By Marshall Auerback, a market analyst and commentator. Produced by Economy for All, a project of the Independent Media Institute
We’ve been sold an empty threat for years. And now it’s finally happening: ahistorical bluff is getting close to being revealed for the paper tiger that it is. According to accounts in several local newspapers, China is poised to embargo shipments of rare earths to strike back against the U.S. in response to the mounting trade war between the two countries. A representative example is the People’s Daily, an official organ of the Chinese Communist Party, which recently wrote: “We advise the U.S. side not to underestimate the Chinese side’s ability to said safeguard its development rights and interests. Don’t say we didn’t warn you!” The International Business Times noted that“ the phrase ‘Don’t say we didn’t warn you’ was only used two other times in history by the People’s Daily—in 1962 before China’s border war with India and preceding the 1979 China-Vietnam War.”
So are we on the verge of World War III? Certainly, Beijing’s threats sound ominous, but in this case, the warning, likeChina’s threat to sell U.S. Treasuries, is more apparent than real. As for the historical military references, it’s also worth recalling that neither the border war with India nor the conflict with Vietnam ended particularly well for Beijing in terms of decisively securing its strategic objectives when the attacks were launched. China is said to have “won” the 1962 war with India, but the disputed border issue is not fully resolved, and ultimately created a more formidable adversary when India modernized its army in response to Beijing’s attack; in Vietnam, the end was widely considered to be a military debacle for China’s People’s Liberation Army. By the same token, today’s threatened rare earths embargo may well prove to be disruptive (and expensive) for the United States in the short term. Long term, not so much, and, in fact, it may prove profoundly self-defeating for Beijing.
For starters, even today the United States can access rare earths from non-Chinese sources if and when circumstances necessitate it, including from hitherto dormant domestic producers. And from China’s perspective, given the multinational nature of supply chains, just how does the country plan to isolate the American end-user of this commodity?
The last time Beijing attempted an embargo of rare earths against Tokyo in September 2010 (allegedly in response to a trawler collision that occurred in the context of a longstanding territorial dispute between the two countries over a group of uninhabited islands known as the Senkaku Islands in Japan, or the Diaoyu Islands in the People’s Republic of China), the suspension of Chinese shipments lasted a mere seven weeks. And even that might overstate the true duration of the embargo because, as authors Amy King and Shiro Armstrong of Australia National University point out:
Analysis of Japanese port data from the Japanese Ministry of Finance shows that there was no uniform dropin Japanese imports of Chinese rare earths following the trawler collision. Similarly, a 2012 article in The Chinese Journal of International Politicscites Japanese and US news media to demonstrate that Japanese officials and businesses had been aware since mid-August 2010 [i.e., one month beforethe trawler collision] of Chinese plans to reduce their worldwide rare earths exports.
In any case, King and Armstrong note that within several weeks, then Premier Wen Jiabao signaled an end to the embargo when he announced: “China does not and will not use rare earths as a bargaining tool in international trade because China strives for sustainable development throughout the entire world.” However much one may laud the Chinese premier’s professed environmentalist objectives for sustainable development, the more likely reason why the embargo ended so abruptly was that it ended up doing as much damage to China’s economy as it did to the Japanese companies it was designed to punish. The real lesson to be drawn from that experience is the ineffectual nature of these attempted embargos in the context of a world of multinational supply chains.
Not only did the supply cutoff undermine Beijing’s credibility (and concurrently expose the underlying weakness of its position), but the attempted weaponization of rare earths ultimately undermined China’s quasi-monopoly dominance in the sector by calling into question its reliability as a dependable long-term supplierin the global marketplace that China (and therest of the world)depends on for every advanced sector of its economy. It also induced sourcing from other countries in response. Consider that in 2011, China controlled around 97 percent of the global rare earths market.Today, that figure is closer to 80 percent. In the mineral industry, a decline rate like that is warp speed. Within the next three years, it will be smaller still, as more American production comes into play.
What are rare earths? According to Geology.com, they are a group of 17 chemical elements,all of whichend in -ium and sound like a Latin flash card memory exercise.Periodic table aside, their import lies in the fact that these metals are used in a multiplicity of vital industries, among them being computers, rechargeable batteries, cell phones, catalytic converters, wind turbines, magnets, and fluorescent lighting, as well as in defense applications, such as guided missiles.Given the increasing level of sophistication the mining industry has for rapid extraction, Beijingsimply can’t pretend to be holding a long-term strategic card here, even though “it sits on close to 40% of global rare earth deposits, produces 120,000 metric tons of rare earth a year, or roughly 80% of the global supply. For comparison, Australia, the world’s second largest supplier, produced just 20,000 metric tons last year,” writes Eamon Barrett of Fortune.com.
And there is yet more production promised from non-Chinese sources: America’s Mountain Pass deposit used to be the world’s largest source for most of the globe’s rare earths. The current owner of the deposit, MP Materials, recently announced that it was set to produce about 5,000 tonnes by next year, along with a Texas-based company that will begin production by 2022at the earliest. In the same report, Reuters indicates that these companies are heavily lobbying the Trump administration to prioritize the consumption of domestically sourced rare earths. That prospect can only be enhanced by Beijing’s short-sighted threat to weaponize these metals.
It is true that the mining of rare earths is both hazardous and highly toxic, as well as being expensive to extract in the United States, relative to historic prevailing prices (where the mines have been largely uneconomic in comparison with China’s lower cost deposits). So for both environmental and economic reasons, the United States and other countries have long elected to “export” much of this activity to China (especially after the bankruptcy of Molycorp, which once owned the Mountain Pass deposit). The environmental considerations are obviously less of a factor today, given the prospect of a Chinese embargo and a smokestack industry-loving American president. And higher anticipated rare earth prices substantially improve the underlying economics of American-based production (as will the backstop of a guaranteed market from the Pentagon).
It should also be noted that even though rare earths are used in a number of crucial industries, the United States itself is a very small market for the direct importation of the raw materials themselves (the dollar total of imports is around $160m). Japan remains a substantial importer of Chinese sourced rare earths, and this time around, Tokyo is not being threatened by the proposed embargo (so it could likely help its U.S. ally in a pinch). The only rare earths that the United States still imports directly in relatively large quantities are lanthanum (where its alloy is used in hydride batteries for hybrid cars) and cerium (for catalytic converters).
For the most part, the United States, including the Pentagon, buys components and finished products from global supply chains that start with mines and rare earth separation/production plants in China, but could also start in Australia (via Australian producer Lynas Corporation, whose stock price hit a five-year high on the newsof China’s threatened embargo), or Malaysia (via Lynas’s rare earth refinery in Kuantan), or Estonia (via Silmet, an Estonian refinery). Even if sourced from China, it is hard to see how the latter could disaggregate these orders to isolate U.S. end-users.
A leading Canadian producer in which I once invested when I was working as a fund manager, today known as Neo Rare Metals (I neither hold a position in the company today, nor do I work any longer as a fund manager), has a number of customers in Europe who insist on a China-free supply chain (a legacy of the last embargo, the requests for which are likely to multiply if China does in fact proceed with this threatened supply cutoff). Neo is able to accommodate these requests, the chairman indicated to me recently in email correspondence. In these cases, the company simply supplies its customers with magnetic materials from its plant in Thailand for which raw materials are sourced from either Estonia, or Lynas, or both.
As far as China’s much-ballyhooed embargo of Japan launched in September 2010, the effects were over before the end of that year, largely because of the mutual interdependence of the two economies. While Japanese companies were reliant on China’s rare earths to make chips, magnets, motors and other components, the problem from Beijing’s end is that its companies were also buying back a lot of Japanese-manufactured components for their own assembly plants. Consequently, when the Japanese component manufacturers ran out of rare material inventories, they could not ship requisite components back to China. The end result was that there were thousands of assembly line workers laid off in Dongguan and Shenzhen (in China’s manufacturing hub province of Guangdong) because their plants had to be idled. That is the more plausible reason as to why the embargo ultimately ended.
The upshot is that trade embargos, like disputes in trade (to intentionally invert Donald Trump’s misguided comments on trade wars), are neither good, nor easy to win. It is much more complicated than suggested in recent alarmist analyses, which overstate the magnitude of the Chinese threat. In fact, a longer-term embargo will almost certainly worsen Beijing’s position, which has enough on its plate these days, given mounting systemic stress in its domestic banking system. In the first instance, the threatened cutoff will undermine the country’s reputation as a reliable supplier, which means expanding searches for non-Chinese sources of rare earths. That was the ultimate outcome of Beijing’s attempt to weaponize its rare earth virtual monopoly last time. And if today’s resultant price spike is sustained for any significant period of time, it will bring forth additional marginal suppliers from other countries, all of which ultimately will reduce China’s market share and diminish its leverage further (so that the next threatened embargo becomes even less effective). The threat will more or less prove to be an example of China cutting off its nose to spite its face.