China, the world’s largest producer of rare earths, has been intervening in the mining and production of these commodities in order to jack up prices. While a few rare earth metals have seen a spike in values, it looks like the invisible hand will eventually triumph over state-sponsored capitalism

Rare earth metals are commodities. Like other commodities they have been on the rise lately, but exactly the reason why stands as a parable for state-controlled capitalism in general and its consequences, especially in China.
 
The name 'rare earth metals' is in itself a misnomer. These 17 elements with exotic names like thulium and lutetium are essential for many high-tech uses including wind turbines, car batteries and many sophisticated defence applications. Even the scarcest of them are 200 times more abundant than gold. China has been blessed with 57% of the world reserves, but that leaves 43% outside of China including substantial reserves in the United States, Central Asia and other countries.
 
As far back as 1992 the then leader of China, Deng Xiaoping, wanted rare earths to be for China what oil was to the Middle East. For over 20 years China has been making heavy investments in the mining and refining of rare earths. In the process as in many other industries, Chinese production forced prices down so low, that mines in other countries could no longer compete.
 
For example from 1965 until the mid-80s the United States was able to provide almost half of the global requirements and was self-sufficient in rare earths thanks to one mine in California. That mine closed at least temporarily due to environmental considerations. Without competition the Chinese have been able to dominate the industry providing the world with over 97% of the demand for rare earths.
 
Although the Chinese have been successful in driving the price of rare earths down and forcing their competition out of business, they have not been very successful in exploiting their monopoly. The price for rare earth metals has climbed only a little more than 20% from 1979 until 2009 when its average price per tonne was $8,500, this despite a tripling of demand in the past decade alone.
 
Part of the problem in China is that as demand rose so did the number of miners including both private operations and illegal operations. Contrary to popular perception the state-owned enterprises' dominance of the Chinese economy is growing, not shrinking. This is especially true in the rare earths sector where licenses to mine rare earths are only given to a few select state-owned enterprises. 
 
Like all monopolies, China has been attempting to restrict the supply to increase the price. Since 2006 they have been cutting exports by 5% to 10% a year. On one level this has been successful. The price of some rare earths like cerium oxide has risen 600% since the start of the year and its price is 20 times higher than in 2005.
 
However recently, the Chinese have tried to mix markets and diplomacy. In September a Chinese trawler captain rammed a Japanese coast guard vessel near some uninhabited islands claimed by both Japan and China. The Japanese arrested the captain. In retaliation the Chinese were suspected of cutting off rare earth exports to Japan.
 
The Japanese embargo is just a part of a broader attempt to boost prices and limit exports of rare earths by up to 30%. To effectuate this policy they're using all the tools of state including export quotas, taxes, and licensing procedures.
 
The Chinese restriction set off alarm bells in both Tokyo, Washington and even Wall Street. The self-styled "Original Gold Bug", James Dines, transformed into the "Original Rare Earth Bug" and forecast an enormous spike in prices.
 
The Japanese have embarked on a "rare earth strategy" by spending $1.2 billion to improve supplies. Toyota, Sumitomo, and Mitsubishi are exploring deposits in India, Vietnam and Canada.
 
Not to be outdone, the American Congress has a bill that has passed the House of Representatives and is pending before the Senate. The US mine in California has restarted production and expects to meet about a sixth of the global demand by 2012. Even South Korea will spend an additional $15 million as part of a long-term plan to secure supplies.
 
So Chinese state-run capitalism has succeeded only in providing a temporary spike in prices that will dissipate in a very short period of time, as other nations subsidise competition. They have also created collateral damage. The high prices and restrictions have of course created an economic incentive to smuggle, which is easy enough because it is easy to confuse exports of rare earths with shipments of ferroalloys. It is estimated that smuggling provides Japan with about 20% of its supplies. Worse, since rare earths are often mined next to radioactive elements, their processing has created vast wastelands of devastated land.
 
The disregard of the rules by metastasizing state-owned enterprises in furtherance of a single-minded political goal has permeated and affected other areas of the Chinese economy. The attempts to rein in the present real-estate bubble have been an abject failure, yet like rare earth mining, the horrific consequences will last for generations.
 
(The writer is president of Emerging Market Strategies and can be contacted at william@emergingmarketstrategies.comor w.gamble@alrroya.com)