C.M.O. 4.26.2010

Credit Market Overview

April 26, 2010

Much of what has been written recently regarding China has been headlined by Yuan worries.  The amount of effort spent in getting those that steer the Middle Kingdom to revalue the renminbi is at least equivalent to that of Messrs. Frank and Dodd in convincing the country that the credit crisis was solely and completely caused by the mercenaries and their minions on Wall St.

Ian Bremmer, President of Eurasia Group, is interviewed by Vito J. Racanelli in this week’s Barron’s and floats a few ideas regarding China’s “state capitalism” and the force it will exert on the multinational corporations of the Western world over the next generation.  While I’m about to cherry pick a few of Ian’s choice points I would suggest that you read the full article in Barron’s as well as the book he is about to publish on May 13th, “The End of the Free Market”, which provided the back ground for many of the answers to Vito’s questions.

The main challenge Ian sees for western business going forward is that “the world’s largest and second largest economies now have economic systems that are fundamentally incompatible”.

Mr. Bremmer likens China’s control over its economy to that of OPEC, in that before that organization existed, “an international oil company used to be able to go up to a country, stick a straw in the ground, and make a lot of money”.  OPEC changed all of that and Ian sees China doing the same thing to those who believe they can have unfettered access to the Chinese consumer.

Google’s recent scuffle is just a prelude of things to come as Bremmer thinks we are “going to see increasing regionalization of trade” with “targeted tariffs pop[ping] up all over the place in countries where the multinational corporates can’t participate.”

While the limiting of freedom of the Chinese people in accessing information over the web received most of the press in the West Ian is more concerned about the effect that having “massive state-supported industrial espionage attacks, precisely China’s asymmetrical advantage, against multinational corporations, [causing] Western tech firms [to] feel like they aren’t going to be able to compete effectively in China”.

Ian goes on to discuss a number of other topics in his interview but I want to stay on the China theme here and after reading that interview I did some work of my own to see if I could substantiate any of Ian’s ideas.

With regard to what Ian calls “state capitalism” but which I have also heard called a “command economy” I noticed three main categories where it seems the Chinese government would like to influence the natural course of economic events.

The first is in removing the stimulus they put in place during the Great Recession.  Here we have heard of the reduction in loans allowed by the state banks as it was becoming increasingly apparent that some of these funds were making their way into more speculative endeavors such as the stock and property markets.

On the property side China’s State Council took steps to further reduce speculative property investments by allowing banks to refuse mortgages to anyone who already owns two or more properties.  Other measures included the raising of down payment amounts and mortgage rates.

As evidence that Uncle Sam is not the only purveyor of unintended consequences the Chinese government’s actions have had little effect on property values as data showed that prices in 70 of China’s large and midsize cities rose 11.7% YoY in March, the fastest pace since China began releasing data in July of 2005.

Where the effect is being felt, however, is in the stock market as the Shanghai Composite index has fallen precipitously since April 6th, dropping 4.7% last week alone.

Having just witnessed what the popping of a housing bubble can do, China’s efforts in this area seem to be more a benefit of “state capitalism” than a curse.

With regard to Ian’s point on restricting the ease with which business is conducted, a survey by the American Chamber of Commerce in China or Amcham is it is affectionately known polled 203 members about planned government procurement regulations and the general business climate in China and found that the percentage of companies that feel they are “unwelcomed to participate and compete” in the Chinese market rose to 38% from 26% a year ago and 23% in 2008.  Among technology companies questioned, 57% said they believed things would get tougher in the future and 37% said they were already having issues.

This is occurring as China is moving forward with a new system to vet foreign acquisitions of local companies for national security concerns.  “The definition of national security is bound to be somewhat broader than what people think of as national security in the U.S. – it’s going to be economic security and economic development and stability,” was how Peter Wang, a partner with Jones Day in Shanghai described the initiative.  Going on to say the planned review system is “not unexpected, and it’s not necessarily unreasonable, but it’s certainly not making things any easier.”

To the extent that all of the focus so far has been “incoming” there is also a concerted “outgoing” effort from the Chinese.  This has been primarily intended to secure the raw materials China will need to continue its growth.  China Petroleum & Chemical Corp recently purchased ConocoPhillips’ stake in a Canadian oil-sands project for $4.65BN and in March Cnooc Ltd., China’s top offshore oil explorer, agreed to pay $3.1BN for a stake in the largest Argentine oil-exploration company, Bridas Corp.

There was also news lately of a $20BN loan from China to Venezuela, according to that country’s President Hugo Chavez.  HC has been very vocal regarding his distaste for his country’s biggest buyer of its crude oil, Uncle Sam, and is seemingly happy to diversify his list of buyers.

The $20BN in “soft-loans” as they were described by China’s state-run Xinhua news agency would be provided by the state-owned China Development Bank and rank among the countries biggest foreign loans ever.  As such they are testament to the growing importance of oil in China’s energy mix.

As it takes a little longer to write a book than it did for me to put this together it is safe to say that Ian Bremmer has been thinking about this a little longer than I.  That we can see in real time, much of what Ian saw a year or so ago not only adds to his credibility but makes Mr. Bremmer someone to listen to in the future.

Enjoy the week.

Jim Delaney

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