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China has initiated new military drills around Taiwan, focusing on precision strikes and a potential encirclement of the island. An increasingly aggressive posture from the Chinese military raises severe risks to the global semiconductor economy, which is heavily concentrated in Taiwan. Though the US has enacted legislation to begin reshoring some chipmaking, it will take time and even more reform to materially shift the semiconductor supply chain. 

Increasingly strict trade restrictions targeting China’s chipmaking capabilities could increase the probability of a war in Taiwan, considering the strategic value of the island’s advanced chip fabrication technologies and Beijing’s desperation to avoid falling further behind its adversaries. Chinese companies have taken a specific interest in Taiwan Semiconductor Manufacturing Corp.’s (TSMC) products, reverse engineering 7 nanometer chips that appear to be copycat versions of TSMC’s last year.

Related ETFs and Stocks: iShares Semiconductor ETF (SOXX), iShares MSCI Taiwan ETF (EWT), Invesco China Technology ETF (CQQQ), Taiwan Semiconductor Manufacturing Company Limited (TSM)

Tensions over Taiwan have been heating up significantly over the last year, creating continual risk to supplies of the world’s most advanced chips, as production is heavily concentrated on the island. Per Voice of America, chip powerhouse Taiwan Semiconductor Manufacturing Corp. (TSMC) accounts for more than 90% of output of advanced chips, and 65% of all semiconductors. It is the leading chip contractor as well, manufacturing chips for companies as large as Nividia.

The US has tried to siphon off some of this capacity by bringing a larger share of chip fabrication back to its domestic market. Last year, congress enacted the distribution of tens of billions of dollars in investment tax credits and other incentives for chipmakers building in the US via the CHIPS and Science Act. That bill will have some positive impact, but leaves other issues unaddressed. Per Bloomberg, producing chips in the US still takes 25% longer and costs nearly 50% more than doing so in Asia.

Over the last three days, a new set of military drills by the China’s armed forces around Taiwan have kicked off, which included the deployment of an aircraft carrier toward Taiwan and live-fire exercises. Per Nikkei Asia, Taiwan’s defense ministry said it spotted 59 Chinese military planes near the island in the 24 hours through 10:00am on Monday, with 39 of them crossing the median line in the Taiwan Strait, which acts an unofficial barrier between the two sides and forms part of Taiwan’s air defense identification zone (ADIZ). That comes just a week after a separate spate of 10 aircraft crossed the median line on April 1, compounding hundreds of other ADIZ incursions since 2021.

A critical facet of China’s strategy to neutralize Taiwan would be a naval blockade. This methodology is not a secret as Chinese state television said earlier on Monday warships and aircraft staged drills to “form a multi-directional island-encompassing blockade situation“; an encirclement maneuver around the island. Taiwan’s defense ministry said it…

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