Dust off your periodic table. U.S. strategists need to get back in chemistry class. Hydrogen and plutonium may have played a leading role in national security, but the natural resources known as rare earth elements (REEs) are also a key part of new energy and defense technologies—and most of them are supplied by China.

China accounts for nearly the entire global output of the seventeen REEs. And many countries, the United States and Japan in particular, are concerned about the Chinese monopoly on the world’s rare earths supply.

A recent congressional report poses several of the most salient questions. REEs are critically important for new energy technologies and have significant national-security applications. But production of REEs occurs largely outside of the United States. Given these facts, how vulnerable is the U.S. supply? Is the U.S. dependence on Chinese REE suppliers potentially threatening our national security and economic well-being?

The Chinese Monopoly

The world’s demand for REEs is estimated to be about 136,000 metric tons per year. A recent Chinese white paper claims that it has 23 percent of the world’s total reserves—although a United States Geological Survey report released last year estimated that China’s reserves made up half the world’s supply. But the real rub is that China dominates REE production at well over 90 percent of annual output. If REEs aren’t coming from China, they probably are not coming at all.

So where is the rest of the REE supply hiding? Russia, the United States, Australia, India, Malaysia, Vietnam and Canada (just to name a few) all have reserves. “Great,” you might say. “So, what’s the problem? Why not just dig up REEs from these other countries?”

First, not all rare earths are made equal. Some REEs have more important commercial and military uses than others. For example, if there were a major disruption in our yttrium supply, microwave communication for defense and satellite industries, color televisions and computer monitors would be affected. On the other hand, should we face a holmium shortage, some of our glass might not be adequately tinted.

Second, some of the more critical REEs are in shorter supply than others or are harder to access. Dysprosium, important for high-strength magnets, is already in short supply. Should the market demand continue to grow, following current trends, we will soon be faced with a growing deficit.

Third, the mining of REEs has a serious impact on the environment, generating toxic and hazardous gasses, pollutants and waste water. This is why so much of the production market moved to China in the first place. The country’s lax environmental regulations made it easier for industry to mine rare earths.

China has not always been King of Rare Earths. The United States used to be one of the world’s leaders in both rare earth production and innovation. The Mountain Pass mine located near the California-Nevada border used to account for 100 percent of the U.S. domestic demand and one-third of global exports of rare earths, according to a November 2010 report. But following the “reform and opening” that began in 1978, China began to realize what a gold mine it was sitting on and rapidly increased its own REE production capacity. As Deng Xiaoping said in 1992, “There is oil in the Middle East; there are rare earths in China.”

But rising production capabilities were only made possible with significant and sustained government support—in essence, state subsidization of the industry. This allowed unprofitable companies to export REEs at artificially low prices, causing the global price to fall considerably. As time went on, most non-Chinese producers of REEs, the United States included, were forced out of the business entirely. Mountain Pass mine, for example, was shut down in 2002. And in 2005, the mine was nearly taken over by the Chinese giant China National Offshore Oil Corporation, which tried to buy it for $18.5 billion—but these takeover attempts were thwarted by domestic political opposition.

There may be some good news. After shifting hands to Molycorp in 2008, Mountain Pass is being modernized and will reportedly come back online later this year.

Rare Earths and National Interest

Many countries are starting to realize that reliance on China for REEs may not be in anyone’s national interest—except for China’s, of course.

Japan is a good case study. In September 2010, a Chinese fishing trawler allegedly struck two Japanese coast guard vessels near the Senkaku/Diaoyu islands. The resulting dispute between China and Japan led to what seemed like a Chinese decision to cut off Japan’s supply of rare earth materials. China’s minister of commerce, Chen Deming, denied that this was a state-sanctioned embargo and Premier Wen Jiabao claimed that “China is not using rare earths as a bargaining chip.”

But Japan saw things differently and signed an agreement with Vietnam to cooperate in the exploitation of rare earth elements. As the BBC reported just this week, the two countries opened a jointly financed technology center to help process and separate the ore with the rare elements and ship them to Japan.

Japan and Vietnam are not alone in their distaste for China’s rare earth monopoly. As nearly the sole exporter, China is seen as having too many aces in its pocket, especially when it comes to setting export quotas. Earlier this year, Japan, along with the European Union and the United States, submitted an official complaint to the WTO regarding China’s export restrictions.

These restrictions are not insignificant. China’s rare earth exports quota has fallen dramatically between 2006 and 2011. In 2006, the quota was set at 61,560 metric tons, but by 2011, the quota had fallen to 30,246 metric tons. (Other reports show that the Chinese quota looks like it will rise slightly in 2012 to 31,438 metric tons.)

Though some in the industry see this reduction as a means of aligning quotas with actual demand, China claims that it is curtailing its supplies because of the toll rare earth extraction is taking on the environment. As the new Chinese white paper states, “Excessive rare earth mining has resulted in landslides, clogged rivers, environmental pollution emergencies, and even major accidents and disasters, causing great damage to people’s safety and health.” In fact, some reports suggest that environmental concerns will be used in China’s defense in the WTO case; that organization’s rules allow a country to set export restrictions for environmental protection and the conservation of scarce natural resources.

China has pointed out on several occasions that it opposes politicizing the rare earth issue and “is willing to strengthen dialogue and cooperation with other rare earth producers and consumers in a constructive and responsible manner.” But Chinese domination of rare earths production may already be receding, as countries around the world look for new ways to meet their REE demands. Several rare earths experts have laid out possible policy recommendations: stockpiling rare earth elements, establishing REE reprocessing facilities in a third-party country and developing an alternative to rare earth elements.

Whatever the solution, the rare earths industry is ripe for closer multilateral coordination and cooperation between the United States and countries around the world. It is also an industry where the United States should spearhead innovation, research and development—and stop ceding this territory to others.

A. Greer Meisels is Associate Director and Research Fellow, China and the Pacific at the Center for the National Interest.