The Coming Trade War

By
Henry C.K. Liu

Part I:   The Coming Trade War and Global Depression
Part II:  Dollar Hegemony Against Sovereign Credit

Part III: Trade in the Age of Overcapacity
 
This article appeared in AToL on July 8, 2005


Neo-liberals have created a false dichotomy between so-called command economies and market economies. The spurious distinction is propagated by ideologue free traders in order to give market fundamentalism an aura of truth beyond reality. Market fundamentalism is the belief that the optimum common interest is only achievable through a market equilibrium created by the effect of countless individual decisions of all market participants each seeking to maximize his own private gain and that such market equilibrium should not be distorted by any collective measures in the name of the common good. It is summed up by Margaret Thatcher’s infamous declaration that there is no such thing as society.

The fact is that in a world of sovereign states, all economies are command economies. The US, the Mecca of market fundamentalism, commands her alleged market economy in the name of national security. While the US tirelessly advocates free trade, foreign trade is a declared instrument of US foreign policy.  President Bush declares that “open trade is a moral imperative” to spread democracy around the world. The White House Council of Economic Advisors is organizationally subservient to the National Security Council. National security concerns dictate trade policies the US adopts for its economic relations with different foreign countries.  World trade today is free only to the extent of being free to support US unilateralism.  For the US imperium, the line between foreign policy and domestic policy is disappearing to make room for global policy. The sole superpower views the world as its oyster and global trade is to replace foreign trade in a global economy the rules for which is set by a world trade organization dominated by the sole superpower.

Free trade and national security

US trade policy with regard to China, the world’s fastest growing and most populous economy, is a case in point. The US is undecided on whether China is a strategic partner or a strategic competitor or a potential foe. National security concerns envelope the current controversy over the bid from a Chinese 70% state-owned enterprise, China National Offshore Oil Corporation (CNOOC), to acquire Unocal, a US-based independent oil company, even though 70% of Unocal asset and operations are located in Asia.  The proposed deal is subject to review and approval by the secretive Committee on Foreign Investment in the US (CFIUS), a federal multi-agency group chaired by the Treasury Secretary that rules on foreign investment on national security grounds. In 1988, Congress enacted the Exon-Florio legislation authorizing the President to suspend or prohibit foreign acquisitions, mergers, or takeovers of U.S. companies when there is credible evidence that a foreign controlling interest might threaten national security and when other legislation cannot provide adequate protection. The President delegated authority to review foreign investment transactions to an interagency group, the CFIUS.

Some members of Congress have publicly served notice to the White House that they expect the proposed deal by CNOOC to be dealt with as one with serious geopolitical dimensions that directly impact US national security.  The CNOOC/Unocal deal is precedent-setting because it moves the CFIUS beyond its normal high-tech concerns into strategic commodities. It is also a signal of a trend of more to come.<><>

In 1989, the President ordered China National Aero-Technology Import and Export Corporation, a People’s Republic of China aerospace company, to divest from MAMCO, which involved a US aircraft parts manufacturer.  This was the only case blocked out of 1,500 CFIUS notifications in 15 years.<>

In 2003, a negative review by the CFIUS caused Hong Kong-based Hutchison-Whampoa Limited (HWL), a publicly-traded multinational corporation, to withdraw from a joint bid in partnership with Singapore Technologies Telemedia Ltd (STT) for Global Crossing (GC), a distressed telecom carrier in bankruptcy, leaving STT as the sole acquirer of GC. STT was allowed to acquire GC because Singapore is considered an ally of the US.<>

Richard Perle, former Assistant Secretary of Defense for International Security Policy under Reagan, and one of the key architects of the War on Terrorism and the Iraqi War, had to resign from the chair of the US Defense Policy Board after it became known that he was lobbying on behalf of GC. Perle was reported to be helping to make it possible for HWL to overcome US national security concerns in order to buy the bankrupt GC. The FBI found at the time that selling GC to HWL would give it control of the world’s largest fiber optic network, and allow it to oversee existing contracts for secure Pentagon communications. Perle was to receive a total payment of $725,000 for his advisory work, $650,000 of which would be contingent on the sale going through. The neo-conservatives in the Bush administration, while aggressively militant to China on security issues, are solidly in bed with the neo-liberals on in the US business community with regard to trade with China.<>

According to New York Times columnist Maureen Dowd, Perle might have had a conflict of interest in that he was Chairman of the Pentagon’s Defense Advisory Board.  Perle defended himself: “Maureen Dowd’s view of this is very misleading. Ms. Dowd’s recent editorial suggested that I was retained to ‘help overcome Pentagon resistance’ to the proposed sale of Global Crossing to Hutchison Whampoa. That is not why I was retained.” Perle asserted that “I have not been retained by Hutchison Whampoa, nor have I been retained by Global Crossing to represent them in any way with the US government. I have been retained by Global Crossing to help them put together a security arrangement that is acceptable to the US government.”

In March 2003, an exposé in The New Yorker by Seymour Hersh that Richard Perle had improperly represented Saudi Arabian interests. Perle, in turn, has vowed to sue Hersh and the New Yorker for libel.In an effort to address national security concerns, the prospective purchasers offered to place GC’s US assets within a “secure” domestic subsidiary staffed by US persons. When that proposal did not persuade CFIUS, the parties withdrew their application and re-filed after formulating a new plan whereby HWL’s ownership interest in GC would be held in trust by a proxy group of four distinguished US citizens who would exercise HWL’s voting and corporation governance rights. This arrangement would reduce HWL to a mere passive investor in GC, an option that caused many foreign investors in previous deals to abandon their proposed acquisitions. Usually, such concessions have been sufficient to garner CFIUS approval. However, CFIUS has decided to conduct a full 45-day investigation of the GC transaction, which implies that CFIUS was not satisfied with the latest arrangements. Following this announcement, HWL dropped its bid, leaving STT to proceed alone.

HWL, a venerable century-old China trade firm dating back to the British empire, is now controlled by Hong Kong tycoon Li Ka-shing who has just donated $40 million to University of California at Berkley. HWL is a leading international corporation with businesses spanning the globe. Its diverse array of holdings ranges from some of the world’s biggest retailers to property development and infrastructure to the most technologically-advanced and market-savvy telecommunications operators. HWL reports consolidated revenue of US$23 billion for 2004. With operations in 52 countries and about 200,000 employees worldwide, Hutchison has five core businesses: ports and related services, telecommunications, property hotels, retail and manufacturing and energy and infrastructure.In 1991, HWL acquired the United Kingdom’s busiest port, the Port of Felixstowe, without political opposition. Reflecting its global expansion and internationalization, Hutchison Port Holdings (HPH) was formally set up in 1994 to hold and manage the HWL’s ports and related services worldwide. Since 1994, HPH has expanded globally to strategic locations in 19 countries throughout Asia, the Middle East, Africa, Europe and the Americas. Today, HPH operates a total of 219 berths in 39 ports along with a number of transportation related service companies. In 2004, HPH handled 47.8 million TEUs (Twenty-foot equivalent unit containers).

HWL is a leading global telecommunications and data services provider operating with a high growth strategy in 17 countries and territories.  Hutchison Telecommunications International Limited (Hutchison Telecom) has been listed on the Hong Kong and New York stock exchanges since October 2004, but not on any Chinese exchanges. Hutchison Telecom has a significant presence, and in many cases is a market leader, in developed or rapidly-growing markets in eight countries and territories, operating mobile networks in Hong Kong and Macau, Ghana, India, Israel, Paraguay, Sri Lanka, Thailand and Vietnam. HWL sold EUR1 billion in 10-year bonds on June 22, marking it the largest euro-denominated bond from Asia this year.  In November 2003, HWL raised a mammoth $5 billion in euros and dollars to a gargantuan $9.5 billion from five different offerings.

When the United States gave Panama full control of the canal on December 31, 1999, critics raised concerns about foreign influence and control over the canal’s operation, particularly during an international crisis. Congressman John L. Mica (R – Florida) gave a speech on April 27, 1999 entitled: “China’s Interest in the Panama Canal” in which he asserted: “Hutchison has worked closely with the China Ocean Shipping Company, COSCO. . . . [which] you may remember is the PLA, and the PLA is the Chinese Army, PLA-controlled company that almost succeeded in gaining control of the abandoned naval station in Long Beach, California. . . .”  The offer by HWL and COSCO to purchase the decommissioned military port of Long Beach, California failed after the US Department of Defense raised national security concerns over the proposed sale.

A June 1997 Rand report, “Chinese Military Commerce and U.S. National Security” stated: “Hutchison Whampoa of Hong Kong, controlled by Hong Kong billionaire Li Ka-shing, is also negotiating for PLA wireless system contracts, which would build upon his equity interest in PLA arms company Poly Tech-owned Yangpu Land Development Company, which is building infrastructure on China's Hainan Island.”<>

Prompting the national security concern was the alleged potential strategic reach of the Chinese military through the financial interests of Hong Kong billionaire tycoon Li Ka-shing, whose fortune and power were inaccurately linked by misinformed US politicians to his alleged links to the Chinese government. Panama Ports Company, a subsidiary of Hutchison Port Holdings of HWL, began a 25-year lease (with a 25-year renewal option) in1999 to operate port facilities at Balboa (Pacific side of the canal) and Cristobal (Atlantic side of the canal). This arrangement produces more efficient handling of shipping that benefits all shipping nations, including China, which is the third-largest user of the canal and sells more than $1 billion in goods a year through the Colón Free Zone.<>

A headline in the Miami Herald on August 25 1999 read: “Canal Deal Gives Strategic Edge to China, Critics Charge China-Panama Canal Deal Draws Scrutiny.” According to Miami Herald, “Li and his business empire are linked to several companies known as fronts for Chinese military and intelligence agencies. One of the companies has been indicted for smuggling automatic weapons into the United States. . . . Li has also been accused of helping to finance several deals in which military technology was transferred from American companies to the Chinese army.”

All these accusations were subsequently proved baseless by official US investigations. Anyone with knowledge about the history of the business world in Hong Kong knows that Li was a favorite son of British colonialism long before his cozying up to China. Li got his start in business exporting plastic flowers from Hong Kong to the US in the 1950s and later became a real estate tycoon in Hong Kong with the help of British-owned Hong Kong and Shanghai Bank (HSBC) which saw Li as a promising leader of a new generation of the comprador class the British were looking to nurture in post-war colonial Hong Kong. Li’s friendly overture to China was embarrassingly belated and undeniably opportunistic, and his sympathy for communism totally non-existent even today. Following the mode of many other successful international businessmen, Li has donated more than $100 million to medical research institutions in the US, Canada and the UK.

In October 1999, the Clinton White House publicly denied that billionaire Li Ka-shing was “working for the communists in Beijing.” The White house press secretary labeled such accusations as “silly” and dismissed them as “the kind of thing you see around here from time to time.” Most US corporations active in China are working hard to develop the same degree of cooperative relationship with the Chinese government and its state-owned enterprises. This includes IBM, General Electric, General Motors, Microsoft, United Technology, Boeing and many other big name defense and space contractors. Nevertheless, the propaganda effect on a US public long conditioned to view China with hostility lingered.

Taiwan also has a container-handling operation at Coca Solo, at the Caribbean end of the canal, and the Evergreen Group of Taiwan, which runs it, also has construction, port and hotel projects there. Ten Taiwanese companies are installed in the Fort Davis industrial park, and the Taiwanese construction company King Hsin submitted a bid to build a second bridge over the canal, at a cost of US $270 million. But the US is not concerned with Taiwan because it is a virtual US protectorate.

Panama Ports Company, a subsidiary of Hutchison Port Holdings of HWL, began a 25-year lease (with a 25-year renewal option) in 1999 to operate port facilities at Balboa (Pacific side of the canal) and Cristobal (Atlantic side of the canal). This arrangement benefits all shipping countries, including China, which is the third-largest user of the canal and sells more than $1 billion in goods a year through the Colón Free Zone.  Notwithstanding that HWL is not even a Chinese company and its shares are not traded in any Chinese stock exchanges on the mainland, HWl was accused of being closely linked to, or perhaps even directly controlled by China.  In reality, HWL investment in the canal is reflective of it attraction to commercial opportunities in Panama, rather than a threat from China to control the operations of the waterway. Taiwan also has an extensive business presence in the canal area. Besides, the Constitution of Panama reserves direct authority and control over the canal.  Chinese officials dismissed the idea that China is attempting to influence or take over the Panama Canal is "sheer fabrication with ulterior motives.” Chinese residents in Panama are descendants of immigrants who originally formed the main source of forced labor on the Trans-isthmian railroad. They now represent about between 4 and 8 percent of the local population depending on the definition of ethnicity as much integration has occurred through inter-ethnic marriages. This is about the same number of citizens as Panama’s indigenous peoples of the Kuna, Guaymie and Chocoe tribes. There are more US citizens living and working in China than there are Chinese citizens in Panama. With a history of being a main target of US embargo for more than three decades, China’s interest in Latin America is unrestricted access to trade and natural resources for all countries. From a Panamanian point of view, intervention by the US is a more credible threat than a Chinese takeover.

No free trade for oil

While the current rise in oil prices reflects systemic dynamics in oil economics (see The Real Problem of $50 Oil - May 26, 2005 AToL), many in US political circles find it convenient to blame it on a single component of increased demand by China and India.  On April 26, 2005, President George W Bush, meeting with Saudi Crown Prince Abdullah at his ranch in Crawford, Texas, told the press that “the price of crude is up because not only is our economy growing, but economies such as India and China’s economies are growing as well,” notwithstanding that the announced purpose of the US-Saudi summit was to get Saudi Arabia to increase production, the short fall of which was driving oil prices up.

The Vice Chairman of Chevron, the rival bidder for Unocal, publicly suggested that “this is sort of geopolitics we are playing here, not commercial business.”  He explained that Chevron would put oil on the market for sale to the highest bidder whereas a Chinese-owned CNOOC would use the oil it produces for domestic consumption that would yield “less oil on the world market which meant higher prices for US consumers.”  Yet CNOOC’s interest in Unocal is mainly in its natural gas reserves in Asia, which poses no national security threat to the US. North American gas supply, counting both US and Canada, faces no shortage. Both the US and China are rich in coal which generates more than half of the electricity in both economies. In a public statement, Fu Chengyu, Chairman and CEO of CNOOC reaffirmed that substantially all of the oil and gas produced by Unocal in the US will continue to be sold in the US, and the development of properties in the Gulf of Mexico will provide further supplies of oil and gas for US markets. Fu also repeated the commitment on behalf of CNOOC to retain the jobs of substantially all of Unocal employees, as opposed to Chevron’s plan to lay off redundant employees after the merger, especially in the Unite States.  Secretary of State Condoleezza Rice was a director of Chevron for a decade before joining the Bush team, and even had a Chevron tanker named for her.

It’s a tossup how the CFI will eventually rule, assuming CNOOC can put together the winning financials to request a CFI ruling.  There are reservations in China that CNOOC may be forced to pay too much for a company that is worth less than $1 billion even at high current energy prices.  But the CNOOC/Unocal deal is an early signal of a rising trend, which has already ignited a visible split between anti-China forces in some faction in the US political establishment and the pro-trade forces in the US business community which view China as a great market the US cannot afford to pass up. To China, a negative ruling will look as if the US will welcome China to buy as much oil as it needs at market prices, but not will welcome it to own any oil resources even if such resources are not critical to US national security. Yet, the history of the US using the supply of oil as a geopolitical weapon is long and obvious.  It was a key factor behind the Japanese attack on Pearl Harbor in 1940. Further, even on a commercial basis, the US for decades had restricted the export of domestic oil to keep domestic prices lower than world prices. Now it is trying to prevent China from doing the same.

And in the two decade since China began to integrate its economy into the global economy, China has received far more foreign direct investment (FDI) than it has made overseas.  In 2004, China received $61 billion of FDI while Chinese companies invested only $3.6 billion overseas, even when China has become the world’s second largest creditor nation with foreign exchange reserves of over $660 billion by the end of March 2005.  Congress is heading towards a vote to impose a 27.5% tariff on Chinese goods if China does not revalue the yuan at the command of the US, despite Federal Reserve Chairman Alan Greenspan’s public warning that the yuan’s revaluation would have no significant impact on the US trade deficit and job loss and that protectionism against China would put the US economy at risk for no discernable purpose or advantage.

There are those who argue that Chinese companies would be welcome to participate freely in the US market if they were not state-owned enterprises (SOE) controlled by the Chinese government.  The counter argument is that allowed Chinese SOEs to invest abroad will accelerate the withdrawal of government control over commerce in China. Besides, European and OPEC member state-owned enterprises routinely participate in international mergers and acquisition. Every US oil company, including Chevron, is also eying business opportunities in the development of Chinese offshore oil exploration.  Many major US corporations are aggressively trying to invest and acquire Chinese government-owned companies in China. It is hard to argue that Chinese government-owned companies should not be allowed to acquire US corporations in the US. Thus the argument of a two-way street is a strong one.

British Nuclear Fuels plc (BNFL), owned by the British government, acquired without controversy Westinghouse Electric Company, the commercial nuclear power businesses of CBS in 1999. (Westinghouse acquired CBS in 1995).  Britain is of course an ally of the US.

On a trip to China last April to discuss high-stakes issues of terrorism and North Korea nuclear proliferation, Vice President Dick Cheney made a pitch for Westinghouse’s nuclear power technology. At stake could be billions of dollars in business in coming years and thousands of jobs in the US. The initial installment of four reactors, costing $1.5 billion apiece, would also help narrow the huge US trade deficit with China. China’s latest economic plan anticipates more than doubling its electricity output by 2020 and the Chinese government, facing enormous air pollution problems, is looking to shift some of that away from coal-burning plants. Its plan calls for building as many as 32 large 1,000-megawatt reactors over the next 16 years.

The US Department of Energy reported in March 2005 that Chinese industries were energy intensive with significant economy-wide waste. The country uses three times more energy per dollar of its GDP than the global average and 4.7 times more than the United States. Westinghouse faces French and Russian competition in contracts for third generation China National Nuclear Corporation (CNNC) plants at Sanmen (Zhejiang) and Yanjiang (Guandong) to be awarded this year. Recognizing that nuclear technology sales to China would help address massive US trade imbalance with China, the US Nuclear Regulatory Commission has cleared the transfer of technology while the US Export-Import bank has approved $5 billion in loan guarantees for the Westinghouse bid. Domestic political opposition to US participation in the China nuclear power program is mounting to stop the pending deal. Meanwhile, Chinese planners are warning investor to exercise caution to avoid blindly over-investing in the Chinese energy sector.

The reason the US never got excited about Japanese and German acquisition of US assets is that these countries, as once-defeated nations and now-subservient allies, know their place in the pecking order in geopolitics enough to voluntarily restrict their acquisitions to non-strategic real estate, and stay clear of strategic sectors such as oil.  The Japanese and Germans have dutifully kept themselves restricted to oil trading and refrained from aspiring to be owners of oil assets, a sector reserved exclusively for Anglo-US interests as war trophies.  But the Chinese, encouraged by US neo-liberal advisors to imitate the US model of globalized business strategy, are beginning to accept the propaganda of free trade to assume the audacity of daring to buy into US strategic assets with the fiat dollars they earned in their trade surpluses with the US.  China appears to be tired of merely holding US papers, and want some real asset for a change in return for shipping real wealth created by cheap Chinese labor to the US. The zealous convert, who has become a fervent believer in the God of free trade, is challenging the Pope. US policymakers are beginning to realize that a capitalist China in a neo-liberal world order is by far more of a threat to US national interests as a superpower than a communist China in the Cold War.

The June 24, 2005 Wall Street Journal reported that celebrated economist Kenneth Courtis, Vice Chairman of Goldman Sachs Asia and outside director of CNOOC, caused a postponement of the initial planned $16.7 billion offer in April.  The delay opened the way for Chevron to strike a deal to buy Unocal instead, causing CNOOC to have to bid in June $2 billion more than it had contemplated in its initial offer in April.  Courtis, an expert on Asian economies, had been humbled by facts divergent from his optimistic pronouncements on the Japanese economy at its strongest in 1989 with regard to strong future prospects, which promptly began in a downhill slide ever since.  His bullish projections on the continuing growth of Asia just before the Asian financial crisis of 1997 proved to be another embarrassment. But economists are like cats with nine lives who can afford to leave clients who followed their bad advice to perish while they themselves move on to new theories. Courtis, the free-trade enthusiast, resurrected his tarnished reputation by playing a revisionist role against market fundamentalism in the decision of the Hong Kong government to make a defensive “market incursion” to ward off manipulative speculation of the Hong Kong market by overseas hedge funds.  The Hong Kong Monetary Authority, with a war chest of over $100 billion, easily demolished the hedge funds by using $18 billion in three days to stabilize the Hong Kong equity market where the normal daily trading volume was only around $1 billion. For three days, Hong Kong, consistently voted by the Heritage Foundation as the world’s freest market economy reverted back to a command economy to protect its stock market from the destructive effects of manipulation by hedge funds on the fixed exchange rate of its currency.

While no outsider knows why Courtis recused himself on the CNOOC decision, it would not be unreasonable to suspect that geopolitics was part of the consideration.  For a Chinese state-owned enterprise to buy a US oil company might have been a bridge too far at this time in view of rising hostility in US domestic politics toward China.  After all, do the Chinese, with thousands of years of sophisticated political culture, and decades of exposure to Marxist theories, not know that free trade is merely a slogan in US policy?  Or is China, advised by US neo-liberals, simply making the US face its own music?

General Motors and China

China has also become something of a whipping boy in the US debate about job loss to nations with super-low wages, based on a misguided conclusion, springing from the recent growth of China's trade surplus with the United States to $124 billion in 2004. Total US trade deficit for 2004 with all countries was $666.2 billion in 2004, $164 billion of which was in oil import at an average price of $32 per barrel. What has happened is that other Asian exporting economies, notably Japan, Korea, Taiwan and Hong Kong, have moved much production to mainland China on products destined for export to the US. So China’s trade surplus with the US has soared while US balance of trade with other Asian economies has flattened or dipped slightly.

The Chairman of Toyota Motor Corporation, Hiroshi Okuda, is urging Japanese automakers to raise prices or find other ways to level the playing field for ailing US rivals General Motors and Ford in hopes of heading off a possible protectionist backlash in the crucial North American market. The world’s largest automaker, General Motors, had $52.6 billion in cash and marketable securities on its balance sheet at the end of the first quarter 2005, even as it reported a $1.1 billion net loss for the quarter. The GM finance unit, GMAC, made $729 million profit in the first quarter. And even though GMAC commercial paper was cut to junk bond status along with the debts of the rest of the company, the finance unit still has sufficient access to cheap capital to keep posting strong profits going forward. But GM has serious enough problems that its executives would not even project when it might return to profitability. The downgrade to junk bond status is one warning sign. Another is its market capitalization sliding below $19 billion, well below its cash on hand of $52 billion, with a debt of $300 billion. This means investors are saying that the company has negative value if its cash is taken out. By contrast, and as an indication of a bubble economy, Google’s market capitalization, less than 11 months since its IPO, has topped $81 billion, trading at 50 times estimated earnings, compared to 22 times for Time Warner, 21 times for Disney and 19 times for Viacom.  Google sales in 2004 totaled just $3.2 billion while Time Warner stood at $42 billion. GM sales in 2004 totaled $193.5 billion with net income of $2.8 billion, yielding a market capitalization of only 6.8 times of earnings.

The problem is that GM’s key product -- its gas-guzzling sport/utility vehicles -- are seeing declining demand that has forced the company to step up the cash-back offers needed to maintain sales.  That should not have been a surprise, given rising gasoline prices that are not expected to moderate because of a shortage of refining capacity. But GM has not responded effectively to sudden market changes. Instead of introducing new vehicles to fit new market conditions, it has tried to keep sales of unpopular vehicles strong through ever-increasing financial incentives. It is very unwise for a high-cost producer to lead a price war. The result was financial loss accompanying market share loss to more cost-effective foreign competitors.

GM is in talks with the United Auto Workers union (UAW) over its health care costs, which cost GM an average of $1,500 more per vehicle than that of foreign competitors, even on cars and trucks made at the Japanese automakers’ US plants.  Some observers thinks the best alternative could be to file for bankruptcy protection, and try to have the court force health care savings and other cutbacks on the UAW. Another alternative is that only the auto operations file for bankruptcy, thus preserving the corporation’s finance unit and other assets, such as its horde of cash. The rating agencies and stock market are sending a clear message that they think GM will continue to lose money for the foreseeable future and eventually go bankrupt. Bankruptcy is a defensive strategic option or an unavoidable eventuality.

But even the profitability of GMAC, the finance unit, would be under threat as the Fed raises short-term interest rates.  The rising cost of funds will make it more difficult for GMAC to offer attractive financial incentives to sell unpopular GM cars.  GM has been following the strategy of GE to try to turn itself into a global finance company which incidentally also manufactures, selling its uncompetitive manufactured products with aggressive compensatory vendor financing. This finance game has overtaken the entire US economy where all the profit is being made by the financial sector, while its manufacturing base in the US falls into decay through outsourcing to low-wage locations overseas.  GM’s strategy now is to be the finance and marketing arm of an auto sector in the process of being relocated from Detroit to China, while maintaining its profit margin from finance.

When the outspoken Toyota chairman said he feared the possibility that U.S. policy could turn against Japanese auto makers if domestic giants such as GM and Ford were to collapse, he was not being truly outspoken. “Many people say the car industry wouldn’t revisit the kind of trade friction we saw in the past because Japanese auto makers are increasing local production in the United States, but I don't think it’s that simple,” Okuda said in a press conference, “General Motors Corp. and Ford Motor Co. are symbols of U.S. industry, and if they were to crumble it could fan nationalistic sentiment. I always have a fear that that in turn could manifest itself in policy decisions,” speaking as the head of the nation's biggest business lobby, the Japan Business Federation.  But what was not said was that Toyota has a more serious hidden apprehension than a revival of US protectionism from the collapse of GM or Ford. What Toyota really wants is to keep GM manufacturing in the US where it can never achieve cost competitiveness, and not move its manufacturing to China with a new business paradigm to compete with Japanese auto makers there.

Okuda raised eyebrows and invited criticism on both sides of the Pacific with his call for fraternal aid to U.S. auto makers, such as by raising Japanese product prices, as US producers reel under massive health-care costs and sliding sales. It is a call for price signaling if not outright price fixing.  According to US anti-trust laws, inviting competitors to match your price increases can be illegal price signaling, says lawyer Jim Weiss, former head of an antitrust unit at the Justice Department.

GM has announce plans to cut at least 25,000 manufacturing jobs and close more US assembly and  component plants over the next few years. Both GM and Ford have been cutting back output as they lose sales to Asian brands led by Toyota, which now controls 13.4% of the US car market, the world’s biggest to date. But the China market is looming large as a new opportunity for GM, which ended 2004 with a market share of 9.3% in China.  The GM China Group includes seven joint ventures and two wholly owned enterprises in China. In 2004, GM’s vehicle sales in China grew 27.2% on an annual basis to 492,014 units, an all-time high.  China’s market is still in its infancy, with less than 5 percent of the population able to afford even a tiny car. GM Chairman and CEO Rick Wagoner predicts China will overtake Japan as the world's second-largest car market within five years.

Detroit Free Press columnist Tom Walsh reports that in 2003, GM and its Chinese partners made $2,267 per car sold in China while in North America, GM made about $145 per vehicle. GM and its Chinese partners had a combined net profit of nearly $875 million, or about $2,267 per vehicle sold in China.  In North America, GM's net profit last year was only $811 million on sales of 5.6 million cars and trucks in the United States, Canada and Mexico, or about $145 per vehicle.  That means GM China was nearly 15 times more profitable, per vehicle sold, than GM North America.  GM, for example, is selling Buick Regal models in China for more than $40,000 that are less powerful than a 3.8-liter, 4-door Regal sedan that costs about $24,000 in the US.

“GM is making money hand over fist in China, selling cars as fast as they can make them, at very attractive prices,” says Kenneth Lieberthal, a University of Michigan professor and China expert who was senior director for Asian affairs on the National Security Council under President Bill Clinton. “Most of the jobs lost to Asia were lost years ago. Now they're moving around Asia,” says Lieberthal.  “If what’s good for General Motors is good for America, as former GM President Charlie Wilson once said, China’s emergence as an economic powerhouse can’t be all bad,” writes columnist Walsh.

Okuda told the press: “If you think about GM's current output volume and vehicle lineup, laying- off 25,000 to 30,000 employees is inevitable.” But within a decade, GM could be again the world’s largest profitable car producer if its China strategy is successful. And its success is dependent on whether GM can become a truly multinational corporation instead of merely a transnational US corporation active in China. Chinese consumers will relieve the global overcapacity problem in the auto industry, but they cannot do so if transnational corporations continue keep robbing them of the consumption power by keeping Chinese wages low to siphon profits home.

GM has been closing and idling plants over the past four years and will have to cut its annual North American assembly capacity to 5 million vehicles by the end of 2005 from 6 million in 2002. Meanwhile, top Japanese auto makers are adding jobs and assembly lines in North America to meet shifting demand there at the expense of GM and Ford, but not the US economy, prompting executives, including Toyota President Fujio Cho, to dismiss concerns that their success would reignite a political backlash. Thus Okuda’s concern is not about US protectionism, a concern refuted by Toyota’s own president. It is about GM plans in China.

Car companies now are merely brand-name designers and assemblers of a generic world car.  All cars today are assembled from parts produced all over the world where they can be produced at the lowest cost. Different band-name designs package the same world car for varying appeals in different market segments, some for speed and power, some for styling and luxury, some for economy, etc. As US car-assembling giants face market resistance, US auto-parts companies have begun to fall like rows of dominoes, made worse by rising material and energy prices and uncompetitive wages. Recently, auto-parts supplier Collins & Aikman Corporation was the latest to file for bankruptcy protection, lining up behind fellow suppliers Meridian Automotive Systems, Tower Automotive Inc. and Intermet Corporation. Whether those companies and the others that might join them at the bankruptcy court will recover – and what form they will take after bankruptcy – is an open question. A restructuring of the entire US auto manufacturing industry and its supplier network is shifting the center of gravity outside the US, possibly to China.  Japan has its own ambitious plans for China where Japanese car makers have already invested over $5 billion. Honda Motors just announced that its joint venture in China has begun exporting made-in-China Hondas to Europe. This is why the Japanese, with their own ambitious plans in China, are thinking about helping Detroit, to keep a terminally ill competitor on anemic life support, not to ward off US protectionism, but to pre-empt unwanted US competition in China. A trade war between the US and China will play directly into Japanese hands, not to mention the EU.

The sudden decline in the popularity of SUVs - where US auto companies have for more than a decade clocked big profits in the era of cheap oil - has joined with rising material costs, mounting worker benefits costs and expensive unionized workforces to eat into huge chunks of the sector’s profits. Add to that the relentless pressure from foreign automakers, and the result has been a steep slide for any company that relies on the Detroit automakers for its bread and butter. In April, while North American auto sales rose, both GM and Ford sales of SUVs dropped – as did their total sales.

As the supply sector shrinks along with declining US automakers market share, an industry that once seemed ripe for consolidation is now plagued by the question of who would want to acquire companies in a sector that has had such hard time making money lately and in the foreseeable future. The pool of likely acquirers from within the sector is also dwindling as virtually the whole sector slides in concert. It is hard to consolidate when earnings are weak to non-existent, balance sheet weak, with no access to capital markets and equity merger and acquisition funds dry up. Buying auto-supply companies that are dependent on the struggling US automakers for its business is not the most attractive business proposition at this time for other companies. The only exception is a Chinese acquirer who may buy to facilitate opportunities in the Chinese domestic market and eventual entrance to the US market to increase long-term global market share rather than immediate return. But with current political controversy over Chinese acquisition of Maytag and Unocal, China will likely adopt a wait and see posture to see how US domestic politics on free trade plays out. This delay will make bankruptcy more likely to a host of distressed US companies in many sectors besides autos.

With General Motors’ significant cash reserves, it could be several years before the company is forced to face the music, despite its dwindling market share and mounting loss. With over $50 billion in cash, even with losses at the rate of $5 billion a year, it will take 10 years before GM runs dry. Long before that, GM’s China strategy may already bear fruit if no trade war erupts to derail its plan.

The steel and airline industries have dumped under-funded pension plans on the federal government’s Pension Benefit Guaranty Corporation (PBGC). The auto industry may be next. Beyond the airline industry, the federal insurance program faces tremendous exposure from the auto sector. PBGC says the pension assets of auto makers and parts companies fall short of the pension promises they have made to workers by up to $50 billion, more than the $31 billion shortfall in the airline industry’s pension plans.  A Credit Suisse First Boston analysis of pension plans in 54 US industries, based on 2003 public filings, ranks the auto industry’s plans the weakest of all. Half-dozen auto-supply companies recently sought Chapter 11 bankruptcy protection, which is likely to result in $837 million in unfunded pension obligations being transferred to the PBGC. A total of 26 companies in the auto industry have pension plans with assets that fall at least $50 million short of obligations.

The company that worries the PBGC most to date is Delphi Corporation, the Troy, Michigan, parts operation of GM that was spun off in 1999. Delphi’s plans have pension obligations valued at $11.4 billion but assets of only $7.4 billion. Delphi relies on GM for about half of its $28 billion in annual revenue and is saddled with high labor and raw-materials costs at the same time that GM's production is falling. PBGC calculates pension liabilities based on what it would cost to pay retirement benefits if the plans were terminated; companies give snapshots of the current health of their plans, often a rosier view. PBGC says that if Delphi were to turn over its pension plan to the agency today, the under-funding would total $5.1 billion rather than the roughly $4 billion indicated by Delphi. UBS suggested in a recent report that Delphi should consider a Chapter 11 filing, in part to shed its pension obligations and to pressure the United Auto Workers to help it cut costs. “Bankruptcy has become a management tool these days,” the UBS report noted.
 
Bush administration proposals to bolster PBGC finances could intensify the pressure on companies with low credit ratings. The plan calls for flat-rate premiums for companies to jump to $30 annually from $19 for each employee covered by a pension plan, and higher for companies with low credit ratings. It also seeks to limit the ability of financially weak companies to make new pension promises to workers.

Overcapacity and trade

Tapping into a growing China market will significantly contribute to less painful resolutions of these problems, both for the auto giants and for the government pension agency.  This is one of the reasons why Greenspan says anti-China protectionism hurts the US economy more than it helps and why the White House is dodging the CNOOC/Unocal controversy.  In an age of global overcapacity, the economies with large population and massive untapped consumer power hold the key to the future.  This presents a dilemma for US policy toward countries like China and India. On one level, the world economy needs to develop these populous markets to relieve global overcapacity; on another level, the rise of income necessary for such expanded consumption translates into a leveling of the power differential long enjoyed by the world’s sole superpower.  Suddenly, the needs of the global market to overcome global overcapacity with new consumers are turning against the traditional security and economic interests of the US.  In response, the US is turning back towards its own history of command economy. Emotional debates have emerged within US policy circles on the merits of globalized neo-liberal market fundamentalism versus the need for protectionist economic nationalism.

In some economies, such as the US, policymakers traditionally achieve their command objective through macro management while in others economies, such as Japan until the 1980s, Korea and Taiwan even today, policymakers prefer to do so through micro management. China has recently moved towards macro management of its economy, reportedly with some success, while the US, as exemplified by the ruling authority of FICUS that leads to presidential actions, appears to be reverting to a micro approach to deal with command economy objectives on a case by case basis. Policymakers in self-proclaimed market economies normally manage their policy objective through monetary and tax policies in accordance to macro-economic theories, but even then they do so with national objectives in mind. Such national objectives are known as national interests in policy nomenclature. For example, the Fed defers to the Treasury on determination of the proper exchange rate for the dollar. When market forces move against the Treasury’s view on dollar, moving it either too high or too low in relation to other currencies, the Fed supports the Treasury as a matter of national security in its effort to intervene in the market to bring the dollar back in line, or at least moderate the volatility. All nations employ industrial policy when it comes to defense and defense related sectors. And as military/civilian dual-use definition expands, more and more of research and development, high tech production, heavy manufacturing and strategic materials are removed from free trade to rely on government subsidies and procurement contracts.  Dual use restriction is one of the major factors contributing to trade imbalances between the US and China. Beyond dual use technology, the US has very little to sell. Free trade in the US perspective is not remotely the same as freedom to trade.

Market economies and privatization

The idea that market economies are governed by the unseen hand of the market is pure fantasy. The US has been relying on its petroleum reserves to moderate the rise in oil prices since 1973 and China is only beginning to realize the need of a national petroleum reserves.  And the idea that market forces always produce the best possible social outcomes or the best protection of national security is blatantly false. Without government control, markets merely become command economies that are commanded by powerful special interests. The aim of government command in all economies is to protect the interests of all the people fairly within the nation and to protect national interests beyond a nation’s borders. No nation will allow the market to threaten its national interests or security. The idea that market economies require privatization to operate effectively is also pure fantasy. Markets can operate quite well in socialist economies. All it needs is a different framework from capitalist economies. Some economies are privatized more than others. Even in capitalist economies, privatization is never total. Mutual funds are a sector of voluntary collective ownership. The insurance sector in the US used to be predominantly mutually organized companies, as were credit unions. They operated very well until laws protecting them were rescinded for ideological rather than economic reasons.

Privatization of social security is an oxymoron. It is either private security or social security, but not both simultaneously.  Historically, social security was introduced in the US after private security failed the average US worker in the 1930 depression. How on earth can private security in a market economy be expected to save social security when social security grew out of the failure of private security in a business cycle?   There is an iron law of the market: that when sellers outnumber buyers, prices go down.  Now, actuary problems of social security arise when the number of living retirees is growing faster than the number of tax-paying young workers, causing a bigger draw on the social security trust fund than concurrent contributions.  So if young workers buy stocks during their working years to provide for their future retirement and retirees must sell the shares they have accumulated over their previous earning years in order to live in retirement, and if retirees outnumber young workers by a wider margin with every passing year, how is the market going to rise with more sellers than buyers?

Even in the privatized sectors in capitalist economies, the government still decides what is profitable. In fact, it even decides what profit is, and how much to tax it. Much of the recent issues on corporate fraud have to do with illegally booking debt as profit to mislead the market. Free markets are free only to the extent within the rules of the game set by government. When governmental rules stay for long periods, they become invisible tradition and are accepted by market participants as natural conditions.  Generally accepted accounting principles (GAAP) have a large measure of government-defined concepts and measures in them. Most governmental rules that can be changed easily without political difficulty are changed rather forthrightly.  What are left are rules that for all kinds of political reasons cannot be changed easily by government.  War provides opportunities for governments to change these undesirable, obsolete or dysfunctional rules that are politically difficult to change in peace time. The private sector cannot launch wars to bring about preferred rules for enhancing profitability, but it can co-opt government policy toward war.  This is the economic basis for all wars.

Next: Scarcity Economics and Overcapacity