http://seekingalpha.com/article/230426-china-japan-rare-earth-fracas-continues?source=dashboard_macro-view

Despite earlier news reports that it had come to an end, China’s unofficial embargo on rare earth exports to Japan (which I reported on in a prior post) now appears to be continuing into its fourth week. This rather surprising development gives rise to a couple of thoughts:

• What objective is China pursuing, and who exactly is driving the agenda? The immediate diplomatic flare-up that sparked China’s action has been long since put to bed (both countries have returned each other’s detained citizens), although the underlying territorial dispute over the Senkaku/Diaoyutai Islands remains unresolved. The only logical explanation for continuing the embargo is that China wants to demonstrate its capacity to “punish” Japan in order to gain future leverage in the dispute. Of course, it also runs the risk of alerting Japan and other potential rivals (including the U.S.) of the risks inherent in China’s virtual monopoly over rare earth production, and provoking efforts to open up alternative sources of supply. It’s also unclear whether China’s assertive stance represents a consensus among Chinese leaders, or whether certain elements (like the PLA) are driving policy, while others (such as the Commerce and Foreign ministries) are merely along for the ride. There has been some speculation that China’s upcoming leadership transition, in 2013, offers a prime opportunity for the PLA to flex its political muscles.
• How long until the stoppage starts to have a serious impact on Japanese industry, and how will Japan’s response evolve? Rare earth minerals are crucial to a wide range of electronic components made in Japan, which famously relies on “Just in Time” (JIT) techniques to minimize the very kind of stockpiled inventory that might provide a cushion in the event of an extended cut-off in supply. One report, in the New York Times, indicated that Japanese manufacturers might begin encountering shortages as early as late last week, and that if supplies do not resume shortly, Japan and its allies may consider filing an official WTO complaint. So far, Japan has shown no sign of backing down on its territorial claims: on Thursday, its foreign minister said Japan would ask Google (GOOG) to remove the Chinese names for the disputed islands on its online maps (as though Google really needs any more conflicts with China). But it will be interesting to watch how Japan’s position unfolds as China ratchets up the actual pain.
• The manner in which China has halted exports is highly revealing and instructive. Chinese customs officials are preventing all shipments to Japan from leaving port, but there has been no overt directive or policy announcement. In fact, according to the New York Times, China’s Minister of Commerce, Chen Deming, has officially denied that his country has imposed any embargo on rare earth exports, “suggesting that entrepreneurs in the industry had decided on their own to stop sending shipments to Japan because of their personal feelings toward Japan.” While this explanation may seem laughable (the Times notes that Chen did not explain “why all 32 foreign-owned and domestic rare earth exporters in China stopped shipments to Japan on the same day”), it’s also quite savvy. China’s official denials, implausible as they might be, will probably make it extremely difficult for Japan to prove an embargo case before the WTO. This fits a growing pattern. In the past few years, China has become remarkably adept at adhering to the letter of the WTO agreement, while flagrantly violating its spirit. Among the foreign business community here in China, the issue of monitoring China’s formal WTO “compliance” has become passe, with the focus shifting to more substantive matters related to market access. Unfortunately, in the eyes of all too many Chinese officials, the country’s WTO commitments have become an obstacle to be circumvented, rather than a direction to be embraced.

In the meantime, yesterday (Saturday) saw some large anti-Japanese street protests in several Chinese cities. According to the Associated Press,thousands of studentsmarched in Xi’an, Chengdu, and Zhengzhou. The accompanying photos from Xi’an were emailed to me, and give some sense of the size and vehemence of the rallies (pardon the language, but it gets the point across clearly enough). Hong Kong’s Apple Daily puts the overall number of participants at 50,000, and adds Hangzhou to the list. It also reports that several students said the protests had been organized by official (state-sponsored) student organizations at their universities. Although China’s Xinhua news agency issued a report in English, AP said the protests had not been covered by the Chinese-language state media, and local police refused to acknowledge they had taken place. Chinese authorites tend to be pretty cagey about mass protests, even on “safe” state-sanctioned issues, using them to make a point, then sharply reining them in if they threaten to take on their own momentum.

So the question remains: precisely what game are China’s leaders playing at here, and how far are they willing to take it?