The future of AI and the U.S. economy hangs in the balance, and it's a story that begins with rare earth elements. These elements, crucial for AI's growth, are controlled by China, posing a significant threat to U.S. stocks and economic prosperity.
AI's infrastructure relies heavily on rare earths, and the U.S. economy's growth is intricately linked to AI. Capital spending on AI has been a major driver of U.S. stock market returns, and its impact on GDP is undeniable. Harvard economics professor Jason Furman's calculations reveal that AI spending accounted for a staggering 92% of U.S. GDP growth in the first half of 2025. Without AI-related investments, GDP growth would have been a mere 0.1% on an annualized basis - a stark contrast.
But here's where it gets controversial: the U.S. faces a potential crisis of rare earth element access, reminiscent of its oil dependence in the 1970s. Rare earths are essential for AI's computational and memory demands, and they're also integral to national security, used in radar, lasers, and satellite systems.
From the 1960s to the 1990s, the U.S. led the world in rare earth elements production. However, two pivotal decisions in 1995 changed the game. First, the U.S. approved China's purchase of Magnequench, a rare-earth magnet company, from General Motors. This move gave China access to advanced technology that would have taken years for them to develop independently. Second, China joined the World Trade Organization, allowing them to sell rare earth elements globally at lower costs, ultimately leading to the closure of MP Materials Corp., the U.S. rare earths mining company, in 2002.
MP Materials was reopened in 2017 for national defense purposes, and U.S. production has increased, reaching 45,000 tons in 2024. But this is still a fraction of China's production, and the U.S. may struggle to meet its defense-related demand for rare earths by 2027. Even if it does, the massive commercial demand, including the AI build-out, will remain unmet.
China's dominance in rare earth elements is undeniable. They control around 70% of the world's rare earth resource output and a staggering 90% of processing capabilities. This has been a key bargaining chip in U.S.-China trade negotiations.
To address this issue, the U.S. is diversifying its rare earths supply and seeking reliable exposure through allies like Australia and Canada, which have significant rare earth resources. New technologies may also reduce the need for rare earths and improve recycling efficiency. Additionally, government policies can influence demand, as seen with the Trump administration's elimination of EV tax credits, which discourages the production of rare earth element-intensive products like electric vehicles.
Rare earth element independence is as crucial for the U.S. as energy independence was 50 years ago. Until a viable alternative to China's dominance in the rare earth supply chain is found, AI capital spending and, by extension, the U.S. economy and stock market, remain vulnerable. Stock investors should stay vigilant, monitoring trade deals and policymakers' comments, and considering supply chain risks when evaluating AI-related investments.
This article was written by Kristina Hooper, Chief Market Strategist at Man Group, which manages alternative investments. The opinions expressed are her own.
