One of Senator Hillary
Clinton's Asia policy advisers quit her presidential campaign
several days ago, complaining that the candidate was engaging in
"gratuitous China bashing." And, in fact, the Senator has of late been
engaged in a jeremiad on China.
To be sure, a good portion
of the sourness nurtured in the Democratic Party's base against
China is undeserved, and more about big-labor politics than genuine
security concerns, yet Senator Clinton has spotlighted at least two
grave vulnerabilities in America's defense industrial base: Chinese
state-controlled investments in key U.S. defense suppliers and the
impact on defense supplies caused by seemingly unrelated
environmental litigation that closed down the world's
second-largest rare-earths mine and thereby gave China a monopoly
on oxide ores that are absolutely essential to all defense
The first concern was
addressed in 2007 when Congress passed the Foreign Investment and
National Security Act (FINSA), which seeks to balance the
exigencies of America's national security with its "open
investment" policy. FINSA codifies what the Committee on Foreign
Investment in the United States (CFIUS) has been doing for the past
20 years, and while it is not perfect, there have been some
significant changes. The 2007 amendments now require that CFIUS (1)
publish guidance in the Federal Register on the types of
transactions that it has reviewed and that have presented national
security considerations and (2) notify Congress after each review
and investigation. FINSA also created the concept of "lead agency"
and the responsibilities thereof, particularly in following up on
and enforcing mitigation agreements relating to "covered
transactions." These were positive steps.
The question is whether
Senator Clinton or any other presidential candidate is up to the
challenge of questionable foreign investments in U.S. defense
industries-and CFIUS may now be the least of the problems.
China Bought Magnequench
Magnequench's story is
indeed a story of executive branch disregard for the health of the
nation's defense industrial base, but the Administration of Bill
Clinton bears culpability for letting it happen in the first
Magnequench had a unique
expertise in the manufacture of high-powered neodymium magnets,
which it pioneered in the 1980s for its parent company, General
Motors, to use in airbags and mechanical sensors. When GM
restructured in the early 1990s, the company began to divest itself
of subsidiaries that were not in its "core competence."
Magnequench, in spite of its high-tech pedigree-and the fact that
it provided critical component parts to "precision guided
munitions" that were then in great demand by the U.S. Department of
Defense-was put up for sale.
supplied 85 percent of the neodymium magnets used in servo motors
for PGMs, but neodymium magnets are far more
important and ubiquitous than their use in advanced weaponry might
suggest. They are the sole reason high-speed, high-capacity
computer data storage devices can work. They are found in literally
every computer in the world, and in 2004, Magnequench, together
with its merger partner NEO Material Technologies (and its
integrated Chinese joint-venture partners), supplied about 80
percent of the world market share of neodymium and rare-earth oxide
powders used in those magnets.
So when GM put Magnequench
on the block in 1995, who should come up with the $70 million
asking price? An investment consortium headed by
Archibald Cox Jr. (son of the illustrious Watergate prosecutor)
acting in concert with two Chinese state-owned metals firms, San
Huan New Material and China National Nonferrous Metals Import and
Export Company (CNNMIEC), which had been pestering GM to sell
Magnequench since 1993.
In the deal, the two
Chinese firms took at least a 62 percent majority of Magnequench
shares, with the senior Chinese investor taking over as the
company's chairman and Cox as chief executive officer (CEO). (In 2005, when Magnequench merged with
a Canadian firm then known as AMR, Cox was listed as owning a
significant minority share of AMR and was named AMR chairman.
The chairman of San Huan,
a Mr. Zhang Hong, son-in-law of former Chinese "paramount leader"
Deng Xiaoping (and now director of the Research and Development
Bureau of the Chinese Academy of Sciences), took over as chairman of
Magnequench. No doubt, Mr. Zhang's desire to
acquire Magnequench was informed by the Chinese government's-and
his father-in-law's-"Super 863 Program" to develop and acquire
cutting-edge technologies for military applications, including
"exotic materials." The other Chinese investor in
Magnequench, CNNMIEC, was at the time run by yet another Deng
Role in Magnequench
But the United States
government surely would not permit the Chinese simply to walk in
and take over a significant U.S. high-tech firm, would it? Several
sources indicate that CFIUS did reach a "mitigating agreement"
with Magnequench's new owners that the Chinese companies could not
remove Magnequench's production equipment or jobs from the U.S. for
a period of ten years.
It is, however, an old
Chinese tradition that "rules are made to be broken" (shang you
zhengce, xia you duice). Magnequench's Chinese owners cleverly
reinterpreted the CFIUS conditions. One Magnequench employee
reported that shortly after the Chinese took over, Magnequench's
neodymium-iron-boron magnet production line was "duplicated in
China" and that, after the Chinese "made sure that it worked, they
shut down" the U.S. production in Indiana. The employee added, "I
believe the Chinese entity wanted to shut the plant down from the
beginning. They are rapidly pursuing this technology."
It is quite likely that
the Chinese government realized (even if the U.S. government did
not) that neodymium-iron-boron supermagnets are absolutely
essential to the assembly of U.S. precision weaponry and that there
was basically only one U.S. supplier of those magnets to the U.S.
defense firms that assembled such arms.
In 1997, the Magnequench
shares held by the two Chinese firms were transferred to Onfem
Holdings, a Chinese state-owned holding company based in Hong Kong
and run at the time by a Mr. Wu Jianchang, yet another son-in-law
of Deng Xiaoping. Archibald Cox, in the meantime, became
the titular Magnequench President and CEO, and although a Chinese
firm held at least 62 percent of Magnequench's stock, his firm's PR
office began to hold the company out as a "U.S.-majority owned
company headquartered in Anderson, Indiana."
Shuts Down World's Second-Largest Rare-Earths Mine
A few months later, in
March 1998, Magnequench's major U.S. supplier of rare-earth oxides,
Molycorp (then owned by Unocal), was obliged to shut down its
rare-earths mine at Mountain Pass, California, and pay a $410,000
fine for leaking what the Environmental Protection Agency (EPA)
termed "low level radioactive waste." Mountain Pass, the "only
producer of rare earths in the United States," was the
second-largest rare-earths mine in the world and included a "world
Overnight, this removed 20
percent of the world supply of rare-earth powders from the market.
Magnequench, however, was controlled by China National NonFerrous
Metals Corp. (CNNMC), the Chinese state-owned corporation that had
a virtual monopoly on key rare-earth supplies, and found it very
easy to source its supplies from partners and affiliates in
By September 2001, citing
slack demand, Cox announced that he would shut down the Magnequench
production lines completely even though the company posted revenues
of $250 million in the year 2000. Cox explained that "almost all of
the raw materials for Magnequench's powder products come from
China, and 90 percent of our customer base is in Asia."
In April 1999, Magnequench
announced that it would open a 30,000-square-foot laboratory
facility on a 10-acre site mostly in the Research Triangle Park in
Raleigh-Durham, North Carolina. But by September 2003,
Magnequench had abandoned North Carolina and relocated its entire
research operation to Asia, and the U.S. company's revenues dropped
to $158 million. One could speculate that Magnequench's
Chinese owners in the CNNMC (Onfem's parent in Beijing) were more
than making up for their U.S. losses in the vast expansion of
supermagnet sales from Chinese companies.
By the first months of the
Bush Administration, Magnequench's crown-jewel technologies had
already seeped off unnoticed to China, and the entire production
line was already being dismantled in the United States. U.S.
Senator James Inhofe (R-OK) complained in October 2005 that "over
12 years, the company has…moved piecemeal to China, leaving
the U.S. with no domestic supplier of neodymium, a critical
component of rare earth magnet." The blame, he said, rested with
CFIUS because "CFIUS approved this transfer" in 1995 and failed to
enforce the terms of its approval.
Of course, the real reason
Magnequench could not source neodymium in the United States was
that the EPA had closed the world's second-largest source of the
mineral-the Mountain Pass mine-charging that the mine effluent was
not "beneficiated" (i.e., "earthen in character") as the mine
operator claimed, but rather "processed." It does not appear from
the court record that the mine's effluent endangered either human
health or animal habitat.
By 2005, Magnequench
remained a proprietor of several important rare-earths magnet
patents and production processes and, presumably with financing
from its Chinese owners, was sought out by other North American
firms in the rare-earths business. Magnequench merged with a
Canadian rare-earths firm, AMR, in 2005, and Archibald Cox was
listed as the largest shareholder on the board of directors,
apparently on behalf of an unnamed "initial holder." AMR is now
known as NEO Materials Technologies (which still retains the www.magnequench.com Web
NEO and its Magnequench
affiliate report that 85 percent of their manufacturing facilities
are in China (the other 15 percent is in Thailand); that 95 percent
of their personnel are located in China; and that all of their
China manufacturing facilities are in the form of "joint ventures"
with Chinese state-owned enterprises. It now appears that the
United States has no rare-earth oxide magnet production capacity.
This is unsettling when one considers that virtually no piece of
advanced information technology can be fabricated without
rare-earth oxides-which, of course, means that no weapons system
can be assembled without them.
In short, America's
defense industry already relies on China for some of its most
indispensable components-and the problem did not begin with
President George W. Bush. It goes back to the early part of the
Senator Inhofe was
understated when he noted in 2005 that the United States no longer
has a domestic supplier of neodymium, a critical component of
rare-earth magnets. Treasury representatives believe that CFIUS's
writ runs only to items specifically covered in arms-export control
legislation, and there is little that it can or should do with
regard to ensuring supplies of strategic materials not so
No responsible policymaker
seeks to restrain foreign investment in the United States. Foreign
investment introduces new technologies and skills to America's
economy, helping to promote U.S. competitiveness abroad. About 20
percent of all U.S. exports originate from U.S. affiliates of
In the Magnequench case,
Chinese investors found a number of different vulnerabilities in
the U.S. defense industry base: a poor appreciation of the
importance of small and medium niche suppliers and the Achilles'
Heel of environmental litigation, which has handed to the
Chinese-up to now-a virtual monopoly on supplies of an essential
resource to modern computing electronics.
It is not clear from the
record that either Republicans or the Democrats, Bushes or
Clintons, have the intestinal fortitude to take the steps necessary
to monitor problematic foreign investment in America's
high-technology manufacturing sectors, which supply our defenses,
or to balance sane environmental concerns with national security
exigencies. If they did, a reasonable solution to the Mountain Pass
mine effluent could have been found without closing the entire
operation, and Magnequench's gradual metamorphosis into a
China-based company and the consequent loss of its products in the
U.S. defense supply chain would not have happened.
John J. Tkacik, Jr., is a
Senior Research Fellow in the Asian Studies Center at The Heritage
 For a broader discussion
of the importance of the Mountain Pass facility, see James B.
Hedrick, "Rare-Earth Metals," U.S. Geological Survey, 1998,
rare_earths/740497.pdf. See also U.S. Geological Survey,
The Mineral Industry of California, 1998, at /static/reportimages/E7631A3835E1BA09F65214BB5D60F281.pdf,
and David R. Jessey, field report, "Mountain Pass Rare Earth Mine,"
California State University at Pomona, at
With rare-earths prices at historic highs, Molycorp reportedly
intends to reopen the Mountain Pass mine in 2008. See Jane Spooner,
"RARE EARTHS," Minor Metals Trade Association Mining Journal
Review, January 1, 2006, at