China unlikely to answer chips controls with rare earths holdout

The U.S. may be able to increase its computer chip production capacity without concern of potential trade retaliation from China.

Comments from a member of the Chinese central government about the possibility of tariffs or trade restrictions on rare earth materials are being brushed off by U.S.-based industry observers who believe that China will ultimately opt to avoid a major disruption of trade dynamics.

China is by far the largest global producer of rare earth materials crucial to U.S. chip production. President Joe Biden signed the CHIPS and Science Act into law in August to boost America's semiconductor manufacturing base, followed later by new semiconductor export restrictions that included directives for U.S. companies to obtain licenses to export high-performance chips to China.

The U.S. government's measures are poised to deal a significant blow to the Chinese economy, analysts previously said. The U.S. is second only to Japan in terms of the value of semiconductor-making machines it exports annually to China.

Yu Miaojie, a member of the Economic and Trade Policy Advisory Committee of the Chinese Ministry of Commerce, said in an October interview with the state-backed Hong Kong China News Agency that China could restrict rare earth exports or impose higher export tariffs on rare earth minerals. On Dec. 13, Beijing filed a complaint against the U.S. with the World Trade Organization in response to the new semiconductor controls, according to The Wall Street Journal.

China, however, is unlikely to disrupt its rare earths trade, according to industry observers, as cutting the U.S. off from rare earth materials would likely only hurt China's position in the sector while leaving the U.S. relatively unscathed in the long term. The Chinese embassy in Washington, D.C., did not immediately respond to a request for comment.

"Most of the types of retaliation [the Chinese government] could think of would disrupt the supply chains that China is a part of and would likely end up with China playing a less active role in rest of the world economy," said Chris Miller, a fellow at the American Enterprise Institute think tank researching semiconductors and technology geopolitics.

"Right now, if you're China, your goal is to keep what foreign investment you've still got to keep what international technological advantages you still have because the U.S. is trying to cut you out of a fair number of them," Miller added.

US gets it started

The U.S. Commerce Department's Bureau of Industry and Security, which manages U.S. export controls on China, did not appear concerned about retaliation from China when asked for comment. The agency added over 30 Chinese AI and semiconductor entities to a trade blacklist that builds upon current export controls as of Dec. 19, according to a document filed Dec. 15 in the Federal Register.

"The measures address significant threats to the shared national security interests of our allies and partners," a Commerce Department spokesperson said. "We won't speculate on [Chinese] reactions. We have designed these measures to be surgical in their approach and carefully targeted to restrict access only to the specific advanced chips, end-uses, and end-users of greatest concern, and to have minimal impact on industry and consumer goods."

Previous restrictions forbid the export of machinery to Chinese companies that manufacture advanced chips. They also force Americans working in China's semiconductor industry to resign from their positions or risk losing their U.S. citizenship, among other things.

The National Security Council, which advises the president on matters of national security, military and foreign policy, did not respond to requests for comment.

The rare earths problem

As America works to promote a domestic semiconductor manufacturing base, it relies on China's abundant capacity to refine rare earth minerals such as neodymium and scandium needed to manufacture chips.

In 2022, China accounted for nearly 98% of rare earth imports into the U.S. through mid-November, according to data from Panjiva, the supply chain research unit of S&P Global Market Intelligence. China accounted for 60% of the world's mined rare earths supply in 2021 and holds roughly 36.7% of global rare earths reserves, according to the U.S. Geological Survey.

"The U.S. and Europe, which are the largest markets for rare earth permanent magnets probably outside of China and Japan, are at this point in time totally incapable of self-sufficiency. The key basis is that not only do we not have the mined material, we don't have the processing," said Jack Lifton, executive chairman of the Critical Minerals Institute, an organization representing critical minerals companies.

Rare earth permanent magnets are made using rare earth alloys and are used in advanced technologies including electric vehicle batteries.

"In the last 10 years, [China's] ramped up [refining]," Lifton said.

China has taken other measures to respond to U.S. action. The country is crafting a support package comprising 1 trillion yuan, or about $143 billion, for its domestic semiconductor base to make its chip supply framework more self-sufficient in the face of the ongoing export controls, Reuters reported Dec. 13.

China needs US customers

Semiconductor and mining experts say the effects of such a scenario on the U.S. economy would be short-lived and would likely back China into an unescapable corner. The USGS estimates that U.S. imports of rare earth compounds and metals were valued at $160 million in 2021, increasing from $109 million in 2020, with China accounting for the vast majority. This has positioned the U.S. as one of China's biggest customers, and it could be bad business to box out the Americans.

Rare earths retaliatory measures, for instance, would push the U.S. to begin importing rare earths from another nation such as Australia or commence more mining domestically, Miller said. For China, news of the U.S. pivoting away from the nation for chip minerals while already eating into its semiconductor base would make it look unattractive to other trading partners.

"Firstly, it's not necessarily within China's best interest to ban the export of magnet material and other rare earth materials to wrestle a country like the U.S., because on the permanent magnet side, the U.S. is a large importer of that material, so obviously it's a revenue generator," said Ross Embleton, a research analyst at Wood Mackenzie, a research group specializing in energy, metals, renewables and mining. "[Also], a lot of countries around the world ... are significant importers of permanent magnet material. ... Cutting off that trade link would create a lot of instability within the Chinese market."

China has previously worked to weaken U.S. access to its exports, such as the nation's response to American national security authorities blacklisting Huawei Technologies Co. Ltd. in 2019, when it rolled out various regulatory mechanisms as a countermeasure against American electronics firms.

Those mechanisms did little damage, and it was a similar story for the rare earths market, Miller said. China's complication is that all its methods of retaliation are not asymmetric, meaning any damage it does to another major player in the world economy would ultimately affect itself, Miller added.

Broader implications

A rare earths retaliation from China would have cascading effects on the broader semiconductor landscape, said Jeff McElroy, an analyst researching China and Taiwan semiconductor policies in Market Intelligence's economics and country risk practice.

"[Semiconductors] are a very globalized industry, and there are a few choke points," McElroy said, citing various nations' specializations in the chips supply framework, such as South Korea's robust chip manufacturing base or the Netherlands' ASML Holding NV, which specializes in semiconductor lithography equipment.

U.S. chip companies rely on all of these players for final-product chips. While China would prefer global supplies of chip components be disrupted in such a way that their own supply chains become high value, this would be impossible given the industry's globalization, McElroy said.

But China also imports certain materials from America that are needed to manufacture electric vehicles and solar panels, which are shipped to other trading partners in Asia.

"Everything is so connected now that I think it's extremely unlikely that they would weaponize [rare earths] against the United States specifically," McElroy said.

As of Dec. 16, US$1 was equivalent to 6.97 Chinese yuan.

S&P Global Commodity Insights produces content for distribution on S&P Capital IQ Pro.

Panjiva is the supply chain research unit of S&P Global Market Intelligence, a division of S&P Global Inc.