EFFECTS OF CHINESE ACQUISITIONS
Jim Willie CB January 19, 2005
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Jim Willie CB is the editor of the "HAT TRICK LETTER"
This summer marked an historical development in the commodity arena, which can only be characterized as "guerrilla trade war." A pre-emptive attack on North American properties has begun. China has tendered an offer to purchase Noranda Copper. They submitted an offer to purchase undeveloped land in the vast energy fields of Alberta. They have approached Silver Standard for equity ownership. They have also approached Australia and Brazil to secure supplies of minerals. Their tactics have become more clever, with humanitarian goals as well as strong-arm methods in the bidding process. This is a huge sequence of events which strongly indicates intention by China to secure their supply chain. In early January, China tendered their boldest offer of all. They have submitted a bid to acquire the US energy firm Unocal, their first offer of a US company. This might actually awaken the US Sleeping Dog. Energy supply assurance strikes at the heart of national security. Danger is rising that when it comes to not only energy supplies, but also industrial metals and more, the US Economy might find itself on the outside looking in. Risks are rising that the USA might someday find itself locked out.
China has begun its bold attempt to execute an end run around the commodity market, to secure their future supply, and in effect to gradually lock out American customers. This is a brilliant pre-emptive attack, which US leaders do not recognize yet. To the untrained eye, this appears to be a positive development. It is, but mainly to investors and producers of gold, silver, copper, oil, gas, and other commodities. To all others, it is an utter curse yet to be acknowledged, and a precursor to trade war. The captured booty will be mineral and energy properties, which will elevate the tone of the commodity bull market and eventually trigger a bidding war on mining and energy stocks in the coming years. Political fallout is certain. Tensions will heighten.
This spring the US Economy suffered interruption to large Florida construction projects, due to unavailable cement supply. Such disruption will become commonplace across North America. Due to its size and authoritarian government, China will be better able to manage any new disruption as they secure future supply, whereas the USA is preoccupied by its inflationary machinery, financial speculation, housing bubble building, profligate consumption, general pervasive omnipresent waste, and war initiatives. China can also handle economic pullback and internal chaos far more capably than the USA. They can both subdue social disorder more easily, and absorb bank portfolio losses with less interruption. A recession in either nation would affect the world, since they are the factory workshop and the US is the debt-driven consumer behemoth. If more copper is gobbled up by Chinese interests across North and South America, a day will come when shortages rage acutely inside the US Economy while China hums along. China also has grown to become a large silver refiner. As they secure silver in raw commodity form, they will eventually release less and less refined silver to markets. They will keep it in China for their own usage in electronics and other applications. Karl Marx warned that a capitalist will sell you the rope to hang another capitalist. In this case, the USA will supply the shipping vessels to send commodity supply to China, as our nation suffers from lack of supply and we are cornered out. Some people such as former Treasury Secretary Robert Rubin (under President Clinton), US House Representative Ron Paul, and PIMCO bond king Bill Gross, have begun to sense our vulnerability, but to date, we have not executed on a single defensive action in response. US leaders are clueless economically, and asleep at the wheel when it comes to commodity supply.
The other purpose for Chinese acquisitions is to purchase expertise, intellectual capital if you will. The secondary benefit is worth far more than can be estimated. So far in the technology arena, the US has given away its principal comparative advantage as it has put into place enormous foreign direct investment within China. US corporations do this with open eyes willingly, as they seek the low-cost advantages. When Noranda Copper is purchased, active professionals come with the deal. China needs expertise to carry out its plans. They have educated workers, but they will need experience. Each acquisition offers additions to their expanding professional expert working class. Asia is educating over four times as many scientists and engineers as the United States and Canada, but they are way short in workers with strong experience and training in business.
THE NEW BATTLEGROUND OF SUPPLY CHAINS
Once upon a time when North American retail chains decided on whose products (or conglomerate products) to place on valuable shelf space, battles were waged in stores. Sometimes tactics were heavy-handed. We saw it with Coke versus Pepsi in the last decade. When system integrators decided on whose software products to install on personal computers, battles were waged. We saw it with Microsoft versus Advanced Micro Devices, played out with the big PC vendors. Warfare has been seen elsewhere. A new battleground will become more apparent soon, supply chain security and guarantee. Expect bigtime supply battles with China versus the West. If Brazil wants better access to Chinese output, then Brazil might have to provide China the first position in the mineral supply chain line. If Canada wants better access to Chinese output, then Canada might have to provide China the first position in the energy and mineral supply chain line. If the USA turns hostile toward our Asian credit masters and factory output providers, they will retaliate. Man oh man, is the USA vulnerable!!! At a later date, when China produces reliable cars at half the cost in quantity, their leverage will increase markedly. What do the Middle East Oil producers need for their economies? Cars, consumer electronics, household items, hygiene necessities, and drug supplies. China will cover much of these needs soon, if not already. With commercial leverage in the form of cheap industrial output in volume, they will take the lead spot in the supply chain for delivery. China is highly likely to transfer the conflict onto a battleground where the USA cannot compete. Our vulnerability is matched by growing resentment of our nation worldwide, hard to fathom and accept. Lack of cultural awareness internationally, and lack of travel habits for the majority of the US population renders them confused in the current climate.
A newly coalesced group has formed. Greater Asia has banded together to form the Shanghai Cooperative Group in order to create what could become a more powerful commodity supply organization than OPEC itself. China, India, Russia, and the former Soviet Moslem Republics form the nucleus. Energy rich, economically undeveloped, and on the Russian border, Kazakhstan, Uzbekistan, Tadgikistan, and Turkmenistan are richer than rich in energy resource deposits. It is widely believed that Turkmenistan contains the second largest natural gas fields in the world. Most Americans are unaware that these four nations even exist, and could not locate them on the globe. Energy resource supply might be the primary motive behind the emerging international cooperative effort. However, recent courting of both Brazil and Venezuela renders the supply coop as potentially much more powerful. It might soon lock in supply chains for industrial metals. Hugo Chavez might react soon to deny the USA certain crude and refined energy supplies, in response to little publicized assassination attempts. Isn't plausible deniability a wonderful political tool? My central concern is and will remain China, which has positioned itself in a strong leading role in the new Shanghai Coop, as well as firming up relationships and contracts with Australia and Indonesia. If anyone expects the USDollar to be the primary currency for transactions within the Shanghai Coop group, think again. The Petro-Dollar monetary system will surely be challenged.
Do not expect the USGovt to sit idly by. The USGovt will eventually attempt to block foreign purchase of hard asset properties, or to discourage them. The main trouble is that the USA does not own much of any prime mining properties or energy fields. The USA will be observing acquisitions, not participating much in them. The Gulf of Mexico is not owned. Exploiting its resources is done by means of leases from government agencies. In time, Canada will be pressured by the USGovt not to cooperate with Asian purchasing agents. This trend will gradually strain the relations between Canada and the United States. Why? Because the USA will need Canada to interrupt the process whereby the USA is locked out of the supply chain for minerals and resources. Much will be learned during the current growing conflict over cheaper prescription drug commerce, as the USA has coerced cooperation with Canada. Each acquisition represents an event leading to removal of supply from the system, and creation of a direct line from Canada to China. The same argument applies to Peruvian and Chilean properties in the rich Andes, and to those in Argentina and Brazil. My eyes will be trained on the IMF and its usage as a weapon against uncooperative South American countries who "collude" with foreign buyers to deny the USA what it needs. The IMF had an effect on stalling the Islamic Dinar, in a quiet display of power.
The United States exports debt, jobs, military hardware, computer software, foodstuffs, entertainment, and not much else in grand volume. Let us not overlook the export of obesity. Most information system hardware that "we" build is actually built in Asia by US subsidiaries. Expect the USA to become locked out, except where we are willing to deploy our military might to pry open markets for ensure supply delivery. The day will come in the next few years when the USA wields the food cartel weapon, but we are not there yet. Technology and food are our comparative advantages, and we give away the technology very foolishly. Food alone remains our probable weapon.
USAGE OF NEW WEAPONS
In the 1980 and 1990 decade, China used a nasty weapon of its own. A keen sense of hard ball was displayed. They complained about high mold content in US grain shipments. Their real motive was to be granted lower price. Their inspectors would halt delivery of grain shipments at the Chinese port for health reasons. They would withdraw orders in a very public manner from markets like soybeans or certain industrial metals, even with statements issued. Traders would respond like prompted herded farm animals. Prices would drop. China would re-enter their orders at substantial discounts.
In almost every single instance, the Chinese won the little battles. We do not stand a chance in overcoming this crafty and patient nation in future battles. Our hand of cards (mostly indebted paper) becomes weaker with each passing year. Watch two focal points, Detroit for its car maker business and Wal-Mart for its retail chain. Bilateral trade with China will break down when China exports fully loaded sedan automobiles to US markets with $12 thousand invoice price tags, sure to deliver death blows to Detroit. Political tumult will peak when Wal-Mart is targeted for strikes by workers whose pay scales and health benefits are sorely lacking. More hubbub will be stirred when the world's largest retail chain is targeted for boycotts by outraged US citizens who point to undesirable jobs at their stores and Asian inventory stocking their shelves. Wal-Mart's public response will point to their success centering on their motivated work force, advanced information systems, superior logistics, hard bargaining by management, and professional opportunity from within. As for the United Auto Workers, their position has become pathetically one whereby they negotiate not jobs, not worker conditions, but plant closures and retained pensioner health benefits.
Has anyone noticed the ratchet higher in conflict with Russia? First was the public criticism of Putin's harsh response to the Moscow movie theatre taken hostage, where over 200 people were killed during the stormed rescue. Then came the Chechen school takeover, where over 200 children were killed during the stormed rescue. In November we heard criticism by the US State Department of Putin's harsh tactics levied against Yukos Oil and his disregard for private property and contract law. Recently came a report that Putin leans favorably toward pricing crude oil in the euro currency, a "practical" measure. In Decembe we had his alleged interference with the Ukraine prime minister elections. This is the same leader who rode on horseback with President Bush a year ago, and who offered up public statements in support of Al Qaeda linkage to Iraq. Putin has played the US leaders as chumps. The tone is changing. The loser will be the debtor and the commodity customer, not the creditor and the commodity supplier. The USA will lose this battle. Canada will be in the cross-fire, and might be able to use its strong position to extract political concessions. Increasingly, conflict will grow among political leaders which will likely spread to commodity supply. Increasingly, conflict will grow in commodity security contracts which will likely spread to politics. Trade war lies over the horizon.
Canada has accelerated its development of Alberta and its vast energy fields. In 2002, Imperial Oil, Exxon Mobil, Shell Canada, and Conoco Phillips agreed to form a consortium called the Mackenzie Gas Producers Group. Their intention was to develop the Mackenzie Delta natural gas fields, and to construct a 1000-mile pipeline. The fertile Arctic delta targeted is reported by a Canadian energy group to contain ten trillion cubic feet of natural gas. Piped gas would be sent to northwestern Alberta, where existing pipelines would direct supplies throughout Canada and the United States. Initial capacity flow is expected to be 1.2 billion cuft/day, which could be increased to 1.9 bcf/day. The US Dept of Energy estimates the cost of the project to be between $3 and $4 billion. Aboriginal Canadians (Eskimos) will own an interest in the project. It is my firm belief that China will somehow assist in the gas pipeline connecting Alberta to the north shore of Alaska where the Mackenzie Delta is located. In doing so, they will win political favor which is critical to their continued supply chain lockdown. In many comparative respects, China has acted in recent years more like capitalists than the USA. If we behaved in a more true capitalist manner, we would embark on a nationally coordinated plan for greater energy independence. A return to nuclear and coal power is urgent. Instead, the USA spends untold billions of US$ on securing an entire hostile foreign nation to guarantee energy supply by the establishment of a central military base in the Middle East.
EFFECTS OF ASIAN HARD ASSET PURCHASES
Few analytic opinions have been submitted on the effect of recent purchases, or tendered offers which might result in purchases, by China. Their interest in Noranda Copper, Athabasca oilsands, and Silver Standard mine properties carries with it formidable implications. The analysis read on my part on the economic and financial impact so far has been inadequate. It is unfortunate, but most economic analysis comes up short on the impact of commodity prices and acquisitions, even from the gold community. We have seen a significant rise in production costs and labor costs and household costs, not final prices. When new money destinations are toward more debt, more speculation in housing, investment in commodities, the impact to real economies is in full support of economic deflation of secular type. What is meant by that is much new money is adding to forces of economic distress months down the road of time, aiding secular deflation which struck in 1997 with the Asian Meltdown, in 1998 with the Russian default, and in 2000 with the stock bust centered on Wall Street. That bust certainly spread across the entire Western world. As commodities rise in price, whether from actual demand or pure speculation, production costs and household costs rise to the point to inhibit economic activity. This plain effect is soft-peddled routinely. Despite analyst unawareness, the impact to businesses and consumers has been great. Businesses feel compelled to reduce their payrolls through layoffs, even as they seal more outsourcing contracts with Asia. Households respond by going deeper into debt, tapping home equity more, and in rare prudent cases spending less. Americans are not known for their spending discipline.
What will be the overall consequential impact to the economies of Canada and the United States? My conclusion calls for an amplification of current trends in a declining USDollar and rising commodity prices, with the added risk of the USA locked out of markets. In no way will wages or final product prices rise to keep pace, not unless Asian imports rise markedly in price.
The Chinese acquisition of Noranda Copper is primarily an acquisition of an ongoing business. It would probably at some point infuse additional cash into copper mining operations. Both the cash layout and added infusions which would add pressure to the Canadian Dollar versus the US$. The effect would be a steady push upward on the Canadian Dollar, since the Chinese would most assuredly use US$ cash or spend surplus money in lieu of their routine recycle US$-denominated purchases. Produced copper output would be more guaranteed to China. Some might continue to North American customers, but one can be sure that China would secure its position as first in line. The direction of copper demand is unlikely to change, unless economies falter broadly, or unless the North American housing bubble gives off an ominous hiss. If China decided to expand production in copper, then more output supply would assist in keeping prices down or at least flat. A critically important secondary benefit to Chinese mining corporations would be the acquisition of mining expertise in the process. China must develop its own mine properties in the Middle Kingdom of Asia, whose land mass rivals the USA.
Take the Chinese purchase of an interest in the Alberta energy fields, and the oil sands. Details are not clear of the Sinopec acquisition offer. One can assume that the cash infusion is intended primarily to add as new productive capacity, to increase oil output, and to guarantee access to energy supplies by China. This is somewhat a different story from Noranda. Much of any cash component in the purchase offer would aim to push development of the oil sands projects. The massive transaction might be in the form of assumed developmental costs, rather than that hefty payday for management and owners. Cash infusion would go into operations and infrastructure like the pipelines. So the Chinese would pour more money into Canada, sure to lift the Canadian Dollar versus the USDollar. China would use its vast base of cash and US$-based securities, whether held in reserves or received in payment for finished goods trade on a monthly basis.
The Athabasca marginal currency effect would be to make Canadian goods cheaper to the USA, with less impact to our European relationship. The additional production would release new Canadian crude oil output. It would also increase usage of natural gas in the expanded production process. The result would be a small change to natural gas demand, but a sizeable increase of oil in what one might think is made available to satisfy growing world demand. At the margin, however, the Canadian Dollar would rise doubly so, as new oil output hits the markets for US consumption, paid in US$ for Canadian supplies.
NOT SO FAST. China is NOT interested in altruism, in massive investment to assist the United States. Their entire purpose is to secure energy supply for the Chinese economy. A key part of the acquisition deal is to secure energy supply, to gain a top position for oil delivery, SIDE BY SIDE with the USA. If China attains minority ownership at an energy site, they will likely demand a dominant or equal position relative to the USA. They would demand to receive new production ahead of US customers, or on par with us. Oil supply is not likely to increase enough to affect world prices, since overcoming and overwhelming the decline in Middle East production would require a herculean geological feat. The large dominant Saudi oil fields are reputedly already in decline.
Some people might mistakenly come to the conclusion that large scale infusions of money into Canada from China will cause price inflation in the Canadian economy. Not so. A certain currency impact is assured. However, since much of the new capital to enter into the Canadian economy will be dedicated toward productive activity, businesses will spend money, equipment will be deployed widely, jobs will be created, profits will be earned, and their economy will strengthen. The grapevine reports that a large portion of the Noranda buyout will go to retiring owners, who plan to sock their money away in Swiss or other European bonds. Whereas the USA regards our economy as expanding in healthy fashion from debt deployed into speculative ventures, Canada will have a more robust reliable tried & true expansion from actual capital deployed into productive ventures. Offsetting the increased activity, based upon a sound foundation, is the dampening effect from a higher Canadian currency. So the new growth will be forced to work uphill. Export of output unrelated to minerals and energy, such as forest products, cars, and machine tools, will have to withstand price pressures from the higher currency exchange rates.
An additional effect is the potential for a bidding war catching fire on Canadian mining and energy properties. If Chinese acquisition takes place in Mexico or Chile or Argentina, followed by increased production, then the same reasoning holds. Their economies would strengthen in a bonafide fashion. Any Chinese purchase of properties would cause price inflation only if owners are located in North America and have no plans to expand production. For political reasons, do not expect many attempts by China to purchase US properties. The Unocal offer is an excellent test case.
Some common themes emerge as direct impacts from Chinese acquisition.
The lower USDollar exchange rate will worsen the production cost inflation problem facing the US Economy, with rising prices for minerals and resources. They are mostly imported. With Canada its largest supplier of crude oil, acquisitions of any Canadian property will help to drive up the cost of US oil imports. Up to now, the problem of the falling US$ has inhibited economic growth. It has brought about no notable rise in US wages. Without wage growth, all rising costs suppress economic activity. Anyone who believes rising costs (for gasoline or food or copper or steel or cement or lumber) yield price inflation has ignored China completely. THERE IS NO COST PUSH WHATSOEVER. Chinese imports of finished goods, and outsourcing of service jobs to Asia, together combine to keep a lid on our economy's entire price structure.
The United States and Canada suffer from a massive price ceiling imposed by China and global trade. In the face of Chinese presence, production cost inflation from the US$ decline is not price inflationary, but rather the exact opposite. It causes lost jobs, lost income, and increased debt burdens, each presaged hallmarks of secular deflation and economic smother. As for the Canadian economy, expect a net positive benefit with substantive economic expansion mitigated by a rising currency in the looney.
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Jim Willie CB is a statistical analyst in marketing research and retail forecasting. He holds a PhD in Statistics. His career has stretched over 23 years. He aspires to thrive in the financial editor world, unencumbered by the limitations of economic credentials. Visit his free website to find articles from topflight authors at www.GoldenJackass.com