Can China be trusted?

John Garnaut's Sydney Morning Herald article of July 14, "China's Plan to use internet for propaganda" highlighted China's latest addition to the Central Propaganda Department's network. It also further discredits the reliability of China's official data releases and media reporting at a time when the decision makers of economies around the world are seeking fact and not propaganda to ride out the global economic crisis. These nations are relying on Beijing's claims of continuing record economic growth to plan their own economic recovery. To have that trust betrayed by blatant propaganda for the benefit of the Chinese Communist Party can destroy China's credibility as a future world power.

John Garnaut's earlier article of July 7, "Beijing Shuts Smelters to Meet Energy Targets" outlines Beijing's explanation for a slowdown in Australian ore exports as part of the CCP's strategy to combat climate change.

The article quotes the official line as the cause of the cutbacks and is just the latest effort in propaganda to conceal the real reasons for the slowdown in the mining and metals industries in China.

China's propaganda machine is also the primary tool to maintain domestic confidence in the CCP by promoting its grand plans and strategies.

The perception that Beijing's strategies or policies could fail is unacceptable and state media under the Central Propaganda Department direction reported the “energy” spin to deflect potential criticism away from the real cause.

Spin on decline in ore demand

Declining ore demand is real, but Beijing's spin infers the slowdown in the metals industries is due to China's efforts to meet its pre Copenhagen climate change commitments to reduce energy demand and greenhouse gas emissions. But this is a charade, designed conceal the truth and win support for China's unrealistic and unsustainable climate change strategies.

The smoke and mirrors behind the spin conceals the realities in the global market place and the looming disastrous effects of China's stimulus package, the prime mover in energy consumption and metals production.

The termination of stimulus spending in the first quarter of 2011 also terminates infrastructure, construction and property development and with it, China's own demand for steel, metals, cement, and glass used domestically and exported to developing nations for China's foreign investment projects.

One component overlooked in China's demand for ores was the role that China's speculative and quirky metal ore trading market played in driving the surge in iron ore buying by a steel industry focused on production rather than market forces and profitability.

Ore prices are in decline and steel mills are reducing inventories by buying from ore stockpiles at the ports and cutting orders for local and imported ores.

The cut back is not the result of shutting down the smaller inefficient and polluting mills across China. The cutback is a direct result of overcapacity, huge stockpiles, and the approaching end of stimulus spending, combined with Beijing's attempts to limit out-of-control bank lending and related bad debts.

It is also directly attributable to Beijing's restructuring strategy for the steel industry. Rather than decreasing capacity as a direct result of closures of hundreds of small, inefficient and polluting mills, capacity is rapidly increasing. This is in line with Beijing's declared objective of making China the world's largest steel producer by 2015.

The Ministry of Industry and Information Technology (MIIT) reported that from May 27 2010, Beijing would no longer provide financial support or approve projects that expand production capacity in industries already marked by excess capacity, high levels of energy consumption and pollution.

To see this in perspective, China's steel industry raised capacity in 2009 by 58 million tons to 660 million tons, and succeeded in achieving overcapacity of 200 million tons. As demand declines, that over capacity rate will continue to increase and mills will face mounting debt.

Beijing's inference that energy demand by the steel and aluminium industries is the cause of supply problems lacks credibility.

Thermal power

The spin ignores China's massive thermal power generation expansion and contribution from alternative energy sources, and where low dam levels in many areas have affected hydro generated power supply for some aluminium smelters, the major steel mill bases are less affected.

China's thermal power expansion is not only rapidly outpacing renewable energy development; total planned thermal capacity is further increasing to provide backup supply for wind and solar projects using large base load units.

The comment in John Garnaut's July 7 article on pricing decline on long-steel products, in fact merely reflects the decline in construction and the approaching end of China's major domestic and foreign rail construction program. While Beijing may be giving comfort to investors in the aluminium industry inferring resumption of "full production in 2011", it is ignoring the reality of the post stimulus economy.

Beijing needs an excuse for the cutbacks and hopes that by creating an image that China is sacrificing aluminium and steel production to reduce energy demand and emissions as part of its climate change "policy", it will win foreign support and confidence at home.

State-owned enterprises, local governments and manufacturers, embraced stimulus lending as the promise of quick profits from the property and stock markets. The sudden growth of divisions and subsidiaries of these entities produced a needed boost to balance sheet profits, replacing the core revenue stream and in many, corporations avoided trading losses. Unfortunately, these assets are still recorded at "book value", yet to be realised in the market place.

With property and stock markets declining and wages and conditions on the rise, Beijing has to factor in the impact of these events on its future economic strategy in falling property and stock markets and rising bank risk loans and bad debt.

Beijing is relying on incentives to move low-tech labour industries to the interior, and while this has the capacity to provide work closer to home for the rural migrant workers, Beijing will inherit the problem of unemployment and rising civil unrest in the adversely affected industrial centres along the east coast. The moves will also require supporting administrative, middle level management and trained technicians, not just the migrant workers.

Misleading information

While Garnaut's article on "China's Plan to use internet for propaganda" merely highlighted what was commonly known, it was timely and highlights the problems of relying on official data, or China's media releases for credible source material.

One example of this media propaganda was highlighted during the disastrous auctions of NPLs (non performing loans) by the asset management companies. A release by the China Banking Regulatory Commission reported "… the four AMCs [Asset Management Companies] had either written off or recovered, US$104.9 billion in NPLs ... of which only US$22 billion was recovered in cash."

How can the AMCs write off debt?

The Central Bank created the AMCs as warehousing organisations to acquire non-performing loans and assets from the four state banks in preparation for their initial public offerings (IPOs). The NPLs were "purchased" at full book value, paid for in part with cash loans from the Central Bank, plus 10-year bonds carrying 2.25 per cent per annum interest issued by the AMCs. The Central Bank also guaranteed the bonds to relieve the banks from further risk. The AMCs have no assets, but do have substantial unrecorded operating costs, the funding source unknown.

The only entity with the capacity to write off NPL related liability is the Central Bank itself.

A 2009 CBRC report stated that the AMCs were profitable. Then in June 20 2010, the CBRC revealed that the AMCs were insolvent and that Bank of China's AMC (China Orient) was unable to meet its bills due June 30, 2010.

State secrets

Another classic example of information concealment is the immediate deletion from internet notice boards of comments on currency losses on the foreign exchange reserves by the Ministry of Public Security, the operator of China's Great Firewall and part of the Central Propaganda Department network.

Then there is the information catchall of the State Secrets legislation that gives information any meaning that Beijing may wish. All information relating to the finances of state-owned enterprises, including the financial institutions and China’s economy as a whole, fall within the State Secrets net and require approval from Beijing prior to publication.

Ernst & Young was one high profile foreign entity that apparently experienced Beijing's wrath following the release of their 2006 Report on China's national debt. The report revealed that that exposure to NPLs by the four state banks seeking listing at the time of the report was US$911 billion, double official data and equal to 40 per cent of GDP. Under pressure from Beijing, Ernst & Young withdrew the report and publicly apologised, but released no details.

World Bank was also subjected to similar pressure following the compilation of their 2007 report, "Cost of Pollution in China", that revealed the extent of pollution related mortalities in China each year. Beijing rejected the report and World Bank reduced the numbers to 750,000 pollution related annual mortalities. Beijing also demanded the removal of the map identifying the related villages and provinces.

China's future

Regardless of the spin from China, John Garnaut's articles send clear warnings to Canberra and other nation's capitals to treat data from China with the credibility it deserves.

Australia may also be prepared to revise the anticipated windfall revenues from the new Minerals Resources Rent Tax, and its projected return to surplus.