Why the furor at the bid by China's third-largest oil company,
( UCL), the ninth-largest U.S. oil company?
What's the surprise? That oil-hungry China would buy an oil company? That the Chinese, who are swimming in U.S. dollars, would use them to buy something other than U.S. Treasuries, with their 4% yields? Were the Chinese just supposed to start burning piles of greenbacks to heat their homes and run their factories?
And the outrage? Because the Chinese are buying
oil? Hello! Unocal's most-valuable fields are off Thailand, Indonesia and Myanmar. Because our national security will be in danger if the Chinese get new seismic technology from Unocal? Hello! The Chinese already have nuclear weapons and routinely conduct underground tests of their bombs; they don't need to buy Unocal to get better seismic data. Or because, horror of horrors, CNOOC is getting below-market-rate loans from its government (we never, never do that to help U.S. companies) so that it can overpay for Unocal? Hello! Considering our trade deficit with China, don't we want it to overpay?
I say, bring 'em on. We need more bids like CNOOC's and the bid by
, China's largest appliance maker, for
( MYG). Let's sell more struggling divisions of our multinationals to Chinese companies, a la the purchase of
chronically money-losing PC operation by China's
. And I hope that some of the current rumors -- including that
Aluminum Corp. of China
is on the prowl for aluminum companies when stock prices are near the top for this commodity cycle -- turn out to be true.
World Economy Needs This Deal
The U.S., no, make that the world, needs more deals like this if we're to have any hope of recycling the huge dollar balances now building up in China. And those dollars have got to be recycled back into the world economy if the fragile monetary system that underpins global economic growth now is to have any chance of surviving.
Now, the global economy depends on U.S. spending. In the year's first four months, the U.S. bill for imports ran $229 billion above our receipts for exports. At that rate, the U.S. is on track for a record trade deficit of $686 billion dollars. (The old record, set in 2004, was $618 billion.)
But without that spending, the world would be looking at economic recession or worse. Europe isn't growing: The Organization for Economic Cooperation and Development pegs 2005 real economic growth at just 1.2% in the countries that use the euro. (Real growth is growth after subtracting the inflation rate.) Japan, at a projected 1.5% real growth rate for 2005, looks good only in comparison to Italy (-0.6% for 2005), Germany (1.2%) and France (1.4%).
Among the biggest economies in the developed world, only the U.S. is providing any real push to the global economy. And we're doing so in two ways: through our economic growth at a projected real rate of 3.6% in 2005, and through our spending on goods from China and India. Those two countries, with economies larger than Germany's, measured using purchasing-power parity to account for price differences in these three economies, are projected to grow by 9% and 8%, respectively, this year. The U.S. economy accounts for a big chunk of that growth. In April, for example, U.S. imports of goods from China climbed to $18.1 billion, a 12% increase from March.
We're China's Biggest Debtor
We're paying for these imports -- we're driving the global economy, if you will -- on credit. China, for example, sends us socks, golf clubs and furniture, and we send back dollars that we've borrowed. We borrow from just about every country in the world, but a big share of that borrowing comes from China. It's only just, I suppose, since we're China's biggest customer.
To simplify drastically, the current global economy is a giant round trip. Goods (and services) flow from everywhere in the world -- most importantly from our biggest trading partners of Canada (at 19.8% of our total trade, both imports and exports), Mexico (11.3%), China (10.1%) and Japan (7.9%) -- into the U.S. Meanwhile, dollars flow out from the U.S. into the economies and central banks of our trading partners.
This system works only as long as our trading partners are willing to take dollars and then lend them back to us. Without that recycling of dollars, the global economy would come to a grinding halt.
Our trading partners have been willing to do this because 1) it's in the interest of our trading partners to keep this system going, and 2) as the world's largest economy and dominant financial power, the U.S. is able to turn out a high-quality IOU.
Let me take the first of these two points first. Consider what China, for instance, gets out of this system. By lending us dollars so we can buy Chinese goods, the Chinese government generates economic growth that provides more jobs to its citizens. More jobs means less social unrest and more years in power for the current regime. It's a case of "You scratch my back and I'll scratch yours," but on a global scale.
Above Our Means
Although there's much gnashing of teeth here in the U.S. about the way this conveyor-belt economy results in U.S. jobs being shipped to China, and about the increasing level of debt it imposes on future generations, the U.S. also benefits. It's straightforward: We get to live above our means. People around the world are scrimping and denying themselves to save money. Then they send their savings to us so we can spend them.
Pretty neat, huh? Or it is until the bill comes due. At some point, logic tells us, people who live in the rest of the world will decide not to lend us any more money. They'll look at our national balance sheet and say, not another dollar in credit. Cut that deadbeat off.
That's where the quality of our IOUs comes into play. The better the IOU -- the more attractive it is to the creditor who will hold it -- the longer we can put off that day of reckoning. (Put it off long enough and, who knows,
might happen to get us out of this hole.)
The paper put out by the Treasury Department, for example, is a pretty high-quality IOU. Let me count the ways. The U.S. is very stable politically. Even when an election has to be settled by the Supreme Court, you don't see tanks rolling down the streets. Inflation in the U.S. is so low and generally so well-contained that investors don't have to worry about the real value of their Treasury note dropping. And finally, U.S. interest rates are relatively high. Hey, 4% on a 10-year Treasury note may not seem like much, but it sure beats 3.28% in Germany on a 10-year note or 1.26% in Japan.
Just Another IOU
There are, of course, limits to how much of even a high-quality IOU any creditor might want to hold. Prudence demands diversification. Hence the dollar's weakness last year when it looked like creditors had decided they held enough dollars and would buy IOUs in euros or yen instead. Just to be safe. (Fortunately for the U.S., Europe imploded into political crisis and staved off that threat for a while.)
And you can certainly understand their point. China's central bank holds about $700 billion in foreign reserves, and somewhere between two-thirds to four-fifths of that is in dollar IOUs. That might be enough concentration by itself to make a Chinese banker worried, but the problem keeps on growing. China will add about $250 billion to its foreign reserves this year and is likely to add another $250 billion next year.
Put yourself in the shoes of that Chinese banker: Would you want to put another $500 billion into dollar IOUs, even if you thought U.S. Treasuries were the greatest financial product since wampum?
Which, finally, brings me back to the CNOOC bid for Unocal and other recent Chinese offers for U.S. corporate assets. I think of these as another form of dollar IOU. A Chinese company can exchange dollars for oil fields or refrigerator plants. A deal like these looks very different from an IOU like a Treasury note until you look at the financing. CNOOC has offered $18.5 billion for Unocal.
If the deal goes through, CNOOC will take $3 billion out of its own coffers -- recycled U.S. dollars -- and borrow $7 billion from its parent company, Chinese National Offshore Oil, and $6 billion from Chinese banks, more recycled dollars. (The final $3 billion is in the form of a bridge loan from
J.P. Morgan Chase
That one deal, if it goes through, amounts to better than a month of our trade deficit with China.
There's a good chance that the U.S. is getting even more of a recycling bang for its buck from this deal. CNOOC is quite probably overpaying for Unocal. At the end of 2004, Unocal had total reserves of 1.75 billion barrels of oil equivalent divided between oil at 38% and gas at 62%. It's easy to understand why CNOOC wants to do this deal. It'll expand the company's reserves by about 80%.
A Steep Price
But it's not clear why CNOOC is willing to pay what it has offered. The deal values Unocal at 3.3 times book value. For comparison,
trades at 2.6 times book value, and
at 2.14 times. And once you figure in the high percentage of natural gas in Unocal's reserves -- and the relatively lower price of gas -- the cost of the acquisition comes to $15 a barrel.
That's well above the cost of other recent acquisitions.
( XTO), for example, just acquired 21 million barrels of reserves from
in western Texas and New Mexico for $200 million.
Congress, which has been issuing loud threats about the Chinese peril, should keep its hands off this deal and let the chips fall where they may among Unocal, CNOOC and
, the other bidder in the battle for Unocal. It's important because we need to establish that Chinese and other overseas creditors will be allowed to buy our assets without political interference and at inflated prices if they so choose.
That would go a long way toward establishing U.S. corporate assets as a quality IOU in the dollar-debt marketplace. The overseas investors who're lending us their profits and savings so we can spend them -- and keep the global economy going -- need to be assured that they will be able to cash those dollars in for oil fields, factories, real estate or whatever owned by U.S. companies. After all, who would lend to a debtor who, when it came time to pay, refused to honor the debt?
And a country that'll run up a $700 billion trade deficit tab this year can't afford not to honor its IOUs.
Changes to Jubak's Picks
hit my $77 target price for September just a little early -- in July -- and I'm selling the shares out of Jubak's Picks. If you're a long-term buy-and-hold investor looking for a big-cap, blue-chip vehicle for investing in oil services, you'll want to hold on to your Schlumberger shares.
But right now, I think lesser-known oil service and drilling stocks such as
offer larger potential gains: As an institutional favorite, Schlumberger tends to move up ahead of the rest of the sector and to sell at a premium to its peers. I'm selling with a 44% profit since I added the shares to Jubak's Picks at $53.89 on Jan. 16, 2004. (Full disclosure: I'll be selling my shares of Schlumberger after this column is posted.)
At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: Noble and Schlumberger.