Digging Ourselves Out

I was reading a book about cyber warfare last week and I came across an interesting statement concerning non-battlefield warfare.  The book sites a Chinese official statement indicating that non-traditional warfare, such as economic disruption and control of rare earth metals (REMs), will be as important as battlefield warfare in any major war.  The book, and the Chinese statement, was published several years ago.  Is it surprising to find out that today the Chinese control a vast majority of the world’s rare earth element mining?

Why is the control of REMs so important?  Basically, the REMs are used for much of our advanced military weapons, such as nuclear weapons, cruise missiles, advanced electronics, and more. Non-military usage includes many consumer electronic devices and much of the green technologies.  By controlling the market, China has already reduced the supply of REMs available to the rest of the world and this has increased the overall cost for other countries by imposing taxes on the REMs.  A more sinister use of their control of the REMs market would be to shut off supply in the time of battlefield war.  Opposing countries would start having difficulty resupplying equipment and munitions lost and used during the conflict.

The name rare earth metal is something of a misnomer.  REMs are not really that rare.  The U.S. and Canada have a large supply of such elements, in the ground, if needed.  The problem is that it could take over a decade to startup a new mine and generate a significant output level.  Even reopening or expanding an existing mine will take years to produce significant quantities.

Regulation and restriction on mining in the U.S. makes it a long and expensive process for any company to do mining.  Even with China artificially increasing the cost of REMs, they are still cheap enough where U.S. mining still will not be profitable enough to invest in new REMs mining here. 

What can the U.S. do to address the current problem and protect ourselves against a future cutoff of supply?  Under the goal of national security, the U.S. needs to subsidize domestic mining of REMs so that companies can adhere to U.S. regulations while still being able to be profitable.  Mining regulations are needed to protect our environment for the long term.  China will eventually have to address their growing national pollution problem due to their lack of environmental protection. 

Now is the time to put money into mining.  According to a 2009 study of the effect of mining on the economy in 2007, almost 1.5 million direct and in-direct jobs are due to U.S. mining operations.  For every one mining job, there are 2.9 other jobs created that are needed to support the mining job.  In addition, mining jobs average annual wage is about 33% higher than the overall national average for all industrial categories.

I honestly do not believe that China is thinking about a battlefield war with the U.S. anytime soon.  I do believe that China has already shown that they are in an economic war with the west.  If China feels that it is in their long term interest to cripple the U.S. economy, by any means, they would do it in a heartbeat.  It might not be in China’s interest today, but what about ten years from now.  Since it could take us that long to be truly prepared, we need to start now.  In the end, it is a win-win for us.  By taking REMs off China’s list of possible threats, the U.S. stimulates the economy effectively with high value mining jobs while protecting national interests against already identified threats.

Every year, the United States and China have a forum called The United States-China Joint Commission on Commerce and Trade.  In past years this forum has often been more for show then action.   This year, with the possible exception of intellectual property rights, it seems that it is more of the same.   The United States complains about access to their markets, and in past years how they artificially keep the value of their currency low.  The Chinese agree to look into opening up markets and proceed to blame the United States for the problem.   

On the issue of intellectual property rights, the United States has been asking the Chinese government to crackdown on counterfeiters for years.  Other than some high profile “raids” against counterfeiters of product where the legitimate companies set up shop in China, not much was done.   The counterfeit market in China is continuing to grow exponentially and was estimated at almost $8 billion last year.   The Chinese government is not incented to address the problem since most of the counterfeit goods are produced there.  Shutting the counterfeiters down hurts their economy more then it helps.  Since the Chinese government continually has shown that they do not care about international laws do not expect much of a change moving forward.  The potential positive from the talks this year revolve around one person, Mr. Wang.  Mr. Wang is a top economic policy maker who took the unusual step of agreeing to personally oversee the “public campaign” against piracy.  It would be better if the oversight was on a crackdown instead of a “public campaign”, but it is a step in the right direction if he actually does more than talk.  

The talks did have its share of issues that seem do something, but did not really accomplish much.  China agreed to “revise”, whatever that means, a catalog of industrial equipment and heavy machinery used to promote the production of the items by Chinese companies.   They also agreed to work with the United State on “smart grid” technology standards, but there was no commitment to have a unified standard.  On the issue of wireless technology China agreed to “remain neutral”.  I am not sure how the Chinese agreeing to not change anything equates to easing access to those markets.   The last major accomplishment touted is the Chinese government’s willingness to let foreign companies use their experience in wind farm development in other countries to qualify them for projects in China.  This change gets them in the game, but how many of these projects do you think will actually be awarded to foreign companies, and especially those who manufacture outside of China.

In the end, the Chinese again put the blame for the trade imbalance on the United States by implying that there would be no imbalance if we just reduced the export restriction on high-tech items.   Relaxing the export restrictions would only account for a relatively small percentage of the trade imbalance, so it does not solve the problem.  The bigger issues are really that we cannot trust the Chinese in how they would use, and more importantly, how they would protect the high tech technology.

My biggest hope for the talks is in an area that they agreed not to cover, the valuation of the renminbi.  The Chinese have often shown an unwillingness to do things that they are being pressured into doing.  By taking the renminbi out of the talks, the Chinese can appear to the world as making a change on their own and not under pressure from the United States.  Maybe it is just wishful thinking, so as with everything with China we will have to wait and see.

There is a bill in congress, S.3816 – Creating American Jobs and Ending Offshoring Act, which has a stated goal of removing an incentive given to multinational companies to offshore jobs. The OpenCongress.org summary describes the bill as “This bill would give companies a two-year payroll tax holiday, reducing the amount of Social Security taxes they would have to pay, for new employees who replace workers doing similar jobs overseas…” In a time of high unemployment and an economy that is not creating enough new jobs, I thought this legislation would be a slam dunk and have broad support. Therefore, I was surprised to learn that the National Association of Manufacturers (NAM) actually opposes this legislation. NAM’s major concern is that the removal of a tax break for moving jobs offshore will put our multinational manufacturers at a disadvantage in penetrating new markets. There is also additional criticism, from both the left and the right that either the bill does not go far enough or is really just another tax on multi-national manufacturers.
The opposition by NAM had me worried that the bill threw the baby out with the bathwater. I do think it is reasonable that some tax deferments be made for US base multinational manufacturers that need to develop manufacturing in other parts of the world to gain market access. I was perplexed to find that the bill actually addresses this concern and is only subject to jobs moved offshore that produce products that are imported back into the United States. In other words, if the offshore job is to gain access into other markets everything remains the same. If the offshore job is to produce goods for the U.S. market then that job should not be subsidized by our taxes. I could understand why multinationals would be against this bill, since it remove their incentive to offshore jobs.
For the timing of the bill, it comes at a good time both politically and economically. Politically, it should play well with most voters, but will have a tough time with our elected officials who are tied to big business. Our voters just need to let their elected officials know what they want. Economically, we are starting to see some companies already starting to re-shore some manufacturing jobs. This could only help tip the scales for those companies looking for a better ROI on re-shoring jobs.
Criticism calling this bill a tax might be technically correct, but it is disingenuous at best. This bill does not create any new tax; it just removes a tax deferral for moving a job offshore and provides a tax break for moving that job back to the United States. Other criticism is that after the two year tax break, companies will re-move the jobs back offshore. This is just speculation and if true, we can look to expand the tax break, but at least there will be no government sponsored incentive to move the jobs back offshore.

China Might Be Right About Currency

I do not say this much, but China is right, well in the short to midterm timeframe. China is right in saying that a quick currency revaluation between China and the United States of America will not alleviate the current trade imbalance between our countries. That is not because the revaluation will not have an effect; it is because the Chinese have more tools in their toolbox to use to keep their product prices at an artificially low level. To think that the Chinese government would not respond using other means would be naïve at best.

Do not misunderstand me, I still think that the Chinese will do everything that they can to prevent their currency from having a normal valuation, it is just that when it happens they will move the battle to another area. We are already seeing the Chinese push the envelope in other areas.

The Chinese have shown that they will do more than just illegal subsidies and no payback loans to keep their production costs down. They have even started to penalize foreign business to a much greater extent. It is common for the Chinese government to “force” the transfer of trade secrets to local companies before approving access to their markets. The government even “allowed” workers to strike, for higher wages, at foreign owned manufacturers. By doing this, foreign companies will then pressure their home countries to hold back in their efforts so the companies can try to gain market share. We know from experience that China has used these methods effectively. Fortunately, with the world economy in the midst of a shaky recovery we are seeing more resolve for both our administration and the world at large.

Everything is about perception. If businesses see that the United States of America and other major economies of the world are serious about China, business decisions will be affected. That is why it is imperative that we do not back down. By continuing the pressure on China to play fair, we are showing businesses that the artificial Chinese manufacturing advantage will disappear. With that artificial advantage going away, many companies will not see the ROI needed to justify the migration of manufacturing off shore. This will have the effect of reducing the manufacturing loss to China. It might even have an effect on re-shoring of manufacturing. Either, in any amount, is better for our economy in the long term. Unfortunately, it does not help us in the short term and might even have a negative effect.

In the long run, when China has no more “heavy weapons” in their assault of the world economy a more natural balance will occur. Unfortunately, that might still be decades away. The only real short, to mid, term improvement we can see will be due to a proactive change in domestic buying habits.

Guilt by association? Maybe, but I don’t care!!

I couple of weeks ago my family started the process of looking for a car for my daughter.    The problems with the braking systems on several Toyota models was already well know.   Because of the braking problems we decided not to look at Toyota, even though they were starting to make some nice deals.   Not including Toyota did not affect other  car company choices.  Two of the auto dealerships we went two where Honda and Ford.

The reason why I mention these two dealers specifically is because I asked them both the same question and got two different answers.  When I asked him if the problems at Toyota lead to increase in their foot traffic and sales I was told “no” by the Honda sales person, and “yes” by the Ford salesperson.  I admit my survey’s sampling size was small, but I thought their respective business would have definitely risen. 

 So why would Ford see an increase and Honda not?  I can think of a few explanations;  First, more Americans are reading my blog and are making a patriotic choice with their purchases.  Second, some consumer lump Honda, and other Japanese manufacturers, in with Toyota concerning safety.   Lastly, this is just a continuation of the sales momentum domestic manufacturers, lead by Ford, have been enjoying for the past several months. 

So is there any proof of an actual sales shift consistent with my two person survey?   Numbers from January show the U.S. trade deficit dropped.  A major reason, beside less oil imports, was a reduction in auto imports.   The trade deficit with both the European Union and Japan saw a significant drop, 56.3% and 27.3% respectively, in the monthly deficit.  Both drops were mostly attributed  to lower auto imports.

Overall, U.S. automobile sales have been mediocre at best, even for domestic brands.  What is good is that the domestic manufacturers are doing relatively better.  The surge in domestic sale comes at a good time for both the U.S. manufacturers and the economy.   The comparative quality of the domestic nameplates has improve a great deal over the past decade.  From initial quality to cost of ownership, domestic brands have, in many cases, overtaken their international competitors.  This has a twofold impact on sales.  First, there is great word of mouth for domestic nameplates.  When my daughter mentioned that she was looking for a car, one of her friends told her how much he loved his Ford Focus.  These factors will greatly increase the number of customers who return to Ford and GM for their next auto.   Another more important reason that this surge is important is that our economy needs it.  The increase domestic production needs has already started to add ten’s of thousand of manufacturing jobs back into our economy.  In addition, the reinstatement of over 600 “to be close” GM dealerships keeps thousands of more jobs which would have been lost.

There is a significant chance that we will have a double dip recession.   Just look at January’s trade numbers: As our imports dropped so did our exports.  It seems that only a few countries are producing more and/or consuming more in any significant way.  China continues undeterred with their global economic game playing, which will artificially improve their growth while subtracting growth from the rest of the world.   The financial crisis in Greece, even though their economy is relatively small, will drag overall growth in Europe down.   Although the worst might be over, there are still significant problems to solve.  As with the first recession, and even if there is no double dip, it is imperative that we re-double our efforts to buy American.  Our country’s standard of living depends on it.