Ten years ago during the last rare earths supply “crisis,” Mr. Yi Gang, then Vice Governor of the People’s Bank of China, said,

“In addition to boosting the flexibility of the Yuan exchange rate, China also should adjust resource prices to address imbalances, as many resources are still traded in China at below their natural prices. China also should boost wages and social benefits to lift consumption, step up its enforcement of environment regulations and undertake other structural reforms to address imbalances.”

Repeat after me: The selling prices of the rare earths and other commodities within China are still today too low. Thus, if the Chinese Government did not strictly control their export then the market would drive much of, if not all of, the supply out of China chasing the higher prices in the foreign marketplace. One current driver for such a foreign accumulation would be the stocking of strategic materials (stockpiling) by governments to protect their domestic industry’s security of supply. Another driver could well be inventory building by once-burned, twice-shy private corporations, finally reversing the 50-year reign of the just-in-time, no-inventory philosophy, which was a principal driver in the creation of this problem.

Danger to China’s industrial supply

Chinese central planning economists, however, also see this danger to Chinese industrial security of supply. And, by extension, potentially then leading to high unemployment in the very important domestic Chinese alternate energy, green, and cleantech sectors,

I don’t think that the Chinese central bank, the People’s Bank of China (PBOC) wants to buy commodities as an alternative to U.S. Treasury Bonds, because this could disrupt the commodities market. It would cause price volatility in the very asset trying to be used to stabilize prices and the currency. Even more importantly, no commodity accumulation of sufficient size to soak up excess Chinese liquidity would be likely to make a dent in reserves as large as those of China in any case, but it would certainly interrupt the flow of raw materials for industry.

Volatility in commodity prices

Note that the dramatic swings in commodity prices in the Western economies since 2008, a result of too much free money needing a home, known as the commodity “Supercycle” has massively damaged the manufacturing sectors of most of the world by driving up manufacturing costs and the prices of consumer goods while simultaneously fueling inflation. China has massively benefited from this foolish cycle because the prices of all of the commodities in the Supercycle are set by China’s dominance in their sourcing, processing, and end-use. The increased prices that Tesla (NASDAQ: TSLA) pays for rare earth permanent magnet drive motors and lithium-ion batteries directly benefit China.

The PBOC is determined to force China to grow its consumer sector without causing inflation, one of the two of the PBOC’s greatest fears. The other is a massively corrected and thus much more expensive Yuan. Yet by continuing to buy up surplus and hot money inflow dollars at a fixed rate, the PBOC feeds (and it knows it is feeding) inflation and increases the pressure on it (the bank) to revalue the Yuan or let it float.

Are rare earths priced too low in China

The prices of rare earths in China will have to increase soon or smuggling will become uncontrollable. That is human nature. In the long run, the production of rare earth metals outside of China will help the Chinese by increasing the global supply and reducing global prices and thus eliminating the need for export controls. This is doubly true when one considers that China itself is the world’s biggest market for rare earth metals, and its neighbor, Japan, accounts for almost all of the rest of the global demand.

The rare earth mining economy within China is tiny as a proportion of the GDP. However, the number of jobs dependent critically on the properties of the rare earth metals required to manufacture green, clean, communication as well as entertainment technologies, is not trivial. China’s central planners’ dilemma is that it must keep rare earths cheap in order not to drive rare-earths-based component jobs offshore to lower-cost countries such as Vietnam or India. Its own entrepreneurs are already doing this, by the way.

The result for junior miners with rare earth claims is that the race is on to produce more of what China needs to be produced outside of China, to relieve the pressure on its two-tier pricing economy for commodities such as rare earths.

The Chinese government maintains strict overall control of China’s economy from Beijing. Chinese businessmen, however, have the same mindset as any other businessmen, maximize profit and reduce costs. In today’s China, the government wins. It just may use a meat ax rather than a scalpel to enforce its decisions, such as with the rare earths recently.

Final thoughts

But to think that Chinese economists and central bankers do not see the problem is foolish.

I believe that the selling prices outside of China of the rare earths will continue to be robust until, and if, there is significant non-Chinese production of rare earths. Then if demand exceeds supply, which I think is likely, there will be a massive culling of those companies not in production, or of those that are too large, or have too high costs, or are too skewed to light rare earths.

So long as China continues to maintain that its supplies are being exhausted, the prices of the heavy rare earths must continue to be strong and even climb. If China does not find domestic new supplies of dysprosium and terbium then it will become increasingly dependent on its “near shore (to China)” suppliers such as Myanmar and need to cultivate “friend shoring” from places like Brazil, which, in case you didn’t notice, is happening right now!

Be cautious when investing in the rare earth sector. Very large forces are intersecting in it and could make prices very volatile in the near term, or even permanently.

China’s Real Rare Earth Infrastructure is based on a dedicated, and educated, specifically Experienced, and Skilled rare earth industrial and R&D workforce, financed, where needed, and supported by the State.

There is a debate among Western economists on the value and effect of industrial policies, set by governments, on the marketplace. It’s argued that when governments, instead of the markets, pick winners and losers in industries it never ends well.

China’s admittedly authoritarian central government does exactly that; it defines an industrial policy for the long term, and it picks winners and losers. But, unlike the American government, it does not careen from policy to policy based on the politics of the moment. China’s government’s long-term focus is on the growth of the overall economy, price stability, and domestic social harmony.

I think that it is the issue of price stability that has caused the Chinese central government to step into its domestic rare earth’s industry lately. Stable, or at least predictable, prices allow the long term planning characteristic of the Chinese industrial economy.

Just before Christmas China announced that it had formed a large and state-supported vertically integrated rare earth products’ company called, eponymously, China Rare Earths. This event, a merger of the rare earths operations managed by three mostly state owned and state controlled  companies has been widely reported. What journalists seem to have missed is that this will be a well financed rare earth company from the start. The Peoples’ Bank of China (the PBOC) is the lender of last resort to any State Owned Enterprise (SOE) and if that enterprise is producing anything required by the current industrial policy then profit and loss take a back seat to security of supply. In rare earths, for example, mining and separation are today rarely, and then only barely, profitable especially in any country with strict worker health and safety and environmental management regulations. The profit is in downstream products, metals, alloys, and magnets, phosphors, and catalysts. This is why stand-alone rare earth ventures even with separation capability and capacity, such as Lynas Rare Earths Limited (ASX: LYC), make relatively little profit, while by contrast China’s vertically integrated, and so far, mostly private Shenghe Resources, which is vertically integrated from the mine to the magnet does much better in sales volumes and profits than Lynas.

China’s rare earths industry has had a long learning curve, and this has generated the world’s largest rare earth R&D, rare earth mining, and rare earths production (processing and manufacturing) engineering reservoir of skilled and well-educated individuals dedicated to rare earths, in the world.

China Rare Earths inherits this human infrastructure, and, unlike, an American venture, such as MP Materials Corp. (NYSE: MP), does not go far to seek out specifically educated, experienced, and skilled engineers and workers from outside of the new company.

Each year China has a ruthlessly competitive national exam to determine admissions to its top universities. Last year some 15 million sat for the national exam. The top tier was selected for China’s most prestigious universities. Those chosen were mostly directed to what we call the STEM curricula, (the hard) sciences, technology, engineering and mathematics. This choice of direction is made in accordance with and support of China’s Industrial Policy, of being independent of the West in 10 technologies by 2025, and becoming a permanent center of technological innovation, superior to any other nation.

The United States, where social forces are denigrating college admissions’ qualification through the cancellation of blind testing, and where even mathematics may be branded as “racist” by half-witted college faculty and administrators, is surviving today as the top tier innovation nation through the work of legacy researchers, many of whom are foreign born, and most of whom are already in their peak productive years.

The American military pretends to be surprised by Chinese prowess in modern weaponry, and the American mainstream media simply does not report on China’s astounding space program. Both are described as based on stolen intellectual property by a smug American media. Can they say the same about China’s dominance in rare earths and battery materials and the end-use consumer products mass produced in China based on those groups of metals?

The United States can and will supply its military needs for rare earth and battery metal enabled products from domestic sources or through domestic processing of imported ores, and, perhaps, restrictive tariffs to politically level the price competition.

But such self sufficiency will not be possible for the entire civilian economy. Compromise and rationing are the future of the domestic supplies of technology metals for green energy purposes. The best we can hope for is a hybrid energy supply, green where possible, but mostly from fossil fuels and nuclear, if the US intends to retain a domestic industrial economy.

More than ever now, the domestic production, processing, and fabrication of the critical metals and materials needed for a broadly prosperous technological society is itself critical. Depriving ourselves of STEM graduates to ensure those skills survive chosen is a step towards the national suicide of America’s standard of living.