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Blackwater USA – Daily Brief 6/6/19

Strategic Minerals

  • Reuters says the Pentagon has been reaching out to African and other rare earth producers, in an effort to diversify its supply of rare earths away from China—just in case China cuts its supplies off in a trade war reprisal. Article pasted below.
  • As a result of China’s recent threats to stop rare earth exports to the U.S., prices for Chinese rare earths are hitting their highest levels in years. Analysts seem to expect the rare earths used in magnets—like dysprosium and neodymium—to be the most vulnerable to price swings, since they’re used in critical, sensitive industries like nuclear power and defense.

Mexico

  • Trade talks between the U.S. and Mexico broke down yesterday, and they were unable to reach an agreement to avoid new tariffs that would go into effect on June 10th. I’m not sure if that means they’ve stopped looking for a deal altogether, though.
  • A great WSJ op-ed wonders what a U.S.-Mexico trade war would look like, drawing parallels from the Arab oil embargo. Article pasted below.
  • Meanwhile, Mexico does seem to be doing more on migration, as requested—though it’s not clear whether its response will be enough for Pres. Trump. Yesterday, Mexican security forces confronted and blocked hundreds of migrants who had crossed Mexico’s southern border, detaining dozens of them.
  • Fitch cut Mexico’s credit rating from BBB+ to BBB, and Moody’s downgraded the outlook for its A3 rating. Both ratings agencies said that rising debts for state oil company Pemex (already the most indebted oil company in the world) are a big red flag.

China

  • Pres. Trump told reporters that he could add tariffs on another $300 billion in Chinese imports, if the two sides couldn’t make a deal (“but I think China wants to make a deal.”)
  • The Pentagon and State Department formally notified Congress about a plan to sell $2 billion in arms—including 108 M1A2 Abrams tanks—to Taiwan. China’s Foreign Ministry said it was “severely concerned” about the sale.
  • Xi Jinping cozied up to Pres. Putin on a trip to Moscow, calling Putin his “best friend.”
  • During the same trip, Huawei signed a contract to build Russia’s 5G network.
  • Separately, Huawei’s Chairman said he was willing to sign a “no-spy” deal with the U.S. to assuage concerns that the company’s technology could be used for surveillance. Huawei is also selling its majority stake in an undersea cable company, which was also scaring skeptics. However, neither of these moves will be enough for Huawei-phobes.

Niger

  • The Pentagon completed its review of the initial investigation into the IS ambush that killed four U.S. soldiers in October 2017. The new review found that the prior report was “thorough and appropriate,” and seems to close the book on the incident (though families of the soldiers that died are still calling for senior officers to be held accountable for chain-of-command issues that played a role).

DRC

  • CDC’s Director said he expects to run out of the Ebola vaccine that health workers have been administering in affected parts of the Congo, and for a stupid reason: Merck closed the Pennsylvania facility where it used to produce the vaccine, and moved production to Germany—but hasn’t been able to get the necessary regulatory approvals there.

Sudan

  • The UN is evacuating most of its staff from Sudan because of security concerns over the government’s heavy-handed response to recent protests.
  • Sudanese officials roughly confirmed the opposition’s death count, admitting to 46 protester deaths on Monday.
  • Yasir Arman—the Sudanese former rebel leader who just returned to Sudan, despite an outstanding death sentence for two rounds of leading rebel militaries—was arrested in Khartoum…at the offices of the SPLM-N rebel military / political party.

Pakistan

  • Pakistan reportedly agreed to trim its ballooned military budget, as part of an agreement for a $5-6 billion IMF loan. (Pakistan has an odd devolved system of government, in which over half of federal funds go to the provinces, and—after debt service and military spending—the federal government is left with little).

DPRK

  • Several new media reports say that Kim Hyok Chol—the negotiator rumored to have been executed over the failed Trump-Kim summit in Vietnam—is still alive, but was just detained. Overall, it sounds like a purge happened, but wasn’t nearly as bad as initially reported.
  • A new study estimated that North Korea’s last nuclear test—which was in September 2017—had a TNT equivalent of approx. 250 kilotons. That’s 16 times the size of the bomb dropped on Hiroshima in 1945, and powerful enough to kill everything in a radius of 0.85 mi (1.37 km).

Venezuela

  • In a secret recording, SecState Pompeo commented that it “has proven devilishly difficult” to keep Venezuela’s fragmented opposition united enough to challenge Pres. Maduro. Pres. Guaido appears to have lost his standing as a unifying leader, after botching a coup attempt a few weeks ago.

Other News

  • A gunman killed four people in an urban part of Darwin, Australia. He used a banned 12-gauge pump action shotgun that was likely stolen before Australia started to tighten its gun laws in 1997. We don’t know a lot about the guy or his motive yet, except that he was a convicted felon wearing an ankle monitoring bracelet that he could’ve easily cut off.

Exclusive: Pentagon eyes rare earth supplies in Africa in push away from China (Reuters)

The U.S. Department of Defense has held talks with Malawi’s Mkango Resources Ltd and other rare earth miners across the globe about their supplies of strategic minerals, part of a plan to find diversified reserves outside of China, a department official said on Wednesday.

The push comes as China threatens to curb exports to the United States of rare earths, a group of 17 minerals used in a plethora of military equipment and high-tech consumer electronics.

Although China contains only a third of the world’s rare earth reserves, it accounts for 80% of U.S. imports of minerals because it controls nearly all of the facilities to process the material, according to U.S. Geological Survey data.

“We are looking for any source of supply outside China. We want diversity. We don’t want a single-source producer,” Jason Nie, a material engineer with the Pentagon’s Defense Logistics Agency, said on the sidelines of the Argus U.S. Specialty Metals conference in Chicago.

The DLA, which buys, stores and ships much of the Pentagon’s supplies – ranging from minerals to airplane parts to zippers for uniforms – has also held talks with Burundi’s Rainbow Rare Earths Ltd about future supply, as well as offered to introduce the several U.S. rare earth projects under development with potential financiers, Nie said.

“We can make connections,” he said.

The DLA routinely talks with potential suppliers as part of its due diligence, steps that do not necessarily result in purchase agreements. Still, the inquiries show that the Pentagon is increasingly focused on diversifying supplies of critical minerals.

As of September 2016, the most recent operational report, the DLA held stocks of many critical minerals worth $1.15 billion.

For the current 2019 fiscal year, the DLA expects to buy rare earths on the open market (up to a maximum 416 tonnes), lithium ion battery precursors (0.02 tonnes) and tin (40 tonnes), among other strategic minerals, according to a government report.

Some of the equipment the Pentagon buys, including night-vision goggles and aircraft, are made using rare earth minerals. The Pentagon has long supported efforts to require military contractors to buy domestically sourced minerals, though there are no current U.S. rare-earth processing facilities.

China, as part of the escalating trade conflict with the United States, implied through its state-controlled media last month that it could restrict rare earth sales to the world’s largest economy. Such a step would have precedence, as China in 2010 culled exports of rare earths to Japan after a diplomatic dispute.

“If you put yourself in China’s shoes, this is their main weapon in the trade war,” said Mark Seddon, an Argus metals analyst.

Mkango Resources is developing a rare earths mine and processing facility in Malawi that is still several years from coming online. Rainbow Rare Earths began operating in Burundi in 2017 and has an offtake agreement with ThyssenKrupp AG.

China dominates global processing capacity for rare earths, with Australia’s Lynas Corp the only non-Chinese company with any significant capacity.

“It is not a good idea to be reliant on a single major source of any material,” Amanda Lacaze, chief executive of Lynas, told Reuters on the sideline of the conference. Lynas last month signed a memorandum of understanding to build a rare-earth processing facility in Texas with privately held Blue Line Corp.

Texas Mineral Resources Corp is pushing to develop the Round Top rare earth deposit in a remote corner of the state’s western edge, and Rare Element Resources Ltd is moving forward on a Wyoming project.

But those projects will take several years to come online, reflecting the reality that efforts to build rare earth processing plants in the United States are still in the early stages.

Privately held MP Materials, which owns the Mountain Pass mine in California, aims to open a processing facility by next year.

The U.S. Commerce Department on Tuesday recommended urgent steps to boost domestic rare earth production.

The report includes 61 specific recommendations – including low-interest loans and a buy American provision for defense companies – to increase U.S. rare earths supply. It also called for closer cooperation with U.S. allies, which dovetails with DLA’s outreach to miners in Africa and elsewhere.

As Tariffs Bite, Get Ready for a 1970s-Style Supply Shock (WSJ)

Arab oil embargo in early 1970s holds lessons on impact of possible trade war

Market turmoil over mounting U.S. tariffs on China and the threat of the same on Mexico in large part stems from a fear of the unknown: No one knows what a major trade war would do, as the U.S. hasn’t been in one since the 1930s.

There is, however, a more recent analog: the 1973 Arab oil embargo. Both that embargo and the new tariff barriers represent a supply shock in which a reliable supply of cheap imports—oil then, manufactured goods now—is suddenly curtailed. Prices paid by American consumers and businesses go up, hitting confidence and purchasing power.

The 1973 embargo tripled the price of oil and plunged the U.S. into what was then its worst recession since the 1930s. The circumstances, of course, were different and a similarly severe slump today looks unlikely. Nonetheless, the oil shock provides a useful road map for the present. Perhaps most important: Even after the short-term pain passes, permanently more expensive inputs require costly adjustments to supply chains and business models, weighing on growth for years to come.

In 1973, after Egypt and Syria attacked Israel, the U.S. rushed arms and aid to the Jewish state. In retaliation, Arab oil exporters cut production and suspended exports to the U.S. American business and consumers, long used to plentiful oil for less than $4 per barrel, were utterly unprepared when it rose above $11. The country’s bill for imported oil and related products shot to $132 billion in today’s dollars in 1974 from $28 billion in 1972—a de facto tax increase equal to about 1.5% of gross domestic product. The Federal Reserve initially cut rates, then raised them sharply as oil sent inflation into double digits. Governments compounded the chaos with rationing and price controls, which led to long lines at gas stations.

The recession ended in 1975, but the reverberations lasted for years. Countless companies and workers found their factories, products and skills—developed for a world of cheap oil—no longer useful. American auto manufacturers never mastered the switch from big to small cars. Productivity growth slowed sharply after 1973 and economists believe the oil shock was a major reason why.

The U.S. until recently was as reliant on cheap manufactured products from China as it was in the 1970s on cheap oil from the Middle East. But just as the U.S. came to regret its dependence on Arab oil, many now want the U.S. to disentangle its economy from China’s as tensions have risen over its trade and technology policies and geostrategic rivalry.

And, as in the 1970s, disrupting those bonds has a price.

Economists at Goldman Sachs estimate U.S. tariffs imposed or proposed on steel, aluminum, solar panels, washing machines and imports from China now equal an annualized $200 billion. Adding all threatened tariffs on Mexico brings that to $288 billion by the end of October. At 1.4% of GDP, that is roughly equivalent to the Arab embargo “oil tax.” That doesn’t include the hit from China’s—and potentially Mexico’s—retaliatory tariffs, as well as severed supplier relationships because of U.S. sanctions on Huawei Technologies Co.

The tariff war’s economic consequences should be milder than those of the 1973 embargo, for several reasons. Most important, the Fed’s preferred measure of underlying inflation is just 1.6%, below its 2% target. So while Goldman estimates the tariffs could add up to 1.25 percentage points to inflation, the Fed is likely to worry more about their impact on growth and cut rates rather than raise them.

The benefit of higher prices on imported oil went to foreign oil producers. By contrast, tariffs are paid to the U.S. Treasury, which could spend the money to offset some harm from the levies.

There’s no panic about shortages and no lineups. There are, of course, de facto lineups at the Commerce Department as American importers file thousands of requests for waivers, in addition to pervasive uncertainty about whether threatened and retaliatory tariffs will be imposed, or existing tariffs lifted, which is chilling investment.

Historically, tariffs were meant to boost domestic manufacturing production by protecting it from cheap foreign competition. But globalized production means that imports nowadays often consist of intermediate goods moving from one stage of a supply chain to another, and there are no U.S. substitutes at the ready.

Rather than manufacture in the U.S., many importers are contemplating shifting Chinese production to Vietnam, raising prices or dropping products most affected by tariffs. Some had planned to shift production to Mexico but they may have to reconsider. As with the oil shock, these adjustments could take years and add countless inefficiencies, chipping away at productivity.

One final lesson from the oil shock: The Arab embargo didn’t change American support for Israel. It did, however, cause the U.S. to build strategic reserves, seek more secure supply in the North Sea, Mexico and Alaska and conserve energy through fuel-economy standards. High prices eventually made the fracking revolution possible and that is on the verge of ending net U.S. oil imports. The U.S. has thus largely insulated itself from the foreign “oil weapon.”

The lesson for today is that tariffs may not change China’s behavior. But by breaking the trade, investment and knowledge chains that tie the two economies together, it may in the long run make the U.S. less vulnerable to Chinese influence, which is what the Trump administration wants.