EDITOR: | August 11th, 2014 | 10 Comments

China and the WTO – The Dawn of Passive Aggression?

| August 11, 2014 | 10 Comments
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The Fox and the Grapes“The Fox and the Grapes” is one of Aesop’s fables and is one of the earliest illustrations of the concept of cognitive dissonance or put more simply “sour grapes”.

“Driven by hunger, a fox tried to reach some grapes hanging high on the vine but was unable to, although he leaped with all his strength. As he went away, the fox remarked ‘Oh, you aren’t even ripe yet! I don’t need any sour grapes”.

The fox that covets the inaccessible grapes is taken to stand for a person who attempts to hold incompatible ideas simultaneously. The disdain the fox expresses for the grapes at the conclusion to the fable serves at least to diminish the dissonance, even if the behaviour in fact remains irrational.

Sympathy for China from me is rare indeed and even now in the wake of the WTO decision on China and Rare Earths it would not be sympathy that I offer but somewhere deep inside I must say I agree with the Chinese pleading in this specific case. I don’t feel the Westerners have much of a leg to stand on. Usually WTO cases are brought because of import restrictions (i.e. a country blocking competitors selling products into a specific economy and running local producers out of business) or dumping (where predatory pricing of a product enables an exporter to enter competing markets utilizing non-commercial pricing to gain a foothold and out-compete existing domestic players. In some ways these two “traditional” WTO grounds for complaint are the two sides of the same (or a similar) coin.

The complaint in this case was initiated at the WTO by the U.S., the EU and Japan on March 13, 2012, after China drastically reduced its rare earths export quotas and ostensibly caused a spike in world prices and considerable disruption to the global rare earths market. However, that is the version that suits the Western playbook because some would closer to the REE space would blame speculative hoarding by end-users AND hedge fund operators and other financial intermedaries/traders for the rise in prices beginning back in 2010. It might be said that scaremongering in the New York Times and Wall Street Journal did as much as Chinese quotas to hike the REE prices.

While the complaint reads as “China is kicking sand in our faces by toying with the REE export quotas and thus prices” to us it reads more like “we were happy for forty years to bask in cheap REEs as the Chinese indulged in predatory pricing but now the Chinese have woken up this is not in their best interest and they have a finite resource, we in the West want to keep getting cheap REEs, not invest in our own industries and have the Chinese subsidise our short-termism”. When read in this light the crocodile tears begin to flow. The West didn’t complain when China was selling at cheap prices (the obverse of traditional WTO griping) now they are complaining that the Chinese are price fixing (upwards).

Ironically if one regards China Inc. as an enormous corporation then the closest parallel to China’s attempt to institute RPM (Retail Price Maintenance) in the REE space is actually the iron grip that Apple Inc. has on the marketing, distribution and pricing of its products.

All Stick and No Carrot

Last week the WTO Appellate Body affirmed a WTO dispute settlement panel’s March 2014 finding and rejected China’s appeal, therefore finding for the U.S., Japan and the European Union, which had jointly filed the original complaint with the organization. The decision claimed that the country’s restraints against exports of rare earth minerals, tungsten and molybdenum violated international trade rules.

China had argued that its imposition of export duties and quotas were justified under exceptions in the General Agreement on Tariffs and Trade 1994, specifically as environmental protection measures and as measures related to the conservation of exhaustible natural resources. Both of which have veracity in the evidence that REE observers have noted in recent years.

The WTO panel found that China failed to justify its REE export duties and quotas as legitimate conservation or environmental protection measures. The panel also found the export quota requirements were inconsistent with WTO rules.

Forelock Tugging to the WTO

In the wake of China losing its appeal officials from the Ministry of Commerce (MOC) said the China would adopt measures in accordance with WTO rules. The official state news agency Xinhua reported an MOC official stating that “China regretted the WTOs’ final ruling that China’s export duties, quotas, and administration of rare earths, tungsten and molybdenum products were inconsistent with WTO rules and China’s Accession Protocol”.

Somewhat laughably, U.S. Trade Representative Michael Froman was reported as saying, “This report makes the end of the line for this dispute. …We have sent a clear signal to our trading partners that we will be tenacious in protecting American businesses, American workers, and the role of law.” The irony clearly escapes him.

Upon a U.S. request, the WTO Dispute Settlement Body will adopt the panel and appellate body reports within 30 days and call for China to bring its measures into compliance with its WTO obligations. We can be sure the Chinese are burning the midnight oil working out ingenious ways to get around the ruling. This may end up leaving Western players (particularly the EU and Japan) wishing they had not been inveigled into this complaint process in the first place.

National Champions

Capitalism has evolved in China over the last twenty years in a way that Mussolini would be very familiar with. The Italian fascist economy (and those of other fascists in pre-war Europe) were ruled by corporatist thinking basically where the government dealt with the many economic players by reducing their numbers by forcing them into associations or enforcing mergers that meant that less levers had to be tugged on to have the maximum economic effect. On the eve of the latest WTO appellant ruling, China’s government revealed it had approved the creation of two regional REE monopolies with the mergers to take place by the end of this year. The West might gripe, but how can one deny Chinese entities the right to merge in the same way that a Freeport, Glencore or BHP might do in the West.

In this latest move the Inner Mongolia Baotou Steel Rare-Earth Hi-Tech. Co. and Xiamen Tungsten Co. Ltd. were supposedly approved, by the Ministry of Industry and Information Technology, to lead the formation of the two REE groups, one in the north and the other in the south. The northern combine is led by the Baogang Group, Baotou’s parent, will handle the establishment of China North Rare Earth High Tech, consolidating mining (including Bayan Obo), smelting, separation and utilization companies in the Northern region of Inner Mongolia and will include Gansu Rare Earth Group. Meanwhile Xiamen Tungsten will build a conglomerate covering the southern part of the country, with all related REE companies in Fujian Province, except for state-owned China Minmetals.

Backwards Looking

As with so many international bodies, the ruling and the appeal by the WTO are so much like “old news” it is risible. The appeal, when lodged, was already out of date as the price of REEs had corrected down heavily from their 2010/11 highs. In recent times the market has been flooded by cheap Lanthanum and Cerium emanating from Lynas and Molycorp. If anything one might muse that these two are dumping La and Ce on the market by over-producing these minerals as a means of having a greater output of their lesser volume REEs (for which they receive higher prices). Think about it, if La and Ce were all these two produced they would have shut down by now as the outlook for usage of these two products is torpid to say the least. Ironically the Chinese could say that their REE production from Bayan Obo over the decades was also a “mere” by-product of the much bigger volume iron ore output from that mine.

In any case, the WTO is fighting a battle that is long over. True, the Chinese have still kept a grip on the export quotas (though this is routinely undermined by illegal exports and imports of REEs) but prices are certainly not something that Western users can complain about as they are massively off from the levels that had prompted the complaints in the first place.

Conclusion

It is now that the real fun begins. China will stop announcing publicly its export quotas. Instead, in some smoky back room of a resort in China’s most obscure province, the five or six heavies (pardon the pun) from the Chinese Rare Earth world will gather together and be told what they can and cannot do on a quarterly basis. What goes on will be hermetically sealed with loose lips rewarded by a spell in a re-education camp or even worse, involuntary organ donation!

If the WTO and its claimants think that China will be browbeaten into submission by the latest appeal ruling they are sadly mistaken. REE’s have gone from an obscure object of desire to a strategic playing piece on a chessboard that has as its end-game a millennial struggle to reestablish China’s place in the world after 150 years of humiliations and second-rate status. Churlish complaints from “do-nothing” Western nations about access to a mineral that is not rare only go to reinforce whatever internal view is held in China that the WTO is just a cat’s paw of the West. The Western nations have had five years since the REE crisis first blew up to secure financing for any one of a myriad of mines. The Japanese in particular were very vocal about their vulnerability to Chinese machinations but have steadily withdrawn from the backing they initially offered to quite a number of REE wannabes.

I would suggest that the REE market will be less transparent as a result of this ruling rather than more so. The WTO and its friends may have won the battle but they stand now an even greater chance of losing the war if they rest on their laurels and think the tiger has been tamed.


Christopher Ecclestone

Editor:

Christopher Ecclestone is a Principal and mining strategist at Hallgarten & Company in London. Prior to founding Hallgarten & Company in New York in 2003 ... <Read more about Christopher Ecclestone>


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Comments

  • Harold

    That’s why Stans Energy is the answer. Watch out for this stock to soar to its all time high once an agreement is in place the the government.

    August 11, 2014 - 12:54 PM

    • David Mortimer

      Harold I am an investor in Stans energy for the past 3 years ,we as of now do not have a license because of ironically Chinese bribes given to kyryg politicians ,do you have some information pertaining to stans getting its license back if so I hope you are correct because stans does have a great mine that is been held back by the kyrygs which is galling when you read this article.

      August 13, 2014 - 10:34 AM

  • hackenzac

    The ant and the grasshopper is perhaps as apt of an Aesop’s fable in this situation. May as well throw in the tortoise and the hare for good measure but there’s definitely some sour grapes to consider and perhaps some blind men and an elephant, an Asian elephant..

    August 11, 2014 - 1:40 PM

  • Dean

    Excellent article and commentary as usual, Mr. Ecclestone!!

    August 11, 2014 - 4:56 PM

  • Bill Keenes

    Excellent thought provoking article Chris – thank you.

    What do you speculate are as the possible responses being considered by the Chinese in response to the WTO ruling, to bring China into compliance with its WTO obligations.

    August 12, 2014 - 12:21 AM

    • Christopher Ecclestone

      Lip-service and window-dressing is what the West shall get from the Chinese.. and deservedly so as that is all the West has done about the REE “shortage” itself..

      August 12, 2014 - 2:42 AM

  • Nevada George

    The recent results of China versus the WTO rare earth dispute is a pseudo-win.

    If the USTR actually stated – “this report makes the end of the line for this dispute…..”– then he is playing to the audience or is living a life of denial.

    I am surprised that he did not tear off a piece of cardboard and write on it with a black marker — “We wuv yu China” — take a selfie and broadcast it worldwide. That is the current U.S. administrations foreign affairs strategy being implemented.

    You can deny reality, but you cannot deny the consequences of reality.

    The WTO/ROW is playing a game of checkers with the Chinese and all the while China is getting its’ “shits and giggles” as the actual game being played is Wei-ch’i.

    I have mentioned numerous times, over several years that it does not make any difference how many laws, regulations, agreements that are put into place — if they are not complied with then they are useless.

    China will find work-arounds and I suspect it will be domestic regulatory programs that will be passed down the rare earths supply chain as compliance costs.

    Anyone who is a rare earth advocate knows that the solution is for individual nations to support and encourage REE mining and development to protect the continuity of their industries, military, etc.

    Instead of the USTR pounding his chest and spewing dialogue that the WTO decision is a victory for the U.S., he should be “sounding the alarm” that it would only take a shift in the winds to create a major geopolitical event resulting in China shutting off the rare earth spigot.
    The big hammer is in China’s hand.

    If this happens, then those rare earth advocates out there trying to drive some sense into closed minds — will not take any solace in saying “I told you so” — it will be too late and we will enter the house of pain.

    The Global community is not learning from its’ past mistakes.

    “Learning is like rowing upstream, not to advance is to drop back”
    – Chinese Proverb

    August 12, 2014 - 11:51 AM

  • fred

    China will do what it wants, whatever it happens to be at the moment. Mao wanted China to have as many children as possible, so he would have plenty of cannon fodder for anticipated wars with the capitalists. Then it became the one child policy.

    Currently I think their worry is pollution. REE mining is trashing their environment. The best way to get a handle on it is to consolidate the industry, so there are fewer side avenues into the product stream. And it gives China the chance to be control freaks, which they absolutely love.

    I view China’s current stockpiling of REEs as two fold in purpose. First it lets China purchase the REEs before the tightening of black market REEs drives supply lower and prices higher. And second, it helps keep prices from getting lower, helping the REE industry to get accustomed to what non black market affected prices may ultimately look like in a more traditional free market pricing structure.

    As per the WTO, I think that China feels the necessity to pretend that it honors its decisions. But I think that the countries that took the case to the WTO didn’t have the slightest clue as to what they were doing. The money and effort spent in pursuing the WTO case would have been much better spent developing alternative sources of supplies.

    August 12, 2014 - 1:17 PM

  • Steve Mackowski

    Can someone clarify the WTO position? We hear the ruling applies to rare earths, tungsten and molybdenum. Surely the scenarios are totally different, and if so, the rulings and implications must also be different.

    August 12, 2014 - 7:43 PM

    • Gareth Hatch

      @Steve: in each case, export quotas and tariffs were imposed, in contravention of the WTO rules, and now have to be removed.

      August 12, 2014 - 11:12 PM

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