29) China as a restrictive trading partner

China's Ring of Power
John Lee
Foreign Policy, September 9, 2009

While nobody was paying attention, Beijing was busy cornering the market on a little-known, but much coveted, strategic commodity.

What's green, greatly coveted, and offers extraordinary power to he who possesses it? For comic-book fans, the answer is the power ring wielded by the enigmatic Green Lantern, one of the most popular superheroes ever created by DC Comics. In the real world, the answer is not too dissimilar: It's "green" lanthanide, a blanket term for more than a dozen "rare earth metals" that are used in a range of increasingly important defense and technology applications.

There's just one thing: China caught on to green lanthanide's strategic value early and has been cornering the market ever since. The country now controls more than 95 percent of the world's supply. From the comic-book analogy, one might infer what this means.

These metals, today used in commercial products such as mobile phones and iPods, will increase in value over the coming years, as they are essential in a range of energy-efficient applications from hybrid cars to wind turbines. Lanthanide is essential to radar systems and lasers required in weapons such as America's awesome arsenal of "smart bombs" and other precision-guided explosives.

Although rare earth metals can be found in many countries, few governments or corporations had the foresight to invest and develop lanthanide mines. The United States, for example, has some reserves, but the U.S. government and private corporations depend heavily on existing stockpiles and on imports. Mining of rare earth metals in the United States is rare. Reviving defunct mines and developing sites for new ones will take considerable time -- up to a decade -- and even more money. Currently, the United States imports 87 percent of its lanthanide from China. The rest comes mostly from France, Japan, and Russia.

China's approach to lanthanide couldn't be more different. Fifteen years ago, it set out on a deliberate plan to capture the rare-earth-metals market. Beijing offered cheap loans to Chinese state-owned enterprises to develop lanthanide-rich sites and mine these metals. Thanks to cheap labor costs, poor environmental obligations, and shoddy cleanup standards, Chinese mines have been able to produce rare earth metals at much cheaper prices than foreign competitors -- in the process forcing many of these competitors out of the market. Yet even while squeezing its competitors' margins, Beijing has gradually cut export quotas of lanthanide to regional "strategic competitors" (such as Japan) by 6 percent each year over the past decade. In 2009, China will only sell 38,000 metric tons to Japan -- the same amount that Japanese giants Toyota and Honda consumed in all of 2008.

The stakes have been raised even higher recently. To further enhance its global dominance in this market and build further strategic leverage, China's Ministry of Industry and Information Technology released a white paper proposing to severely slash exports of the rare earth metals -- or even halt them altogether.

The white paper is not only bad news, but it's very bad timing. The news comes just as the Australian Foreign Investment Review Board is debating whether to allow a Chinese state-owned company, China Non-Ferrous Metal Mining, to buy a 51 percent stake in Lynas, one of the handful of Australian companies involved in rare-earth-metals mining. The deal conjures the recent memory of Chinalco's failed bid for an increased stake in British-Australian mining giant Rio Tinto, in which Rio Tinto walked away after the Chinese insisted on one or two seats on the company's board. Yet again, China's moves toward market control could not be more explicit.

Not surprisingly, the white paper -- together with ample evidence that China is not afraid to hoard its lanthanide -- has sparked a panicked rush to buy undeveloped and poorly developed rare-earth-metals mines in Russia, Kazakhstan, South Africa, Botswana, Vietnam, and Malaysia. Japan has already admitted that about one-fifth of its imported lanthanide enters the country as part of a sophisticated black market trade out of China -- a practice tolerated and even encouraged by the government in Tokyo.

These developments feed into fears that Beijing views economics as more about the building of Chinese state power and strategic leverage than it is about seeking profits. China has been trying to convince global markets and governments that they have nothing to fear from its state-owned enterprises -- that these are normal companies, behaving according to usual commercial incentives. They would never be used to acquire strategic leverage for the Chinese Communist Party, Beijing says. But those claims are looking less credible each day. By denying foreign companies access to rare earth metals, Chinese state-owned companies enjoy an unfair advantage, dominating the market for products that use the commodities. Foreign companies requiring the metals may be forced to relocate to China, where the worry of commercial and industrial theft, as well as the illegal acquisition of trade secrets, is very real.

As Ginya Adachi, from the Japanese Rare Earth Association argues, some markets are not really about money; they're about politics. For years Japan has been crying foul about sinister motives behind China's plan to dominate the market. The United States and the European Union are also finally catching on; they no longer view China as a reliable or trusted supplier of rare earth metals, or more generally as a trustworthy trading partner. Major commercial and military firms are already increasing stockpiles and seeking to source rare earth metals from other parts of the world. Japan and the European Union are seriously considering an appeal to the World Trade Organization. If Tokyo and Brussels were to go down that path, Washington would likely offer support, or even join in. Both measures of recourse -- WTO procedures and economic diluting of China's rare-earth-metals monopoly -- will take time. Meanwhile, Beijing will want to continue to restrict exports, even if it does not ban lanthanide sales altogether.

At the end of the day, it will be quiet pressure from Washington, Tokyo, and Brussels, backed by a credible threat of selective retaliatory trade restrictions, that forces China to reconsider the collateral costs of becoming the "OPEC of rare earth metals." Yet even this pressure must be applied carefully. Tensions with China should be shielded from the public realm because Beijing has a deserved reputation for unpredictability when it faces the prospect of "losing face." Turning China into a comic-book villain on this issue will probably only backfire.