Subsidies, stimulus, incentives, disincentives and limitations created by government policies can have a short-term effect. Once in place, these policies become sacred policy mantra to their original perpetrators and are very difficult to remove regardless of their detrimental effect

In the past month all of the central banks around the world have been trying to outdo each other in a massive attempt to manipulate the markets. It seems, especially to many markets, that with their impressive monetary firepower at their disposal, they can easily get away with it. But can they? Governments are constantly seduced by the prospect that they can introduce policies designed to bend the markets to their will in an effort to help their countries often at the expense of everyone else. But do these policies actually work? The Chinese experience with rare earths provides a cautionary tale.

China may not have been blessed with an abundance of natural resources, but it does have an abundance of rare earth metals. Rare earth metal is the generic name for 17 elements with exotic names like thulium and lutetium. They are essential for many high-tech uses including wind turbines, car batteries and many sophisticated defence applications. China has been blessed with 57% of the world reserves, but that leaves 43% outside of China including substantial reserves in the United States, India and Australia.

Despite its dominance of the resource, China was not able to reap great rewards from it. They produced so much of these materials that from 1979 to 2009 the price increased only 20% while the demand tripled. What the Chinese were able to do over that period was to put all of the other miners out of business, so by 2009, the Chinese controlled 95% of the world supply.

With that sort of market dominance, flexing its economic muscle was irresistible for the Chinese government. They did so both domestically and internationally. The government ordered the state-owned Inner Mongolia Baotou Steel Rare-Earth Hi-Tech Co, a subsidiary of the imposing state-owned Baotou Iron and Steel Group, to create a monopoly on rare earths production by taking over most of the other 129 legally registered rare earths mines and closing down many of the illegal mines. Besides consolidation it also restricted exports. From 2006 it lowered the amount of exports by 5% to 10% per year. In 2010 they cut it by 40% and in September of 2010 they cut exports to Japan for two months.

Like the more recent manipulation, China’s attempt to control the rare earth market was temporarily successful. Prices for a basket of rare earth minerals went from $10/kg in 2009 to over $147/kg in 2011. So China apparently attained its goals in consolidating the industry in state hands, limiting exports and increasing the price. Speculators began to bid up any producer of rare earths. In the US Molycorp, the owner of the sole American mine, had an IPO in 2010 at 13 and its price increased over 500% to 74 by 2011. But then other countries and the market took over.

Over the past year the Japanese government began a program costing nearly $1.3 billion to fund alternative sources for rare earths. The government and Japanese companies are also spending about $652 million to find substitutes for rare earth minerals in a variety of products. The US also considered similar subsidies.

The subsidies are supposed to help find other sources and there are plenty of those. An Australian company, Lynas Corp, is spending $200 million to open a processing plant in Malaysia to process rare earths mined at Mt Weld in Australia. Molycorp reopened the US mine at Mountain Pass California. This mine, closed because of Chinese competition in 2002, renewed operation is in August. Another victim of Chinese competition, the state-owned Indian Rare Earths, is renewing operations that were closed in 2004. Not to be outdone the Brazilian mining giant Vale has also been doing preliminary investigations for mining in Brazil.

The results of all of this activity are predictable. Exports of rare earths from China have fallen sharply. Although China increased its export quota in 2012 for the first time since 2005, exports from China are down 37%. Prices have fallen as well. From their high in 2011, prices are down to $50/kg. They have halved in 2012 alone. The stock of Molycorp fell along with the prices. From a high of 74, Molycorp’s shares have fallen back to its IPO price of 13.

The problem with intervention, as the Chinese story shows, is that the ecology of the market in a globalized economy is far more complex than government policymakers originally can predict. Every action intended to have a limited beneficial local effect, will spur unintended consequences somewhere else. Subsidies, stimulus, incentives, disincentives and limitations created by government policies can have a short-term effect, but in the longer run they can flip the food chain. Once in place, these policies become sacred policy mantra to their original perpetrators and are very difficult to remove regardless of their detrimental effect.

(William Gamble is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and has spoken four languages. Mr Gamble can be contacted at [email protected] or [email protected].)