China’s Export-Driven Economy: Is the Party Over?

Update II:

Judging from NewPage's testimony before Congress, the complaint was not a "direct attack on yuan undervaluation" as I characterize it below. NewPage claimed that the Chinese pulp and paper industry was benefiting from preferential government loans and preferential treatment from government-owned banks, and did not stake its claim on the broader issue of yuan valuation.

NewPage's SVP for Sales and Marketing testified:


The government of China provides very significant subsidies to its domestic paper producers, and these subsidies are injuring competing U.S. paper producers. Starting in the late 1990’s the government of China targeted its domestic coated paper industry for rapid development. As part of this development plan, the Chinese government provides low-cost policy loans through government-owned banks. It also provides grants for the development of new paper capacity, and tax breaks based on export performance and domestic equipment purchases. Moreover, government banks in China forgave at least $660 million in loans they had provided to China’s largest paper producer, Asia Pulp & Paper, when that company declared bankruptcy in 2003. The PRC has also fostered the development of timber and pulp production in China -- the key inputs into paper production -- with similar subsidized incentives. These subsidies have had the effect of vastly expanding China’s capacity to produce coated free sheet paper.

The Bush administration may have chosen to favor a complaint based upon a seemingly narrow grievance--loan policy--in order to forestall pressure to go mano-a-mano with China on yuan valuation.

However, it appears to me that the loan policy argument is so broad that virtually every industry can demand immediate relief. And once this principle of injury--and right of redress--is established on behalf of myriad private U.S. parties, it will be a lot harder to manage i.e. put the litigatory toothpaste back into 10,000 tubes--than negotiating a government-to-government deal on the yuan would be.


Update:

Another interesting data point, from the February 22 International Herald Tribune:

Meanwhile, the former secretary of the U.S. Treasury, John Snow, said that the United States could not force Beijing to allow faster gains in the yuan, and that dialogue was the best way to achieve appreciation.

"It's in China's own interest to continue to allow the yuan to expand in terms of flexibility," Snow, now chairman of Cerberus Capital Management, which is based in New York, said in an interview in Hong Kong. "I don't think we can force China to do anything."

Interesting, since the countervailing duty determination by the US government--issued in response to a complaint by NewPage, a paper firm controlled by Snow's firm--looks like a long-planned, confrontational measure to compel quicker revaluation of the yuan.

Thank you to China Redux to linking to my post, below, on NewPage, Cerberus, and the China CVD case.

I'd like to take this opportunity to acknowledge ChinaRedux and note its addition to my blogroll. Ben Landy cares about the same issues I do, and discusses them knowledgably and thoughtfully.

He also reads extensively and discriminatingly in the growing universe of high quality Asia blogs, so his posts also provide an excellent overview of what’s being said on topics of interest. His CVD post is a fine example.

I think that China may have been prepared for the risk that the export-driven party might soon be over, and I suspect it has contingency plans beyond fulminating at the Commerce Department’s CVD ruling.

It will be interesting to follow analysis in the media and on blogs as to how China responds to the ever-more-apparent threat of American protectionism, and this attack on one of the keystones of China’s success, its undervalued currency.

Also, thanks to commenter Will for the tip about John Snow’s recent visit to China.

I had blogged that Snow's investment group, Cerberus, holds the controlling interest in NewPage, the paper company whose complaint that China was subsidizing its competitors led to the whole CVD brouhaha.

Following up, I came upon a profile, Cerberus set to help China, India take flight-Snow, by Alison Tudor, Reuter’s impressively-titled Asia Private Equity Correspondent.

It was dated February 22, 2007, when NewPage was already hip-deep in the CVD complaint.

Mr. Snow unburdened himself of his strategic thinking:

Cerberus Capital Management LP, which has a mandate to invest across all asset classes and sectors globally, believes in China it could add significant value at state-owned enterprises.
Cerberus already has a presence in Japan and Taiwan, and is in the process of setting up an office in Hong Kong. Longer-term it may set up offices in Beijing and potentially India.

“Over time we hope to have a good footprint in India and China, probably China first,” Snow said in an interview with Reuters.

Good luck with that, John.

So I’ve been doing a little thinking about my previous assumption that the Bush administration was coordinating with Snow’s firm when it chose Cerberus affiliate NewPage as the test case for pushing the CVD ruling.

Maybe it was more like assisted suicide, with the Bush administration happily indulging John Snow’s desire to rush to the head of the line and catch spears in his chest for the sake of the CVD determination.

I wonder how incensing Beijing with a highly political and economically incendiary attack on China's export regime fits in with Cerberus’s business strategy.

Per Reuters, Cerberus wishes to stake its claim in one the great (potential) gold rushes of the early 21st century: M&A services to Chinese state-owned enterprises.

Think of those hundreds of billions in forex reserves, the inexperienced managers of SOEs longing to spread their wings overseas, the overvalued properties, the bidding wars, the fees!

Reading between the lines, I think the Cerberus pitch is that the sun is setting on China’s export-driven economic boom. Domestic capital and international political pressures dictate that China can no longer hide behind the wall of its undervalued currency.

So far, so good.

In the new age, it's a reasonable assumption that Chinese capital must flow overseas (and into the pockets of investment bankers).

After all, the Chinese government is tired of the headache of dealing with its mounting forex surplus.

It would like to see some of those billions allocated rationally by market forces and diverted to productive investments overseas, so that China’s economy is diversified and less vulnerable to economic and political risk.

Snow argues that his firm can play a special role:

Snow’s Washington savvy and connections will help its clients circumvent U.S. protectionism and close those rich U.S. deals:

China's companies are keen to spread their wings abroad but several big deals, such as Chinese oil major CNOOC Ltd.'s acquisition of U.S. energy producer Unocal, have run aground during the U.S. approval process.
...

Snow, an experienced politician and well-known name in Asian political circles, hopes to help smooth the way for Cerberus' co-investors.

“In the case of investments in the United States, we would bring a real understanding and sensitivity to the process. We know the rules of that game that could help co-investors avoid legal barriers,” said Snow, who plans to visit Asia three or four times a year.

Not so fast.

Here’s a trip down memory lane on the Unocal bid courtesy of the July 16, 2005 Washington Post:

Chevron's already formidable lobbying staff has been bolstered by a who's who of experts and Washington heavyweights: Wayne L. Berman, a top fundraiser for President Bush whose wife is the White House social secretary; Drew Maloney, a former legislative director of House Majority Leader Tom DeLay (R-Tex.); Kenneth J. Kies, a prominent tax lobbyist; former commerce secretary Mickey Kantor; Democratic trade experts Claude G.B. Fontheim and Kenneth I. Levinson; and David M. Marchick, a senior trade official in the Clinton administration who specializes in national security reviews by the high-level Committee on Foreign Investment in the United States.

All of the action is coordinated daily during an 8:30 a.m. conference call led by Lisa Barry, Chevron's vice president of government affairs.

"They're fielding a full team, and I think they're making all the right moves," said Todd M. Malan, executive director of the Organization for International Investment, which lobbies on behalf of foreign companies.

Unfortunately for Mr. Snow, the lesson of the Unocal deal is that both sides outfitted themselves with the best investment bankers, lobbyists, and lawyers available, and the competitor with the best gang--including a member of the Bush inner circle married to the White House social secretary--wins.

And Cerberus doesn’t look like the A-Team.

Aside from Snow himself—widely derided as an ineffectual, out of the loop empty suit as Treasury Secretary—what is Cerberus’s secret weapon?

Dan Quayle.

Cerberus also boasts former U.S. Vice President Dan Quayle as chairman of Cerberus Global Investments, a division of Cerberus Capital Management.

In any clash of the titans in the White House or on Capitol Hill, John Snow is probably going to get his and his clients’ lunches eaten.

In this context, the judgment of NewPage’s management—largely Cerberus appointees—in pushing the CVD suit is open to question.

Certainly, Cerberus wants to demonstrate to its Chinese clients an intimate knowledge of the regulatory, legal, and political pitfalls that await them in the U.S. market.

But is launching the CVD suit that has ignited Chinese anxiety and rage over its export driven business model really the way to do it?

I wouldn’t staff up that Beijing office too hastily, John.

Chinese Paper Chase: NewPage, the CVD regime, and John Snow

The application of the CVD (countervailing duty) regime to China over the price of coated paper is a big thing.

Anti-dumping penalties—the preferred mechanism in the past—made assumptions about Chinese costs and made the call that U.S. prices were below cost i.e. dumping.

The countervailing duty regime is an assertion that Chinese prices are so low because the Chinese government is subsidizing Chinese exporters.

And that means big, punitive industry-wide sanctions.

In the narrow sense, the CVD call is, I think, unfounded. The Chinese government doesn’t hand out checks to papermakers.

This decision probably finds its justification in the broader structural and political sense—that China’s exchange rate regime is a de facto subsidy to Chinese industry.

So if the CVD holds up in the final decision, there will be a swarm of complaints and CVD will probably apply to everything. Literally everything.

So it’s no surprise that the stock market sagged in response to a threat that the price of Chinese goods would rise 10%--20%--the countervailing duties awarded in the paper case.

Of course, despite Commerce’s assertion that this was just U.S. due process and not a matter for negotiation, there will undoubtedly be negotiation a.ka. a game of chicken, as the New York Times reports:

Although the tariffs imposed by the decision today are effective immediately, the action is subject to review by the Commerce Department, and a formal decision is due in October. But the administration’s position is not expected to change unless it is ordered to do so by a court or by the World Trade Organization.

The decision, however, is certain to become a focus of talks in the “strategic economic dialogue” begun by Mr. Paulson last September. The first meeting of top Chinese and American cabinet members to discuss a range of economic issues was in December, and another is due in Washington in May.

Mr. Paulson’s effort is aimed at getting China to move on a number of issues, including the suspected manipulation of its currency, that Washington regards as unfair.

I was very interested that a U.S. paper company would push such a theoretical, policy-heavy case—and a case that, if subsidies were narrowly understood, would probably have no merit.

But there was broad-based support for the move, again per the Times:

The NewPage complaint was backed in separate filings by leaders of several industries, including steel. The ruling on Friday was hailed by several groups critical of current trade policies, from manufacturers to labor unions to environmental groups, none of which have been very complimentary toward the administration on these issues in the past.

The steelworkers union—which represents most paperworkers—put its shoulder to the wheel.

Even the Sierra Club piled on, supporting NewPage's complaint with the sort of airy-fairy anti-business logic that would normally have Bush administration regulators spitting out their cigars with indignation:

The Sierra Club wants the Commerce Department to treat lax enforcement of environmental laws in foreign countries as a "subsidy" that the U.S. could counter with duties on imports.

So we’re looking at a complaint in which the importers’ lobby a.k.a. Walmart + is being countered by manufacturers + unions + environmentalists + nativist Republicans + China-bashing Democrats.

The Chinese probably regard this as serious business.

Why was NewPage leading the charge?

There’s an interesting answer.

NewPage, which filed the complaint, is a brand new company, a debt-laden creature that lumbered onto the papermaking scene by purchasing the coated-paper assets of MeadWestvaco.

It’s losing money ($20 million in the 4th Quarter) and, in a normal world, its $1.7 billion in debt would be seen as the explanation for its financial woes.

And it would not be regarded as the poster child for beat-on American mom-and-pop industries.


In fact, if you turned it around and looked at the way CEOs in debt-laden companies prefer to evaluated—EBITDA (Earnings Before Income Tax, Depreciation, and Amortization a.k.a. not taking into account the crazy stuff the investment bankers did), NewPage would have made $56 million in the 4th Quarter, a tidy payday, again not exactly an advertisement for government relief—or an indictment of Chinese dumping.

But NewPage has a special identity.

It is the creature of Cerberus Investments, an investment outfit run as of October 2006 by...

...John Snow, ex-Secretary of the Treasury, the go-to guy for browbeating the Chinese government on exchange rates before he handed the hot potato over to Henry Paulson.

Cerberus, in addition to financing the buyout of MeadWestvaco’s assets, also provided the company with its new President and COO, Rick Willett, and CFO, Jason Bixby.

Hmmmmm...


Wonder if there was any coordination there.

And in the best Bush tradition of “doing well by doing good”, Cerberus Investments holds interests in a raft of U.S. rust belt industries, such as Formica Corp., GDX Automotive, GMAC, and Guilford Mills, that should do very well if the countervailing duty craze spreads (although, to be fair, they do hold stakes in apparel and retailing companies that might take it on the chin under the CVD regime).

Cerberus also has a Taipei office (and no China office), something that the Chinese will no doubt note with some disgruntlement.