History, not logic, wins with China
Thursday, 16 July 2009

COMMENTATORS on the Stern Hu situation should remember some history – and worry about the future. The Outcrop by Robin Bromby.

 

No one envies people locked up in prison, particularly a Chinese prison.

But the plight of the unfortunate Rio Tinto iron ore executive is tending to simplify the issue of relations between China and Australia when it comes to natural resources.

Yes, this is no doubt triggered by China’s loss of “face” over the Chinalco deal. But where everyone is making a big mistake here is in trying to apply logic.

Just this morning we read comments that the strengthening iron ore spot market shows China has over-played its hand.

True again – but irrelevant. Commercial considerations are not dictating the way Beijing plays its cards. To understand what is happening, you have to understand what has moulded Chinese thinking.

So it may just be the time to ponder two events in Chinese history – one 1100 years ago, the other 50 years ago – to see why Mr Hu is in this unenviable position, and to realise that we have got the tiger by the tail.

First, back to the year 907AD, the end of the Tang dynasty. China by this stage was accustomed to having vassal states surrounding it, states that did what Peking (as we used to call it) demanded, and whose rulers would kowtow to the Chinese emperor.

Japan was at one stage a vassal state and Korea was for centuries. Tibet, what we know now as Indochina and even central Asia, including what is now Uzbekistan and Tajikistan, also came into this category.

Now for the second event. Just 50 years ago there was Mao Tse-tung’s Great Leap Forward. This involved forcing all peasants into communes, but it is the metals aspect of this that shows another element of the Chinese experience.

About 1000 Chinese counties had some form of coal deposit and about 200 counties had iron ore. Mao’s idea was that every commune would have a blast furnace and suddenly China could double its steel production.

The problem for the counties without iron ore was where to get the iron ore. Well, they ended up feeding their shovels, rakes, pitchforks, plow blades and soup pots – even working machinery – into the furnaces to meet their quotas.

As Dean LeBaron and Donna Sammons Carpenter pointed out in their 2001 book, Mao, Marx and the Market, all these vital pieces of village equipment were melted down into a low-quality steel that was “fit for absolutely nothing”.

Hillsides were stripped for fuel to keep the furnaces going and fields were neglected as the peasants toiled at steelmaking.

An estimated 30 million Chinese perished during the Great Leap Forward, many through starvation.

So where is this history lesson going?

First, I suggest, Chinese political thought is still suffused with the concept of the greater China sphere of influence, of surrounding states (now apparently including Australia) owing deference to Beijing. They see Canberra and big companies like Rio Tinto as being the same, and both have offended the modern equivalent of the emperor. Some modern equivalent of kowtowing is required.

As to the second historical example, my theory is that we are seeing a modern-day version of the Great Leap Forward. Instead of ordering the peasants to build blast furnaces, Beijing is now attempting a top-down flood of money to stimulate economic activity, all $US586 billion of it.

But look at what has happened: much of the money has gone to the wrong places. The Shanghai stock index has risen by more than 70% with banks lending some of the stimulus money for speculation. Some of that cash, as I pointed out here recently, fuelled all that metals stockpiling. China’s housing sales have surged 45%.

On the other hand, exports keep falling, down 21.4% in June (year-on-year), following a record collapse of 26.4% in May. It is a dislocation of the Chinese economy every bit as grave as turning all the farmers into steelmakers.

We now see a rising flow of warnings that China is creating a credit bubble which is in imminent danger of bursting. While, this time, 30 million Chinese will not die of starvation, the consequences of such a financial debacle would be horrific, and the demand for our mineral commodities would plunge.

Then it would be fascinating to watch the fate of all the deals that have been done between Chinese companies and our miners and explorers. How many would be honoured?

What the Rio and Stern Hu case tells us is that China may have all these shiny new cities, but underneath it is the country that expected vassal state tributes and launched the Great Leap Forward.

The problem is, I suspect, that not too many of the people who have tied our miners to Chinese deals realise what they have let themselves in for.

Disclosure: the writer owns shares in Rio Tinto.

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