Trade War 2011

by Addison Wiggin – December 29, 2010

  • Today, we unpack the X factor: What could torpedo the stock market in 2011?
  • China cuts rare earth export quotas far more than first reported… with the prospect of more to come
  • U.S. dominance of the Pacific all but over as Middle Kingdom deploys “carrier-killer” missile…
  • How congressional paranoia over China could start the next trade war… and a cautionary tale from 1929-30…
  • Bailouts of foreign banks… perspective about yesterday’s retail numbers… and the mysterious slashing of book shipments… all in today’s mailbag

Well, the vice is tighter than we expected.

China’s new limits on the export of rare earth elements turn out to be more extensive than early reports indicated.

Yesterday, we were under the impression that exports during the first half of 2011 would be cut 11% from 2010 levels. Today it turns out the official number from the Chinese Ministry of Commerce is 35%.

The new limits are sending shivers down the spines of executives from Apple, where rare earths are used in iPad screens, to Sony, who gobbles them up for TVs, Vaio laptops and PlayStations.

“At this point in time, there is no direct impact on our company,” reads a Sony statement this morning. “But further restrictions could lead to a shortage of supply or rise in costs for related parts and materials. We will watch the situation carefully.”

The U.S. Trade Representative’s office is mildly freaking out, too, saying they are “very concerned.” Last week, the office issued a report to Congress hinting at launching a complaint with the World Trade Organization (WTO).

Officials with the European Union wrote a strongly worded letter of their own, explaining to whomever might actually read it that they expect “China to respect its recent assurance of a guarantee of rare earth supplies to Europe.”

The Chinese controls 97% of current world production of rare earths. Heh.

Meanwhile, China’s dropping hints that it will further tighten the reins on exports. The Wall Street Journal quotes an anonymous source saying China will soon devise separate export quotas for “light” and “heavy” rare earths. The “heavy” stuff is more precious, and more lucrative.

“Light rare earths are fairly abundant in terms of volumes,” explains Byron King, who’s delivered two money-doubling rare earth plays in 2010 to readers of Energy & Scarcity Investor. “The market drivers for the light elements are mostly in the field of magnets. Think in terms of neodymium, going into those big windmill magnets to the tune of 500 pounds each.

“Heavy rare earths are far less abundant in terms of volumes. The market drivers for heavy rare earths are more in electronics. Think in terms of a fraction of an ounce of material going into the chips and other electronic circuitry in your cell phone or in a small medical device.”

So far, this is just rumor. But coming within hours of the existing export quotas being cut, it’s raised fears and frustrations that much more.

Into this volatile mix throw a geopolitical flare-up: The Chinese military has perfected a “carrier-killer” missile, according to the top U.S. commander in the Pacific, Adm. Robert Willard.

“Initial operational capability” was the term Willard used, Pentagon-speak that indicates it has been deployed and is ready for use, although testing would likely continue several more years.

The objective? “Area denial,” to use a bit more Pentagon lingo — to keep the U.S. Navy away from areas China considers its own backyard. No longer can the United States wield its might in the South China Sea as readily as it can the Gulf of Mexico.

“This kind of capability poses a challenge to any naval or air operations that would be conducted in that area were it to be employed,” says Willard.

In other words, the era of America’s domination of the Pacific, dating back to World War II, has been effectively challenged.

Undoubtedly, the Chinese use rare earths to help the missile reach its intended target.

For a Congress whose collective skivvies are already in a wad over “currency manipulation,” the growing limit on rare earth exports and this new explosive toy are sure to make sitting in the House all the more uncomfortable.

While it’s not conventional wisdom in Washington, we see the prospect of a trade war with China growing in 2011.

“With more control by Republicans,” counters Su Hao, director of the Strategy and Conflict Management Research Center at China Foreign Affairs University, told The Washington Post, “the Obama administration’s policy on China will be softened and more rational. Sino-U.S. relations will stabilize in the future.”

Don’t count on it. The mind-set in Congress among members of both parties was captured well by outgoing Rep. Carol Shea-Porter of New Hampshire, if unintentionally.

“I think it’s strangling us,” Shea-Porter said of special interest money influencing the outcome of campaigns. “[Special interests] are in the halls of Congress everywhere, and it means, for example, that you sit on a committee and you say something about concern about Chinese influence or something, you don’t even know if in the next election, somehow or another, they manage to send some money to some group that now doesn’t even have to say where they got it.”

Huh? That China thing came out of nowhere. Fascinating Freudian slip.

“Fed up with China’s trade practices,” Fox News reported of a similar environment in 2005, “singling out Beijing’s currency manipulation, theft of intellectual property and bans on certain U.S. imports,” Congress’ united opposition was enough to kill the China’s acquisition of the oil company Unocal.

Not coincidentally, we think, Unocal owned the only operating U.S. rare earths mine. Chevron, who ended up buying Unocal, spun off the mine to private investors… who then took it public earlier this year.

A trade war does all sorts of nasty things to the stock market.

“The initial downturn of 1929-30 was caused by the threat and eventual passage of the Smoot-Hawley Tariff Act,” writes our friend Nathan Lewis in Gold: The Once and Future Money. The protectionist tariffs included in the act led to a drop in tax revenue, which led to higher taxes, which led to an even worse economic contraction, and so on… and so forth. Before long, you had folks talking about the downturn as a depression. Then it became Great. And the rest is history.

Any serious talk of a trade war in Washington will send a chill through the market.

[Ed. Note: Lewis’ treatment of both the Great Depression and the development and impact of the U.S. dollar as the world’s reserve currency is required reading among our writers. You can find your copy of Gold: The Once and Future Money alongside all the others on the shelf at Laissez Faire Books for 60% off.]

[Also worthy of note: A developing ugly scenario — like a trade war with China — is at the root of our passion for the Agora Financial Reserve. With a onetime fee, membership gives you access to our entire suite of services, so you can see the scenario from all possible angles and maximize your gains in a potentially treacherous environment.

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Stocks are eking out small gains on thin holiday trading made even thinner by the Northeast blizzard. The S&P has topped 1,260, territory last seen more than two weeks before Lehman and the Panic of 2008.

Gold has firmed up again today the spot price $1,412 as of this writing. Unlike yesterday, the buying appears driven mostly by dollar weakness. The dollar index is off more than half a percent, hanging by its fingernails to 80.

“My local paper,” a reader writes, “carried an AP story this weekend reporting that GE Capital just completed sale of its $2 billion Mexican mortgage portfolio — for $170 million.

“It also referenced the June sale of its Central American banking ops with $5.1 billion in loans for $1.92 billion. It wrapped with a note that the WSJ was reporting that Credit Suisse is going to unload its $2.8 billion in European commercial property loans for $1.2 billion.

“So the intellectual and economic Wizards of Wall Street are getting an average of about 33 cents on the dollar when they have to negotiate at the table with Mr. Market.

“Is there public information about what financial savant Bernanke et. al. paid the same actors for all of the paper they’ve loaded onto the Fed balance sheet, or is that something we’re praying Ron Paul will get answered for us? I’m guessing the answer is somewhere between 100% all the way down to maybe 98% of par.”

The 5: Much of the balance sheet of the Fed remains under wraps thanks in part to campaign contributions made to Max Baucus. He was chair of the Senate Finance Committee when they gutted HR 1207, Dr. Paul’s effort to audit the Fed.

We did learn today from the Financial Times that foreign banks accounted for more than half the lending performed by the Term Auction Facility, the largest of the Fed rescue programs. But the story was thin on details.

The Fed, surprisingly, had no comment, except to say everything was paid back in full. Go figure. We suspect a lot of that collateral is still rotting on the balance sheet valued at 100% on the dollar. Oy.

“Your item yesterday about the latest retail numbers mentions only an increase of 5.5% over 2009. This is a pretty worthless number as an indicator since 2009 was not exactly a gangbuster year.

“It would be much more helpful to see a chart with the absolute retail numbers for the last 10 years, instead of percentages. That would show us better where we are. Anything like this available?”

The 5: Uh, the increase was a survey of retail numbers for the month of November published by the Commerce Department. You can do with the number what you like.

The total for the period Nov. 5-Dec. 24 was $585 billion. It compares to $566 billion in 2007… just as the recession was “officially” setting in and unemployment was 5.0% nearly half the current rate. Our point is the retail number looks good… the source of the money people are spending remains a mystery.

“I would have potentially purchased more books” under our current special at Laissez Faire Books, “but purchased only one to get the free copy of Economics in One Lesson.

“The free book offer seemed to work fine as long as you purchased one other book, but I did not understand how to get 60% discount on other purchases, as no coupon code has been provided.”

The 5: Sorry for any confusion. Here’s the coupon code: THE5ED. You can use it here.

“I am writing with great concern!” writes another reader, apparently concerned. “I ordered the book Economics in One Lesson, along with several other books. It was shipped USPS and received with red stamped messages reading: ‘Media Mail Subject to Inspection.’ The envelope is slit open along the bottom and has a strip of tape about an inch wide that reseals the package.

“Obviously, the government is well aware that ‘the pen is mightier than the sword.’ Therefore, they invade the privacy of citizens to keep us FREE of dangerous ideas.”

The 5: Right… or they just suck at business transactions.

Here’s what’s happening. When we first reopened the bookstore, we used the USPS “flat rate” shipping to get your books to you ASAP. But that meant you got charged $5.99 regardless of how many books you purchased. With our 60% discount, there were occasions where the shipping costs exceeded the price of the book. Meaning, you were sending more money to the USPS than to Laissez Faire for the effort of stocking and shipping the book. Not cool.

We switched to “media rate,” which is a pricing category the USPS allows for books and videos, etc. They also maintain the right to “inspect” the boxes to make sure we’re not shipping you coins or chocolates or sex toys or other nonmedia items, God forbid. On occasion, the knuckleheads have slit the boxes open and resealed them so poorly that the books have fallen out entirely.

They then proceeded to deliver empty boxes. Doh.

We’re exploring alternatives in the private sector. After the new year, when our 60% inventory blowout offer is done, we’re going to suspend operations on the site for a few days and re-examine all our processes.

Until then, if you’re interested in getting great books for 40 cents on the dollar… now’s the time and here’s the place.

Addison Wiggin
The 5 Min. Forecast

P.S.: If for some reason you don’t like viewing our video “presentation” format, you should know that your membership invitation to join the Agora Financial Reserve is in plain text. To review all the lifetime benefits of a Reserve membership at your own pace, please begin here.

Subtle reminder: The total value of the Reserve totals $14,906 in annual subscriptions and includes many exclusive offers not available to the hoi polloi. But with this onetime invitation, you’ll get the whole deal for a one-time-only payment of $6,797, plus an annual maintenance fee of $149. Please review your benefits here.

As we’ve explained, because of the new services we’ve added to the menu, as well as those we plan to add in the new year, we cannot afford to offer the Reserve membership at this low price any longer. The offer will remain open for only five more days. Then the price goes up forever.


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