Wednesday, 12 September 2012

Chinese offshore purchases suggest economic bubble

It is almost a reflexive negative public reaction in New Zealand whenever a Chinese company purchases an otherwise proud New Zealand business. The North Island’s controversial dairy farms and this week’s Fisher and Paykel Appliance purchases are just two recent examples.

The circulating rumour is that China is buying up large and slowly taking over the world. Beijing certainly seems to be flush with cash from years of strong export profits and is ready to throw those funds into investments.

But why do they not like to invest domestically? This trend of capital flight reveals a less-than-optimistic attitude among China’s elites about the country’s financial future and its ability to safeguard their assets.

Chinese exports increased 2.7 percent year-on-year to US$177.97 billion in August, up from 1 percent in July, according to data released Sept. 10 by the General Administration of Customs. A slowdown in these indicators may point to a larger problem China is facing economically.

It is within living memory that the Japanese behemoth caused similar levels of fear as it purchased huge foreign companies and property. Tokyo knew in the 1980’s what the rest of us didn’t. If it were to invest domestically it would lose everything because the Japanese economy was in a bubble.

When it proceeded to collapse in spectacular fashion it was clear that Japanese investors understood the inherent weaknesses of their economy.

China has bought many assets in the United States such as property in Pebble Beach, the Bank of East Asia U.S.A. located in New York City, and the American whiteware manufacturer Maytag.

Indeed it was Fisher and Paykel’s new shareholder Haier that made the crucial offer of US$16 a share to purchase Maytag in 2005.

The cripplingly low price at which manufacturing or services can be provided has been termed “The China price”. Other countries and companies simply can’t compete with the China price if they wish to make a profit.

This term could also apply, in the inverse, to the way Chinese firms are buying well-known companies around the world at a much higher price than the company is valued, and are so quick to do so.

Daniel Gross of Slate magazine explained in 2005 that purchasing an established American whiteware company carries the added bonus of a well-known and trusted brand name.

For a new entrant, especially a Chinese company, breaking into a target market in a foreign country is incredibly difficult. It is much simpler to buy into a reliable brand like Fisher and Paykel or Maytag.

Below the surface worry of sending important intellectual and agrarian property overseas to a largely opaque country lies a deeper question about the reasons why China is investing heavily in foreign countries and not domestically.

Some have pointed to the looming point where the Chinese economy will outpace the American economy as if these numbers somehow prove Chinese predominance. If this economic success exposes anything it is that China’s miracle growth is unsustainable and probably short term.

This is because China is saddled with a billion people living in poverty, most living in conditions only experienced in sub-Saharan Africa. The United States is not experiencing poverty anywhere near these levels.

What is likely a blip on the American economic radar in terms of growth is equally anomalous for China. Beijing understands the importance of moving away from a GDP growth-oriented economy.

To continue this growth China must invest more than it consumes. Beijing is struggling to do this due to lack of quality domestic businesses and poor Chinese consumption.  So cripplingly cheap have Chinese exports been and so strong has Beijing’s policy of vigorous lending practises been for citizens that they have to turn to foreign investments simply as a store of wealth.

 As it develops, China is investing less at home and consuming more as living standards increase in the rich coastal regions. The dilemma for Beijing is balancing the inflationary pressures of lending with the threatened social instability resulting from high unemployment rates if that funding dries up.

Unemployed, hungry people do not author civilised letters to their mayors, they always riot. Beijing lives in constant fear of civil instability that it suppresses by supplying cheap lending rates to small and medium Chinese enterprises. These loans are almost always non-performing.

China is also feeling less competitive globally as other developing country’s cheaper goods and services begin to contend with them. Simply put, China is not the only country these days competent enough to deliver quality services and high tech goods at a cheap price.

It is unclear whether the rising Chinese middle class, who are consuming 25 percent of luxury goods by some estimates, can be domestically satisfied with Chinese manufacturing. Chinese industry relies on export capital for survival because its profit margins are so low, in some areas consistently running at a loss.

In this context, the Fisher and Paykel share purchase is a consistent Chinese trend. Yet as they buy overseas assets they are subtly showing not how strong their economy is, but its inherent weakness. Chinese double-digit growth rates were impossible to maintain indefinitely, they are falling now as the economy contracts dangerously.

The widening prosperity gap created by the Chinese elites through offshore investment decisions will further restrain the facility of the country’s poor and middle class to develop.

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