China’s rare earths give it leverage over America

He could, as he did early this year, deny China access to Boeing jet engines and aircraft parts. China does have some military engines it has developed itself, and its key aircraft manufacturer, Comac, is developing an engine for its C919 narrow-bodied commercial planes, but it is still heavily reliant on Boeing and Europe’s Airbus for engines and parts.

He could also deny – and has been denying, until recently – China’s access to the most advanced US semiconductors.

When Trump first slapped new tariffs on China earlier this year, China retaliated with tariff hikes of its own – and stopped allowing exports of rare earths and rare earth magnets to the US. A meeting in Sweden saw the confrontation de-escalated, with the US reducing its headline tariff rate to 30 per cent and China its rate to 10 per cent.

(The headline rates are misleading because Trump added to pre-existing tariffs, dating back to his first term, and China has also been subjected to the general sectoral tariffs on commodities like steel and aluminium and products derived from them, as well as those slapped on Canada and Mexico for their claimed role in fentanyl trafficking. The Peterson Institute for International Economics puts the average US tariff on China’s exports at 57.6 per cent and China’s rate on US exports at 32.6 per cent).

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There have since been a succession of 90-day extensions of the truce agreed in Stockholm and confirmed at a subsequent meeting of the trade negotiators in London which have deferred any final agreement on trade until early November.

As part of that truce deal, China has allowed exports of rare earth magnets to resume, although it wasn’t until July, when the volume of rare earth magnet imports from China suddenly jumped 76 per cent, that the supply regained pre-confrontation levels.

China knows that its dominance of rare earths and the magnets in particular – it controls more than 70 per cent of the global supply, more than 90 per cent of the processing of rare earths and more than 90 per cent of the processing and manufacturing of rare earth permanent magnets – gives it tremendous leverage over the US.

When it throttled supply of the magnets earlier this year it nearly shut down the US auto industry. The magnets are also critical to many other commercial and military applications.

The US doesn’t have meaningful alternate sources of supply, although it is racing to develop some, including Defence Department funding for Australia’s Lynas Rare Earths to build a separation facility in Texas.

It has also arranged a $US1 billion ($1.5 billion) debt facility, $US150 million of Defence Department loans, $US400 million of equity and a 10-year floor price – at twice the current level set by China –as part of guaranteed purchase commitment for 100 per cent of the output from America’s only significant producer, MP Materials.

There are, however, estimates that it will take 15 years and $US120 billion for the US to completely distance its rare earths supply chain from China, which developed its dominance over decades. Indeed, it ambition of dominating rare earths dates back to the 1980s.

China, while it might prefer to maintain its trade with the US, isn’t petrified by the prospect of extreme tariff rates, as its response to Trump’s 145 per cent rate earlier this year demonstrated.

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Since Trump first deployed tariffs against it in 2018, Xi Jinping has deliberately diversified China’s range of trading partners and reduced its reliance on America for some key imports – it has, for instance, nearly halved its imports of soy beans, with Brazil displacing the US as its major supplier – while also developing alternate export markets in Asia and South America.

Trump’s tariffs are a crude weapon, but China’s dominance of rare earths gives it the ability to use it in a highly strategic way. While it has resumed exports of rare earth magnets to the US, for instance, it appears to be limiting sales to the US defence industry.

China has tightened its export controls for rare earths progressively, and recently added imports of rare earths that it processes for third parties – including MP Materials – to the continually expanding list of minerals subject to its controls and monthly monitoring.

It can dial up, or down, its export quotas almost instantly and bring America’s advanced manufacturing base to a near halt.

While Trump, understandably, has tried to play down the threat posed by China’s control of the market, it is clear that his administration does understand the degree of leverage it gives China.

That’s why it backed down from its extreme tariff rates in Stockholm and that’s why it has adopted a more conciliatory tone since.

Both the first Trump administration and, even more substantially the Biden administration, progressively shut semiconductors off China’s access to America’s most advanced semiconductors, with the ban on sales of Nvidia’s H20 chips maintained by the second Trump administration.

A complete closure of US markets to China’s exports would hurt China’s economy, but it wouldn’t destroy it.

The US has a very significant edge over China in designing the most advanced chips required for artificial intelligence.

Trump has, however, lifted the ban on sales of a modified H20 chip to China, in return for 15 per cent of Nvidia’s Chinese sales, and the administration has been discussing potential sales of a modified version of Nvidia’s most advanced Blackwell chip with the company.

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While the revenue share no doubt appeals to Trump, the larger motivation for allowing China access to more powerful chips than it can produce itself is to try to avert the threat posed by China’s stranglehold on rare earths.

For the moment, both governments appear content to leave the current trade relationships in place, keeping their powder dry while controlling the trade of strategic products rather than risk the mutual assured destruction that could occur if they deployed, not just an exchange of extreme tit-for-tat tariffs, but their dominance of key inputs to the most strategic sectors of each other’s economies.

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