The Curious Case of the PRC’s Yuan
There is one major foreign currency against which the value of the dollar has declined gradually since 2000: the yuan of the PRC. The value of the U.S. dollar declined by more than 18 percent relative to the PRC yuan between the end of 2005 and the middle of 2008.
The PRC government rigidly held the exchange value of the yuan at about 8.3 per U.S. dollar for many years. At the end of 2005 and the middle of 2008, it gradually began to loosen the strings and allowed the value of the yuan to increase (meaning the value of the U.S. dollar relative to the yuan was decreasing).
Rather than $1.00 U.S. converting to 8.3 yuan, by late May 2009, the conversation ratio had changed to only 6.83 yuan.
The change in the value (the rising of value) of the yuan relative to the U.S. dollar had two effects. First, it made the U.S. goods and services less expensive to Chinese customers. A Chinese customer purchasing say, $100 worth of U.S. goods and services now only had to present 6.83 yuan rather than the 8.3 yuan; the same items would have cost years previous. Second, the alteration in the exchange rate also made Chinese goods appear to U.S. consumers to be more expensive. A computer monitor that cost $1,500 yuan previously (this was $180.72 in U.S. dollars) now cost quite a bit more - $219.62.
Although the government of the PRC is notoriously opaque about the rationale behind the financial decisions, it appeared to have several goals in mind. One was pragmatic and probably related to U.S. political pressure. Many Americans argue that the PRC yuan has long been seriously undervalued. Indeed, even at 6.83 yuan per U.S. dollar, many observers believe the yuan still is undervalued and should be trading as low as a 5:1 ratio.
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We will go out on a limb (but not very far, we believe) and predict that the United States will again see such inflationary pressures and the onset of new asset price bubbles – especially for physical commodities – in 2010. The cheapened U.S. dollar will help motivate these asset price bubbles and will inexorably attract foreigner investors and assets purchasers. A year or two of this scenario will have editorialists wondering whether one-time Fed Chairman Paul Volcker might not be brought back to conquer yet another inflationary beast nurtured by the anti-recessionary policies of 2008 and 2009.
New commodity price bubbles are likely to develop as we move into the next decade. The Fed’s historically large expansion of the money supply (see Chapter 2) will exert upward pressure on prices of nearly all goods and services. The oft-cited equation MV=PQ retains its simple relevance. It is quite likely that output (Q) will not expand as fast as the money supply (M). Holding velocity (V) roughly constant, this implies that P (the price levels) must rise. Price increases in basic commodities markets (coal, copper, steel, aluminum, nickel, oil, lumber, natural gas, etc.) will rise even more, because productive capacity in those industries was decimated by the recession that began in December 2007 but then conflated dramatically by the financial crisis in the fall of 2008. We believe the United States will begin to see substantial commodity price bubbles in 2010. No doubt, policymakers found themselves between the proverbial rock and a hard place in 2008, as they reacted to the worst economic crisis in the United States since the Great Depression. In the process, however, they set the stage for another inflationary spiral reminiscent of the late 1970s.
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Setting the Stage
Wheeling Pitt had led a charmed life over the past 20 years. It had declared bankruptcy twice and survived only with financial help from the U.S. government and the state of West Virginia.
However, even during good times, Wheeling Pitt typically struggled and carried almost a half billion dollars of debt as the credit crunch of 2007 unfolded.
Of the 15 banks and financial institutions that somehow were “new” Esmark creditors, 14 asked for and received repayment of their loans during the credit crunch, leaving G.E. Finance as the only bank to show full confidence and support for the company’s management team and strategy.
Needless to say, G.E. Finance’s attention was welcomed, but these circumstances also conferred substantial financial leverage on G.E. Finance, and it appropriately insisted on favorable terms to it.
By all odds, Esmark was vulnerable to a takeover, hostile or otherwise. Although Esmark owned some impressive assets and portions of the firm, such as the “old” Esmark service centers, were profitable, it was not vertically integrated in the fashion of many successful steel firms; it was almost a basket case financially, and it badly needed owners who could plunge considerable capital into the old Wheeling Pitt portion of the company in order to bring its often-outdated plant up to date. Only a great optimist could have regarded the negotiating clout of Esmark and the Bouchard brothers as high at this time.
Nevertheless, despite these negatives, during 2008, the Bouchards were able to stimulate and manage an international battle for Esmark’s assets. In the event, in August 2008, Esmark’s investors reaped an incredible price for its share ($19.25 per share after the stock had traded at $10 only months earlier), while steel company stock prices around the world began plummeting to record lows. Was this superb ending the result of brilliant strategy on the part of the combative Bouchards and Esmark’s talented board of directors, or was it jut good old-fashioned luck? Immodestly, we believe skill and superb analysis were involved much more than luck. Regardless, the Esmark episode is an entrepreneurial U.S. story worthy of note. It also supplies an exclamation point to the story of the sale of U.S. firms and assets.
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The Battle for Wheeling Pittsburgh Steel
The Wheeling Pitt saga began one evening in May 2005 when the Bouchards were riding in a car with Jim Tumulty, their investment banker from Raymond James. Tumulty was a steel specialist and well connected to both hedge funds and the USW union. The USW often relied on Tumulty as an informal steel industry analyst.
Tumulty posed a question to the Bouchard brothers. Would they be interested in working with the USW to find a better home for Wheeling Pittsburgh Steel, Algoma Steel (a Canadian mill), or both? The USW had concluded that both firms needed management and strategic changes if they were going to survive. Jim Bouchard’s response was immediate. Yes, Esmark would have interest in Wheeling Pittsburgh Steel, but not in Algoma because of its remote location in Ontario, Canada. Swiftly, Tumulty was on his cell pone, relaying this message to Ron Bloom at the USW headquarters in Pittsburgh.
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On March 26, 2006, after acquiring support for its investors and banks, Esmark returned to Jim Bradley with a written proposal to merge Wheeling Pitt with Esmark. Then the fun started. The Wheeling Pitt board of directors reacted strongly, even a bit frantically, in opposition. Because the proposed merger would have enriched Wheeling Pitt’s stockholders, aligned Wheeling Pitt with a profitable, expanding company (Esmark), and received the endorsement of the USW, the Wheeling Pitt board’s strenuous opposition appeared to reflect other considerations. It was not irrelevant that each Wheeling Pitt board member was receiving almost $100,000 in annual compensation as a director, and, arguably, this encouraged some board members to oppose the merger.
In fact, Wheeling Pitt recently had looked unsuccessfully for partners that might provide it with capital, because it was in a liquidity squeeze. It was running out of money and did not have an ability to borrow more from financial institutions at anything other than unattractive terms. Thus, at this point, Esmark appeared to be the only game in town. However, CEO Jim Bradley bought some time. In a meeting in the Wheeling Pitt boardroom with Esmark and Franklin Mutual, Bradley shook hands with Jim Bouchard on a rough deal and stepped to the next room to discuss taking care of this management team. The Esmark team went home thinking they had made a deal. However, nothing had been signed, and it turned out there was no deal.
Jim Bradley was invited to the home of Jim Bouchard for a business dinner, to bond with his apparent new partners and talk strategy. He was offered a senior position in the new company. Present at the dinner were the Bouchards, Bradley, senior executives from Franklin Mutual, Leo Gerard and Ron Bloom from the USW, Victor Rashnikov, the owner of Magnitogorsk Iron and Steel Works (MMK), one of the largest Russian steelmakers and a potential steel slab partner for Esmark, and legendary hockey star Mario Lemieux, Jim Bouchard’s neighbor and owner of the Pittsburgh Penguins. The business discussions that evening were pleasant, with all present expressing interest in building a brand new company together.
Rashnikov took a tour of the mill during his visit. He had interest in a potential partnership with the Bouchards, who he had met in Turin, Italy, at the Olympics just a few months before. Rashnikov also had a non-steel agenda. Lemieux had acquired the draft rights to a young Russian Olympic hockey star named Evgeny Malkin, reputed to be the best hockey player in the world not yet playing in the National Hockey League (NHL). But Malkin’s rights were controlled by Rashnikov, who also owned the best hockey team in Russia.
Lemieux came to the dinner wearing a smile. He hoped to encourage Rashnikov, Malkin’s hockey employer, to surrender his rights to the young player. Rashnikov was not interested in giving up his star, but, in the fashion of Russian oligarchs, he thought it might be very nice to own an NHL team and perhaps a steel mill as well in the same geographic location. Such were the kinds of plans that had made him rich and famous in Russia. At that moment, the value of Rashnikov’s business holdings exceeded $8 billion.
The USW in turn was interested in finding new ownership for Wheeling Pittsburgh Steel. Gerard and Bloom worked the room that night in their normal politically astute fashion. The conversations were fascinating, and all seemingly left the dinner that evening in the mood to make something good happen.
All but one person, that is. The dinner ended with Esmark and Franklin Mutual thanking Bradley for supporting their proposal. Bradley returned the good cheer, but he carefully omitted mentioning the fact that the next morning he would board a plane for Sao Paulo, Brazil, where he would meet with representatives of Companhia Siderurgica National (CSN), one of the world’s largest steelmakers. Ultimately, he would cut a very different deal with CSN, and it would result in CSN attempting to purchase Wheeling Pitt. This would leave the Bouchards, Franklin Mutual, and the USW out in the cold. Business dinners and toasts were just fine with Jim Bradley, but the Bouchards concluded later that he wasn’t about to sell his company to a bunch of service center guys. Also, he probably did not care much for the aggressive Bouchards, whom he likened to a pair of Doberman Pinschers nipping at his heels. In addition, if he succeeded with his gambit with CSN and was careful, then he probably would serve as Wheeling Pitt’s CEO for several more years.
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More Dinner Intrigue
Shortly after his dinner at Jim Bouchard’s home, Malkin secretly left Russia and wended his way to Pittsburgh, where he joined the Penguins.
This resulted in an unsuccessful lawsuit launched by Rashnikov against the Penguins and the NHL. Malkin became an instant star in the NHL.
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Esmark and Jim Bradley (the CEO of Wheeling Pitt) were adversaries in the battle for control of Wheeling Pitt. However, they also turned out to be allies when Wheeling Pitt later collected $260 million in a court suit against Massey Energy. Mr. Bradley, by then gone from Wheeling Pitt, testified very effectively on behalf of Esmark and was instrumental in Esmark’s legal victory. He need not have done so, and earned the respect and appreciation of many for his efforts.
