Tough Rocks

Eliminating the Chinese Rare Earth Chokepoint

Introduction

Last Thursday, China’s Ministry of Commerce (MOFCOM) announced a series of new export controls (translation), including a new regime governing the “export” of rare earth elements (REEs) any time they are used to make advanced semiconductors or any technology that is “used for, or that could possibly be used for… military use or for improving potential military capabilities.”

The controls apply to any manufactured good made anywhere in the world whose value is comprised of 0.1% or more Chinese-mined or processed REEs. Say, for example, that a German factory makes a military drone using an entirely European supply chain, except for the use of Chinese rare earths in the onboard motors and compute. If this rule were enforced by the Chinese government to its maximum extent, this almost entirely German drone would be export controlled by the Chinese government.

REEs are enabling components of many modern technologies, including vehicles, semiconductors, robotics of all kinds, drones, satellites, fighter jets, and much, much else. The controls apply to any seven REEs (samarium, gadolinium, terbium, dysprosium, lutetium, scandium, and yttrium). China controls the significant majority of the world’s mining capacity for these materials, and an even higher share of the refining and processing capacity.

The public debate quickly devolved into arguments about who provoked whom (“who really started this?”), whether it is China or the US that has miscalculated, and abundant species of whataboutism. Like too many foreign policy debates, these arguments are primarily about narrative setting in service of mostly orthogonal political agendas rather than the actions demanded in light of the concrete underlying reality.

But make no mistake, this is a big deal. China is expressing a willingness to exploit a weakness held in common by virtually every country on Earth. Even if China chooses to implement this policy modestly at first, the vulnerability they are exposing has significant long-term implications for both the manufacturing of AI compute and that of key AI-enabled products (self-driving cars and trucks, drones, robots, etc.). That alone makes it a relevant topic for Hyperdimensional, where I have covered manufacturing-related issues before. The topics of rare earths and critical minerals have also long been on my radar, and I wrote reports for various think tanks early this year.

What follows, then, is a “how we got here”-style analysis followed by some concrete proposals for what the United States—and any other country concerned with controlling its own economic destiny—should do next.

A note: this post is going to concentrate mostly on REEs, which is a chemical-industrial category, rather than “critical minerals,” which is a policy designation made (in the US context) by the US Geological Survey. All REEs are considered critical minerals by the federal government, but so are many other things with very different geological, scientific, technological, and economic dynamics affecting them.

How We Got Here

If you have heard one thing about rare earths, it is probably the quip that they are not, in fact, rare. They’re abundant in the Earth’s crust, but they’re not densely distributed in many places because their chemical properties typically result in them being mixed with many other elements instead of accumulating in homogeneous deposits (like, say, gold).

Rare earths have been in industrial use for a long time, but their utility increased considerably with the simultaneous and independent invention in 1983 of the Neodymium-Iron-Boron magnet by General Motors and Japanese firm Sumitomo. This single materials breakthrough is upstream of a huge range of microelectronic innovations that followed.

Economically useful deposits of REEs require a rare confluence of factors such as unusual magma compositions or weathering patterns. The world’s largest deposit is known as Bayan Obo, located in the Chinese region of Inner Mongolia, though other regions of China also have substantial quantities.

The second largest deposit is in Mountain Pass, California, which used to be the world’s largest production center for rare earth magnets and related goods. It went dormant twenty years ago due to environmental concerns and is now being restarted by a firm called MP Materials, in which the US government took an equity position this past July. Another very large and entirely undeveloped deposit—possibly the largest in the world—is in Greenland. Anyone who buys the line that the Trump administration was “caught off guard” by Chinese moves on rare Earths is paying insufficient attention.

Rare earths are an enabling part of many pieces of modern technology you touch daily, but they command very little value as raw or even processed goods. Indeed, the economics of the rare earth industry are positively brutal. There are many reasons this is true, but two bear mentioning here. First, the industry suffers from dramatic price volatility, in part because China strategically dumps supply onto the global market to deter other countries from developing domestic rare earth supply chains.

Second, for precisely the same reasons that rare earth minerals do not tend to cluster homogeneously (they are mixed with many other elements), the processing required to separate REEs from raw ore is exceptionally complex, expensive, and time-consuming. A related challenge is that separation of the most valuable REEs entails the separation of numerous, less valuable elements—including other REEs.

In addition to challenging economics, the REE processing business is often environmentally expensive. In modern US policy discourse, we are used to environmental regulations being deployed to hinder construction that we few people really believe is environmentally harmful. But these facilities come with genuine environmental costs of a kind Western societies have largely not seen in decades; indeed, the nastiness of the industry is part of why we were comfortable with it being offshored in the first place.

China observed these trends and dynamics in the early 1990s and made rare earth mining and processing a major part of its industrial strategy. This strategy led to these elements being made in such abundance that it may well have had a “but-for” effect on the history of technology. Absent Chinese development of this industry, it seems quite likely to me that advanced capitalist democracies would have settled on a qualitatively different approach to the rare earths industry and the technologies it enables.

In any case, that is how we arrived to this point: a legacy of American dominance in the field, followed by willful ceding of the territory to wildly successful Chinese industrial strategists. Now this unilateral American surrender is being exploited against us, and indeed the entire world. Here is what I think we should do next.

Policy Recommendations

First, the bad news: the path forward is not going to be forged by the private sector alone. It will require government involvement. The question is what kind of government involvement is optimal, not whether there is a role for the state to play. Second, even more bad news: while it is true that the rare earths industry is overregulated, the solution to this problem is not one of deregulation alone. This is not a case of “get out of the way and let the private sector cook.”

But there is good news too. The first is that, to borrow Tyler Cowen’s mantra, “supply is elastic.” What this means for our purposes is that markets, in response to sudden shifts in demand (in this case, the need or strong desire of many firms to purchase non-Chinese REEs in response to the imposition or threat of Chinese export controls), can coordinate efficiently to increase supply.

This response can happen far faster than bureaucrats or chatterers realize from their vantage point, surveying the ground as they do from atmospherically situated armchairs. A great example is COVID. At the beginning of the pandemic, the World Health Organization recommended against masking, not because they thought it was imprudent but because they feared limited supplies of masks being diverted from hospitals. They supposed it would take years to produce sufficient masks for an entire population. It is true that in the opening months of the pandemic, masks were hard to find—yet this problem was resolved in a matter of months, if not weeks.

The same dynamic can apply with rare earths, though the story is somewhat more complex because of the lack of clarity on the extent of China’s enforcement. I suspect China will savvily adjust their enforcement (not the policy itself, which is written broadly to enable just this sort of flexibility) to attenuate the benefits of supply elasticity. Still, many firms will see the writing on the wall and realize that they need to find alternate sources—as some did years ago.

On top of this, recent policy moves have created favorable conditions for development of non-Chinese rare earth capacity. Congress in 2018 mandated that the Department of War shift to non-Chinese sourcing for several critical minerals and rare earths by January 1, 2027. Even better, the One Big Beautiful Bill earlier this year authorized $100 billion in loan authority for the Department of War’s Office of Strategic Capital to invest in projects specifically related to critical minerals mining and refining.

These factors all militate in favor of faster-than-the-pundits-expect development of robust non-Chinese supply chains for rare earths.

The second piece of good news is that the field of rare earths is itself highly susceptible to technological innovation. Here and in other industries, we must see the bright side of American deindustrialization: we get the blessing of a clean slate, onto which we can make designs based on the capabilities and assumptions of today’s technology, not that of 30 years ago.

Invest in Industry and Ensure Price Stability
The prices of rare earths are volatile, and this is made worse by deliberate Chinese intervention in the market. The successful financing and operation of domestic or allied rare earth capacity will require price floors supported by the government.

The Department of War’s pathbreaking deal with MP Materials, mentioned above, has much to recommend it. Most importantly, the arrangement creates a price floor for rare earth magnets produced by MP, leveraging Title III of the Defense Production Act to do so (which, incidentally, I recommended in a paper earlier this year, though I had no direct role in this deal during my time in government). In essence, if the market price of the magnets falls below $110 per kilogram, the government will pay the shortfall. If the market price exceeds $110 per kilogram, MP and the government split the upside.

The deal also comes with a federal government equity stake in MP. I am less supportive of this, because it creates an implicit “national champion” and thereby crowds out potential new entrants. Government is better positioned to be a source of price support (especially the kind mentioned above, which allow the public to share in upside), non-dilutive capital grants, and loans. Having government on the cap table creates numerous political economy risks without providing much benefit.

I also realize that the ship has sailed, given the Trump Administration’s decision to use government equity in private firms widely. Still, I would be remiss if I did not recommend against public equity positions going forward.

Before I depart from this theme, a quick observation: America enacted a remarkably flexible and capacious industrial policy statute 75 years ago. It is called the Defense Production Act (DPA). The DPA is typically associated with its command-and-control Title I (priorities and allocations authority, allowing the government to commandeer private resources for its benefit), but Title III is more my cup of tea. It can be used for any industry or technology and allows the government immense flexibility in contracting: traditional grants, loans, equity, and the price floor mechanism described are all possible within existing statute.

Currently, Title III can be directed to projects within the United States, Australia, and Canada—all rich sources of rare earths. Congress should consider adding Greenland to the list of eligible countries in the upcoming National Defense Authorization Act or other relevant legislation.

Create Market Infrastructure
There is a fundamental problem with the MP deal: the price itself. Unlike most commodities, which rely on global—and candidly, often US dominated—financial plumbing, China has been building market infrastructure of its own to support rare earths. Indeed, the MP deal’s price floor is indexed to the China-dominated Asian Metal Market index. Even absent the obvious threat of Chinese manipulation, this index’s prices incorporate regulatory, taxation, and logistical considerations not relevant to the US.

Arnab Datta has written, by a very wide margin, the best work on how the US can build market infrastructure for rare earths and other critical minerals. He proposes a technocratically managed reserve for critical minerals modeled on the existing Strategic Petroleum Reserve. I have some quibbles but agree directionally.

The primary point to understand is that this market infrastructure provides the liquidity, risk hedging, and other benefits common in all commodities markets and crucial for a robust industry in the long term. All purely public support is brittle without the traditional foundations of market capitalism.

Streamline Regulations
As Congress contemplates permitting reform, it should consider a National Environmental Policy Act fast-track for critical minerals projects, with a single agency responsible for publishing template permits and environmental mitigations coupled with litigation shot clocks (time limits on when litigation can initiated by plaintiffs), to the extent such litigation limits are not a part of the broader permitting reform package.

In addition, Congress (optimally) or the Treasury Department, through guidance, should ensure the existing 45X tax credit program created by the Inflation Reduction Act applies to rare earth magnet manufacturing, in addition to processing.

Foster Innovation Throughout the Supply Chain
A great deal of innovation is possible at every link in the rare earth chain of production. First, there is discovery of rare earths and other critical minerals in the ground: new techniques employing machine learning (“AI”!) in combination with more sophisticated sensing equipment, such as hyperspectral imaging, are being used to locate new deposits.

The rest of the value chain consists of mining, extraction, processing, and manufacturing finished goods (magnets, in this case). Traditionally, no single firm would handle all of these steps. But given the necessity of scale for building robust manufacturing businesses and the brutal economics outlined above, it is likely the case that vertical integration of most or all of these four steps will be needed. This is precisely what MP Materials hopes to do.

AI has increasing utility to many of these processes. To name just a few I find myself excited about: with robust datasets, we can design use AI based materials science tools to design superior extractants and other chemicals used in the processing and extraction stages. Coupled with autonomous materials science labs to test these AI-designed materials in the real world, we can rapidly accelerate the discovery of new materials for the rare earth industry. We can use reinforcement learning and other AI-based methods to optimize the extraction process itself.

Government can provide support to these efforts in various ways (for instance, by funding a network of autonomous materials science labs, which the National Science Foundation already is, though this could use much more funding). The fundamental point is this: successful firms in this industry will reexamine every step of this process and use the technologies of the present to improve or reimagine all of it. Government policy must therefore not be overly tied to any specific firms (new entrants, with new ideas, must always have a clear pathway to success) or to any specific mode of production.

Indeed, the long-term solution may well be to rebut the presumption of rare earths altogether. It is worth remembering that our current mass reliance upon rare earth magnets in particular was driven by a single materials science innovation: the Nd-Fe-B magnet. Perhaps someone will invent something new that makes us dramatically less dependent on rare earths. Is this particular magnet the end of microelectronics history? Somehow I doubt it.

New approaches altogether, likely enabled by the same autonomous science infrastructure I described above, must be pursued. And so we must avoid policy decisions that foreclose such future innovations. A tight relationship between government and one firm—with one specific business model—is exactly the kind of thing that restricts, rather than expands, our options.

Conclusion

There is much more to say here, including topics like workforce development and, crucially, international collaboration; the US absolutely cannot develop non-Chinese REE supply chains alone. I will likely have more to say in other formats soon.

The only thought I want to leave you with is this: for years, American elites have self-flagellated about deindustrialization and the hopelessness of ever “bringing manufacturing back.” And yet almost nothing I describe above is novel; almost all my recommendations are for business and policy processes already underway.

There is a tremendous amount of work to be done, but things are not quite as dire as they seem. China will not long leverage this weakness against us. Supply, ultimately, is elastic.