Monday, October 05, 2009

Derivatives - what would Chairman Mao have Thought?

The global capitalist crisis is still being played out. Even if there is some movement towards a recovery, it is a movement characterised by twists and turns, a recovery in which speculative and parasitic finance capital is more or less successfully resisting the social democrats who believe that future prosperity rests on regulation of the sector.

Here in Australia we have sheltered from the storm under the protective umbrella of Chinese resource purchases…actual purchases of the ores themselves, and more recently, some fairly aggressive purchasing of resource sector private companies.

However, the umbrella is not without its own holes.

Having “opened to the outside world” for three decades, (a cute phrase that lets the US off the hook for the cordon sanitaire and blockades that it maintained against China through the fifties and sixties), China has lost some of its financial sovereignty and is only just realising its vulnerability as part of the imperialist world economy.

This is particularly so in respect of derivatives, those arrangements through which companies try to take advantage of fluctuations in commodity prices or, at the least, protect themselves if the fluctuations head consistently south.

The derivatives industry is huge. The Swiss-based Bank for International Settlements recently estimated that the value of global derivatives contracts was 1.14 quadrillion dollars. Can’t visualise that? Look at this post of mine for some idea of what it means.

So how does the derivatives industry relate to China?

Keen to participate in the global economy, some of the biggest state-owned enterprises (SOEs) seem to have forgotten their socialist origins and their responsibilities to the Chinese people.

They have embraced the get-rich-is-glorious-regardless-of-how-you-do-it ideology of those “pragmatists” who set the pace for much of what happens in China and have entered into the shady world of derivatives perhaps not fully understanding the pitfalls underlying speculative capital transactions.

Mushtaq Kapasi was a derivatives dealer employed by Western banks to get into the pants of Chinese companies. He confessed that “Many Chinese firms had little experience with complicated financial products such as derivatives before they bought billions of dollars worth of these investment products” (Confessions of Chinese Derivatives Deals Pt. 1).

He cites the example of China Eastern Airlines.

“Quite sensibly,” he writes, “the airline bought derivatives that would pay if oil became more expensive. But to make the hedge cheaper in the short term, China Eastern agreed that if oil prices dropped past a certain point, then it would have to pay double what the bank would have to pay if the price of oil went up. After the oil bubble burst last year, the company admitted these derivatives cost them 6.2 billion yuan – and obliterated their profits for 2008.”

In the end Kapasi pulled out of the derivatives game in China having observed too many international banks conning Chinese firms, state-owned and otherwise, with what he called “tricky products”.

The scale of losses suffered by Chinese firms has shaken officialdom.

The State-owned Assets Supervision and Administration Commission (SASAC) concedes that 28 SOEs have taken out derivatives contracts and that most have suffered losses to such beneficial institutions as Deutsche Bank, Goldman Sachs Group, J.P. Morgan Chase and Co, Citigroup and Morgan Stanley.

As Lenin said in a somewhat different context, What is to be done?

SASAC has authorised the SOEs to begin withholding payments to the banks; indeed six SOEs are believed to have begun legal proceedings to break their contracts.

One school of thought holds that this is a bad move that will tarnish China’s business reputation; another holds that the banks know that they took advantage of Chinese inexperience with derivatives and will accept the loss of the contracts in return for continued involvement with other lucrative projects in China.

At least the SOEs have the Chinese government to support them. As Kapasi noted, however, “Most small investors are not as lucky…Many are linked to markets that could go haywire at any time. Chinese derivative holders would then face enormous costs that many can’t afford.”

Meanwhile, I read in a recent Women of China magazine the case of a teacher in Yunnan Province who has paid the tuition fees of her poverty-stricken students so that they can keep attending school.

I guess that's the difference between serving the people and serving big capital….

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