Wednesday, March 10, 2010

Was Stern Hu one of the few Australians who understood China? That John Garnaut article.

It was in the Herald Monday. Here's the text:

Barely a week goes by without another multi-billion dollar reminder of the gap between the supply and demand of credible information and analysis on China.

The information deficit is partly due to China's failure to improve the transparency and credibility of its statistics in line with the growth of its economy.

It is also linked to the Chinese state's efforts to constrain and distort the flow and interpretation of information internally and abroad, led by institutions such as the Department of Propaganda and the State Secrets Bureau.

But it is also because of a shortfall of impartial analytical capability in the rest of the world....


Three weeks ago, for example, the financial world was needlessly thrown into panic with headlines like "China dumps US treasuries" and "Japan overtakes China" after the US Treasury Department published interim foreign holdings data showing China's holdings of US government debt had fallen by $US34 billion ($37.4 billion) in December.

Reports suggested China was punishing the US for its many misdemeanours and was willing to escalate its war of words into the economic realm, with scary implications for the US dollar and the global financial system.

But the first-round Treasury data has always masked China's trading activity because it does not account for buying through proxies, such as investment houses in London.

Each previous time the data showed a fall in Chinese holdings, that fall has been more than reversed in subsequent survey data that includes purchases made through intermediaries.

You would expect that data about a $US2.4 trillion fund that was growing by $US50 billion a month would be minutely analysed and explained by investment bank economists. But some of the largest investment banks have an interest in not publicising information about China's State Administration of Foreign Exchange because it is a bountiful source of fees. SAFE officials have been known to go apoplectic at analysts who have dissected their buying activities, on the grounds that other traders will use the knowledge to move the market against them.

Brad Setser, an economist, had filled that vacuum with his authoritative blog on sovereign holdings, but the US President, Barack Obama, took him offline last year when he needed him in the White House.

So global markets and analysts had to wait 10 days to learn what was really going on, when the US published its revised survey data.

"Japan didn't surpass China to become the world's largest foreign holder of US Treasury securities in December, after all," said Dow Jones.

The China information deficit distorts Chinese policy making, too.

On Friday the Premier, Wen Jiabao, committed his government to employment targets that are almost meaningless, because China publishes no reliable statistics that they can be measured against. A source close to the National Bureau of Statistics says it has been piloting an urban household survey that will go some way to fill the employment data gap, but it may not be available publicly for years.

Indeed, it is a minor miracle that China's statistics are as meaningful as they are, given the bureau's paucity of manpower and the rubbish that it is fed to it from below.

"We had 20 people in our gross domestic product office, and in the last few years that's increased to 40, but it should be 100," says the source. "We totally ignore provincial numbers."

The terrain becomes more treacherous when it shifts from information to interpretation and judgment.

In the recent ASIC court case against Australia's richest man, Andrew Forrest, some saw testimony about the Chinese official He Lianzhong as evidence of China's ruthless, treacherous quest for control of Australian resources. But that clear picture would have been clouded or even inverted if seen in the light of Chinese-language reports that the same state planning official has been charged and jailed for 44 counts of bribery. It turns out that his mendacity was driven by personal rather than national profit, which implies a different set of challenges to Australia's national interest.

Some Australian companies that depend on China are improving their analytical capability, although most are yet to acknowledge that they have a problem.

There is not a single Australia-based scholar with up-to-the minute knowledge on either Chinese elite politics or macro-economics.

Last year Stephen Joske, previously the Australian Government's top China economist, said "there's no one in Treasury who can tell up from down on China, beyond what they read in the newspapers".

The four China-based journalists with Australian media houses, myself included, are hopelessly outnumbered by the range and complexity of events and trends that readers expect to be informed about.

The Reserve Bank is throwing its formidable resources at understanding how China's economic statistics work and has set up a China research team but, unlike Treasury, still has no permBarely a week goes by without another multi-billion dollar reminder of the gap between the supply and demand of credible information and analysis on China.

The information deficit is partly due to China's failure to improve the transparency and credibility of its statistics in line with the growth of its economy.

It is also linked to the Chinese state's efforts to constrain and distort the flow and interpretation of information internally and abroad, led by institutions such as the Department of Propaganda and the State Secrets Bureau.

But it is also because of a shortfall of impartial analytical capability in the rest of the world.

Three weeks ago, for example, the financial world was needlessly thrown into panic with headlines like "China dumps US treasuries" and "Japan overtakes China" after the US Treasury Department published interim foreign holdings data showing China's holdings of US government debt had fallen by $US34 billion ($37.4 billion) in December.

Reports suggested China was punishing the US for its many misdemeanours and was willing to escalate its war of words into the economic realm, with scary implications for the US dollar and the global financial system.

But the first-round Treasury data has always masked China's trading activity because it does not account for buying through proxies, such as investment houses in London.

Each previous time the data showed a fall in Chinese holdings, that fall has been more than reversed in subsequent survey data that includes purchases made through intermediaries.

You would expect that data about a $US2.4 trillion fund that was growing by $US50 billion a month would be minutely analysed and explained by investment bank economists. But some of the largest investment banks have an interest in not publicising information about China's State Administration of Foreign Exchange because it is a bountiful source of fees. SAFE officials have been known to go apoplectic at analysts who have dissected their buying activities, on the grounds that other traders will use the knowledge to move the market against them.

Brad Setser, an economist, had filled that vacuum with his authoritative blog on sovereign holdings, but the US President, Barack Obama, took him offline last year when he needed him in the White House.

So global markets and analysts had to wait 10 days to learn what was really going on, when the US published its revised survey data.

"Japan didn't surpass China to become the world's largest foreign holder of US Treasury securities in December, after all," said Dow Jones.

The China information deficit distorts Chinese policy making, too.

On Friday the Premier, Wen Jiabao, committed his government to employment targets that are almost meaningless, because China publishes no reliable statistics that they can be measured against. A source close to the National Bureau of Statistics says it has been piloting an urban household survey that will go some way to fill the employment data gap, but it may not be available publicly for years.

Indeed, it is a minor miracle that China's statistics are as meaningful as they are, given the bureau's paucity of manpower and the rubbish that it is fed to it from below.

"We had 20 people in our gross domestic product office, and in the last few years that's increased to 40, but it should be 100," says the source. "We totally ignore provincial numbers."

The terrain becomes more treacherous when it shifts from information to interpretation and judgment.

In the recent ASIC court case against Australia's richest man, Andrew Forrest, some saw testimony about the Chinese official He Lianzhong as evidence of China's ruthless, treacherous quest for control of Australian resources. But that clear picture would have been clouded or even inverted if seen in the light of Chinese-language reports that the same state planning official has been charged and jailed for 44 counts of bribery. It turns out that his mendacity was driven by personal rather than national profit, which implies a different set of challenges to Australia's national interest.

Some Australian companies that depend on China are improving their analytical capability, although most are yet to acknowledge that they have a problem.

There is not a single Australia-based scholar with up-to-the minute knowledge on either Chinese elite politics or macro-economics.

Last year Stephen Joske, previously the Australian Government's top China economist, said "there's no one in Treasury who can tell up from down on China, beyond what they read in the newspapers".

The four China-based journalists with Australian media houses, myself included, are hopelessly outnumbered by the range and complexity of events and trends that readers expect to be informed about.

The Reserve Bank is throwing its formidable resources at understanding how China's economic statistics work and has set up a China research team but, unlike Treasury, still has no permanent representative here.

The Office of National Assessments and Defence Intelligence Organisation have a core group of China specialists, but would no doubt love to increase their numbers.

Even the Department of Foreign Affairs pulls up short - nobody can think of an obvious candidate to fill the shoes of the ambassador, Geoff Raby, when his term expires this year.

So traders, analysts, activists and politicians are left to wander through the maze of partial-information to assemble almost any story they like about what China is and where it is going. And the public has to sort the credible from the half-true and the spurious, weighing what they see and hear against their own preconceptions of how China works.anent representative here.

The Office of National Assessments and Defence Intelligence Organisation have a core group of China specialists, but would no doubt love to increase their numbers.

Even the Department of Foreign Affairs pulls up short - nobody can think of an obvious candidate to fill the shoes of the ambassador, Geoff Raby, when his term expires this year.

So traders, analysts, activists and politicians are left to wander through the maze of partial-information to assemble almost any story they like about what China is and where it is going. And the public has to sort the credible from the half-true and the spurious, weighing what they see and hear against their own preconceptions of how China works.



And here he is on Stern Hu, and how he came to know more about part of China's economy than China did:

In the second week of last October, after the collapse of Lehman Brothers but before the global financial crisis was confirmed to have become an Australian economic one, Rio Tinto sent a survey team of more than 20 people across China to find out what was going on.

The fast deployment was evidence that Rio was more attuned to the dynamics of the Chinese market than either its competitors or its customers.

Rio's survey team was hired through a Shanghai consultancy called CBI, which markets itself as providing "a wide range of intelligence products".

Despite the self-puffery, CBI's mode of operation was not to give brown paper bags (or red envelopes) in exchange for state secrets or even commercial secrets. The contract and terms of reference made that very clear.

Nor did it set out to discover the internal cost structures and production data of Chinese steel mills. That would not be worth the trouble, as China's 540-odd steel makers are not known for their business planning and the Chinese Government's monthly steel production data is fast and reasonably reliable.

Rio only had to glance at its own order books or the iron ore spot market to understand that demand had fallen through the floor. Its challenge was to efficiently collate public data and form a view on leading indicators such as lending growth and floor space under construction.

But a large portion of the supply side of the iron ore equation remained a mystery.

Rio knew how much the rest of the world was producing from sharemarket announcements of Vale and BHP Billiton. But unlike steel data, China's domestic iron ore production figures are worthless.

Most of China's 5000 iron ore mines keep a low profile for the sensible reason that they are illegal. They lack some or all of the six government licences required and survive by quietly feathering the nests of officials.

A rough Chinese production number can be implied by working backwards from how much iron ore must have been fed into Chinese blast furnaces, adjusting for stockpile movements and then subtracting the volume of imported iron ore.

But Rio needed better than that, so it sent the CBI team to find and knock on the doors of hundreds of mines until they had a large and reliable sample.

CBI had previously done similar work for Rio, which had allowed the miner to model a cost curve that could predict how much Chinese iron ore mining capacity would be shut down when prices fell below certain thresholds. A version of that cost curve was published by Rio's chief executive, Tom Albanese, in May last year and has since been borrowed, adjusted and relabelled by leading investment bank analysts to become the industry standard.

Within a fortnight the CBI team had confirmed what Rio's cost curve model had predicted.

China had been producing about 400 million tonnes of iron ore a year when adjusted for equivalence with Australian imported ore (the raw tonnage is actually much larger because Chinese ore quality is so poor).

About 110 million tonnes was dug from large and generally more efficient mines that were either state-owned or "captured" by a particular steel mill and therefore had muted incentives to shut down. But of the remaining smaller, private, higher cost and often illegal mines, which accounted for 300 million tonnes of Chinese production, CBI discovered half of them (by volume) had shut their doors.

So Rio knew the precipitous decline late last year in Chinese steel production would be offset by global miners being able to displace about 150 million tonnes of Chinese iron ore. Regular iron ore mine surveys continued until Stern Hu was led away from his Shanghai home on the morning of Sunday, July 5.

The China Iron & Steel Association had privileged access to data. Indeed, Rio had formed the view that the association was getting real-time updates from whoever was listening to its phones and watching its email traffic (presumably the Shanghai State Security Bureau). But CISA's conclusions about the market were always driven by politics and wishful thinking rather than clear-eyed analysis.

CISA continually asserted that Chinese domestic miners would somehow roar back to life so China would not need Rio's iron ore. And it refused to comprehend the rising steel production trends made plain by official Chinese Government data.

To this day CISA claims China will produce 500 million tonnes of steel this year, even though production rose to a new record above 50 million in July. Through little more than multiplication, Rio predicts a full-year result of about 570 million tonnes.

At each round of iron ore price negotiations - and this year there were surprisingly few - Hu and his negotiating partner would simply point out the window at what was going on in the real world and hold their ground.

The Rio team would say the market was strong; CISA would deny it, and Rio would turn out to be right every time. For CISA it was beyond humiliating.

Rio's negotiating advantage over its Chinese customers was and continues to be that it collates information systematically and analyses it intelligently. This advantage is compounded because Rio is dealing with a steel association that acts as if it has no idea how far China's steel and iron ore industry has moved beyond its powers of command.

It would be strange if Rio were ''stealing'' state or commercial secrets because there is no Chinese mill, mine or official who has confidential information worth knowing.

Rio Tinto's intelligence advantage over the Chinese steel industry was more powerful and less sinister. Hu is nevertheless paying the price.



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