The most significant sanctions loophole isn't physical chip smuggling but 'compute smuggling.' Chinese firms establish shell companies to build and operate data centers in neutral countries like Malaysia. They then access this cutting-edge compute power remotely, completely bypassing physical import restrictions on advanced hardware.
Related Insights
A proposed policy for China involves renting access to US-controlled chips (e.g., in Malaysian data centers) instead of selling them outright. This allows Chinese companies to benefit commercially while giving the US the ability to "turn off" the chips if they are misused for military purposes.
Reports of China building a working EUV lithography machine are misleading. The effort appears to be an assembly of smuggled components from ASML's existing supply chain, not a story of domestic innovation. This frames the primary challenge as one of export control evasion rather than a rapid technological leap by China.
The US government revived the name "Operation Gatekeeper," once used for a 90s border project, for a new mission: cracking down on illegal AI chip smuggling to China. This demonstrates how semiconductors have become a national security priority on par with physical border control.
The "Operation Gatekeeper" bust uncovered a massive illegal AI chip smuggling operation into China. This indicates that prior to the recent policy change, a significant black market existed to circumvent US export controls, suggesting high, unmet demand that official numbers don't capture.
The most dangerous policy mistake would be reverting to a 'sliding scale' that allows China to buy chips that are a few generations behind the cutting edge. In the current era of AI, performance is aggregatable. China could simply purchase massive quantities of these slightly older chips to achieve compute power equivalent to frontier systems.
A major, clandestine production run by TSMC for Huawei shell companies supplied China with millions of advanced AI chips. This single violation artificially propped up China's AI compute capacity, effectively delaying the full impact of U.S. export controls by two years and obscuring the true state of China's domestic capabilities.
Contrary to their intent, U.S. export controls on AI chips have backfired. Instead of crippling China's AI development, the restrictions provided the necessary incentive for China to aggressively invest in and accelerate its own semiconductor industry, potentially eroding the U.S.'s long-term competitive advantage.
China's superior ability to rapidly build energy infrastructure and data centers means it could have outpaced US firms in building massive AI training facilities. Export controls are the primary reason Chinese hyperscalers haven't matched the massive capital spending of their US counterparts.
Despite Nvidia CEO Jensen Huang's claim of being "100% out of China," the company is experiencing massive, unexplained business growth in neighboring Singapore and Malaysia. This suggests these countries may be acting as intermediary hubs to quietly funnel chips into the Chinese market, bypassing direct restrictions.
U.S. export controls on advanced semiconductors, intended to slow China, have instead galvanized its domestic industry. The restrictions accelerated China's existing push for self-sufficiency, forcing local companies to innovate with less advanced chips and develop their own GPU and manufacturing capabilities, diminishing the policy's long-term effectiveness.
