In an all-too-predictable development, our trade problems with those devious, untrustworthy Chinese have come to the fore again. In an election year, politicians must find someone to blame for America's economic woes.
Balance of trade and currency questions are complex, but the bogus story making the rounds goes like this: if the Chinese would allow the yuan (China's dollar) to float, it's value relative to other currencies (the U.S. dollar, yen & euro) would stengthen, which would make U.S. exports more competitve. Thus we would boost exports both to China itself and China's export markets, which would lower our trade deficit and create manufacturing jobs in the United States.
This story sounds good, especially to dummies like Paul Krugman, but there are many, many obstacles standing between us and this happy result. I laid out my own views When In Doubt, Blame China, which I wrote last March. Nothing much has changed since then, so I recommend you read that post today if you haven't already looked it over. (I don't think Krugman is unintelligent. Rather, he is always enmeshed in politics, and so is an exemplar of my aphorism politics makes you stupid.)
Michael Hudson's America's China Bashing: A Compendium of Junk Economics (hat tip, Mish) addresses all the ugly economic details, but his first paragraph summarizes the key take-away message—
It is traditional for politicians to blame foreigners for problems that their own policies have caused. And in today’s zero-sum economies, it seems that if America is losing leadership position, other nations must be the beneficiaries. Inasmuch as China has avoided the financial overhead that has painted other economies into a corner, nationalistic U.S. politicians and journalists are blaming [China] for America’s declining economic power.
I realize that balance-of-payments accounting and international trade theory are arcane topics, but I promise that by the time you finish this article, you will understand more than 99% of U.S. economists and diplomats striking this self-righteous pose.
However, there has been one important "new" development which has very recently come to light. China and Japan have been engaged in a territorial dispute which is exacerbated by downward pressure on Japan's exports due to the strength of the yen with respect to the yuan. China is Japan's biggest export market, and recent Chinese purchases of Japan's debt have "contributed to yen appreciation." In response, "the Bank of Japan [BOJ], disconcerted by the conjuncture of a strong currency and weak economy, [recently] intervened in the foreign exchange market to push down the yen." After the BOJ sold off $20 billion yen, and with tensions mounting, the Chinese turned a territorial dispute into a trade dispute by halting shipment of rare earth elements to Japan.
Not only did this send a strong message to Japan—they released a Chinese fishing boat captain they were holding—it also conveyed the same message to the United States. In July, China had reduced rare earth element export quotas for the rest of the year by 72 percent, which sent prices up more than sixfold for some elements (Bloomberg, September 29).
All of a sudden, America's trade war with the Chinese didn't look like such a good idea! I will quote the Bloomberg story at length—
A generation after Chinese leader Deng Xiaoping made mastering neodymium and 16 other elements known as rare earths a priority, China dominates the market, with far-reaching effects ranging from global trade friction to U.S. job losses and threats to national security.
The U.S. handed its main economic rival power to dictate access to these building blocks of modern weapons by ceding control of prices and supply, according to dozens of interviews with industry executives, congressional leaders and policy experts. China in July reduced rare-earth export quotas for the rest of the year by 72 percent, sending prices up more than sixfold for some elements.
Military officials are only now conducting an inventory of where and how U.S. suppliers use the obscure but essential substances -- including those that silence the whoosh of Boeing Co. helicopter blades, direct Raytheon Co. missiles and target guns in General Dynamics Corp. tanks...
The U.S. Congress’s investigative arm, the Government Accountability Office, in April warned of “vulnerabilities” for the military because of the lack of domestic rare-earth supplies. The House of Representatives Armed Services Committee will hold a hearing in October, the same month a Pentagon report on how to secure future supplies of the metals is due.
“The department has long recognized that rare-earth elements are important raw material inputs for many defense systems and that many companies in our base have expressed concern regarding the future availability of the refined products of these elements,” Brett Lambert, director of the Pentagon’s Office of Industrial Policy, said.
While two rare-earth projects are scheduled to ramp up production by the end of 2012 -- one owned by Molycorp, Inc. in California and another by Lynas Corp. in Australia -- the GAO says it may take 15 years to rebuild a U.S. manufacturing supply chain. China makes virtually all the metals refined from rare earths, the agency says. The elements are also needed for hybrid-electric cars and wind turbines, one reason supply may fall short of demand in 2014 even with the new mines, according to Kingsnorth of Imcoa...
Export Quotas
Export quotas and taxes for overseas buyers that the GAO says can reach 25 percent are pushing up prices of elements even in relatively large supply. For example, the cost of a kilogram of samarium powder, needed for the navigation system of General Dynamics’ M1A2 Abrams tank, jumped to $34 in early September, from $4.50 in June, according to U.K. researcher Metal Pages Ltd.
Well — that doesn't sound so good! I covered the rare earth elements (REE) situation at length in The Rare Earth Elements Crisis. You should review that post if you haven't read it already. In the Bloomberg story, I hope you can see the inconsistency of saying on the one hand
the U.S. handed its main economic rival power to dictate access to these building blocks of modern weapons by ceding control of prices and supply
and then saying
the GAO says it may take 15 years to rebuild a U.S. manufacturing supply chain
on the other. Allow me (and the Gee Whiz Kid) to explain the situation.
Due to depletion of our reserves, production of REEs in the United States was no longer cost competitive and thus not economic. China had big reserves which were relatively cheap to develop. The United States did not "cede control" of prices and supply. China had an overwhelming competitve advantage, and that's all there is to it.
Let's use an analogy from the oil industry: if you've got newly discovered ultra-deepwater reserves you can develop for $105/barrel, but the price of oil on the international markets is about $80/barrel, it's not economic to produce that oil field. The same situation obtained with rare earth elements in the 1990s when America supposedly "ceded" control of prices & supply to China. And saying it may take 15 years to rebuild a secure manufacturing supply chain is merely a guess on the part of the GAO. In truth, they have no idea how long it might take to regain control of the production of the REEs we need. America's only option at present is to re-open shuttered REE mines and produce what we can at costs well in excess of China's price, which will still be lower than ours even when we take China's export quotas into account. Otherwise, as I suggested in my original Rare Earth Elements Crisis article, we can kiss China's ass.
As the years go by and the Empire Declines, there will be many insoluble dilemmas coming our way. The trade and resource problems we're having with China form just one example. China's on top. Get used to it.
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