Tuesday, October 2, 2012

China is not allowed to own nice things.

Do you have any idea how hard it is to pick up a barrel with chop sticks?

It's not that does China not want to own nice things. Or that they are necessarily unready to own nice things. It's mainly that other members of the world community won't let them buy up those nice things. Their money may be good enough to buy US Treasury bonds, but apparently is not good enough to buy US and Canadian Energy companies.

China has decided to use its enormous cash-on-hand created by trade surpluses to purchase natural resources and mineral rights around the globe; from Africa to East Asia and now to the Americas. Doing so would secure a steady supply of raw materials for their manufacturing base for the foreseeable future. It goes beyond that, though. It secures China's manufacturing base period. With rising wages and an appreciating currency, China is losing its low cost advantage as compared to other third-world countries. To form and maintain middle class, China needs to be able to maintain the jobs it currently has instead of experiencing capital flight as other Southeast Asian countries have. We have another word for this in the West, deindustrialization; or outsourcing; or, a more loaded term of its eventual conclusion, Rust Belt. And its lead to stagnation in median incomes.

In a totalitarian state, economic growth means legitimacy for the government. Even if China has to pay more for raw materials and pay more for labor compared to the global market, it allows China to maintain jobs. No (or even low) growth means no jobs, which means no more current leadership. See Arab Spring.

Thus the Chinese state-owned company CNOOC has put in a bid to buy Canada's oil and natural gas company Nexen at a 61 percent premium over open-market share price value, $15.1 billion dollars. If it goes through, it would be China's largest overseas purchase. Economically speaking, it's a great deal for stock holders of Nexen. No wonder the stock shot up after the announcement. 56 percent of business leaders think that the deal should go through without any preconditions, but 50 percent of Canadian residents oppose it. It doesn't sit right with the voters to sell one of the largest Canadian companies, as well as the natural resources it owns, to China. There is reason to believe that this deal will be denied.

Another part of this calculus is that there is backlash in the United States over this deal as well. Nexen owns a lot of US-based assets, especially offshore drilling rigs in the Gulf of Mexico. Therefore the deal is subject to Committee for Foreign Investment in the United States (CFIUS), which studies national security implications in foreign takeovers. The US government and Nexen currently has a deal that allows Nexen to sell its US-drilled oil free from federal royalty payments. At the bare minimum, that is going out the window. At worst, Nexen will be forced to sell all of its US-based assets before the deal can proceed.

Just last week, for the first time in 22 years, CFIUS blocked China from buying four US wind farm companies. China was attempting to do the same thing that they are with Nexen. By buying the installation and maintenance companies, they can make sure that the manufacturing (and manufacturing jobs) stay(s) in China. In the middle of an election season where both presidential candidates and political parties are appearing to be "tough" on China, it was just not going to happen. We'll see how much this is campaign rhetoric in a few months.

Let me leave you with this though, China will never be a full member of the world community until the West lets it. The West wants China to crack down on intellectual property right issues - basically putting an end to corporate espionage by stopping state-owned companies from making exact duplicates of Western products - but that won't happen until China has more skin in the game in the global economy and therefore sees that it is in their self-interest in doing so. The way that this will happen is by letting China own nice things.

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