China grabs a chunk of GM (at US taxpayer expense)

BOSTON — Tucked away in the euphoria over General Motors’ stock offering is the news that the Chinese government is now one of the company’s largest shareholders, with a stake valued at about $500 million.

Ironically — some would say tragically — as Beijing snaps up GM shares, U.S. taxpayers will lose some $4.5 billion on the stock offering, about 25 cents for every dollar of stock sold. This effectively means that American taxpayers are subsidizing China’s purchase to the tune of some $125 million.

In the United States, the taxpayer loss and subsidy to China have barely raised heckles.

The American people generally believe that a company like GM shouldn’t be held by the government, and the administration of President Barack Obama decided that $4.5 billion was an acceptable loss to bear to return it to private business.

Of course, the Chinese adhere to no such ideological constraints. On the contrary, China’s Communist Party runs many of the country’s businesses. Not only that, they pick winners in the marketplace and take the long view, focusing for many years on turning them into national champs.

So should Americans be concerned about Chinese ownership of an American company like GM? For now, given that the stake is relatively small, it’s difficult to foresee any significant risk. But as a cautionary tale, consider another sale to China, in 1995, involving a GM subsidiary called Magnequench.

In GM’s universe, Magnequench was a relatively modest asset. It manufactured cheap, tiny “Neo magnets,” made from the rare earth element Neodymium. Neo magnets were first discovered in the early 1980s, simultaneously by GM and a Japanese firm.

Because of their durability, small size and cheap cost, Neo magnets are critical to modern electronics. They are in multitudes of products, ranging from computers and smart phones to the Pentagon’s smart bombs. Without them, the revolution of small digital devices we now depend upon would have been impossible.

Among the greatest challenges to making Neo magnets is obtaining the Neodymium, which is exceedingly difficult to extract from its ore. While Magnequench initially sourced its Neodymium from a mine in California, it just so happens that the bulk of the world’s Neodymium (as well as other rare earth elements) is found in China.

As the magnet market took off, the Chinese leadership sensed an opportunity. In January of 1992, on a trip to Inner Mongolia, paramount leader Deng Xiaoping reportedly declared that “The Middle East has its oil, China has rare earth,” suggesting that the country prioritize mining these materials.

But in addition to mining, China needed the technology to manufacture Neo magnets. In 1995, two Chinese companies teamed with the Sextant Group, an American firm founded by investor Archibald Cox Jr., to buy Magnequench.

Because the magnets were critical to the military, the sale was subject to U.S. government review. The Clinton administration allowed it to go forward, under the condition that the company remain in the United States for at least five years. As that deadline approached, the Bush administration declined to interfere in Magnequench’s affairs.

Those decisions were a nail in the coffin of the American Neo magnet industry.

“The day after China’s deal to keep Magnequench in the U.S. expired … the entire operation, along with all the equipment, disappeared,” according to a report by the Institute for the Analysis of Global Security (IAGS). China now has more than a hundred facilities producing Neo magnets, according to the report. The U.S. industry is essentially nonexistent. In order to produce smart bombs, the Pentagon now reportedly needs to source magnets from China.

As China ramped up production of Neodymium and other key rare earths, they priced mines elsewhere out of the market. The United States — formerly the largest supplier of rare earths — ceased mining them in 2002. Now China produces 97 percent of the world’s supply. In recent years, Beijing has dramatically cut rare earth export quotas, in an effort to get companies that use these materials to relocate to China, and to bring their technology with them.

China’s export cuts have left the rest of the world with a tight supply, rapidly increasing prices. Beijing, it appears, is seeking dominance not only of Neo magnets but also of rare earth elements and the technologies that depend on them — such as wind turbines and hybrid automobiles.

The United States is now scrambling to rebuild this strategic sector. Fortunately, all is not lost. Magnequench has changed hands several times. In 2005, it merged with Toronto-based AMR Technologies. In June, the new company, NEO Technologies Inc., announced that it was negotiating to manufacture Neo magnets with Molycorp Minerals Inc, a company that plans to revive the California mine that once produced the bulk of the world’s rare earths.

With China’s meteoric rise, and with America’s struggle to recover from a colossal meltdown triggered by private sector excess, government’s role in business is shaping up to be one of the defining ideological issues of the early 21st century.

But scroll back a quarter century and the same fears were being aired about “Japan Inc” — a supposedly unstoppable industrial machine centrally engineered by savvy, powerful bureaucrats. Of course, few foresaw Japan’s current predicament: economic lethargy; a tired, aging population; and a bureaucracy-laden government with a debt problem far worse than Washington’s.

Certainly China faces its own hurdles: massive income inequalities, a demographic bulge caused by the (coddled) single-child generation, and political problems on its borders. Yet with trillions in excess capital and a weakening dollar, Chinese investment in America is likely to increase. Invaluable assets like GM and Magnequench will no doubt be the targets.

David Case heads the international research service GlobalPost Research. Follow him on Twitter: @DavidCaseReport