China, Dollars, and Commodities

The global view offered up in the pages of The Economist is a refreshing alternative to the news and opinion available from the mainstream media here in the U.S.

Such is the case in the most recent issue (which, sadly, is now more likely to arrive on Monday instead of Friday) where three stories tell of China's continuing impact on the world economy and their seemingly intractable problem of what to do will all those U.S. dollars piling up in their central bank vaults.

None of these articles require a subscription.

The first report describes their money woes, mentioning gold in a way that is not condescending and quoting Brad Setser of the increasingly popular (and increasingly bearish) office of Roubini Global Economics.

BY THE end of October China's foreign-exchange reserves are likely to top $1 trillion, twice their level two years ago and more than one-fifth of global reserves. This handsome sum would be enough to buy all the gold sitting in central banks' vaults (indeed, twice over) or almost all of London's residential property.

China's massive hoard is the result of its large current-account surplus, significant inward foreign direct investment, and big inflows of speculative capital over the past couple of years. In theory, flows of foreign money into China should push up the yuan, but China has resisted this, forcing the central bank to buy up the surplus foreign currency. The growth in reserves has slowed in recent months, but it is still averaging a hefty $16 billion a month.

China's official reserves already far exceed what is required to ensure financial stability. As a rule of thumb, a country needs enough foreign exchange to cover three months' imports or to settle its short-term foreign debt. China's reserves are equivalent to 15 months of imports and are six times bigger than its short-term debt. The explosion in reserves is also a headache for the central bank. It creates excess liquidity, which risks fuelling higher inflation, asset-price bubbles and imprudent bank lending.
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How that money is invested has big implications for the world economy, not just for China. Brad Setser, head of global research at Roubini Global Economics, estimates that about 70% of it is invested in dollars, mainly Treasury securities. This has propped up the dollar and reduced American bond yields—by up to 1.5 percentage points according to some estimates. A big shift out of dollars could therefore push up bond yields and hence mortgage rates, damaging America's already crumbling housing market.

What to do with all that paper? Buy things.

The continuing relationship with nations in Africa as described in this story paints a picture of industrious, level-headed businessmen and government officials creating relationships and striking bargains with those who are rich in natural resources, yet needy in other areas.

Let's have a meeting.

Next week China will host more than 30 African leaders from the wrong continent in Beijing, offering them a pinch of debt relief, a splash of aid, plus further generous helpings of trade and investment. China already buys a tenth of sub-Saharan Africa's exports and owns almost $1.2 billion of direct investments in the region. A Chinese diaspora in Africa now numbers perhaps 80,000, including labourers and businessmen, who bring entrepreneurial wit and wisdom to places usually visited only by Land Cruisers from international aid agencies.

What is in it for China? It no longer wants Africa's hearts, minds or giraffes. Mostly, it just wants its oil, ores and timber—plus its backing at the United Nations. Thus, even as the Chinese win mining rights, repair railways and lay pipelines on the continent, Africa's governments are shuttering their embassies in Taiwan in deference to Beijing's one-China policy.

Well, with nearly a trillion U.S. dollars in their coffers, that $1.2 billion figure can easily be increased in a meaningful way.

More meeting details are found in this report.

The summit in Beijing is being greeted by Chinese officials and the country's state-run media with an effusion reminiscent of the cold-war era, when China cosied up to African countries as a way of demonstrating solidarity against (Western) colonialism and of outdoing its ideological rival, the Soviet Union. It supported African liberation movements in the 1950s and 1960s, and later built railways for the newly independent countries, educated their students and sent them doctors.

China's main aim then was to gain influence. Now China wants commodities more than influence. Its economy has grown by an average of 9% a year over the past ten years, and foreign trade has increased fivefold. It needs stuff of all sorts—minerals, farm products, timber and oil, oil, oil. China alone was responsible for 40% of the global increase in oil demand between 2000 and 2004.

The resulting commodity prices have been good for most of Africa. Higher prices combined with higher production have helped local economies. Sub-Saharan Africa's real GDP increased by an average of 4.4% in 2001-04, compared with 2.6% in the previous three years. Africa's economy grew by 5.5% in 2005 and is expected to do even better this year and next.

Which countries are the main beneficiaries? For copper and cobalt, China looks to the Democratic Republic of Congo and Zambia; for iron ore and platinum, South Africa. Gabon, Cameroon and Congo-Brazzaville supply it with timber. Several countries in west and central Africa send cotton to its textile factories.

Oil, however, is the biggest business. Nigeria, Africa's biggest oil-producer, has been getting lots of attention. CNOOC, a state-owned Chinese company, paid $2.7 billion in January to obtain a minority interest in a Nigerian oilfield, and China recently secured exploration rights in another four. In Angola, which has now overtaken Saudi Arabia as China's biggest single provider of oil, another Chinese company is a partner in several blocks. China has shown similar interest in other producers such as Sudan, Equatorial Guinea, Gabon and Congo-Brazzaville, which already sells a third of its output to Chinese refiners.

It's all about the acquisition of natural resources for a large and growing nation that has little of their own. The downside?

The love affair with China, however, may be sour as well as sweet. For countries that do not sit on oil or mineral deposits, higher commodity prices make life harder. Even for producers there are risks. A recent report by the World Bank argues that Africa's new trade with China and India opens the way for it to become a processor of commodities and a competitive supplier of cheap goods and services to Chinese and Indian consumers. But another report, from the OECD, a club of industrialised countries, argues that China's appetite for commodities may stifle producers' efforts to diversify their economies. Oil rigs and mines create few jobs, it points out, and tend to suck in resources from other industries. And if Africa is to escape its vulnerability to the capricious movements of world commodity prices, it must start to export more manufactures. On this the World Bank adds its own warning: China and India must end their escalating tariffs on Africa's main exports.
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Some say China's involvement will erode efforts to promote openness and reduce corruption, especially in oil and mining. Nigeria insists that Chinese companies must respect its new anti-graft measures, and the latest bidding round for oil blocks in Angola has been the most open so far. In both countries it is unclear whether China's presence is making corruption better or worse. It is clear, though, that China is not interested in pressing African governments to hold elections or be more democratic in other ways. That helps to explain why China directs so much money towards Sudan, whose odious regime can count on China's support when resisting any UN military intervention in Darfur. China invested almost $150m in Sudan in 2004, three times as much as in any other single country. When American and Canadian oil companies packed their bags there, China quickly stepped in, drilling wells and building pipelines and roads. The Chinese are supposed to be building an armaments factory as well.

Comparing the global adventures of the world's current super-power with those of what many believe will be the world's next super-power really makes you stop and think.