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The new China syndrome: The threat to Canada

Though its money is welcome, we should have no illusions that China is a normal investor that plays by our rules
By Fen Osler Hampson, Financial Post
September 14, 2009

The “China Syndrome” describes a nuclear meltdown in which molten material from an American nuclear reactor blasts a hole through the Earth’s crust and reaches China. It could just as well describe the consequences of the U.S. financial and economic meltdown, which has left China with trillions of U.S. dollars that it is now using to go on a global shopping spree to meet its insatiable demand for oil, copper, iron ore, aluminum and other minerals while reducing its exposure to a fall in the value of the increasingly vulnerable U.S. dollar.

Should we be worried that China is eying Canada’s oilsands and mineral deposits? The short answer is yes. China is in the lead of those countries whose actions represent a return to state sponsored capitalism.

In the 17th century, British and Dutch imperial power was exercised through two corporations, the British East India Company and the Dutch East India Company. These were joint stock corporations that operated under royal charter and enjoyed huge monopolies over trade in cotton, silk, tea, opium and other commodities. They were backed by the independent fire power of the British and Dutch army and navy. These companies had the power to establish colonies, wage war, negotiated treaties and make peace. If you got in their way, you did so at your peril. They were the engines of the British and Dutch empires and their success was founded on the mercantilist belief that a country’s wealth depends on a secure supply of raw materials, the accumulation of capital, a trade balance that favours exports over imports, and tightly controlled markets.

Students of Canadian history will recall that the Hudson’s Bay Company (very much modelled on the British East India Company) was the extension of British imperial power in Canada. Incorporated under a royal charter in 1670, it exercised exclusive control over a vast territory in Canada, and guaranteed a steady supply of fur (for trade in Europe) and timber to build the ships of the Royal Navy.

China’s 21st-century brand of mercantilism has somewhat different origins though the goals are the same. China has artificially manipulated its exchange rate to guarantee favourable terms of trade and consequently has run up huge trade and capital count surpluses with the U.S. and to a lesser extent Europe and other nations.

Until some 18 months ago, the People’s Bank of China (the central banking authority) was content to accumulate massive foreign currency reserves, to invest them primarily in U.S. Treasurys and to issue its own local currency government bonds in order to take back the extra money in circulation, thereby reducing the net increase in money supply and the inflationary consequences.

With the global economic crisis, however, China was forced to limit its monetary sterilization polices in order to encourage internal bank credit growth as part of its own stimulus program. It has also become increasingly concerned with the prospect of inflation in the United States, which would greatly diminish the value of its holding of U.S. Treasurys.

China is now trying to shed itself of U.S. dollars. This is one reason why it wants a new world currency, which it believes would be more stable than the U.S. dollar. It is also why China has embarked on a major global expansion through the power of its massive sovereign wealth funds to buy foreign assets while simultaneously meeting its insatiable demand for raw materials.

China is using its sovereign wealth directly and indirectly to manipulate global commodity markets. In the case of energy, it has extended huge loans to major oil companies, like Brazil’s state-owned Petrobras and the Russian state-owned company Rosneft, to secure long-term contracts for oil and gas. These loans are to be repaid not in cash but with assured, long-term shipments. The government is also extending highly favourable loans to major Chinese corporations, which are essentially controlled by the state, to make lucrative overseas purchases. Among them, the ill-fated bid by the Aluminum Corporation of China (Chinalco) to buy a stake in the Australian minerals company Rio Tinto and a potential bid by the Chinese trading company Minmetals to purchase the Australian mining company, Oz minerals.

Beijing’s global hunt for energy has also led it to sign deals with unsavoury regimes in Iran and Sudan. But its efforts have also met with stiff opposition in the U.S. When the Chinese National Offshore Oil Company, CHOOC, offered to buy the Californian energy giant Unocal, there was such an outcry in the U.S. Congress that CHOOC withdrew its offer. Unocal was subsequently bought by Chevron.

Chinese sovereign wealth funds and state-influenced companies are fast becoming large-scale investors in Canada. The China Investment Corporation (CIC), a sovereign wealth fund, recently bought a major equity stake in Teck, a Vancouver-based mining company that is a leading producer of copper, metallurgical coal, zinc, gold and aluminum. Petro-China, a state-owned oil company, also recently bought a 60% share of the Athabasca Oil Sands Corporation’s Mackay and Dover projects to the tune of a whopping $1.9-billion. CITIC Canada Petroleum Limited (formerly Tartan Energy Inc.) operates as a subsidiary of CITIC Resources Holdings, Ltd., the major Chinese metals producer turned oil supplier, which has key oil exploration and production operations in Canada and other countries, including the United States, Kazakhstan, and Azerbaijan. The list goes on.

Chinese investment in Canada, especially the oil sands, is seen as plus because it will help diversify Alberta’s oil exports away from the United States at a time when U.S. environmental groups are lobbying hard to restrict such exports and when the investment climate because of the economic downturn has become decidedly chilly.

Welcome though these investments are, we should have no illusions that China is a normal investor that plays by our rules. As we all have seen in the iron ore price negotiations between the Australian firm Rio Tinto and the Chinese, everything is political. Rio Tinto was in direct negotiations with the Chinese government to set the price for its iron ore exports to Chinese steel mills. The Chinese sought a reduction in the price of iron ore. When they didn’t get what they wanted, they threw four senior members of the Australian company into jail on trumped up charges of industrial espionage and bribery.

This is just one example of the meddling by the Chinese government in the business sector and the brutal lengths it is willing to go to get its own way. We are in real danger of returning to an almost 17th century mercantilist world where the Dutch and British East India Companies are being replaced with the likes of Chinalco and mother sovereign or quasi-sovereign enterprises.

There is still little respect in China for intellectual property rights and the law of contracts. If they can copy something and pay nothing for it, they will, as Monsanto discovered with China’s own generic competition to its herbicide business. If the Chinese don’t like the terms of a contract they will repudiate it, as the Chinese are now threatening to do: they are encouraging their state-owned companies to tear up their financial derivative contracts on the price of oil with some of the world’s major banks because the price of oil has dropped and they want to recover some of their losses.

As China’s grip on the market for global commodities strengthens, it will soon be in a position to exercise control over prices and supply chains for iron ore, copper, aluminum, other minerals and even energy. The absence of transparency and proper regulatory oversight over Chinese state-owned companies and sovereign wealth funds should worry us. Our own lack of power in dealing with the Chinese when things start to go wrong and they behave badly as they did with Rio Tinto is also worrisome.

Unlike the United States, Europe or even Russia, Canada, as a medium-sized power, has little political and economic clout. We will need a policy that says every acquisition that is made over a certain size or in a particular strategic sector, which is controlled by a foreign sovereign entity, will undergo a mandatory special review. We can tell the Chinese and others that they can’t have a majority stake in our mining and energy sectors. There are obvious precedents as in the case of telecommunications or banking where we have refused to cede majority control to foreigners. Right now we are only talking about a few billion but as we look to future investments in our resource sector running into the hundreds of billions, it certainly will matter.

As we engage China, they will play hardball and by another set of rules. Our best defence is to look out for ourselves and our own core national interests.

Financial Post
Fen Osler Hampson is Chancellor’s Professor & Director at the Norman Paterson School of International Affairs, Carleton University. Photo: The Canadian oilsands are a target of Chinese investment. (KRT)

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