Rare Earths may Provide Leverage

Many American observers argue that the trade imbalance gives the US an advantage in a trade war with China. The US enjoys escalation dominance in tariffs because Chinese imports of US goods are so much less than the US imports of Chinese goods. However, the focus on quantities may be misleading. For example, the ability to find substitutes for the more expensive tariff imports could be a critical part of the evaluation. In addition, some products are not equally important. These asymmetries are both vulnerabilities and opportunities.

Consider the reports that China imports 80% of its semiconductor chips. This is a vulnerability and will most likely change regardless of the current trade tensions. China cannot be so dependent on foreign technology. That will be one of the lessons from the current tensions. Similarly, the US imports 80% of its rare earths from China. This is also a source of vulnerability. China has used its rare earths as a weapon to express its displeasure with Japan a few years ago. President Xi and Vice Premier (and lead trade negotiator) Liu visit earlier this week to a rare earth fabrication plant was a thinly-veiled threat.

Although the US initially slapped a 10% tariff on Chinese rare earths, they escaped the more recent increase. On the other hand, one mine in California ships ores to China to be refined, and these ores were subject to the tariff increase as of June 1 to 25%. A recent US geological study found that 35 minerals were crucial for the US economy and defense, and it is entirely dependent on imports for more than half.

Rare earths comprise around a dozen and half chemically related elements that are used in modern technologies, including electric vehicles, wind turbines, and advanced precision weapons. They are not so rare, but they are found in light concentrations, which requires extensive refining and processing. Malaysia process some rare earths from Australia. Russia, Brazil, and Vietnam also have rare earth deposits.

Back in 2010, as China was imposing export quotas on rare earths, I compared it to Sputnik as galvanizing policymakers and businesses to overcome their dependency. At first, it looked promising, but since Molycorp, the last US producer, sought Chapter 11 protection in 2015, the US has no domestic separation facility.

The relatively small dollar value of US rare earth imports means that for many it simply gets lost in the shuffle. Consider that of the roughly $420 bln goods deficit the US recorded with China last year, rare earths imports rose 17% but were still valued at less than $200 mln. Their importance is greater than the dollar value suggests.

Despite the end of the tariff truce, the US and China have not climbed very far on the escalation ladder. Both sides are showing restraint, but the blacklisting of Huawei, ostensibly not related to trade conflict per se, is arguably a more potent blow to China than the tariff increase, which as most acknowledge, is paid for by Americans in the first instance.

President Trump's claim that due to past practices, he will not agree to a 50/50 deal, as the US needs to be compensated, would seem to rule out a trade agreement that China can accept. Trump's pledge that China will not surpass the US on his watch plays into Chinese fears that America's real aim it to curb its development. If this is indeed the path the US is on, it makes sense for the US to free itself from dependency on China for rare earths.