On The Emergence Of China, Or, Zhou Knew This Was Coming

After doing a bit of mountain hiking a few days back, I had a chance to get involved in a great afternoon conversation with the Alliance for American Manufacturing’s Mike Wessel, who also serves as a Commissioner with the U.S.-China Economic and Security Review Commission; the conversation was about how we’re doing when it comes to our relationship with China.

As it turns out, the two events went well together, because what I’m hearing from these guys is that we have a great big ol’ mountain to climb if we hope to get back to a level playing field in our interactions with this most important country.

There’s news to report across a variety of issues; that’s why today we’ll be talking about trade, human rights, cybersecurity, poverty and development, and the methods by which you can apply “soft power” to achieve hard results.

The entirely unanticipated result: all of this will reveal the naïveté of Ron Paul when it comes to foreign policy; we’ll discuss that at the end.

The King of China's daughter
So beautiful to see
With a face like yellow water
Left her nutmeg tree

--From the song “The King of China’s Daughter”, by Natalie Merchant

So let’s start with the background stuff: the U.S.-China Economic and Security Review Commission exists today because of the legislative wars surrounding China being granted Most Favored Nation status back in the day.

At the time, there were concerns about the way China does business on the international stage, and the Commission provides a follow-on monitoring program to examine questions regarding the Chinese human rights record, issues related to economics, cybersecurity issues, the intentions of the Chinese military, and lots more.

The Commission issues annual reports to Congress, and this year’s report has just been released.

Now normally I would present a point of view, followed by a counterpoint; today, we’ll do the opposite: there are folks I listen to out there, including Thomas P. M. Barnett, who would tell you that you are not going to be able to keep spending $900 billion a year on the defense budget if you can’t find an opponent worth $900 billion a year, and China looks like that kind of opponent, in a number of ways that Al Qaeda never could…even if, in Barnett’s opinion, China is a great big paper tiger.

Al Qaeda will never build aircraft carriers, or intercontinental ballistic missiles; they’ll never put to sea in submarines or build a stealth fighter, and they darn sure aren’t going to be mounting military operations in space or engaging in cyberwarfare.

And yet, if you’re a defense contractor, a General, or an Admiral, that’s where all the money is; naturally, if the money goes away, some of those Generals and Admirals are not going to have the chance to “graduate” from the military and become defense contractor representatives themselves.

Put it all together, and some would tell you that the biggest battle facing the Military/Industrial Complex today…is making sure we’re always nervously looking under our beds at night, just to be safe.

You should also know that our first Secretary of the Treasury, Alexander Hamilton, convinced his brand-spanking-new country to put in place a series of protective tariffs. The intent was to foster manufacturing in the then-agrarian United States; this was intended to create a climate favorable for non-farm businesses and to allow a far more disparate group of immigrants to come to the new Nation than what would have occurred if the only major business activities around the country were farming-related.

So with all that in mind, let’s talk China.

The U.S.-China Economic and Security Review Commission (the USCC) wants you to know that China is very much on a knifedge: the country is ruled by the Chinese Communist Party (the CCP) and the People’s Liberation Army (the PLA).

The USCC would tell you that the primary goal of the CCP and PLA leadership is to “protect their phony-baloney jobs” and the corruption that goes with ‘em (thanks for the line, Mel Brooks), and that they have to do a few things to keep those jobs safe: they have to find a way to make 900 million near-peasants into a middle class, quickly, because the peasants have seen how the other 300 million live, to secure markets and resources China has to begin to project power around the world, by military or other means, and they have to make extra sure that nobody in China, except the CCP, gets the opportunity to take over the political conversation – in other words, ensure that the “Arab Spring” doesn’t become the “Jasmine Spring”.

There’s more: in a country without something like Social Security, China’s population will age faster than any in history, and many of the 900 million seem to want to move from the country to the city in numbers so large that they literally can’t build cities fast enough.

So how does the Chinese Government deal with all this?

What China has been doing is seeking internal “quietude” by growing the economy through manufacturing, and they have decided to choose certain industries as the linchpin of “valuing up” that growth, so that China’s low-tech manufacturing becomes more high-tech. (Think computers and telecommunications, space, alternative fuel vehicles, aviation, green energy technologies, that sort of thing.)

China has decided that virtually the only way a foreign company can do business in any of the “chosen” areas is to mandate technology transfers that allow Chinese companies to obtain the methods and tools needed to compete with the foreign supplier down the road. (This is officially against WTO rules; China disputes that assertion. The USCC says they now make these demands in subtle ways that are less “enforceable”.) Chinese buyers are told to give preference to “state-innovated” technologies.

China also uses their currency as a way of “preferencing” the local economy. The Renminbi (RMB) is, according to most observers, deliberately undervalued in order to make Chinese goods cheap overseas and imported goods expensive at home. Mike Wessel would tell you it’s about 40% undervalued, and that that “trade tax” (my term, not his) costs the US budget about $500 billion a year, with a similar impact on State budgets. Despite much USA pressure and some recent upward valuation (roughly 6% last year), it looks like China is not going to move much on the RMB anytime soon.

Wessel anticipates China will spend about $1.5 trillion on anti-poverty subsidies to quell unrest over the next 5 years; that would become a lot more difficult if a revaluation were to occur.

During the 1990s China began to move to a free-market model that emphasized the growth of privately-owned businesses; Wessel says today China is going back to promoting the State-Owned Enterprises (SOEs) to the detriment of a free market.

This has been bad for our own industrial strategy, such as it is, which assumed we would be selling China lots of high-tech goods, even as they sold us cheap goods. That has not worked out; in fact, China is now the largest market for cars and cell phones, among other products…and those products are not being manufactured in the USA.

It’s reported that the theft of intellectual property is the normal way business is done in China; as an example Wessel notes that something like 80% of the software on Chinese corporate computers is stolen.

We are told that the PLA is looking to create an “area of influence” that extends from the South China Sea to space; to this end the first Chinese aircraft carrier is being readied for service, a stealth fighter is in development, antiship missile systems are being upgraded, and a “counterspace” capability has been demonstrated. (The idea is that Chinese satellites explode near other satellites, thus disabling them. The USA and Russia seem to have similar capabilities.)

Chinese military doctrine, Wessel tells us, advocates shutting down the “network-centric” model of US military operations; it is believed that a significant campaign of computer-based intrusions and attacks on the USA have already taken place, including two events that took place at Department of Defense-operated satellite-control facilities that seem to have been external attacks.

Wessel anticipates that a war with China would begin with China attempting to disable various USA computer networks and infrastructure; the resulting confusion would be used to China’s advantage.

Beyond that, Wessel worries that we’re buying so much of our telecommunications and computing infrastructure from China that we may be vulnerable to being spied upon by our own laptops; he cited two examples of this problem: a computer sale to the State Department that involved Lenovo laptops and classified data, and a sale of network equipment by Huawei to Sprint that might have allowed classified computer traffic to be compromised.

Chinese spying, Wessel would tell you, is widespread and not limited to government: trade secrets are up for grabs in a big way, and even the US Patent and Trademark Office had to upgrade its security after it discovered patent applications were being snatched out of the system and appearing as Chinese products, with Chinese patents, before the applications could even be acted upon in the USA.

Wessel also wants you to understand that China uses “soft power” to advance its interests: there are lots of “hosted” opportunities to study in China, former military officers of various nations, including the USA, are recruited as “representatives”, and there are lots of “get to know us” opportunities that have been created around the world; all of this is intended to “sell” China in ways we do not.

And with all that said, let’s talk about Ron Paul.

Paul’s attitude toward China seems to be that we should allow free, unimpeded trade, and that the currency manipulations about which many complain would not exist if we went back to a gold standard. Paul stated in 2001 that:

Concern about our negative trade balance with the Chinese is irrelevant. Balance of payments are always in balance. For every dollar we spend in China those dollars must come back to America. Maybe not buying American goods, as some would like, but they do come back and they serve to finance our current account deficit.

Free trade, it should be argued, is beneficial even when done unilaterally, providing a benefit to our consumers.

If I’ve been paying attention during the recent Republican debates, this is still what Paul believes about China, and here are a couple of thoughts about how he’s got it entirely wrong:

Paul may not like it, but Hamilton succeeded when he used tariffs to jump-start a manufacturing economy in this country, and not having free trade is working pretty well for China as well. Unfortunately, it’s working very badly for us.

On the one hand, Wal-Mart and all the others who import less-expensive products from China have done a great job of masking the fact that incomes have been either stagnant or declining for about 99% of us, but Wessel would say that’s been at the cost of sending millions upon millions of jobs to a country that is working hard on every level to ensure we can never again compete as a manufacturing nation – and while we thought we would make up that difference with our high-tech advantages, theft and spying and a devalued currency and “partnerships with benefits” and protectionist “state-innovation” rules have made sure we don’t.

A gold standard won’t fix this, and simply advocating that we allow China unfettered access to USA markets while they rob us blind seems a bit like suggesting everyone leave their houses unlocked so that the market can more efficiently decide which ones are the best for burglars.

So we’ve covered a lot of ground today, and let’s wrap this thing up with a summary of where Commissioner Wessel says we’ve been:

We have a competitor in China who will do more or less anything to keep its current political leadership in power, even as that leadership is forever worried that 900 million of its citizens will discover that you can overthrow a government.

The PLA is busy as well, with the South China Sea and everything above being the “area of influence”; computer warfare seems to be the next phase.

“Soft power” is also being applied; we have former military officers and Chinese language students and lots of other folks either hearing or telling China’s story all over the world and we don’t do a good job of answering back.

All the while, the CCP is working hard to create a higher-tech Chinese economy, by hook or by crook, and that’s putting the future of our own economy at risk, not to mention the operations of our government.

We, as a people, seem to be unaware of all of this, and that plays out in the form of ignorance in our politicians, with Ron Paul being a recent prominent example.

So now it’s up to you to figure out what all this means: is this really a substantial threat that we have to defend against (and there’s lots of evidence to suggest it is), or is this an effort to find a way to keep spending that $900 billion every year?

My take: Wessel’s not a defense lobbyist, even as he is trying to promote manufacturing in the USA, and there is a lot of evidence to support his thinking; with all that in mind I’m more inclined to believe he’s sending a warning we better pay attention to than he is seeing Commies under the bed.

Nonetheless, there are lots of folks who would like to keep stackin’ that big cheddar, at your expense, and even as we think very hard about China, we better also keep in mind that Northup Grumman could be just as dangerous.

On Stimulating The Future, Or, "It's The Ytterbium, Stupid!"

We’re diving deep into “geek world” today with a story that combines economic hardball, the periodic table of the elements, and a barely noticed provision of the Defense Authorization Act that seeks to break a monopoly which today gives China near-absolute control over the materials that make cell phones, electric cars, wind turbines, and pretty much every other tool of modern life possible.

If we successfully break the monopoly, we’ll be able to create millions of new manufacturing jobs in this country—and if we don’t, somebody else owns the 21st Century.

Ironically, the global warming we’re trying to fight with new green technologies might be an ally in our efforts to make those very same green technologies happen.

There’s a revolution in industrial processing going on, rare earths are at the center of it all...and in today’s story, the revolution will be televised.

“Everything in the Universe comes out of nothing.
Nothing—the nameless is the beginning...”

--Lao Tzu, “Tao Te Ching”, Chapter One
(Translated by Man-Ho Kwok, Martin Palmer and Jay Ramsay)

So What Are Rare Earths?

Rare earths are materials that are, as it turns out, not always especially rare; nonetheless, they all have properties that are quite rare, indeed. You’ll find them hanging out in their own special section of the Periodic Table of the Elements, kept well isolated from all the others.

For example, your television and computer monitor rely upon the element europium, which makes the color red appear on your screen. There is nothing else known to exist that can be used for the same purpose. Therefore, the ability to make TVs and computer monitors is entirely dependant on access to this material.

Cerium is the most effective agent available for polishing glass, and if it wasn’t for cerium, your eyeglasses—and everything else in the world with a lens—would be a lot tougher to produce...and they would be lenses of lower quality, to boot.

Erbium lasers work better than carbon dioxide (CO2) lasers for facial surgery, and its unique ability to emit and amplify light under optical excitation makes it essential (and, at the moment, irreplaceable) when producing either fiber optic cable for transmitting data or the optoelectronic “building blocks” of the next-generation data storage systems that will eventually replace every hard drive and memory chip on the planet today.

And what is the rare earth application with which you are probably the most familiar?

Magnets.

As it turns out, if you mix the rare earth element neodymium with iron and boron, you get what is by far the most powerful magnetic material available—and it’s easily fabricated into lots of useful shapes.



These magnets have found their way into the headphones and speakers you listen to, the hard drive in your computer, your DVD player, every power everything in your car (they’re used in electric motors), and, eventually, into the electric motors that are likely to be actually propelling your car.

(Driving a Prius or some other hybrid vehicle? You’re driving around with about a kilo of neodymium under the hood, a number that’s soon expected to double.)

Of course, I could be wrong.

The rare earth application you’re most familiar with might be...batteries.

The nickel metal hydride battery (NiMH) has been the rechargeable battery of choice for about a decade now, turning up in everything from your cell phone to your camera to hand tools. This type of battery can be fabricated using several chemical formulations; the key here is that either cerium or another rare earth element, lanthanum, are essential to whatever formulation is chosen. Other rare earths are used as additives to make these batteries work better in high-temperature applications.

(Just for the record, that hybrid or “all-battery” vehicle you’re driving has at least 25 pounds of lanthanum on board.)

“New and improved” in rechargeable battery circles means lithium ion batteries; they also require lanthanum (although europium, yttrium, and protactinium are being considered as experimental additives).

These materials are also critically important if you’re in the business of building missiles or rockets or military communications systems—or civilian communications systems, for that matter.

So Why Is All Of This Such A Big Deal?

It’s a big deal because there is, shall we say...a bit of a supply problem.

"There is oil in the Middle East; there is rare earth in China...."

--Deng Xiaoping, 1992

You may recall that europium is the only thing that can make the color red on a TV set, and from the 1960s until the 1980s the only place in the world that was producing any rare earth element (REE) in any quantity was Molycorp’s Mountain Pass mine, in California’s Mojave Desert.

All of that changed in the 1990s as China decided to “...[i]mprove the development and applications of rare earth, and change the resource advantage into economic superiority", to quote Chairman Jiang Zemin. Since that time China has worked to expand ore production at its two major deposits as well as to expand the associated refining and fabrication industries that actually turn raw metals into finished products.

China was able to do this primarily because of two big cost advantages: cheap labor and access to REE as a byproduct of other mining activities (which basically means that if your copper mine’s ore also contains trace elements of REE, you do it cheaper than digging for just the REE). REE, we should mention, do not readily “gather” in large and easily mined “veins”, unlike other minerals, making mining more difficult.

Because of environmental problems at the Mountain Pass operation and price competition from the Chinese, there has been no US mining for REE since 2002, and today, more than 95% of the world’s REE production is based in China.

And all of a sudden, the Chinese might not have any spare REE for the rest of us.

What’s happened is that all those companies moving to China to do fabrication of REE material are raising the local demand, and it’s now being suggested that exports of REE from China could soon end. (A quick example: lanthanum and neodymium demand and supply were equal in 2008; this means supply will have to increase before lots of new hybrid or battery-only cars can hit the road.)

Some are suggesting there may be additional motives on the part of the Chinese Government, but I was unable to substantiate those rumors.

(The complete supply picture is a bit more complex; this because scrapping today’s consumer products for tomorrow’s REE is also an option, but at some currently unknown cost and efficiency.)

So Now What?

So that was the bad news; here’s the (potential) good news, located about 850 pages deep in a conference report that finalized the Legislative Branch’s work on the 2010 National Defense Authorization Act:

“...Report on rare earth materials in the defense supply chain (sec. 843)

The House bill contained a provision (sec. 828) that would require a report on the usage of rare earth materials in the supply chain of the Department of Defense.
The Senate amendment contained a similar provision (sec. 837).
The House recedes with an amendment combining the requirements of the two provisions..."

Of course, we better do more than just write a report, as all too often “write a report” is actually just another way of saying “ignore problem for now”—especially if, as the not enacted Rare Earth Supply-Chain Technology And Resources Transformation (RESTART) Act Of 2009, said:

“China’s ability—and willingness—to export REE’s is eroding due to its growing domestic demand, its enforcement of environmental law on current producers, and its mandate to consolidate the industry by decreasing its number of mining permits. The Chinese government’s draft rare earths plan for 2009 to 2015 proposes an immediate ban on the export of dysprosium, terbium, thulium, lutetium and yttrium, the “heavy” REE and a restriction on the exports of all the other, light, rare earth metals to a level well below that of Japan’s 2008 demand alone.”

Another source of good news: we have friends who also have access to REE, including Canada, Iceland, and in what has to be a “silver lining, dark cloud” moment, Greenland, who is just about a month away from gaining control over its natural resources from Denmark and assessing what, for the moment, appears to be the world’s largest known find of REE on the country’s southwest coast.

(This good news is, of course, balanced against the fact that access to the site will be much, much, easier...thanks to global warming.)

Of course, access to ore isn’t enough, and whatever supply is located, we’ll still need the ancillary capabilities that we lack today to refine and fabricate these metals into the American-made products we want to produce over the course of the next several decades.

So how’s that for a tale of geekiness?

The entire world that we know today—and the one we want for the future—depends on a small batch of odd metals, 95% of which currently come from China, who appears to be leveraging that advantage in a way that is not just an economic threat, but a National Security threat as well.

We have the potential to fix the problem, if we are so inclined, but we better get to it, and quickly, as our clock seems to be running a bit short.

And we need to do more than just dig holes in the ground. We need to establish an entire production chain—otherwise we’ll be mining ore that we’ll be shipping to...China...which is what we’re trying to avoid in the first place.

You know, a green economy is one thing...but a green economy that trades Big Oil for Big Battery is quite another—and if you’re just trading one “resource master” for a different one, what's the point?