from Follow the Money

Forget Unocal. China really wants Intel

July 27, 2005

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At least that is what "John Rutledge, a former economic adviser to President Bush" thinks. 

To maintain its competitive advantage, Chinese companies must acquire technology that will make the country more productive -- the real key to improved living standards.  That was the thinking behind Chinese computer giant Lenovo's purchase of IBM's (IBM ) PC division earlier this year (see BW Online, 5/9/05, "Lenovo and IBM: East Meets West, Big-Time"). It wasn't for the brand, which Lenovo only can use for a few years. It was all about the technology, according to Liu, who heads up the company's China business.

Bigger tech deals are on the way. "Chinese companies need to acquire top-tier technology in the U.S. and Europe. Buying second- and third-tier companies doesn't really help, because they don't boost productivity. What they really want to buy is Intel (INTC )," Rutledge says.

"They" also rather clearly won't be allowed to buy Intel, no matter how much of China's $750 billion in reserves is made available to Chinese tech firms. To be fair, the Business Week story goes on to make a set of far more reasonable points - in the near term, China will buy only smaller tech companies and China political system almost certainly would have to evolve before a Chinese firm can buy one of America's corporate crown jewels.

There is a strategic case that the US should let China buy Unocal.   China, after all, is emerging as a major oil importer - and compared to European and American majors, Chinese oil companies have relatively few offshore assets.  Sharing the oil pie - and getting paid for it - is a way to accommodate a rising China, a reasonable part of a broader "engagement' strategy.   Better for China to prospect for gas on the New York Stock Exchange than in Tehran, so to speak. 

As Lael Brainard and Michael O'Hanlon note:  

China's share of global oil production is modest and well below what it needs for its own consumption - a useful benchmark for assessing potentially troublesome dominance. Unocal accounts for much less than 1 per cent of global oil production (China's total assets account for well under 10 per cent). Rather than seeking domination of world oil markets, Chinese leaders probably want assurances over their energy supplies given their economy's extreme dependence on the resource. Moreover, given the amount of dollars we are putting in China's pockets through our enormous appetite for imports, we should not be surprised that Beijing would seek higher yielding investments than Treasury bonds.


Intel is a whole different story.  I think it would fit in the first two categories that Brainard and O'Hanlon set out - crucial technology and more specifically crucial computer technology.   

O'Hanlon and Brainard also focus on the real issue: the United States' growing overall financial dependence on a country that is neither democratic nor a US ally. 

The final benchmark is the question of overall economic dependence. Leaving aside the specifics about what trade the US carries out with China, it is not prudent to allow a huge share of the US economy to depend on favourable future political relations with one of the world's last great autocratic states. Although overall imports from China account for just 2 per cent of US gross domestic product, the nation depends heavily on China to finance its deficit. China's recent loosening of the renminbi is not likely to change the situation dramatically.   ... The Unocal bid has sparked a sobering debate on how much of the US - and the world - we can safely see controlled by a communist regime with a claim on Taiwan that the US is not prepared to concede and could well fight to oppose. Few issues will be as important or intellectually challenging for American policymakers in the ­decades ahead.

The Rutledge quote is not the only off the wall comment from a current or former government official that caught my eye this week.

I cannot believe that any member of China's monetary policy committee truly believes that China's capital controls are all that stands between China a massive depreciation, like other Asian currencies in 1997-98.

China won't make its currency fully convertible for at least five years because it worries hedge funds may force the yuan to plunge, much as happened to the Korean won and Thai baht during the 1997 Asian financial crisis, said Li Deshui, a member of the central bank's monetary committee.

``There's more than $800 billion to $1 trillion of hedge funds in the world and the Chinese financial system is relatively weak,'' Li, 61, said in an interview. ``If the (yuan) becomes fully convertible it would be attacked by these hedge funds.''

Li is right, without controls, China would be attacked. But by hedge funds betting on a revaluation, not a devaluation.  I don't think many funds would follow Lushkin's advice on this.  China - unlike Thailand, Malaysia, Indonesia and Korea back in 1997 - is running a rather significant current account surplus.  All the crisis countries were running deficits.  

There is a reason why every Chinese official in the world seems to be trying to discourage "speculation" on further RMB appreciation right now.

To be fair, right now China's controls both prevent Chinese residents move their savings out of the Chinese banking system and western residents from buying most Chinese financial assets (onshore assets that is).   I will speculate on the likely impact of a full lifting of the controls at another time -- but the debate is rather academic. As Li notes, China is not going to drop its capital controls anytime soon.  

No matter.  right now, it is fairly clear that China's controls currently serve to keep foreign - and even Chinese -- money out, not to keep Chinese money at home.  Chinese citizens took money out of China in 1998 and 1999 - they anticipated the RMB might be devalued along with other Asian currencies.  That changed, big time, starting in 2001.  Since then, more hot - often Chinese -- money has tried to get into China than to get out.  Chinese citizens with onshore dollar deposits are shifting their savings into RMB.    Chinese citizens with funds offshore (illegally) are moving them back (illegally) into China, even if that means placing their funds in "bad" banks. 

And to be honest, the risk of having a deposit in a state owned bank is a lot smaller than some commentary suggests.  So long as the Chinese government stands behind "its" banks, depositors won't take any losses on deposits in "bad" banks.  Remember: the US had a lot of bad "S&Ls" for a while.   China's taxpayers, not China's bank depositors, are likely to be left with the bill for its bad banks.

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