to ship the cars from China. Wow. Yeah, they are. They have their own fab. Yeah, they have their own fab. They make all the semiconductors. And the semiconductors are because they're becoming larger and larger parts of cars and they are the most profitable. They are the largest gross dollar profit pool within cars. Huh. And so if you just do it. We talk about batteries all the time, but the real profits are in the chips. Well, batteries as well, batteries and batteries and semiconductors.

31:10And they're doing both completely vertically integrated. So what they're going to do is they're going to collapse all that margin that the suppliers make, and then they're going to take it out of the price of the car and they'll make the full stack margin. But if you're a European or American company competing against this, you will never compete on price. And I think that this is. I mean, you see it with Tesla, right? Tesla has the highest gross margins in the industry. You can say what you want about their cars, right? But they have the highest gross margins. And especially after the seventh price cuts this year, they're cheap, right?

31:40And BYD is the same, except even better in many regards and even more vertically integrated. Yep. And it's happening a lot quicker than people realize. And I think that that's something that it's another example of where the industrial policy is just going as fast as possible with there's hundreds of billions of dollars of subsidies and people are not really paying attention to the story that's happening right in front of us. I'm glad you brought up the car chips because it does seem as though the disruptions to car chips that we saw in 2020 is sort of what brought the semiconductor supply chain to the forefront.

32:12It's what sort of got everyone's consciousness. So we can't make cars because we can't get the chips. But those aren't the lagging edge chips. So we sort of it feels like there is this sort of incoherence that we maybe tell about the story here where it says, okay, we need to invest in chips, but then we're talking about we need to invest in the leading edge, whereas actually the real disruption was at the lagging edge. Can you talk a little bit more what you said about how the US companies gave up on the lagging edge, whereas you said TSMC and others continue to improve their yields on the lagging edge?

32:42We don't have that here with, say, Intel. So in some cases, right, with companies like Analog Devices, who used to vertically manufacture all their chips, they're moving more and more to having TSMC make for them. But in other cases, Texas Instruments, right, both of these companies are over$100 billion companies, but Texas Instruments, they are actually investing hugely in making more fabs and having more than 80 % of their chips manufactured by themselves. And, you know, I think, you know, just a little bit of a chime in on the whole term lagging edge is a bit of a misnomer because it's not like they're selling the same chip that they designed in the 1990s, right?

33:15Well, they are, but they're also selling many, many specialized chips that just aren't low nanometers, but they have some material innovations or, you know, they have some different properties with them that aren't necessarily the smallest possible, but definitely specialized. And there's a humongous variety of these chips, right? So it's not like, oh, there's one chip, right? It's, you know, phone chips are quite easy to understand. It's a single chip that it has a tens of billions of dollars market, right? AI chips, same thing, tens of billions of dollars of market, right? So we can point to that one NVIDIA chip and be like, wow, look at it.

33:46But when you look at Texas Instruments catalogs, the catalog is like so thick, it's like, it's incredible of how many different chips they sell. It's thousands of products. It's thousands and thousands of products. And I think Texas Instruments will say this, that like half of their products have been from 1990 and earlier. So there's a lot of lagging edge chips. But the difference here is that Texas Instruments is making like a 65, 70 % gross margin. And the business is managed extremely like a mature semiconductor company it is. But then you have the new entrants in China that are just saying, let's like completely screw up the industry structure.

34:21And that's something that's very new. MCUs, microcontroller units in China, that is like the hottest topic of disruption and what people are trying to do. And MCUs, yeah, it might be a 28 nanometer chip, or maybe it's like a 14 nanometer chip or something like that. It's not the sexiest thing. But that's a tens of billions of dollar market there. And I think for the reason why it's maybe not as viewed as strategically important is let's put this in the context of AI, right? It is not a leading edge AI chip that, you know, and the original restrictions that we put on China was to stop AI progress, right?

34:54So that's not exactly, you know, strategically, quote unquote, important. But in terms of for the businesses for economics, it's a big deal. So what they've done is they've kind of refocused on the lagging edge where they can, and they're throwing as much money into there and is going to probably create crazy price. Going back to this sort of idea of that, hey, this catalog is thousands of chips. This is why no one competes with each other, right? Like Texas Instruments, they're the only player in many markets, right? Or analog devices. And maybe the chip is only eight cents to sell, but it maybe only costs them two cents to manufacture.

35:25The thing about China is they've literally psyoped their entire generation into wanting to work in semiconductors. It's literally the coolest job. There are two different dramas that I know of. I was about to ask, like, are there any TV characters that are working in semiconductors? Because that's when you know. Yeah, there's one of like this kid who's in college and he's lame, but then he like goes and works in the semiconductor industry and now he's super cool. And then there's another one where it's like a love story and they both work in a fab and they like fall in love and it's like a drama.

35:55Right? They're like gazing at each other through the glass and stuff like that. That'd be pretty funny. Yeah. Both wearing bunny suits. Wait, I don't know if anyone heard um but i i think uh the sound earlier was both joe and i uh scrambling to pull up the texas instruments catalog literally we both how did you know what i was typing we just know each other that well that we both googled texas instruments catalog but i can tell you i'm looking at the page just for mcus and it looks like it's more than a thousand two hundred that is just one category product yeah yeah 1238 microcontrollers and processors can we just order them online I guess you can.

36:34I mean, click the box. See what happens. Each of those has a couple hundred pages of PDFs associated with how to design them into a product. And it's like, there's a reason no one redesigns this stuff. But now when you have thousands, hundreds of thousands of people coming into the supply chain and like, hey, we can't order this from TXN anymore. We need to order this. We need to do this domestically. It's like, and then you also have subsidies that say, hey, if every time you design a chip of certain ages, you get pure tax credits. You get you get you get just straight up a payout. Local governments, essentially each tape out will give you like a million bucks.

37:08Tape out is a design of a chip. Yeah, a tape out all the way to design. So if you make one of these, it doesn't matter what it is. You just get money. And, you know, if you're engaged in doing anything related to a semiconductor, you have five years for every company, 10 years for leading edge companies tax free, like 200 percent R &D credits, meaning that like for every ten dollars you spend or let's say one hundred dollars you spend in R &D, you get two hundred and twenty dollars back for certain leading edge categories. Like the subsidies here, you know, they want you to work in it. They want to give you as much money as possible to, you know, be moderately successful.

37:38You don't have to be that great at it. Honestly, if you if you're just taping out bad chips, you can probably make a living doing this. Now, that that probably creates some pretty messed up incentives there. But the focus and the desire to, you know, to get to Chinese domestic by 2030 or whatever, and that number, they're meaningfully below that. But this is a long journey and it's pretty clear how they feel about it. Right. Like this is this is like splitting the Internet. One of the most interesting like observations of this sort of like warped incentive structure is that the company that makes rail cars in China is has made it their like national goal to like because they make profit from that.

38:15Right. Which company? CRRC. Yeah. Yeah. CRRC. Yeah. So one interesting thing about this warped incentive structure is that state-owned enterprises or very successful companies that are doing really well in some market are expanding to places that make no sense logically, right? Because they have profits and they're like, as Doug mentioned, right? You don't have taxes for a certain amount of time. So, hey, let me take all the profits from this business and throw them into another sector. And so CRRC is a national railway car company, and they're plowing all of their money into making their national goal to basically disrupt Infineon, which is Germany's largest chip maker, right, who makes chips for power.

38:57Nothing sexy, right, but hey, converting from one form of power to another is a very important job for chips, and that's what Infineon's chips do, right? And this is what CRRC's sort of goal is to do, is to do that, which is nothing at all related to railway cars. But, hey, I might as well do it because now if I make any money on the semiconductor business, I don't get taxed. And what I was getting taxed on my profitable, stable business is now being funneled into this new business. This is the irony of Xi Jinping's crackdown on disorderly capital in e-commerce and consumer tech. And now there's just money kind of flowing indiscriminately in other sectors.

39:35You know, Joe mentioned in the intro that it's been a while since we've done a semiconductor episode. And I think the last one that we did was actually on NVIDIA. Is that right? Yeah. I think that's right. And since then, the stock has absolutely exploded and there's been this frenzy over AI. NVIDIA is just the absolute leader here. Obviously, China wants to develop its own AI models. It has its own AI models, its own large language models, its own open AI competitor, etc. Where is it in terms of its own access to the quality of chips that it needs to make cutting edge AI models? So that's probably the most effectively enforced part of the China restrictions so far, right, in 2022, now 2023, is cutting back on, hey, you can't get the chips that NVIDIA makes, has been the most successful part, basically.

40:26And NVIDIA has tried to circumvent this by, you know, releasing new China specific versions and China's able to get some. But really, this is this is where China's ecosystem looks the most interesting for breakthrough innovation, right? Which is, hey, you know, you guys are going in this route, which is awesome. You know, we can't really go that route, but we have more people working on this. So why don't we try and do different things that will actually generate outcomes that are in the same vein, but not in the same path, right? So Huawei, of course, is making chips. They're making this mobile chip on 7 nanometer, but they also have this AI chip on 7 nanometer domestically made.

41:02NVIDIA's AI chips are on 7 nanometer. So only one generation behind on process technology. But more importantly, what Huawei and SMIC are doing is that they're investing heavily in technologies that are sort of a few generations out for everyone else because they're sort of not necessary, right? So things like bringing optical fibers directly to the AI chip, right? So it's called co-package optics is the technology. Other things are called like hybrid bonding, which is like stacking chips on top of each other. They're doing really interesting things there to enable breakthrough innovation, to enable performance that is on par with the U.S.

41:34chips like from NVIDIA or AMD, right? And they aren't there yet, but they're going to be there. And one interesting like sort of phenomenon is that like, you know, because they can't order all these NVIDIA chips, there's really only two places in the world that will let you build data centers and have cheap power, right? East Asia can't do it because they have to import all their power. Europe hates, you know, natural gas and natural gas is basically how you have to power data centers. And so the US and China are really the only places that can build data centers. And China has been blocked off.

42:00So now China has like these companies flooding into Malaysia and Indonesia trying to build data centers that they can install foreign chips in. And meanwhile, they're also building these chips, trying to do this breakthrough innovation domestically. Yeah, and I believe there was also a loophole that might have been priorly closed talking about how you can essentially rent a chip. So for example, a Chinese company could rent something, you know, in AWS, you can rent to GPU that's in the cloud and say, Signapore or something like that. But I think the conversation about hybrid bonding and co-package optics is really interesting and kind of where we, you know, at the beginning, we were talking about how by cutting them off, we would effectively force them on their own roadmap.

42:38And that's kind of what's already happened. The SMIC roadmap is completely different than what is sort of the industry standard roadmap for leading edge. And as we continue to cut them off, they're going to have to kind of create a new roadmap for semiconductors going forward and the especially co-packaged optics, which is always five years ahead. And the reason why it's never adopted in the United States or in the Western semiconductor world is because it's just too expensive. But if you don't have an option, and this is your only option for scaling out chips, they'll pursue the expensive option.

43:09So there's going to be know-how created because of the necessity of this. Tracy, I think when we release this episode, we should publish a glossary to all these terms with like little like definitions. I think that would be very helpful. Okay, have fun doing that, Joe. Well, actually, speaking of new terms that will no doubt need to be added to the glossary, who makes the best chips for Qstar? That's been in the news. We don't know what it is yet, but I'm going to go ahead and ask. Someone tried to kind of explain it to me last night, actually. I don't even know what... My favorite take on this, and this is Dylan's take, is that Qstar is a psyop.

43:45It's a... Yeah. So I'm in the Bay a lot. A lot of my friends are researchers. And we sort of have this idea that anytime OpenAI tweets about something that's related to research, they're actually just trying to psyop everyone into wasting their time on a path of ML research that is actually not going to result in a better model. Because there's limited amounts of GPU, limited amounts of time. So if you're wasting your time doing that, instead of actually working on what's the correct path, at least what they think, because they've done all the experiments sort of ahead of everyone else. It's easier to innovate what's already been innovated than it is to innovate something completely new.

44:23And so sort of the thought is, hey, they're doing these psyops and QSTAR is one of those. We'll see. There's a million more questions we could probably ask, but we got to wrap up. So we'll have to have you back. Dogo Laughlin and Dylan Patel, thank you so much for coming on Oddlaw. It's an amazing conversation. Thanks for having us. Always love to chat with you guys and always love to chat chips for sure. Yeah, this was a blast. I didn't realize you two are even more funny when you're sitting in the same room. Thank you. When we're pointing at each other and making faces. Yeah. All right. Thank you.

44:52That was so much fun. That was amazing. Thank you so much.

45:06Tracy, I thought that was an amazing conversation. I guess it freaked me out a little bit. Yeah. You know what's bothering me? enormously now is i've realized if you step away from semiconductors for like a month there's some new breakthrough yeah there's like five new technologies and probably like more companies with like four letter acronyms involved somehow is that like a rule i remember having the same thought about stepping away like every time i would ignore crypto for six months there'd be some new scheme except in the end none of that mattered because it was all it didn't matter i This stuff actually matters.

45:43And so you do. It does feel like you really have to pay attention constantly to know what's going on. There was so much in there. You know, one thing just that struck me when I was thinking about U.S. versus China industrial policy. And here we freak out politically due to a waste. So we're still talking about, say, Solyndra. So one company that was doing tech and it ended up being a scandal that for years cast aspersions on the idea of the government investing. And it sounds like listening to Dylan and Doug that, yeah, they probably have their equivalent of plenty of Solyndras in China. There's probably plenty of fraud, plenty of waste, plenty of disasters, plenty of endeavors that don't have the chance.

46:22It just seems that they have the appetite to continue investing in those areas, even with some level of fraud. But also, like, they are so explicit about what they're doing. And I can't remember. I'm going to have to go back and look who said this. but someone was basically like the equivalent of follow the money. Like China is telling you where they're going to put the money in semiconductors. This would have been around 2021 when they first started cracking down on like for profit education and the e-commerce platforms and things like that. And this person, I remember them saying like, China's telling you what it wants you to do as a domestic investor or someone who's working in tech.

47:01They don't want you building, you know, video games or something like that. They want you to make chips that might power those video games or something much more important. And here it's like, yes, we have messaging, but it's never it's never quite that way for obvious reasons. I think there's like still a lot of discomfort here about industrial policy in general. But of course, since COVID, that seems to be changing a little bit. So many other details. We need to find one of those shows, the love story of the two people who meet in the semiconductor fab. I also think it's just really interesting, this idea of a rail car company.

47:39Yeah. Say, hey, here's an opportunity to build a chip that we have to buy from a German company. And because of the tax structure, it makes sense for us to invest and see if we can build it domestically. This idea that, you know, we talked about BYD before on the show a couple months ago with Corey Cantor, but that it's also a chip powerhouse and that there's a lot of a lot of margin there so many it's too many interesting things to go over yeah i gotta say i went on uh one of crrc's the high speed trains i think it must have been them um between beijing and hong kong that was a nice train i really enjoyed that so uh i i look forward to seeing the semiconductors too i'm sure they'll also be nice maybe shall we leave it there let's leave it there okay this has been another episode of the Odd Lots podcast.

48:25I'm Tracy Alloway. You can follow me at Tracy Alloway. And I'm Joe Weisenthal. You can follow me at The Stalwart. Follow Dylan Patel. He's at Dylan522P. Follow Doug O 'Loughlin at underscore fabknowledge underscore. Follow our producers, Carmen Rodriguez at CarmenArmin, Dashiell Bennett at Dashbot, and Kel Brooks at Kel Brooks. And thank you to our producer, Moses Andam. For more Odd Lots content, go to Bloomberg.com slash Odd Lots, where we have transcripts, a blog, and a newsletter. And you can chat 24-7 with fellow listeners in the Discord, discord.gg slash oddlots. There's even a room there just for semiconductors where people are posting links to highly technical things that I don't understand but seem very fascinating.

49:09Go check it out. And if you enjoy Oddlots, if you want us to get back into semiconductors on a regular basis, then please leave us a positive review on your favorite podcast platform. Thanks for listening. Thank you.

49:52Here's a paradox. We buy insurance for peace of mind, yet the very policies we trust can deliver the biggest financial shocks. Across America, millions of claims are denied every year, not because people did anything wrong, but because policies quietly excluded the things that happened. The psychology of trust tells us we assume the contract is fair, but in insurance, the information gap is massive. The insurer knows every detail of what's covered. The policyholder rarely does. That's where my policy advocate comes in. For just 27 cents a day, their platform reads your policies and shows you in plain language where you're vulnerable.

50:28They're not selling insurance. They don't do that. It's about transparency, giving ordinary people the same understanding insurance companies have had for decades. Because when you know what's really in your policy, you can plan, protect, and avoid surprises. Before you trust your policy to protect you, let My Policy Advocate tell you what it really says. Visit MyPolicyAdvocate.com today. Peace of mind starts with knowing the truth. MyPolicyAdvocate.com In business, a thoughtful gift does more than say thank you. It recognizes achievement, builds loyalty, and shows someone they are genuinely valued.

51:02With 4imprint, you can choose from thousands of high-quality products, apparel, drinkware, tech, and more. Designed to leave a lasting impression. And with expert support, dependable service, and their 360-degree guarantee, your gift will arrive exactly as intended, on time and on brand. Explore gifting with purpose at 4imprint.com. 4imprint, for certain.