Last night was the start of the Chinese Year of the Rat. Good fortune and good times are promised to the clever rat, who will have made many ambitious plans which will come to fruition this year. Yet the cat is said to be ever watchful of the rat who stole his place. I'm not sure who the cat is in this context – perhaps the Americans – but the rat is certainly China itself. Its many ambitious plans are already popping up all over the place.
So what precisely are China's motives in attempting to gatecrash BHP's assault on Rio Tinto, and, after yesterday's unambiguous rejection by Rio of BHP's latest offer, where does China's Chinalco go from here? Ever since its ill-fated attempt to break up the planned merger of Chev-ron and Unocal in the US, China has trodden warily in its overseas investment strategies. On that occasion, China's National Offshore Oil Company was sent packing after a fierce US political backlash.
The lesson was that though Western markets might very much like China's money, they mistrust her motives, which look too much like economic imperialism for anyone's liking.
Time then to try a different tack. As the world's biggest consumer of base metals, China has an obvious interest in the attempted merger of two of their biggest producers – BHP and Rio. The particular interest is in the production of iron ore, where BHP and Rio combined would emerge as one half of a duopoly in supply with the Brazilians. The possibly inflationary consequences of this for the Chinese development story are a legitimate and obvious cause for concern.
Yet there are a myriad of different competition regulators through which China could express these concerns and reasonably hope to secure satisfaction. Besides, it is not at all clear that a merger of BHP and Rio would in fact lead to higher prices. As things stand, the price paid by steel producers for iron ore is fixed annually in negotiating rooms between suppliers and users in an entirely untransparent way.
This has perverse consequences, one of which is that lower-quality iron ore traded in the spot market now costs roughly double its higher-grade, contract, equivalent. In a nutshell, the mining industry has not been investing fast enough in higher grade extraction to satisfy China's growing demand for the stuff.
BHP's contention is that this would be much more likely to happen if it were allowed to merge with Rio, creating eco-nomies of scale and providing better access to cheap capital. The cost to China of its iron ore supplies might therefore be lower than otherwise.
Few customers with any experience of dealing with monopolies would ever entirely accept this argument, yet there is another, perhaps more powerful, motive in China's intervention.
For better or worse, the mining industry is becoming progressively dominated by a relatively small number of national champions. China wants to match the emerging national champions of Brazil and Russia with its own, global players, bestriding the earth and marshalling its natural resource into the greater glory of the People's Republic. The two motives are in many respects one and the same thing. By seeking to secure supply, China hopes both to protect prices in its own interests and to put itself at the heart of these industries.
I write all this as if I have unrivalled access to Chinese Communist Party central committee thinking. Yet the truth is of course that I am only guessing, for Chinalco is giving very little away about its motives beyond saying that, like any other investor, it is looking for a decent rate of return. That's what all sovereign wealth fund investors say. The Western concern is that a more overtly political agenda lies behind the innocent façade.
As I say, the Chinese have learned to tread carefully. Not for them the confrontational style so beloved of the Russians. Instead they seek to influence affairs through established Western channels. Yet the pretence of passive investment shouldn't fool anyone. If China's only concern was to prevent the establishment of a duopoly in iron ore supply, there are plenty of legal channels through which these aims might be pursued.
China itself is rushing through a new competition law (something of an irony for a still-centrally directed economy) through which it could attempt to exercise jurisdiction over the BHP/Rio merger. According to Marius Kloppers, the chief executive of BHP, the process will have to address the concerns of more than 100 different national regulators before it can be concluded, which will likely take a year or more.
It may be that the conditions eventually demanded by the European Union, the US and China are so onerous that they undermine the deal's value-creative credentials and it therefore falls apart. Or they may seek to block the merger in its entirety. In any case, the line sometimes peddled by BHP, that it must become a national champion itself in order to counter the rise of the Chinese, Brazilians and Russians, is unlikely to cut the mustard among consumer nations. Only the Australians, where the bulk of the iron ore production in question is located, would be impressed by the national champion case.
As for Rio Tinto, it is entirely right to reject BHP's latest offer. There's almost certainly a bit more to come before BHP's powder is entirely dry, and nobody knows for sure what the Chinalco stake is about. Perhaps, backed by sovereign wealth fund money, it will bid for the lot. On the other hand, it is hard to imagine the Australians taking kindly to half their natural resource industry being owned by the Chinese. Nor would the Koreans and the Japanese, who also rely heavily on these sources of supply, welcome it with open arms. The situation has the potential to rekindle a whole mass of geopolitical tensions.
The rat is by reputation a cunning creature, yet, by choosing Chinalco as the front for the pursuit of perceived national interest, the Chinese risk being too clever by half. To pretend that this is something which it is not is disingenuous and only seems to confirm all the suspicions that those who hold free markets dear harbour over sovereign wealth fund investment.
This is not investment as we know it, where capital allocation is determined by the free market according to where it might be applied most efficiently, but a much more politicised, centrally directed process where men in grey suits in faraway places play god over the seething masses whose savings and future they hold in the palm of their hands. The British Government is being naive in thinking there is nothing to fear from sovereign investment. To the contrary, it has the power to wreak merry havoc with the way our companies, and therefore wider economies, are run.
Downsizing fate awaits the Rock
Well, there's a surprise. Both Virgin and the management bidders are planning to slash jobs at Northern Rock should they be selected by the Government to run the show. To the irritation of the Treasury, they have sought to shift the blame for this on to the various restrictions being placed on the business to safeguard the taxpayers' interest and to neutralise complaints from rivals over unfair state subsidy.
If there is no business to grow, say the bidders, then we don't need so many people working for us. Yet even if the Government hadn't hedged its continued support around with conditions, the idea that Northern Rock could simply sail on as if nothing had happened was always complete fantasy.
For the time being, the brand is a busted flush, unable either to attract deposits or finance new mortgages through the credit markets. A large proportion of the workforce is therefore already at a loose end and would have been axed whoever ended up in control and however loose a rein the Government allowed. The workforce's best hope was always nationalisation, for politicians don't like to do the downsizing themselves, particularly when there are votes at stake. If ministers restrict the bidders too far, it may yet come to that.Reuse content