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Beyond China's oil bid, a greater danger

Philip Bowring

MONDAY, JUNE 27, 2005
HONG KONG Is the bid by the China National Offshore Oil Corp. for the American oil company Unocal another act in a classical tragedy that will lead inexorably to the United States and China destroying the commercial embrace they both cherish?
From a political perspective, the bid could scarcely have come at a less opportune time. It is destined to rile many in a U.S. Congress already fretting over trade issues and the Chinese currency peg. It will be another boost to those calling for punitive tariffs against all Chinese goods. From an overall Chinese perspective, the bid could be deemed unwise.
Yet there is also a compelling logic to it. The cash offer of $18.5 billion looks huge enough but it amounts to little more than one month's addition to China's foreign exchange reserves at the rate of accumulation seen over the past year. Where else is China supposed to put its pile of dollars? Into yet more of the low yielding debt paper of Fannie Mae and the other agencies fueling America's housing bubble?
Paying a fancy price for Unocal may be a less dumb investment than buying U.S. debt and helping keeping alive the cheap money era that Alan Greenspan has perpetuated as chairman of the Federal Reserve. At least China gets real assets, not increasingly dubious promises to pay secured on ever more lenient mortgage loans to sub-prime U.S. household borrowers.
Having been encouraged to join the global capitalist system, China naturally feels that it has as much right to buy a U.S. oil company as an Indonesian gas field or an Australian mining company.
And from the perspective of the Unocal shareholders, it looks a good deal too. Who else but China is so flush with cash that they are prepared to outbid the multinational oil giants, in this case Chevron? "Take the money and run," might be the best advice, just as it was when IBM sold its personal computer business to China's Lenovo or U.S. investors unloaded iconic real estate such as the Rockefeller Center to over-eager Japanese buyers in the late 1980s. Such purchases of overseas assets at inflated prices added to the problems Japan faced when its own asset bubble burst in 1990.
But if the reaction of many Americans to the bid confounds their own capitalist principles, Beijing also needs to remember the contradictions of its own position. To finance its bid, China National Offshore Oil Corp., or CNOOC, will have to leverage itself to an approximate 50:50 debt-to-equity ratio - a very high level for a resources company, particularly in a sector with such price volatility.
Such leverage is only possible because CNOOC is a government-controlled state enterprise. The ability of such companies to borrow almost as much as they please explains the problems of China's state banking system and illustrates how far China has to go to reach U.S. concepts of private capitalism.
Lurking in the background, too, is the fact that China's dollar hoard stems at least in part from its refusal to submit its currency even to modest amounts of market force. While its system remains so different, China cannot be expect to be treated as would a bidder from Europe or Mexico.
The Unocal issue cannot be separated from the wider issue of U.S.-China trade imbalances. The assumption that the relationship will endure because the two are dependent on each other - the United States on Chinese savings, China on the U.S. consumer - is dangerous. To the divisions over trade and currency are now being added the even more emotional issues of ownership and national security. In the real world, there is a difference between China's ownership of Unocal and Fannie Mae debt.
The only way to avoid these problems going from bad to worse is to address not the symptoms but the macroeconomic origins. Thanks to Greenspan, money is absurdly cheap in the United States, hence the alarmingly low household savings rate, rising indebtedness and buoyant consumer demand. And money is cheap in China, too, as it pegs its currency and its interest rates to Greenspan's policies, in the process creating growth led by excess investment - not least by state enterprises - and unsustainable export expectations.
Can China and America grasp these fundamental causes before the symptoms overwhelm them? That, not the fate of Unocal, is the issue both countries have to face if their commercial entente is to survive.
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