My role at Institutional Investor’s China Investment Management Summit in Beijing last week was to provide an historical and global perspective to the panel discussion. Here is what I said.

I began my remarks by observing that one of China’s biggest problems today is its lack of developed capital markets. At the same time, I pointed out that China’s single biggest opportunity is to develop better mechanisms for channeling the country’s growing pool of capital resources into the hands of those individuals and companies that can use them most effectively.

Whether it’s toothpaste, car parts or capital, one of the biggest problems in China is distribution. For consumer and industrial products, the problem is an extremely fragmented distribution system with literally hundreds of thousands of wholesalers and retailers for any product. In the case of capital, it’s the opposite—the task of distributing capital in China is concentrated in the hands of a small number of large banks, most of which are state-owned. By and large, China’s banks are not trained to lend to entrepreneurs and private enterprises, the backbone of any economy. Instead, they are most comfortable making “policy loans” to government backed organizations. China’s stock markets in Shanghai and Shenzhen are merely extensions of the policy loans made by the state run banks. The government, not the markets, decides which companies can list and issue shares.

If only China’s entrepreneurs and small and medium-sized enterprises could gain more access to capital, there is no telling how fast the country’s economy would grow. Putting aside Bear Stearns, Lehman, AIG and the other events of the past year, which ultimately will go down as but footnotes in the economic history of the United States, the capital markets in the United States have enabled the country to become the world’s largest economic power and to maintain its status as the globe’s leading innovator. Say what you will, but the U.S. capital markets have done a good job over the years of getting capital to those who can use it best and taking it away from those who destroy value.

I saw this first hand in my career on Wall Street during the 1970’s and 1980’s. When I graduated from Harvard Business School in 1973 and joined the investment banking department at PaineWebber, the Dow Jones Industrial Average (DJIA) was just above 800. By the end of the decade, it hadn’t budged and was still barely above the 800 level.

During my first seven years on the Street, there were few initial public offerings of equity, virtually no public debt offerings for companies rated less than single A, and mergers and acquisitions were few and far between. There were only a handful of venture capital firms, private equity firms (known then as leveraged buyout firms) were just getting started and the hedge fund industry didn’t exist. Goldman Sachs and Morgan Stanley, two Wall Street goliaths today, each had less than $50 million of capital back then. The U.S. capital markets were rudimentary, to say the least.

In the early 1980’s, though, innovation came to Wall Street and things began to change. Drexel Burnham developed high yield debt securities for lesser rated companies (known as “junk bonds”) that not only provided small and medium sized businesses with expansion capital, but also helped unleash a wave of merger and acquisition activity. With more diverse and fluid capital markets, equity values were unleashed and the DJIA soared, tripling to over 2900 by the end of the decade. At the same time, derivative products such as interest rate and currency swaps were introduced, increasing market efficiency. Securities firms prospered, ever larger pools of capital began to be raised for venture capital and private equity, and companies had more financing choices than ever before.

For most of my time here, China has been more like the Wall Street I knew in the 1970’s in terms of its capital markets. Financing alternatives for most companies are extremely limited, and capital, while now plentiful, is still limited as to its availability.

But like the dawn of the new decade of the 1980’s in the United States, things are changing in China. Over the past two years alone, a wide range of Chinese private equity firms, funded by local institutions and investors, have sprung up, and local governments are gearing up equity investment programs to stimulate economic development. Financial futures were introduced in 2006, and though only mock trading has occurred since then, China has at least begun to head down the path of more sophisticated capital markets.

Now is the right time for China to begin to develop its capital markets. The government’s emphasis on increasing private consumption, spending and investment will be enhanced as more diverse pools of capital are created and small and medium sized enterprises gain increased access to funding. In fashioning the future development of its capital markets, China also has a unique opportunity to learn from the events of the past year, avoiding those aspects of the global financial markets that were the cause of the crisis.

If China is successful in taking this next step in the development of its capital markets, the country’s economy will be able to continue its fast development, but do so in a way that is more balanced and sustainable. Conferences like the one sponsored by Institutional Investor that provide a forum for a broad range of expertise will help pave the way.

By Mick Zomnir

China’s futures markets began with the trading of commodities futures in 1990 and experienced a quick and steady expansion until the middle of the decade, when loopholes in the regulatory scheme led to problems of fraud and extreme speculation. At that time, a variety of scandals forced the Chinese authorities to clean up the country’s financial markets. Many futures exchanges and brokerages were closed, and various financial products were suspended from trading. Ultimately, China shut down its bond futures market and prohibited trading of financial derivatives, restricting China’s exchanges to handling commodities futures.

Today, futures trading in China remains limited to commodities. Trading takes place at China’s three commodities exchanges in Shanghai, Zhengzhou, and Dailan.

With the establishment of the China Financial Futures Exchange (CFFEX) in Shanghai in September, 2006, Chinese authorities took a major step towards creating a modern financial futures market. However, activity to date has been limited to mock trading, with no money trades yet authorized for CFFEX.

The first product created by the CFFEX is the CSI300 index, which includes the 300 largest A share companies listed on the Shanghai and Shenzhen Stock Exchanges. While the CFFEX plans to introduce more financial derivatives, including index, government bond and currency futures, no specific dates for the introduction of these products have been set. Likewise there is no specific timetable for the commencement of real money trading on CFFEX.

The Chinese authorities have made it clear that their goal is to have sufficient transparency in China’s capital markets, including futures trading, so as to limit speculation and avoid volatility shocks. For example, China requires banks to disclose to regulators the details of trades in Yuan-denominated derivatives, either by funneling activity onto an exchange or by electronically registering deals after they are executed. This requirement, which makes China unique among major economies, has placed Chinese regulators in a better position to monitor the scale of trading and to clamp down on risky behavior.

In 2008, China used data on commodities futures to unwind a messy set of copper trades. When China first introduced its trade disclosure requirements, they were criticized by many in the West as being “big brotherly” in nature. In the wake of the global financial crisis, Western regulators would like to have such information for their own financial markets.

For clearing and settlement, CFFEX uses a multi-tiered clearing system that is popular in many overseas markets. Under this system, CFFEX categorizes its members as trading members, trading and clearing members, general clearing members and special clearing members according to their respective risk
tolerances. Members in the four tiers have different business scopes, a fact that enables the construction of a multi-tiered risk control system.

China’s three commodities exchanges in Shanghai, Dailan and Zhengzhou are  “non profit-seeking incorporated bodies” regulated by the China Securities Regulatory Commission. CFFEX, in turn, is a joint venture between all three of China’s commodities exchanges and its two major stock exchanges in Shanghai and Shenzhen.

The organizational structure of CFFEX is similar to that of a corporation so as to improve its competitiveness and development potential, while implementing strict risk management policies to ensure its institutional vitality. CFFEX’s shareholders’ meeting is its “organ of power,” and its Board of Directors  exercises the power conferred by that meeting. The CFFEX board of directors appoints an executive committee to carry out the day-to-day functions of decision-making, management and enforcement.

China has been understandably cautious in developing its futures markets. The CFFEX has been created to act as a testing ground for financial futures through mock trading and will become China’s first financial futures exchange. While the global financial crisis has slowed this process, it has by no means halted it. In my next article, I’ll discuss some of the main themes for the development of China’s futures markets that were discussed by the experts at the Institutional Investor’s Third Annual China Investment Management Summit.

This week, Institutional Investor Magazine held its 3rd Annual China Investment Management Summit in Beijing. Established in 1967, Institutional Investor, or “II” as it is commonly referred to in the investment industry, is a preeminent international financial publication with a readership of more than 147,000 financial executives in 160 countries. The magazine’s parent also publishes 22 financial newsletters such as Money Management Letter, Emerging Markets Week and Defined Contribution News, as well as several journals that include The Journal of Portfolio Management, The Journal of Fixed Income and The Journal of Investing.

As might be expected in this post 2008 world, the topics covered at the Summit included: Road to Recovery: The China Story, Re-visiting the risk premium (credit versus equities and asset allocation), and  Seeking value: Is the equities market back in favor? I was asked by Allen Cheng, Asia Bureau Chief of II, to participate on a panel which he moderated, Advancing the securities industry in China: New developments in financial product reform.

Our panel’s topic was quite timely as China is pressing ahead on financial reforms, despite the global economic crisis and historical fears about increasing market volatility. The government has just introduced margin trading for a few selected securities firms, using a margin cap of 50%, and has eliminated stamp duties on sales of securities. The government is also considering the possibility of allowing short-selling, while stock futures will probably be introduced later in 2009.

In addition to me, the panel included senior officials from the China Academy of Social Science and the Shanghai Stock Exchange, as well as the founder and chief investment officer of a $1 billion Hong Kong based hedge fund that invests heavily in Mainland securities. I enjoy participating in conferences like this for a couple of reasons. In addition to being great networking events, they provide excellent opportunities to hear the “state of the art” from real practitioners.

In order to pass along as much of what I learned as possible to MTD readers, I have asked Mick Zomnir, an MIT student who has been interning with JFP Holdings and who attended the Summit with me, to write up his notes from the Summit. In the coming days, Mick will outline the history of financial futures in China and relate some of the main themes described by the panel. I will summarize my remarks in a separate post.

It was as if China Daily had read my mind. It too noticed the dearth of information on the Hummer deal since the transaction was first announced in early June. The newspaper more than made up for it, though, with three articles on the subject in Friday’s edition, one day after MTD’s post.

A front page story, Hummer Set To Go Lean And Green After Sale quoted Hummer CEO Jim Taylor as saying: “All I need is cash. We were looking for companies with the resources to fund our future development and keep the brand and dealers alive. I’ll bring all (the experience and expertise) to the table.”

Taylor went on to allude to the changes that would be made under new ownership with deeper pockets, saying that more environmental awareness in the automotive industry was a positive thing and vowed Hummer would be reborn with new eco-friendly, smaller and fuel-efficient models rolling off the production line. “The Hummer of tomorrow is not as the same as the Hummer of today,” Taylor said. “It has to be more fuel efficient, it is a must, and with an (new) investor we are going to change the image of Hummer.”

In an opinion piece seven pages later, Op Rana, decried the harmful effects of today’s Hummer on the environment and cautioned Chinese and Indian companies against acquiring bad habits from the West.

Chinese and Indian companies have to keep the environment in mind while acquiring Western companies. Let’s not forget that historically it’s the West that’s mostly responsible for global warming. We’ve seen at climate change conferences and forums that we can’t persuade people in the West, especially the US, from even cutting down carbon footprint, which by any standard is very high. But at least we can choose not to acquire their polluting habits.

In a separate article, Yang Yi, CEO of Sichuan Tengzhong Heavy Industrial Machinery, seemed to remove all doubt that the deal would go through. Tengzhong has the financial resources to complete the transaction, he insisted. “We have the resources for the Hummer deal from our own capital and also funding from financial institutions,” he added.

Hummer’s CEO expects the deal to be done by the end of the third quarter. Given the positive coverage in today’s China Daily, and Yang Yi’s positive statements, my take is that he is right. “Book ‘em Danno!”

Ever since the initial announcement that a little-known, special purpose vehicle maker in Sichuan Province had agreed to buy Hummer from bankrupt General Motors, news regarding the proposed deal has been scarce.

The early reaction was that it was a deal that the Chinese government might very well block. After all, it runs counter to every message that the Chinese government wants to convey to the outside world about its burgeoning auto industry–that China wants to emphasize the design and manufacture of smaller, fuel efficient vehicles. Everything that the Hummer is not.

Although it already has 4,800 employees, Sichuan Tengzhong Heavy Industrial Machinery Co., is not a recognized name in China’s auto industry. I had never heard of it in all my years dealing with the commercial vehicle industry, despite the fact that we were very active in this segment, and at various points in time, had two factories in Sichuan. Tengzhong was only established in 2005 and has grown through a series of mergers. News reports describe it as a private company, but it appears to have a great deal of local government backing. Tengzhong makes special-use vehicles, highway and bridge structural components, construction machinery and energy equipment.

In its announcement on June 2, General Motors said that the buyer of Hummer, whom it did not initially identify, would contract to build the H3 model SUV and the H3T pickup truck at GM’s plant in Shreveport, Louisiana, through at least 2010. In addition, GM said the investor would fund future vehicles for Hummer and invest in alternatives to the heavy gas-guzzling engines that are the hallmark of the brand.

While it’s tempting to think that the leaders at Tengzhong must have completely lost their minds to take on a company whose products are so counter to prevailing trends and whose sales in the United States have fallen by two-thirds in the first four months of this year, I have found in my years in China that there are usually reasonable explanations for what may seem like bizarre events. What could they be in this case?

Cheap technology, for one. Despite the gas guzzling characteristics of the Hummer, it is an all-terrain vehicle with valuable technology. Reportedly, General Motors had hoped to get $500 million for the company only a year ago. Tengzhong’s price may be as low as $100 million. If the cash losses at the Shreveport plant can be capped in some reasonable way (admittedly a big if), it may be a very cheap price to pay for difficult-to-find technology.

Manufacturing in China to lower costs is also likely part of the plan. GM’s statement that the buyer had committed to manufacture the Hummer in Shreveport at least through 2010 begs the question as to what happens afterwards. My guess is that it moves to Sichuan Province, where that $71,000 price tag can be reduced dramatically. Small volume vehicles typically do not entail expensive automation and are a natural for China with its low labor costs. I was recently on a panel at the JP Morgan Conference in Beijing with a senior executive from Geely, who said that his company is making the London Taxi Cab at one-half of what it costs to manufacture the vehicle in Coventry.

There is a need in China for vehicles that can handle the country’s harsh terrains. It’s not surprising that a Sichuan company would make this purchase. Sichuan and its neighboring provinces have some of the most inhospitable terrains anywhere in the world. I saw it first hand when I visited many of Mao’s Third Front factories in 1993, and we all saw it in the pictures last year of the devastation caused by the earthquakes in that part of China. Local governments could be big purchasers of the vehicle, particularly if the price can be reduced by manufacturing in country.

The military may also be a big potential market. The Hummer was first developed as the “Humvee,” a multipurpose, off-road vehicle by AM General for the United States military. GM bought the Hummer brand from AM General in 1999. AM General still produces the Humvee for the U.S. armed forces, and with all that is going on in the world today, it can’t make them fast enough. Presumably the technology is the same, and Tengzhong can tap into a big market with the Chinese military.

Finally, never underestimate conspicuous consumption in China. Five or six years ago, a Hummer was showcased at the Beijing Auto Show. I’ve never seen so many people gathered around one vehicle. A great deal of money has been made in China, and many of the newly rich will simply have to have a Hummer.

Those leaders at Tengzhong may be on to something after all.

Is it my imagination, or are the skies over Beijing becoming bluer? More than at any time in recent memory, it seems that Beijingers are being treated to more and more blue sky days. So much so that I have been asking my friends whether they have noticed the same.

The first sign that it wasn’t just my imagination playing tricks came in the form of a notice that I received from the Capital Club on June 12, “Breathtaking Views From Your Club Today,” it read. Founded in 1994, the Capital Club is the oldest business club in Beijing. The Club is located on the 50th floor of what used to be the tallest building in the city, and when the skies are clear, the views can indeed be breathtaking.

In all of my years as a member, though, I can’t ever remember the Capital Club advertising this feature. Nonetheless, it was good marketing this time around. Written over a glorious view of Beijing from one of the club’s dining rooms, the inside of the invitation read, “Dear Member, Come to your club today for a great value business lunch and enjoy the fabulous views of the mountains surrounding Beijing.”

Thanks to the Asia Society, we don’t have to rely on anecdotal evidence alone to determine whether Beijing’s air quality is improving, or whether the Capital Club was merely capitalizing on a one-time event. The Asia Society has a website that provides statistical and pictorial evidence regarding Beijing’s efforts to clean up its air.

As the site explains in “Statistically Speaking”:

Rapid economic development in China has led to significant increases in emissions of pollutants and greenhouse gases.  In 2008, China surpassed the United States as the largest global emitter of greenhouse gases by volume.  On a per capita basis however, Americans emit five times as much greenhouse gas as Chinese.

The Chinese government terms all days with an Air Pollution Index (API) of 100 or less “blue sky days.” An API of 100, according the Chinese scale, is “slightly polluted.”  The government goal was to have 256, or 70 percent, blue sky days in 2008.  In 1998, Beijing recorded 100 “blue sky days;” in 2007, 246 were recorded.

The Air pollution index (API), published by China’s Ministry of Environmental Protection, is derived from measurements of five pollutants: Sulfur Dioxide, Nitrogen Dioxide, PM10, Carbon Monoxide and Ozone.  The average concentration for each pollutant is calculated daily and the concentration of the pollutant with the highest API (0-500) will become that day’s major pollutant, recorded as that day’s API figure. In Beijing, PM10–particulate matter 10 microns or smaller–is the major pollutant most days.

According to the Asia Society, the Chinese have invested about 120 billion yuan ($17.9 billion) over the last ten years to improve air quality in the capital.  Although the levels of many major pollutants like Sulfur Dioxide and Nitrogen Dioxide are now at target levels, the concentration of PM10, or inhalable particulate matter, remains above national targets.

How is Beijing doing in its fight against air pollution? The site’s “Room With a View” section provides statistical and pictorial data. For the last several years, the Asia Society’s photographer has been taking daily photos of Beijing’s skies from the same room. For each day over the past several years, a picture of the sky, along with statistical data on pollution, is displayed. For example, the site explains that Beijing had 25 blue sky days with an average API of 83.2 during the month of May, 2009. For reference purposes, the worst air quality was reported on December 28, 2007 when the API was 500 (ugh!). The best occurred on September 23, 2008 when the API was only 12.

Although I didn’t rigorously analyze the data, a quick scroll through the past several years of statistics and pictures seems to indicate that Beijing’s air quality is improving. For the first ten days in June, Beijing was ten for ten in terms of blue sky days with an average API of 59.6. No wonder the Capital Club saw fit to advertise.

When I was starting up in China, many experts cautioned me on what I would encounter. “It’s not a free market and there’s no rule of law, they told me. “The government controls the courts, the companies and the banks. Central planners in Beijing, not the marketplace, decide what goods to produce and which companies should produce them.”

“Decisions are made for political, not economic reasons,” they went on to explain. “The heads of China’s state-owned enterprises serve at the pleasure of the Party, the banks are told what loans to make, and making a profit is secondary to ensuring employment. That’s the reason why China’s banks are a mess and full of non-performing loans.”

Occasionally, I would push back, noting the economic progress that China had made since Deng Xiaoping opened the economy in 1978. “You don’t believe the government’s numbers, do you?” they would ask incredulously. “Everyone knows they’re manufactured to convey whatever message the government wants. And, when it comes to financial statements, forget it. Chinese companies have at least three sets of books, and you can’t believe any of them.”

Of course, much of what they had to say was true, or at least somewhat true. By the time I began to set up my company, though, I had spent a considerable amount of time studying and traveling the country, so none of their comments were news. I was much more interested in something else that my personal investigation had revealed– that China was changing, and it was changing fast. It was very obvious to me that Deng Xiaoping had scrapped the socialist economic playbook that China had adopted in 1949, in favor of the capitalist economic playbook that the United States had used from inception to make it the world’s leading superpower.

China is still not perfect, no country is. But, China has changed a great deal since I first arrived in 1994, and it now looks a lot more like the United States that I remember back then. Many markets, like automotive components, for example, are hardly regulated today, and most are much less regulated than they were 15 years ago. Over the past 15 years, China has invested heavily in infrastructure, much as the United States did in the 1950s, building the roads, railroads and airports that make a country much more productive. Thousands of state-owned enterprises have been turned over to their managers and employees and encouraged to develop as private companies. Favorable tax policies, free land, and bureaucratic tape cutting have all been used to promote investment, which the Chinese understand is the lifeblood of any economy. And finally, all levels of the government–central, provincial and local–have been committed to economic development.

China’s move from socialism to capitalism, albeit “capitalism with Chinese characteristics,” has lead to tremendous economic progress. During my time here, China has become the third largest economy in the world, the world’s largest market for cars, computers, cell phones and a host of other products, and the country has accumulated $2 trillion of foreign currency reserves. China is now the single largest investor in the United States, unthinkable in 1994 when China had less than $50 billion of reserves. As Deng Xiaoping suggested, the Chinese have learned that it is indeed “glorious to be rich.”

Given all that has transpired, the leaders at Zhongnanhai must be scratching their heads, wondering what their counterparts in the United States are up to.

It began with Enron, Worldcom, Tyco and a host of accounting scandals. In a flash, the financial statements of Chinese companies were just as believable and just as transparent, if not more so, than those of U.S. companies.

Then it was Bear Stearns, Lehman, AIG, Bank of America, Freddie Mac, Fannie Mae, Citicorp and the meltdown of the U.S. financial industry. Hoping to learn how to develop its own financial system, China encouraged investments in its state-owned banks by leading U.S. players. Maybe they aren’t such good examples to follow after all? China’s banks are among the strongest in the world today.

But the sharp left turn that the Obama Administration has taken since coming to power must really have China’s leaders wondering. Not just the banks, but now large industrial companies, are owned by the U.S. government, and the United States is doing what any government does when it owns companies–it meddles, and political, not economic, considerations are taking precedence.

Rather than let the bankruptcy system work as it has over the years to restructure companies, billions of dollars, much of which will never be recovered, have been pumped into General Motors and Chrysler, two companies that represent less than 30 percent of the U.S. automobile market and have been losing market share to foreign-owned companies that now also happen to manufacture in the United States–all in the name of saving the jobs of the United Auto Workers, whose support played an important role in getting the current administration elected.

An administration-appointed car czar, not the company’s board of directors, has fired the General Motors chairman and CEO and installed a new CEO, president and chairman. General Motors is told what plants it cannot close and where its offices should be located. Barney Frank personally called the General Motors CEO to reverse a decision to close a GM distribution facility in his district, and President Obama himself assured Detroit’s mayor that GM’s headquarters would remain in Detroit, rather than move to a neighboring suburb. Undoubtedly, the Obama Administration and Congress will tell their management appointees what types of cars GM should produce. Toyota, Honda, Nissan, Hyundai and their U.S. workers must be delighted with this turn of events.

A newly appointed pay czar (there are now more than 20 such “czars” in Washington) will now review the compensation of the top 100 managers of any company that has received support from the government. As for the vaunted “rule of law” that the United States has been known for, ask the GM and Chrysler secured bondholders what they think. And as for manufacturing statistics–Americans are being told that the administration will “save or create” 600,000 jobs this summer, a statistic that the Wall Street Journal has labeled an “immeasurable metric.”

Ask any Super Bowl coach about his strategy for the high stakes game, and he’ll tell you that you go with what got you there. Somewhere along the line, the United States picked up that socialist economic playbook that Deng Xiaoping was smart enough to throw away. Perhaps the U.S. should “follow Deng” and go back to what got the United States, and now China, to where it is today?

It was not a good day for China’s steelmakers. What BHP Billiton couldn’t accomplish in iron ore by buying all of Rio Tinto, it will now accomplish in a 50/50 mining joint venture between the two companies. As a result of its new agreement with BHP, Rio Tinto decided to scrap the proposed $19.5 billion investment by Chinalco into the company. Instead, Rio Tinto will use the $5.8 billion of proceeds it expects to receive from BHP as part of the joint venture agreement, plus $15.2 billion from a rights issue and a skipped dividend to cover its cash requirements.

The new joint venture will own the prized iron ore assets in the Pilbara region of Western Australia of both miners, and will topple Brazil’s Vale as the world’s largest iron ore producer. Because RioTinto’s contribution to last year’s aggregate output was 55 percent, a $5.8bn investment from BHP is required to even things up between the two partners. The effect of this joint venture is to reduce the number of major global iron ore producers from three—BHP, Rio Tinto and Vale—to two—the BHP/Rio Tinto joint venture and Vale.

Even before the deal with BHP was announced, fireworks had already started between the miners and China, their biggest customer. Last week, China’s top steel negotiators formally rejected iron ore price cuts negotiated between Rio Tinto and Japanese and South Korean steel mills, signaling a showdown between Beijing and the miners. Look for tough negotiations between China’s steelmakers and the miners in the months ahead.

In the aftermath of the announcement, Australia’s prime minister sought to reassure China, the country’s biggest two-way trading partner, that the failed tie-up between Rio Tinto and Chinalco did not represent a change in attitude from his government towards foreign investment. While there was political resistance in Australia to the proposed Chinalco investment in some quarters, shareholder resistance was the primary reason why the deal was ultimately scuttled. Rio Tinto shareholders have been upset with the company for some time. An ill-timed purchase of Alcan in 2007, which saddled Rio Tinto with a high level of debt, the rejection of BHP’s $147 billion takeover bid in 2008, and the proposed sale of convertible bonds and assets at seemingly bargain basement prices to Chinalco have not sat well with Rio Tinto’s large shareholders.

From the point of view of Rio Tinto’s shareholders, scrapping the Chinalco deal in favor of the joint venture with Rio Tinto and a rights offering makes sense. In terms of global competition for resources that are becoming increasingly dear as China, India and other emerging countries industrialize, however, it’s anything but a positive development. The world’s supply of iron ore, one of the most basic building blocks in an industrial economy, will now be in the hands of a powerful duopoly, one in the Western Hemisphere and the other in the eastern part of the world. Consumers everywhere will pay the price.

“Watch us…and watch what we do—in staging a strong recovery and controlling the rising deficit.”

Those were the words of US Treasury Secretary Timothy Geithner as he faced Chinese skeptics at a China Daily news conference on Tuesday. On numerous occasions over the past several days, Geithner’s message was that the United States will spawn a strong recovery, control the rising budget deficit, and thereby protect the value of dollar-denominated assets. “We are absolutely committed to doing that, and I am completely confident that we will be able to do it,” Geithner told unconvinced Chinese economists at the news conference.

Despite the predictable reassuring statements made by China’s top leaders about the visit, designed more not to offend than to convey any specific message, individuals who attended most of Geithner’s presentations and conferences told me that Geithner was not quite getting what he wanted out of his trip. If he was expecting to get blanket assurances that the Chinese would keep buying U.S. bonds, he came up well short, they said. Throughout the meetings, the message was that the U.S. is by no means “out of the woods” as far as the Chinese continuing to buy U.S. government securities.

In an editorial on the subject, China Daily summed up the attitude of unofficial China best. “Though opinion is divided sharply over the necessity to buy more US treasury bonds, few Chinese would think that the country’s vast holdings of U.S. financial assets are secure as the dollar’s long term value is in doubt.”

When describing what it’s like to work in China, I tell audiences that everyone here is from Missouri, the “show me” state. The Chinese care more about what you do than what you say. Being designated a “big talker” in China is the kiss of death. Geithner will now have to go back to Washington and deliver on what he told the Chinese.

As China Daily put it, “Words alone are inadequate reassurance. Decisive action to rebuild its economy alone can convince foreign creditors that the U.S. is not expecting a free lunch to bail itself out of the crisis.”

The U.S. government deficit is projected to reach $1.75 trillion for the fiscal year ending September 30, 2009, about 12.9 percent of the country’s GDP. The Obama administration aims to reduce that to 3 percent by the end of its four-year term. With the value of its $1.2 trillion of U.S. denominated assets riding on the outcome, everyone in China will be watching.

Before Secretary of the Treasury Timothy Geithner headed to Beijing over the weekend, a senior Treasury Department official was quoted as saying that Geithner plans to press Beijing to take drastic measures to turn China’s economy into one that depends heavily on sales to domestic consumers and less on sales to the U.S. and other foreign markets. That means encouraging Beijing to offer more generous health-care, retirement, welfare, educational and other benefits in order to persuade the average Chinese citizen that spending now doesn’t mean starving later.

I sincerely hope that is not his message. If it is, he hasn’t been reading Beijing’s lips. Premier Wen has already said that he is worried about the U.S. assets that China holds. And the falling dollar is causing additional concerns. Zhou Xiaochuan, governor of the Chinese central bank, said in March that he wants the dollar replaced as the chief monetary unit for global finances with a currency derived from a basket of international currencies. Controversial views like this by senior Chinese government officials are seldom expressed publicly unless there is some consensus among a broader group of leaders.

In my view, Secretary Geithner has only one mission when he arrives in Beijing this week: to assure his largest investor about the prospects for the U.S. economy and to sell U.S. Treasury bonds. As any bond salesman will tell you, he’s got his work cut out for him. That’s because the prices of the products he is selling have been falling, and all indications are that they will continue to fall in the coming months.

The “elephant in the room” that no one seems to want to talk about is the massive $3.25 trillion of debt that the U.S. government must raise by September 30, 2009 – the end of the fiscal year. This is needed to fund a deficit that the Obama administration now estimates will total $1.84 trillion, up by 5 percent from its estimate in February and a deficit that represents an unprecedented 13 percent of the country’s GDP.

That is why long interest rates have been rising in recent weeks, and the prices of bonds–the products that Geithner wants to sell more of to the Chinese–have been falling. (Bond prices move inversely to interest rates. As interest rates go up, bond prices fall and vice versa.) The dollar is also falling, dropping to a four-month low against the euro. And the prospects are for more of the same.

So much so that Bill Gross, the co-chief investment officer of Pacific Investment Management Co. (PIMCO) who runs the world’s biggest bond fund and is one of the most respected investors in fixed income securities, is staying away from U.S. Treasury bonds. “The Treasury is issuing a lot of money,” he said. “The market is beginning to wonder who is going to be buying these bonds.”

The growing deficits and the rise in the overall level of government debt in the United States is creating another issue–the potential that the United States might lose its coveted AAA debt rating. Standard & Poor’s recently lowered its outlook on the U.K.’s AAA credit rating to “negative” from “stable” and said the nation faces a one-in-three chance of a rating cut as its debt approaches 100 percent of gross domestic product. At an unprecedented $6.36 trillion, U.S. marketable debt is about 45 percent of the country’s GDP, according to Bloomberg data.

While a downgrade is not “imminent,” according to Gross, he said that: “Both the U.K. and the U.S. have prospective deficits of 10 percent annually as far as the eye can see. At some point over the next several years,” the debt of each “may approach 100 percent of GDP, which is a level at which country downgrades tend to occur.”

To convince China to continue to help take up the $3.25 trillion of U.S. Treasury securities that need to be sold in the coming months, Geithner needs to convince the Chinese leaders that the prices of U.S. treasuries will not keep falling and that the Obama administration has a strong dollar policy and will reduce deficits. No easy task given recent trends and the broad and expensive social and environmental programs being pushed by his boss.

If Geithner’s message is instead that the Chinese should “shop not save,” and that the government must do more to encourage domestic consumption, his message will fall on deaf ears and he will be seen as talking down to his Chinese hosts. Given the recent economic performance of the United States, China’s leaders will not be anxious to hear such words of wisdom from the new Treasury Secretary.