By rational standards, PetroChina should be valued somewhat less than Exxon-Mobil. Yet it is valued much higher. Why is this so?
The reason is that China is awash with dollars that have no place to be invested. Although currency controls have been relaxed to allow individual Chinese to invest in the Hong Kong stockmarket in a limited way ($50,000), flows of funds to the USA and other countries are still highly limited.
This was brought home to me this spring when a Chinese student friend of mine wanted to buy a car. Although he had access to large amounts of money in China, it was very difficult for him to receive the $10,000 he needed to buy a slightly used car here in America. And herein lies the huge, looming problem for the Chinese government.
The Chinese border has become a sort of semi-permeable membrane. Dollars can flow into the country, but not out of the country. Thus, the country continues to hold onto this huge and growing number of dollars, perhaps because there are those who hold to the old mercantilist idea that currency makes a country rich and strong. Soon, perhaps very soon, the Chinese will find that money is like manure: It does no good to keep it in your barn. You must spread it around to reap its benefits.
Basic macroeconomic theory states that under normal conditions, an efficient producing country will receive currency from a positive export balance. However, these gains will be self-correcting as the profits become re-invested through importing equipment, and through purchasing assets or luxuries from other countries. If the country does not want to or is incapable of sending the currency back across the border, then the exchange rate will move, weakening the trading partner's currency - in this case the dollar - and strengthening the exporter's currency - the yuan.
However, China has also chosen to control this safety valve, intentionally holding the yuan weak versus the dollar. And like any safety valve that is held closed, there can be difficult consequences. In the next year or so, this will likely lead to problems in the Chinese economy.
With all the riches floating around the Chinese economy, Chinese investors are expanding production at a dazzling rate. This is good. However, the Chinese's ability to expand production has now begun to exceed their ability to expand their world market share. In other words, they can't sell this production capability fast enough. Everyday, I have Chinese companies contacting me, looking for another customer for essentially the same goods that I can buy from 20 other Chinese companies. Because we simply can't use their production, individual company owners are now putting their profits into investments where they can't be active players: They are investing in the Shanghai stock market.
Rapidly rising share prices has led to a classic speculative bubble as everyone now looks at the tremendous returns that have been generated. When PetroChina offered shares, they were oversubscribed at a rate of 50:1. Imagine an oil company with a 55:1 valuation! That is almost equal to Google's valuation. This bubble, like all bubbles, will soon burst. And there will be tremendous social penalities to pay throughout China as the newly rich loose their riches.
For the other place the money has flowed to is to the purchase of those goods that Chinese think of as luxuries (and the Western consumers think of as ordinary goods). Autos, homes, dishwashers, computers, cell phones, and Internet access are being sold at a torrid pace in China, resulting in a double-digit inflation rate. And as that inflation booms, wages are also inflating. Soon, very soon, the historic Chinese labor cost advantage will be gone and those wonderful export orders will no longer be placed in SE China, but will instead flow to Bangladesh, Vietnam, and Indonesia. Oh, yeah! It's already happening.
Goods inflation combined with a booming, speculative stock market. Reminds me of the 1920's. If I were invested in China or depended upon a stable Chinese supplier base for my livelihood, I'd be looking for the exits. For it is only a matter of time now until the bubble bursts, resulting in loan defaults and thousands of shut factories with the resulting unemployment of millions of people.
Does China have a hope of surviving this crisis? Only if the authorities take quick action to relax currency controls and free the exchange rate. But I fear that the situation may have already passed the point of no return. Pray for China and the Chinese people. Interesting times are soon to be upon them.