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  1. Home
  2. / Investing

Japan and South Korea Start Trade War With Roots in Real War

Japan has cut off supplies of three key chemicals to South Korea, hitting the memory-chip and screen-making industries. The roots of the spat go way back.
By ALEX FREW MCMILLAN
Jul 19, 2019 | 12:00 PM EDT
Stocks quotes in this article: SSNLF, HXSCL, INTC, LPL, NSSMY, PKX

A deepening trade dispute between Japan and South Korea has claimed its first victim, literally. A South Korean man drove a car to the gates of the Japanese Embassy in Seoul in the early hours of Friday morning, and set the vehicle on fire while sitting in it. The 78-year-old man, with a family name of Kim, died in the hospital of his injuries.

The roots of the issue reach back a century, to forced labor after Japan occupied Korea in 1910. But the implications are very modern, with the semiconductor and liquid-panel display sectors the main ones to suffer so far.

This current trade fight has intensified since the G20 summit in Osaka at the end of June. Japanese Prime Minister Shinzo Abe shared a cursory handshake with South Korean President Moon Jae-in. But that was it. While Abe held talks with some 16 world leaders as he hosted the event, he turned down a request for a formal sit-down with Moon.

On July 4, Japan began restricting exports of three chemicals to South Korea. Tokyo says this is due to national security concerns. But Seoul sees the restrictions as "unjust economic retaliation."

South Koreans have responded with an ad hoc boycott of various Japanese goods, and travel to Japan. Koreans are the second-largest source of visitors behind China. Such boycotts rarely shift share prices, but are worth watching if they intensify.

Korea's high-tech industries are, however, right in the line of fire. Samsung Electronics (SSNLF) has written to its partners asking them to stockpile Japanese ingredients in case the dispute lingers.

Japan has choked off the supply of fluorinated polyamides, which are essential in the production of OLED displays, as well as photoresist coatings and hydrogen-fluoride gas, both necessary for the production of semiconductors.

The three chemicals can also be used for military purposes. Japan says South Korean companies have been lax in storing them. It is using that as justification for requiring shipment-by-shipment approval for any exports to Korea, which had previously been expedited.

Samsung rival SK Hynix (HXSCL) has begun testing substitute materials made in South Korea by SoulBrain KR:036830, using raw chemicals shipped from China. Russia is another possible source of the three chemicals, although Japan corners 70% of the market, and supplies more than 90% of the chemicals used in Korea.

Samsung and Hynix sandwich Intel (INTC) as the world's largest chipmakers. Screenmaker LG Display (LPL) is another Korean company that will need to take evasive action to avoid being hit by the dispute.

Their current plight reflects long-term tensions between Japan and South Korea. Although the cultures share many similarities, trade between the two nations is a fraction of what you'd expect from next-door neighbors.

South Korean media have reported that the man who burned himself to death had a father-in-law who was a forced laborer under Japanese rule during World War II.

Japan set a deadline of midnight on Thursday for Korea to accept third-party arbitration that would settle the issue of wartime reparations for good. At issue is how to compensate Koreans and their descendants for labor they were forced to do for Japanese companies during Japan's occupation of Korea, which lasted from 1910 through 1945.

South Korea has rejected arbitration. It has proposed setting up a joint fund with Japan to compensate laborers, something Japan has rejected. This matters now because Korean courts are starting to seize Japanese assets in South Korea.

South Korea's Supreme Court last October ordered the Japanese company Nippon Steel (NSSMY)  to pay 400 million won (US$340,000) split evenly between one surviving Korean man and the heirs of three others who were forced to work for the steelmaker during World War II.

Then, in January, a lower court in Daegu issued an order to seize some of Nippon Steel's shares in PNR, the South Korean steel joint venture between Nippon Steel and the Korean steel giant Posco (PKX) , to allow for the reparations.

Although the settlement is relatively small, there are numerous similar cases working their ways through the Korean courts. Japan believes the issue of reparations was settled with a 1965 treaty that normalized relations between Japan and South Korea. Japan then provided US$500 million in aid to Korea.

This comes at a poor time for the chip business. Business conditions have been deteriorating for quite some time, and share prices began a slide in early 2018.

Those losses were arrested this year. The memory sector on the Korea Stock Exchange has advanced 13.0% so far in 2019, a significant outperformance over the benchmark Kospi's 3.5% gain. That's because valuations became cheaper but also because policymakers changed to a dovish stance. South Korea cut interest rates on Thursday.

Temporarily, the stall on the supply of chemicals may actually help chipmakers since they have an oversupply of chips on their hands. But the memory-market downturn has already been steeper and faster than anticipated. There's real danger that memory-maker stocks will suffer another slump now that the Korea-Japan trade dispute is intensifying.

Things look to get worse rather than better between Korea and Japan.

Japan is considering intensifying its trade pressure by removing South Korea from its "whitelist" of preferential trading partners. Removing Korea from that list of 27 favored nations would require Japanese companies to get a license for every shipment of a wide variety of materials that could be weapons-related.

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At the time of publication, Alex Frew McMillan had no position in the securities mentioned.

TAGS: Investing | Markets | Politics | Stocks | Trading | Technology | Asia | Japan

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