U.S.-China Relations Will Become Strained Over Rare Earth Metals

China and the U.S. share an important economic bond. Over the past few years, tensions have risen between these two great powers. China continues its rapid growth while the U.S. stagnates. Tensions on the U.S. side have resulted in the Senate passing the Currency Exchange Rate Oversight Reform Act of 2011. This bill should not be signed into law. While I am sympathetic to the concerns of the authors of the bill, it distracts from a more pressing issue in Chinese-American economic relations: rare earth metals.

The U.S. continues to be frustrated at the pace of re-evaluation of the yuan. Frustration levels run so high that the gridlocked Senate passed The Chinese Currency Reform and Fair Trade Act with bipartisan support. The bill basically allows the U.S. to label China’s manipulation of its currency a subsidy, therefore allowing America to enact countervailing duties on Chinese goods. None of the supporters of the bill have placated my biggest concern regarding this legislation – its compatibility under GATT/WTO rules. From my understanding of GATT/WTO rules regarding countervailing duties, this bill violates the specificity test.

The specificity test can be found in the Uruguay Round Agreement on Subsidies and Countervailing Measures. This test adds to the definition of a subsidy by requiring the subsidy to confer a benefit to a specific industry or enterprise. China’s fixed currency affects all of China’s products and therefore fails the specificity test.

Also, China has moved forward in revaluating its currency. The nominal exchange rate between the Yuan and the dollar has dropped from around 8.4 CYN/USD in 2005 to 6.5 CYN/USD in 2011. This evidence proves their currency is appreciating, and the U.S. can still work with China on further appreciation. The worst part of the Chinese currency bill is that it distracts from a more pressing concern, Chinese protectionism of rare earth metals.

Rare earth metals are the key natural resource in creating modern electronic products. There are numerous examples of household products that rely on these 17 resources. The U.S. supplied all of its rare earth metals domestically prior to 1980, when China began to control the market. China now produces over 90% of rare earth metals, despite only possessing 30% of the entire world reserves

In October 2010, China decided to further reduce export quotas on rare earth metals. Less than a year later in July, the WTO ruled on the complaint brought by the U.S. and supported by the EU and Mexico regarding China’s export quotas. The Dispute Resolution body ruled that the export quotas on rare earth metals violated WTO rules.

The currency reform bill is related to the rare earth metals controversy. A week following the Senate passing the Currency Exchange Rate Oversight Reform Act of 2011, China’s largest rare earth metals company Inner Mongolia Baotou Steel Rare-Earth decided to suspend production processes of the rare earth metals for a month. Baotou currently produces 60% of the rare earth metals in China. The effect of the suspended production is to raise the price of these resources that have already seen huge price increases. The U.S. has recently petitioned the WTO again regarding China’s continued anti-trade activities regarding rare earth metals.

China continues to ignore the recent WTO ruling by refusing to abate their protectionist policies regarding rare earth metals. By focusing on the currency issue, we fail to notice this more pressing issue. In the coming years, our reliance on Chinese rare earth metals will lead us to wonder why we did not deal with this issue earlier.

Photo Credit: Wikimedia Commons