Chinese Futures Markets

The Wall Street Journal reports this morning that China is seeking to upgrade and expand its commodities futures markets in order to influence commodities prices, arguing that on-shore exchanges will help increase market efficiencies:

Government officials say the country is positioning its futures markets to be major players in setting world prices for metal, energy and farm commodities. By letting the world know how much its companies and investors think goods are worth, China hopes to be less at the mercy of markets elsewhere.

But what’s more likely is that China wants to lure traders on shore in order to use its national bargaining power to obtain more favorable prices.  It’s not until the very end that the reason to be suspicious is mentioned:

International futures-market benchmarking has been slow to shift to China from long-established exchanges like the New York and Chicago venues. Despite China’s huge volumes, its futures markets allow foreigners limited access. By contrast, the London Metal Exchange says 95% of its business emanates from overseas.

General Motors Co., Ford Motor Co. and Tyson Foods Inc. are some of the companies that use futures in the U.S. to protect themselves from volatility in commodity prices. Despite expanding production in China, and being technically eligible to hedge on China’s exchanges, all three say they haven’t used its futures markets.

Instead, the big footprints in China’s futures markets belong to state-owned groups, primarily commodity trader Cofco Corp. and Beijing’s secretive stockpiling agent, the State Bureau of Material Reserve. That makes the government both player and policy maker. (emphasis added)

Right.  Which means that China, which has a classic mercantilist approach to economics – seeking to use national power for the benefit of its industries – will be able to set the trading rules to its own benefit.  China has been practicing what can only be described as a neocolonialist policy all over the world in pursuit of cheap commodities.  It has been, as the article notes, deploying its navy to protect shipping routes, discovering the colonial truth that far from trade following the flag, the flag necessarily follows trade.

In fact, as the first paragraph in the above quote points out, these are world markets, and there’s no reason that China can’t trade openly in accounts no matter where they’re located.  In fact, the three companies mentioned in the second paragraph manufacture in China, and hedge on the US markets.  One likely advantage of trading with a home field advantage is that its government players won’t have to reveal their moves the way they will in more tightly regulated London and New York.

One expects that eventually, with the trading markets established, the right to continue doing business on favorable terms will come with increasing conditions, one of which may be that a company has the hedge its local commodities exposure with Chinese futures.  Given the compromises that companies make to do business in China in the first place, including rarely owning 50% of their own subsidiaries and seemingly deferring profits until the late 22nd Century, hedging on local markets will just be another in a long line.

The eventual effect of such a policy, if successful, would be to drive up commodity prices for the rest of the world while keeping them low for China, hampering competition, shutting down industries in competing countries, such as the US, while allowing China’s exports and domestic markets to develop.  Such a strategy only works, of course, if there’s no comparably-sized competitor, which argues for countermeasures by the US, combined with more open trade with India (which has protectionist problems of its own).

In the long run, of course, such a strategy is doomed.  The imbalances that it creates will inevitably provoke a reaction from the rest of the world, such as what Japan saw in the 1980s.  Moreover, it’s not sustainable forever.  Exports demand markets.  China is aging, and is an unlikely autarky, which is why it’s seeking to use its political (and eventually militaryp) power to secure resources.  But the long run can be very long, indeed, and the damage that China can inflict on us in pursuit of this policy can be great.  Which, of course, may also be all part of the plan.

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