By: Dennis Behreandt
January 7, 2008

Rio Tinto is one of the largest, Western-based, multinational companies few people have ever heard of. Despite its relative anonymity, the company is nonetheless one of the most successful mining companies in the world with diverse and extensive holdings worldwide.

The company owns iron, copper, coal, and diamond mines around the globe, including in Canada and the United States. It also operates profitable uranium mines in Namibia and Australia. In November the company acquired major Canadian aluminum producer Alcan for more than $38 billion. Clearly, UK-based Rio Tinto is a company of immense strategic value as an important supplier of raw materials to industry. But, due to a large amount of debt, the company is up for grabs, and it just might wind up owned by the government of China.

Last November, the world’s largest mining company, Australia’s BHP Billiton Ltd., bid $137 billion for Rio Tinto, an offer the UK company rejected as undervalued. According to press reports, now the government of China may be interested in buying the company. Bloomberg News reported on December 10: “Blackstone Group LP is planning a bid for the mining company that may include China’s sovereign wealth fund.” Both Blackstone, itself partially owned by China’s sovereign wealth fund, and China have denied the reports. But in the shadowy world of mega mergers and acquisitions, such denials are often meaningless. Indeed, Rio Tinto is just the type of Western company the Chinese government has been coveting.

In fact, BHP Billiton’s offer for Rio Tinto was a shock to the Chinese, who have been battling Billiton’s market dominance in a bid to lock up energy and mineral resources. When the Billiton offer was announced, Fang Xiaodong, a top manager with China’s largest steelmaker, the state-owned Baosteel, insisted that the government of Australia block the deal. Fang complained about anti-trust concerns, but the most likely reason for China’s concern was that the new, larger firm would lock too many resources away from Beijing’s grasp.

Rio Tinto, if it ends up in the hands of the Chinese government, would only be the tip of the iceberg. After years of a profitable trade imbalance with Western nations, principally the United States, Beijing has the financial wherewithal to put itself into a position from which it can command the economy of America and, to a large extent, the world. As part of the process, it has the ability, and likely the desire, to purchase controlling stakes in many of the most important private companies in America and the West, effectively putting them under the control of Beijing.

Communist mastermind V.I. Lenin once said that Western businessmen, in an effort to do business with the millions living under communist control, “will close their eyes … and will thus transform themselves into men who are deaf, dumb and blind…. They will toil to prepare their own suicide.” Lenin didn’t live to see nearly the extent to which this would occur, but he no doubt would be impressed with the manner in which the Communist Chinese have maneuvered themselves into position to take ownership and command of the West.

Trade Trouble

How has it come to pass that Communist China, for decades a poor, backward nation suffering from the shortages endemic to socialist forms of economic organization, has come to be the financial powerhouse that verges on having the ability to control the capitalist economies of the West? In large part, the answer lies in a simple manipulation of the value of fiat money — that is, money that’s created out of thin air and is not backed by gold or silver.

Until 2005, China pegged its currency’s exchange rate to the U.S. dollar. In other words, instead of letting the value of its currency, the Yuan, be determined by market equilibrium between supply and demand for the currency, China essentially fixed its price. Moreover, it fixed the price far below what the value of the Yuan would have been if the market had been allowed to operate freely. Since 2005, China has allowed for some fluctuation, the amount of which is very tightly controlled. In effect, therefore, the Yuan remains fixed at a value far below what the market would likely dictate.

Because the Yuan is undervalued, you can get quite a few of them for a single U.S. dollar. This makes goods made in China relatively cheap for consumers bearing dollars and is a major reason that practically everything sold these days in the United States carries the “made in China” label. But every time someone purchases another item bearing that label it means dollars are leaving the United States and heading for the Far East.

Here’s how it works: in order to get that “made in China” item on the shelf at the local big-box retail store, someone had to buy it from a Chinese exporter. Chinese exporters do not accept dollars for such transactions. They do accept the Chinese currency, however. So the U.S. dollars being used to pay for the Chinese item are exchanged for Yuan. Then the Yuan are given as payment to the Chinese exporter and, after a while, the “made in China” item ends up on Main Street, USA.

So far so good, but the exchange of dollars for the Yuan needed to purchase the “made in China” item from the Chinese exporter resulted in increased demand for the Yuan itself. With quite a large number of such transactions being made, the price of the Yuan should rise relative to the dollar. But it doesn’t, because the Chinese central bank wants to keep its currency at the temporarily advantageous artificially low rate. To do this, says Harvard economist Greg Mankiw, “The Chinese central bank, seeing the pressure on the exchange rate, intervenes in the foreign-exchange market. To keep the Yuan from appreciating relative to the dollar, it supplies Yuan and demands dollars.” Simply put, the Chinese government buys dollars with Yuan, inflating the money supply in China and reducing the Yuan’s value.

In the long run, this is bound to have a terrible impact on the Chinese economy. In the short run, however, it is leading to an unprecedented era of easy money, very similar to that which has recently come to an end in America. Here, injections of dollars from the Federal Reserve made money easy to come by, leading to a rapid expansion of credit and a tremendous bubble of demand, principally in the housing market. That demand has now vanished, leading to the economic contortions that have become a regular feature on the front pages of the nation’s newspapers.

The same thing is happening in China and, sooner or later, the bubble will burst there as well. But it is not bursting yet, and China is still booming. Throughout its boom, the Chinese central bank has been vacuuming up dollars and flooding the world with Yuan. All of the dollars it has collected — and there are a lot of them — are held as foreign-exchange reserves. As of the end of September 2007, China reported that it held reserves totaling a mind-warping $1.43 trillion.

Buying the West

The 1.43 trillion-dollar question is, what to do with the money? One potential answer could be to use the money to destroy the economies of the Western nations — primarily the U.S. economy, of course — in one cataclysmic maneuver. This so-called “nuclear option” is just what Beijing hinted it might do if the United States continues to insist that the Yuan be revaluated to a level in keeping with its actual value.

“China has accumulated a large sum of US dollars. Such a big sum … contributes a great deal to maintaining the position of the dollar as a reserve currency,” He Fan, an official with the Chinese Academy of Social Sciences, said in August. China will probably continue to hold dollars, He said, before warning: “The Chinese central bank will be forced to sell dollars once the yuan appreciate[s] dramatically, which might lead to a mass depreciation of the dollar.”

Mass sale of China’s dollar holdings would be immediately devastating to the already shaken U.S. economy, but it would also immediately destroy the very advantageous trade position China currently enjoys with the United States. The “nuclear option” is little more than a threat, though it handily illustrates the point that China views the United States as an adversary.

The more likely course of action is that China will gradually invest significant portions of its reserves in the stock markets of the West — simply put, it will use its dollars to purchase American and other Western businesses.

The mechanism that China will use is one that has already been used by other countries that are flush with dollars as a result of trading on advantageous terms with the United States: the sovereign wealth fund (SWF). These are government-run investment funds, flush with cash in the form of dollar and other reserves. These funds are now being used by the governments of several nations including Russia, China, Singapore, Qatar, and Dubai to make large investments in Western corporations, ostensibly, like any other investor, to maximize returns on investments. In reality, the process represents a profound threat to both private property and to national sovereignty in the Western nations.

The dollar amounts foreign governments can wield through SWFs are staggering. In September, the London Times reported that SWFs “currently manage about $2,600 billion (£1,300 billion), eclipsing the $1,700 billion run by hedge funds. A further $4,400 billion is held in sovereign pension funds, which are likely to be managed by sovereign-wealth funds in the coming years.”

At present, SWFs control as much as 2.6 percent of all global assets. In 15 years it is expected that they will manage as much as $27,000 billion, or nearly 10 percent of all global assets. These are also huge considered individually. China, the London Times reports, “is creating a $300 billion fund that some believe could grow by a mind-boggling $250 billion to $300 billion a year.” These, it should be remembered, are billions of dollars that the Chinese communist government, through its SWFs, will be using to purchase shares of Western companies. To the extent that China purchases controlling interest in the companies whose stocks it is purchasing, the Chinese government will, in effect, be nationalizing Western industries.

Just the Beginning

China’s efforts to purchase Western corporations and assets through their SWF, China Investment Corp. (CIC), have only just begun, but CIC already has been involved in one high-profile transaction. In May, CIC invested $3 billion in purchasing a 10-percent stake in high-profile U.S. investment fund Blackstone Group LP. The purchase raised eyebrows, but a report on CIC and other sovereign wealth funds in The Economist magazine added some perspective.

According to The Economist’s analysis of the deal, when China was rebuffed over national security concerns in failing to secure the purchase of U.S. oil firm Unocal by state-run China National Offshore Oil Corp. (CNOOC), it began looking for a partner that would help cover its investment tracks in the future. Blackstone, according to The Economist, fits the bill. “It is quite possible that by purchasing a non-voting interest in Blackstone, China will be able to bypass the restrictions that might prevent it doing Unocal-style deals in Europe and America,” said the Economist report. “By choosing a private-equity firm, China will also be able to invest directly in a partner that … can keep many of its operations out of the public eye.”

China has good reason to want to keep its investment maneuverings out of public view. In testimony to the Senate Committee on Banking, Housing, and Urban Affairs on November 14, Dr. Gerard Lyons, chief economist and head of global research for UK-based Standard Chartered Bank, pointed out: “Chinese officials have suggested that the objective of [CIC] will include social and political returns.”

At the very least, such “social and political returns” might come through the ability of SWFs, like CIC, to manipulate the market. In his testimony to the Senate committee, David McCormick, the Treasury Department’s under secretary for international affairs, warned: “Sovereign wealth funds can represent large, concentrated, and often non-transparent positions in certain markets and asset classes. Actual shifts in their asset allocations could cause market volatility. In fact, even perceived shifts or rumors can cause volatility as the market reacts to what it perceives sovereign wealth funds to be doing.”

At the very least, the infusion of large numbers of dollars into our economy from the sovereign wealth funds will significantly inflate the number of dollars now circulating, devaluing the dollar and causing prices to rise, likely dramatically.

Even worse, SWFs can present a serious risk to national security because the nation behind the fund will be more likely to view its investments as part of a broader geopolitical strategy than simply as a vehicle for making a monetary return, as Dr. Lyons explained in his testimony. “Making investments for purely commercial reasons [is] one thing, but when they involve government owned funds and the stake is potentially strategic it is clearly another thing. The big worry is that these funds see an opportunity to acquire strategic stakes in key industries around the globe.” China, Lyons pointed out, was likely to use its SWF to lock down key strategic mineral and energy resources. “China stands out here,” Lyons warned, “given its insatiable appetite for all types of commodities, and not just energy.”

There is, however, another reason to be concerned about China’s investment objectives. Try as we might to forget the fact, China is still a communist nation. As such its ruling party claims that the working class should ultimately own the means of production. That’s a fine sounding bit of rhetoric, but what it means when put into practice is that the state, meaning the government, will own the major businesses and will radically restrict — or outlaw — private property. Moreover, communist doctrine has always taught that this nationalization of industry must happen, eventually, around the world. Now, sovereign wealth funds give a communist nation, like China, the ability to purchase private corporations in America and in other Western nations.

In his testimony to the Senate committee, Edwin M. Truman, a senior fellow at the Peterson Institute for International Economics, pointed to this unnerving possibility. “What is distinct about these trends is that they involve a dramatic increase in the role of governments in the ownership and management of international assets,” Truman said. “This characteristic is unnerving and disquieting. It calls into question our most basic assumptions about the structure and functioning of our economies and the international financial system. In the United States, we favor a limited role for government in our economic and financial systems; we have a market-based economy and financial system; we view central planning as a failed economic framework of the past; and we presume that most cross-border trade and financial transactions involve the private sector on both ends of the transaction.”

Unfortunately, Truman’s view that the United States possesses “a market-based economy and financial” system has become less and less true over time. It is also unfortunate, as Truman suggested, that the Chinese and others do not have the same view of freedom and market economics that we claim to hold in the West. “Our orientation is not congruent with certain facts,” he warned, “and we are being called upon to recalibrate our understanding of the world.”

That recalibration should include the fact that Communist China is an adversary that does not engage in trade with America and the West simply for financial gain. Instead, it aims for geopolitical dominance as part of its pursuit of long-standing communist goals. Sovereign wealth funds — and China’s in particular, therefore — represent a fundamental threat to America’s free-market economic system. If allowed to proliferate unopposed, in the future American workers might find themselves drawing a paycheck from the communist government in Beijing, and the country as a whole might find itself in the economic morass that inevitably follows the nationalization of industry in a centrally planned economy.

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