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The joint complaint by the United States, European Union (EU), and Japan filed against the People’s Republic of China (PRC) before the World Trade Organization (WTO) for its restrictive rare earth export policies marks another satisfying act in President Barack Obama’s contain-China political theater. It also provides some insight into where the world is headed, and Japan’s attempts to maintain its economic and geopolitical relevance.

The handwriting is on the wall for the PRC to lose the rare earth case. It is a virtual carbon copy of the raw materials export restrictions case brought by the US, EU, and Mexico against the PRC. Beijing lost, both in the original adjudication and on appeal in January 2012. [1]

In the raw materials case, the WTO found that China’s regime of export duties and quotas for bauxite and other materials created a two-tier system that favored domestically based traders and processors (including FDI entities), and discriminated against foreign purchasers. It rejected the PRC’s defense that these measures were protected under GATT provisions permitting restrictions on exports for the purpose of conserving scarce resources and preventing environmental degradation, observing that price and quantity controls that primarily targeted foreign purchasers was not a plausible implementation of a conservation policy.

At the time, it was widely believed that a rare earth complaint would be next, and indeed the shoe dropped in high-profile remarks by Obama in the White House Rose Garden on March 13.

China-bashing makes for good politics in this election season, and his administration and the media did their best to paint the case as a victory for freedom and fair play against the Chinese menace, citing China’s monopolistic 97% share of current rare earth production.

However, beyond the 97% number, the story gets a little thin. China only accounts for around 30% of world rare earth reserves, begging the question of how vital the WTO complaint is the protection of Western interests. After all, shouldn’t Adam Smith’s invisible handyman be busy knocking holes in the Chinese monopoly?

In fact, the market is responding pretty much as one would expect, with a certain, surprising, amount of help from China.

In addition to enforcement of the export quota system, China’s widely reported measures to consolidate production, decrease pollution, and shut down the wildcatters and their inefficient, polluting mines have pushed up global rare earth prices.

In response, there are at least two major rare earth plays going ahead: the Mountain Pass mine in the United States and the Lynas project (mine & concentration in Australia; refining to metal powder in Malaysia).

Mountain Pass, in California’s Mojave Desert, is the biggest rare earth mine in the world, once responsible for half of global output. It ceased operation in 2002, shuttered by a flood of inexpensive Chinese product. Now owned by Molycorp and flush with IPO money, the mine is reopening. It recently purchased Neo Materials Technologies, a Canadian rare earths processor, for $1.3 billion Canadian dollars.

In the requisite ironic counterpoint that seems to accompany almost every China sanctions story, a dismantling of Chinese duty and quota barriers would push down global prices and, perhaps, strangle these Western rare earth investments in the cradle.

As the Chinese government pointed out, only half of its 2011 rare earth export quota was subscribed, implying that there are limits to the pent-up global demand that can keep prices up to a level healthy to Molycorp and Lynas’ investments.

Also, the Chinese government has openly welcomed development of new rare earth sources overseas in order to relieve pressure on Chinese suppliers to serve the export market instead of domestic users. In fact, Lynas’ CEO, Nicholas Curtis, is a China resource insider with close ties to the PRC establishment; China Non-Ferrous Metals Mining Group would have funded the rare earth play but for Australian government opposition. The process technology for the Lynas processing plant in Malaysia is supplied by China. [2]

As for Mountain Pass, its chairman, Ross Bhappu, told reporters:

”It has been surprising, the Chinese are extremely supportive of us starting this mine, they have told us they don’t want to be the world’s sole supplier…They are concerned they are going to consume everything they produce internally and they won’t have excess production to export.” [3]

A study by Technology Metals concluded that every rare earth element will pass into permanent surplus by 2017 or earlier. [4]

The key issue is not access to the raw material, or even processing technology. The heart of the rare earth kerfuffle lies in Japan and its efforts to maintain its economic and diplomatic relevance as it is overshadowed by China as Asia’s leading exporter and growth engine.

Rare earths attained their current geopolitical celebrity in 2010, when the PRC cracked down on rare earth shipments to Japan (perhaps one third of which are estimated to be smuggled material evading the export licensing system) during the spat over the detention of the crew of a Chinese fishing vessel near the Diaoyutai/Senkakyu Islands at the direction of Japan’s ambitious, pro-US. defense minister at the time, Seiji Maehara. [5]

The PRC’s attempts to fire a shot across Japan’s bow backfired. Despite the fact that Japan had, by its own estimation, stockpiles of rare earths sufficient for six months (the Chinese suspect the figure is much higher) and no disruption to Japanese production occurred, rare earths became the useful symbol of overweening Chinese ambition in North Asia, just as the PRC’s aggressive claims in the South China Sea have come to epitomize the Chinese threat in South Asia.

In an example of diplomatic and political synergy, the United States piggybacked its “return to Asia” on the back of Japan’s rare earth woes.

The rare earth dispute provided a perfect showcase for alleged Chinese perfidy. Not only were rare earth elements declared to be at the core of Western defense technology; enjoyment of the green marvel of the Prius and the high tech wonder of the iPhone were tainted by the awareness that China, with its rare earth monopoly, could snatch them away at any time.

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