Money makes the oil flow in

China’s biggest export for the foreseeable future seems certain to be money. Outflows of capital have topped US$$600 billion over the past three years. A recent HSBC research report suggests that this will swell to US$420 billion annually by 2008, swamping the foreign funds coming into the country. The foreign exchange reserves kitty has now ballooned to a record US$875 billion. That presents a big problem and a bigger opportunity.

Vice Finance Minister Yi Long said at the Asian Development Bank meeting in Hyderabad earlier this month he didn’t like such high foreign exchange reserves. He indicated that the authorities were keen to both trim and diversify the money mountain. So far, the bulk of the surplus capital has been sunk into US treasuries. This makes the Americans nervous and is clearly beginning to bother the Chinese. The accumulation of reserves at such a pace contributes to the perception of the renminbi being grossly undervalued and raises the foreign political heat calling for a revaluation.

One possible course of action is to make jumbo acquisitions abroad. Until recently, the foreign currency required to fund this ambition had to be squeezed through a narrow window at the People’s Bank of China. Now the tellers are slowly opening this window to Chinese banks and institutions, encouraging companies to buy up corporate assets overseas.

Swap solution

The central bank has conducted the first of the necessary currency swaps with 10 commercial banks, exchanging US$6 billion for its equivalent in renminbi. These swaps are expected to become an increasingly regular feature and borrowers embarking on offshore expansion will get priority.

An even more cashed-up China will be scouring the world with a shopping list headed by energy resources, strong brand names and high-tech firms. We have had a taste of what is to come with China National Petroleum Corp’s US$2.4 billion acquisition of PetroKazakah, Baosteel’s US$1.4 billion steel-making joint venture with CVRD in Brazil, and the trail-blazing US$1.8 billion sale of IBM’s PC division to Chinese computer maufacturer Lenovo.

China’s buying spree will put the Middle East petrodollar plunges of the 1970s, and the subsequent Japanese capital invasion, in the shade. After all, much of the proceeds of the first oil shock were dissipated in London casinos, while the Japanese had a penchant for trinkets like Hollywood film studios. HSBC is making a safe prediction when it says: "China is likely to become the dominant source of global capital in the resource sector in the coming years."

The policy of securing supplies wherever possible is being pursued at the highest level. President Hu Jintao underlined this on a whistle-stop tour of Africa when he clinched an oil-for-infrastructure agreement with Nigeria. In return for drilling rights, China will build a hydroelectric power station and a fast-rail link between the capital of Abuja and Lagos. In a separate deal, China National Offshore Oil Corp paid US$2.3 billion for a 45% stake in a Nigerian oil field, while an oil exploration contract was also signed with Kenya.

China is getting sick of being a price-taker in the soaring commodities markets while its demand push has transformed whole economies. Australia is a key beneficiary with its booming stock market largely underwritten by its northern neighbor. When Premier Wen Jiabao visited Canberra in April, all was initially sweetness and light as Prime Minister John Howard finalized a deal to sell uranium to China.

No weapons allowed

Beijing cleared the way by agreeing to additional safeguards that the uranium would only be used for nuclear power generation. Australia boasts almost 40% of the world’s uranium deposits. It sells 12,000 tons a year to the US, Europe, Japan and South Korea. Exports to China are predicted to more than double that amount.

The breakthrough was greeted with euphoria in the mining industry where the most extreme reaction was claims that Australia would become "the Saudi Arabia of uranium". However, Wen unexpectedly left the script when he indicated the two countries should come up with a "pricing mechanism" to cover the sales expected to start in 2008. The Australian assumption was that the open market price would apply, where uranium has sprinted from US$10 a pound to US$38 over the past three years. The Premier then seemed to back-pedal from those remarks so the outcome is uncertain.

You can hardly blame him for the stance. Last year China paid US$18.3 billion dollars for the 275 million tons of iron ore it bought from Australia, a shocking 71.5% rise on the previous year. Traditionally the iron ore price is based on negotiation with the Japanese and European steel mills. This time around China has involved itself in the process and agreement on the price is overdue.

The spat will not last long – China has been investing in the Australian mining industry for over 20 years and no one in Canberra wants to kill the golden goose now that it’s fat with cash. No doubt with one eye focused on Beijing’s foreign currency reserves, the Australian government has opened its arms to Chinese uranium prospectors. It is even prepared to let Chinese-owned mines to set up within its borders.