China and the WTO – The Dawn of Passive Aggression?
“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).
Get our daily investorintel update
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.
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.
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.
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 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>