Brad Setser

Follow the Money

Cross border flows, with a bit of macroeconomics

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Commentary on the People’s Investment Company has been outsourced to Stephen Green

by Brad Setser
March 26, 2007

Stephen Green of Standard Chartered has the best analysis I have seen of the bureaucratic politics behind the creation of China’s new state investment company, as well as the best analysis of the constraints on its operations.  

As Green notes, the management of a country’s reserves — especially a large country's reserves — is fundamentally about supporting a country’s exchange rate regime (“Running FX reserves is not like running an investment or hedge or even pension fund. It should not be about maximizing returns, but first about supporting the chosen exchange rate regime”).  A large state investment company probably faces similar constraints.  

Green writes in Business Week:

There are other issues which will complicate Beijing's pursuit of happiness. ….  First, with the dollar. Premier Wen Jiabao, answering questions at the National People's Congress, went out of his way to make this point, saying the new fund would not have any impact upon the dollar. And for its own part, China is still caught in what former U.S. Treasury Secretary Larry Summers once called "the balance of financial terror", since if they sell their dollar holdings, the value of their residual U.S. holdings will fall. If the markets ever caught wind of China diversifying its holdings, dollar-selling pressure would be immense—and Washington would have something to say, too. But this raises the question why start a new fund if you don't want to do anything differently? That creates incentives to be extremely conservative, diversifying quietly and gradually.

Second, consider the possible impact on the region. How would people react if Beijing bought large quantities of the equities and debt traded in Taipei? Or of those traded in Tokyo? If the fund does indeed turn out to be active in Asian equities, China's relationship with the region will get a lot more complicated. How would other investors feel if China FX Fund owned 5% of their company? Would they be assured that China was only holding a position for financial reasons?

There are also big operational questions. If the new fund went into buying control of ventures overseas—an Indonesian gas field, a failing U.S. corporate, a high-end German engineering venture—how would that entity be operated? Would it be handed over to a Chinese corporate with some experience in that area or would managers and/or directors be sent from the fund? These are immense challenges, and the potential for generating nothing more than dissatisfaction at home and unease overseas are significant. Money, in short, will likely not buy Beijing happiness, at least not easily.


One of the rumors about China's state investment company – reported by Green – is that it intends to invest heavily in emerging Asia.  I don’t quite see how, though, that will make China popular in the region.   Many other emerging Asian economies run current account surplus, so they don’t need the money.   Those with deficits generally are already attracting more money than they need, so they are adding to their reserves.  Big inflows from China would put more upward pressure on their exchange rates – or force their central banks to intervene more.   That shifts the dollar that China doesn’t want to hold over to another Asian central bank.  And I don’t think many Asian central banks are all that keen to add to their dollar holdings.  If China really does try to change its asset allocation, things could get interesting.


  • Posted by steve

    maybe they are planning to buy Africa. The financial maarkets won’t care and the Africans will be more than happy.

  • Posted by Guest

    buy Africa and then securitise it…

    “The world is suffering from a shortage of financial assets.”

  • Posted by Dave Chiang

    Steven Green writes, “Second, consider the possible impact on the region. How would people react if Beijing bought large quantities of the equities and debt traded in Taipei? ”


    The Economies of China and Taiwan are already intertwined. The vast majority of Taiwan’s population supports the status quo and does not support a formal declaration of independence. It is only a small but vocal minority in rural South Taiwan that demands the change of constitution as a independent nation.

    Unofficially, Taiwanese are the 2nd largest investors in the Chinese economy. Increasing pricing pressures have forced most of Taiwan’s computer industry to relocate to mainland China. The Taiwan Semiconductor Industry is following with TSMC opening its 1st integrated chip fab outside Shanghai. Despite political strains in the cross strait relationship, business across the Taiwan strait is booming. The Chinese like to say that business is business and politics are politics; two entirely separate spheres.

    Outside of the small minority of Taiwan separatists, if Beijing bought large quantities of the equities and debt traded in Taipei, there would be little or no reaction since Taiwanese investors already own large equity stakes in mainland China businesses. Like the Quebec separatist movement, the Taiwanese independence movement is rapidly fading with increasing cross-strait economic integration and family ties.

  • Posted by Dave Chiang

    Self-sustaining Asian Economic Growth less dependent on U.S. Economy

    March 27 (Bloomberg) — Asia’s developing economies will grow 7.6 percent this year, faster than earlier forecast, as a pick-up in spending by consumers and companies cushions the impact of weaker exports, the Asian Development Bank said.

    Rising incomes in China, India and other Asian economies are boosting consumer spending and encouraging companies to lift investment. Reduced dependence on export-led growth will make the region’s expansion more self-sustaining, as a slowdown in the U.S. and Europe damps demand for made-in-Asia goods.

  • Posted by Guest

    or outsource it to and/or buy singapore

    but i don’t think there’s any question that china views their “chosen exchange rate regime” as an explicit tool of development policy; they’ve already acted a little thru intermediaries, which i suspect will expand, but when you got a trillion dollars burning a hole in your pocket there’s a learning curve that not only china needs to move up, but the ‘RoW’ as well, as green amply illustrates

  • Posted by Emmanuel

    There are a heckuva lot of countries in the region not running large CA surpluses that could use and would love some Chinese investment. Indonesia, the Philippines, and Cambodia come to mind, among others. Say tah-tah for now to the American master and hello to the Chinese one.

    In any event, my top suggestion for PIC investment remains the same: sell Ford and GM to the Chinese. Despite the obvious political hurdles, it makes fine business sense.

  • Posted by bsetser

    Emmanuel — the CIA data suggests neither the philippines or indonesia ran a large CAD. both actually have surpluses according to the link you supplied, but that may be a bit dated (thailand is listed as having a deficit, and it now has a surplus). but as importantly, China has up to $400b to invest. that is a lot. How much realistically would Indonesia and the Philippines absorb? and how much appreciation would they accept before starting to worry?

    Thailand and Korea already have let their currencies appreciate a bit, and both have made it clear that they will resist further appreciation and don’t really want a lot more capital inflows.

  • Posted by Guest

    “Were the U.S. to persistently earn substantially more on its foreign investments (“U.S. claims”) than foreigners earn on their U.S. investments (“U.S. liabilities”), the likelihood that the current environment of sizeable global imbalances will evolve in a benign manner increases. However, utilizing data on the actual foreign equity and bond portfolios of U.S. investors and the U.S. equity and bond portfolios of foreign investors, we find that the returns differential of U.S. claims over U.S. liabilities is essentially zero. Moreover, were it not for the poor timing of investors from developed countries, who tend to shift their U.S. portfolios toward (or away from) equities prior to the subsequent underperformance (or strong performance) of equities, the returns differential would be even lower. Thus, in the context of equity and bond portfolios we find no evidence that the U.S. can count on earning more on its claims than it pays on its liabilities.”

  • Posted by gillies

    the chinese could invest the trillion at 2.5% per annum and draw 100 billion every four years. the war chests of all presidential election candidates combined are around 500 million dollars – so even the interest on the interest could buy every presidential election, for ever, 20 times over.
    maybe that’s why they would never be allowed to buy an major arms manufacturer – they could use it as a front to corrupt the political process.

  • Posted by carmelus

    I do not think China will be buying minor stakes in companies. As a matter of fact I think China will try to make a new conglomate by buying different strategic companies in the mining field creating a new BHP Billiton and maybe opening its capital. China will be shopping this year and surely has targeted the companies to spend maybe 300 billion dollars , twice BHP`s market capitalization.

  • Posted by Dave Chiang

    The China will be buying minor stakes in companies especially in natural resources. They have already purchased minority ownership stakes in Australian offshore Gas reserves, Russian Oil fields, Iran Gas fields, Nigerian Oil fields, Indonesian Oil fields, Malaysian palm plantations, Cuban Tin reserves, Ecuador Oil fields, Angola Oil fields, etc. It is simply politically unacceptable in many nations to retain majority foreign ownership. But even with minority ownership with several members on the board of directors of a corporation provides a greater degree of security and stability than having no equity stake. The increasing global influence of China’s economy has only just begun.

  • Posted by Guest

    I’m an accountant and tend to view the nations economy as in a company. (Although it makes most macroeconomists raise their eyebrows and sometimes even roll their eyes)

    The exports minus imports equals net income.
    The resources available from net income or debt can either be used on costs or invested in assets.
    The (tangible and intangible) assets are necessary for creating net income in the long run.
    If China invest the resources in assets like infrastructure, its getting richer.
    Sometimes the Chinese investments are not creating a net income and are a waste, but most are good investments and still it’s better than burning up the resources on consumption (costs). It’s always possible to find ways of investing the surplus – the central bank of Norway has an oil fund investing in all kinds of things. Why should the Chinese not gradually do the same, at least with future surplus? China could also invest more in intellectual capital (education & research). I don’t think the investment slump is a big problem for China – an airport too many for the time being is still more productive than investing too much in housing. If growth slows too much, it’s always easy to make a tax cut or write the population a check.

    The US uses the resources on consumption(costs)and unproductive assets like housing and are getting less competitive in the long run, if it continues. The solution for the US is more investments and less consumption. The means could be: higher income taxes, public investments in education, infrastructure etc. and lower corporate taxes.

  • Posted by gillies

    seriously, though – does anyone imagine that the chinese intend to outsource the financial advisory work ? and if they did, would they not do so to some country that showed an ability to generate and manage a surplus of its own ? and it is in any case only a trillion dollars, the kind of sum that the pentagon accounts department could lose through a crack in the floor. and if the chinese are going to act irresponsibly – there has been absolutely no sign of it so far.

  • Posted by BH

    Not long ago, I would have been in full agreement with the accountant, above. But what value is investment when there simply IS no consumption? Koreans have enjoyed great access to liquidity in recent years, and they only bought houses. The rest of NE Asia is similarly inclined to save. So “it’s easy to make a tax cut or cut the population a check” is, I’m starting to think, not as easy as it sounds. They just take the money and invest it. Who, I wonder, will be the customer that gives all those investments actual income?