Part II of Shining City on a Hill or Fading Giant
This essay is a follow up to a piece I wrote close to two years ago in 2023. At the time, the critical metals markets were bucking under their own hype-induced weight, as reality caught up with the trajectory of EV demand and battery raw materials pricing.
To say that a lot has happened in the intervening months is an understatement. This piece will cover the significant changes in investment narrative, supply chain development and its glacial pace in the West, and how the West can compete in next-generation technology development with a Chinese juggernaut that the Trump Administration seems keen to help through self-defeating policies.
In the original essay, I argue that the US is at a crossroads with respect to critical materials supply chain development. The Biden Administration was able to pass the Infrastructure Investment and Jobs Act and the Inflation Reduction Act (the IIJA and IRA) which, over time, would offer a legitimate chance to build next-generation infrastructure to help US economic growth, productivity, and competitiveness. The table was seemingly set thanks to Biden’s progressive industrialization policies. Decoupling from China, started under Trump 1.0 turned out to be much harder to accomplish than first thought. Would a divided electorate rise to the occasion and set the pace for domestic industrial capacity growth to compete with a significantly advanced China? Unfortunately, these policies, along with COVID recovery funds, helped to foment significant inflationary forces in the US economy.
This, coupled with doubts around President Biden’s cognitive abilities, helped to usher Donald Trump back into the White House for Round 2 as POTUS. The answer to the question in my original piece – would the US remain the shining city on a hill – would have to wait.
BETTER LATE THAN NEVER
That said, all was not, and is not, lost. Investors spent much of 2024 up until Trump’s second Inauguration debating one question: Was he serious? Was Trump serious about dismantling the IRA or was this bluffing? What about the tariffs? Rhetoric or reality? With a majority of investment and jobs created located in red states and hundreds of billions of dollars of capital already committed or sunk, there’s no way Trump would harm his base, right?
The answer to this question came in the One Big Beautiful Bill (OBBB) Act which significantly neutered the demand side signals in the IRA such as the 30D $7,500 USD consumer tax credit in favor of more supply side signals such as accelerated depreciation. Fortunately, section 45X in the IRA was preserved as it is enormously economically beneficial to those companies that can take advantage of the 10% production tax credit or the $45/KWh production tax credit on the battery module level.
If the change in subsidies weren’t bad enough for supply chain economics, the downward spiral in various metals prices is the ultimate insult to add to rather serious injury. The peak to trough moves in lithium, cobalt, and nickel should be painfully familiar to readers. Despite a recent rally in lithium prices which looks to be a head fake, a significant portion of the cost curve remains profoundly uneconomic. Copper, the lone star performer, went on a spectacular run which was recently rug pulled thanks to the erratic tariff policy and implementation on the part of the Trump Administration. Higher prices will come, but how can upstream battery supply chain players manage their balance sheets in such an environment until halcyon days return?
Tariffs and the sledgehammer approach in their implementation are the biggest headwind to the buildout of any domestic industrial capacity. Any CEO I have spoken with in the past 8 months wants to know what, if any, tariffs they’ll have to deal with. This one-time shock to the company cost base is increasingly looked at as a cost of doing business in Trump’s Economy. In a perverse way, the tariffs intensify a new economic Darwinism where winners and losers are determined in the political arena and not in the free market. The dismissal of Adam Smith’s Invisible Hand in the current global trading system is a topic I examine further down in this essay. Not to be overlooked are the impacts of investigations such as Section 232, 301, Countervailing Duty Investigations (CVD), and other means under the guise of national security and unfair trade practices such as dumping. The recent completion of the CVD investigation on the part of the Department of Commerce targeting the Chinese dumping of anode materials in the US below cost and the finding weren’t at all surprising. What was a surprise to many was the realization that the roughly 160% tariff possibly slapped on Chinese anode material will sadly increase the cost of a lithium-ion battery in the US by as much as $7 per KWh. Benchmark Mineral Intelligence states that Chinese active anode material (AAM) was priced at $3,700 per tonne imported into the US. With these new tariffs, this import price increases to $9,300 per tonne. CITE. Though the anode is only roughly 12% of the cost of a lithium-ion battery, it’s clear that battery economics can be materially altered through tariffs on other metals and materials.
More distressing is the recent raid by US Immigration and Customs Enforcement (ICE) on a battery plant under construction by South Korea-based Hyundai and Japan-based LG. The raid, unannounced, resulted in hundreds of arrests due to visa issues which, at the time of publishing this essay, were still unclear. A development like this could do more long-term damage to making the US a favorable and welcoming investment destination. It’s a sad day. There doesn’t seem to be any differentiation between friend and foe regarding immigration in the US.
A wholesale rejection of China-sourced battery materials, while a worthy (and achievable) goal, isn’t realistic at this point. Tariffs applied broadly throw sand in the gears of any trading system and the recent immigration crackdown is perhaps a more ominous sign – hurting both economic competitiveness and alienating America’s allies. The tariffs and anti-dumping investigations are designed to hurt China, so it’s worth examining the evolution of China’s strategy and response to the Trump Administration’s approach.
CATCH ME IF YOU CAN
The Chinese investment model of state-directed Capitalism under President Xi is firmly in control but is changing. Moving “up the value chain” and away from less productive sectors of the economy such as low-value intermediate goods or real estate is the path forward. There is plenty of evidence to support this claim including platforms such as Made in China 2025. The plan targets strategic industries including aerospace, mobility, and energy storage. This level of focus is notable in that it also informs how Xi has chosen to respond to the Trump administration’s approach to tariff implementation. While Xi has responded to Trump’s tariffs initially in kind, much of the economic response from China is implemented with surgical precision. China has spent several decades building (excess) industrial capacity, this overbuilding has given the Chinese a unique advantage in the ability to process and produce a whole host of industrial and critical metals. While many here in the US have only recently woken up to this vulnerability, it has been well known in China, and this has been weaponized in the form of export controls. China has significant leverage here and won’t hesitate to use it.
Materials such as gallium, germanium, and graphite may become harder to access outside of China thanks to the need for permits granting access to the material. As the trade war between the US and China has dragged on, the Chinese menu of export restrictions has expanded to include technology such as lithium iron phosphate cathode (LFP) technology and culminating in the temporary halt of the exports of rare earth permanent magnets. It was this last salvo which brought the Trump Administration back to the table given the ubiquity and extreme importance of these materials in consumer electronics and, more importantly, national defense. This vulnerability cemented the $400M investment in MP Materials by the US Department of Defense (DoD). The deal includes a sizable equity stake in the company of 15% (plus a sweetener in the form of a warrant) for the DoD, a ten-year magnet off-take agreement, and a price floor for NdPr of $110/kg, well above the current market though this spread is narrowing. Banks including Goldman and JP Morgan will lend $1B USD and MP must contribute $600M in additional capital. This isn’t likely to be the last public/private investment partnership in critical sectors of the US economy. The price floor in this deal has the potential to completely reframe magnet economics ex-China (who controls 90% of the global market) which is perhaps the point. It’s unclear if MP would be able to build a non-China supply chain without it. Is this the only way companies based in the West can compete with China?
IF YOU CAN’T BEAT ’EM
I have often said that volatility along the strategic metals supply chain is a feature, and not a bug, of the new global trading system. If this is true, what is the best path forward as an investor or stakeholder? Some industries are too important to leave to the free market and it’s not bad to pursue and ensure domestic self-sufficiency, despite the cost. I think we can determine the industries (AI, batteries, etc.), but who decides and what the costs and tradeoffs are? A 15% equity stake in MP Materials makes sense as this is funded by the DoD through the Defense Production Act and is a show of skin in the game. Although that skin is funded by taxpayers who are on the hook for any loss here. What about the US Government taking a 10% stake in Intel? Or a 15% “tax” on NVIDIA chip sales to China? Which master do companies like Intel or NVIDIA serve? We are in a new paradigm where Adam Smith’s Invisible Hand is tied behind his back and other forces are in control. China’s technological momentum in strategic sectors such as batteries, green tech, AI, etc. is not a secret and Xi shows scant interest in having his legacy hemmed in by a Trump Administration still finding its footing around trade and economic policy with the use of tariffs and weaponization of the US Dollar. While these tactics will cause some near-term indigestion in the Chinese economy, one can’t help but assume that Trump’s remaking of the global trading system around an “America First” agenda will serve to accelerate Chinese competition in sectors critical to national and economic defense. This may happen without any participation on the part of the United States. The Biden Administration’s “small yard, high fence” approach to slowing Chinese access to critical technologies may have slowed the Chinese ascent, but the Trump Administration’s purely transactional approach (semiconductor chips for permanent magnets) acknowledges the possibility that in this era of technological development, China may be delayed but not denied.
The shrinking of the manufacturing base in the United States took decades and was exacerbated by the lure of laissez faire free trade across borders, regardless of differences in political systems. Interestingly, the manufacturing workforce is still roughly 12.6 million people, down from 19.5 million at its peak in 1979. It may be decades before any significant manufacturing capacity comes back to the United States, so perhaps a reality check is in order around what can be accomplished.
This all starts with policy certainty in the US. Clarity, once and for all, around tariff levels is a starting point. No CEO can make a significant capital spending decision unless he or she knows their cost structure within a narrow band. A 160% tariff on anode imports may keep Chinese material out of the United States but isn’t likely to accelerate anode production onshore quickly enough to mitigate higher prices throughout the supply chain.
One path to competing is taking the “China model” of welcoming Chinese intellectual property onshore in the US. While the political class inside the Beltway in Washington DC won’t like this, this model (think Ford and CATL in Michigan) offers the path of least resistance to accelerating electrification in while keeping costs in check.
What this speaks to more broadly, is re-engagement with allies through partnerships – another current politically unpopular choice. 15 years analyzing global supply chains has taught me a great deal, but nothing more obvious than nobody – company or country – can do this alone. This is why the recent ICE raid on the Hyundai EV plant in Georgia is so disquieting. Our South Korean partners who were lending their technical expertise were led away in chains for all the world to see. The Chinese must be absolutely dumbfounded by their good fortune sure to result from this misstep.
Other tools to compete are already in play, though they are hanging by a thread in the current political environment. They include subsidies, tax breaks, off-takes and low interest loans. These are a sine qua non to move forward. All energy is subsidized in one form or another and the sooner we come to grips with this, the better. Is a $2.3B USD loan to Lithium Americas (LAC:NYSE) to help the company achieve commercial production and promote self-sufficiency and domestic production of a critical mineral a bad thing? Of course not. Especially when compared with some of the unconventional moves by the Trump Administration including taking equity stakes in companies such as Intel. How exactly does this investment help the company achieve its goals in the same way a loan to LAC has the potential to? We are going to find out if State Capitalism is a superior model to the traditional free market. I’m not optimistic.
CONCLUSION
In some ways, it’s interesting to note how little has changed since I wrote my initial piece in 2023. At that time, conventional wisdom centered around the idea that a robust industrial policy designed to slow China’s ascent and help the US get in a position to compete on the global stage would be straightforward. Taxpayer-subsidized reindustrialization was the new mantra. Runaway inflation and mistrust of the Biden Administration owing to perceived cognitive decline changed that calculus and re-elected Donald Trump. Now, everything from the US Dollar to industrial policy is a weapon. This is a theme that Foreign Affairs has devoted a great deal of ink to in recent months. The Trump Administration’s dismantling of the IRA will leave many wondering what could have been, and the America First agenda, underpinned by tariffs, and a lack of clarity on policy has sown confusion in board rooms and across borders which has yet to be resolved. This reindustrialization narrative was not going to be resolved within a single Presidential administration, so while the main roadblocks to growth in 2023 are still in place, we will be using a new set of State-led tools to compete.
Both the Biden and Trump Administrations have demonstrated the will to compete and reindustrialize. Trump’s “all of the above” energy supply-led approach (deregulation, domestic production, tariffs, fossil fuels) stands in contrast to Biden’s demand-led approach (consumer subsidies, renewables, ESG) but neither approach answers the question on which approach is better or more politically palatable.
In the past two years, the entire electrification narrative in the West has been reset. While metals demand looks strong through the end of the decade, EV uptake will be significantly lower, owing to the stubbornly high price of EVs and lost subsidies. Whether or not this air pocket of demand is filled by BESS demand remains to be seen.
The reindustrialization narrative has been reframed as a hybrid of national security and economic security. Tariffs and export controls are likely to drive up costs and stymie the flow of goods until a new form of global trade emerges. This is a long game, and we aren’t any closer to determining a winner. Until these macro issues around economic policy, immigration, and access to technology are better understood, the shining city on a hill remains a distant beacon on the horizon.
Full Disclosure: I currently hold a long position in Lithium Americas (LAC:NYSE).