Why worry about sovereign wealth funds?
Martin Wolf, as usual, is the voice of reason. I highly recommend his most recent column.
Dr. Wolf notes that a set of countries with a far different conception of the role of the state in the market have emerged as major international investors. He views
“the emergence of these funds as part of the integration [into the global economy and global financial system] of countries that accept a bigger role of the state in markets than western countries do today”
For that matter, the rise of the state as an investor can also be viewed as a byproduct of the gap between the size of the US current account deficit that private creditors are willing to finance and the actual US current account deficit. Official investors have to make up the gap. The latest IMF WEO data shows that private funds are far more readily available to finance current account deficits in the emerging world than in the US. But so long as the emerging world resists adjustment and maintains large current account surpluses, central banks and sovereign funds have to recycle the private inflow — along with the emerging world's current account surplus — back to the US and Europe.
Until recently, that flow has largely been a bond flow. But for very understandable reasons, over time, the emerging world is likely to want to buy more equities and fewer bonds.
That means that the governments of emerging economies will become large investors in a range of US markets, not just the bond market.
Wolf also notes that sovereign wealth funds are potentially much less of a problem than big state firms.
The big truth is that contemporary globalisation has brought players into the game that operate by different rules from those espoused by today’s high-income countries: vast state-owned companies, such as Gazprom; billionaires who have gained fortunes by a mixture of force and fraud; and funds owned by governments. Of these, the last may well turn out to pose the smallest problems.
Very true. I suspect some big Chinese firms fall in the same category as Gazprom. They too operate by different rules than those prevalent in the US and Europe.
Martin Wolf notes that the way governments invest matter. A fund, like Norway, that seeks to maintain a diversified portfolio is bound to cause less concern than a fund that makes concentrated bets on a few companies, even if the concentrated bets are made for commercial rather than strategic purposes.
I agree. That is why I am a bit worried that a lot of funds now want to take concentrated bets, not to hold a broad, diversified portfolio. The CIC is a case in point. It wants to sit on the boards of the companies it invests in. Concentrated bets on an individual companies raise issues of control that a bet on the direction of the broad equity market doesn't.
The potential scale of the sovereign investments in US and European equities also is a source of concern. China and Russia are both setting up investment funds now — and the Saudis are likely to start to manage their non-reserve foreign assets more aggressively.
That matters.
Right now, there are a group of small and aggressive sovereign funds, and a group of large and fairly passive funds — but no large and aggressive funds. If Russia and Saudi Arabia started investing like Dubai and Qatar, the world would notice.
Norway's government fund only bought $3b or so of US equities in 2006. China's investment company could buy far, far more in a single month.
The market will, of course, adapt — just as the market adapted to central bank demand for US Treasuries and Agencies. Many in New York are already salivating over the prospect of managing money for a big sovereign wealth fund. 2% of a trillion — plus a performance fee — is real money, even in New York’s second gilded age (though I suspect the big SWFs will get a volume discount). Some equity investors are looking forward to selling their existing holdings at a very high price to a sovereign fund. US financial firms – and UK financial firms — think that selling a share of themselves to the still nominally communist Chinese government will give them an advantage inside China. History takes strange turns.
And some investors are already trying to use China's fund to their advantage. Want to drive the price of something up? Hint that the CIC is buying …
But markets do not operate in a political vacuum. Big cross-border investments require the support of the host government. And I am not sure that there is a political consensus in the US in favor of allowing big foreign government funds to play an active role on US corporate boards, let alone to let big state firms own big US companies. Judging from Richard Portes' column, there also may not be a political consensus in Europe for the "renationalization" of European firms.
Up until now, US policy makers have generally downplayed the United States dependence on official inflows. The US capital flows data is far better than what the UK produces (the UK's BoP data is rather embarrassing). But even the US data isn’t all that good. Among other things, it tends to undercount official inflows. The US government – at least the technical folks at the Treasury and the Fed – know this. They can see the direction of the survey revisions as well as outside analysts. But US policy makers generally haven't opted to draw attention to this fact.
Now all of a sudden hidden — or at least quiet – official demand for bonds may turn into very visible purchases of large stakes in iconic US firms. Goldman’s stake in ICBC and Bank of America’s stake in China construction could be matched by the CIC’s stake in Blackstone, the CDB’s stake in Barclay’s and, possible, CITIC's stake in Bear Stearns.
Fair is fair, you might say. If US bank can invest in Chinese state banks, Chinese state banks should be able to invest in the US. True enough.
But the US concept of globalization was always that the rest of the world would adopt the US model of market capitalism, not that the US might end up importing the rest of the world’s model of state capitalism.
In some sense, the US conception of globalization has been at odds with its current reality for some time. It is a bit hard to see how the US can export its economic model when it is import huge sums of capital from the rest of the world. But the US public may not see it that way. George W. Bush has argued that US consumers benefits from the low prices on goods imported from China, but he hasn't exactly warned that importing more goods than the US exports might eventually imply pressure to import aspects of China's model of corporate governance.
China’s financial integration into the world is coming almost entirely through the investments of China’s government in the rest of the world – not from an outward flow of private Chinese capital. So long as the RMB is undervalued, this flow almost has to be a government flow – private investors in China don’t want to be underperforming, depreciating assets.
Talk about a recipe for friction.
Right now, though, China doesn’t seem particularly inclined to make the CIC as transparent at Norway’s government fund to try to ward off US — and European — concerns. The battle lines are already being drawn. China’s response to US calls for more transparency is that private hedge funds are a far larger threat to financial stability than sovereign wealth funds.
It certainly is possible that China is right. Almost all hedge funds are leveraged. Only some sovereign wealth funds are leveraged. Most hedge funds are fairly nimble. Only a few sovereign funds are. Some hedge funds are willing to take big risks in the hope of getting big returns. Sovereign funds – I hope – won’t quite have the same incentives.
But China's response also is unlikely to build public support in the US for a larger Chinese state presence in the US equity market. The CIC probably would be better off — politically speaking — if it had started by postings its portfolio composition on its website at the end of the third quarter, setting a new standard for transparency. That would have put its critics on the defensive.
Update: The world has a new investment fund, the Libyan Investment Authority (LIA). I sort of like the Gaddafi fund better, but, well, that isn't terribly diplomatic. It seems to have a close relationship with the QIA (Qatar investment authority). I wonder when Algeria and a few other oil states that still manage their reserves conservatively will get in on the act.
I have highlighted the risks associated with the growth of sovereign wealth funds. But I should note that in this case, Libya's desire to get a higher return on its swelling cash than it could get while subject to US sanctions likely contributed to its desire to normalize its relationship with the world. Call it the lure of Blackstone, and Blackstone-like returns …
Dubai has been the driving model for many of the developments in the Middle East and emerging markets generally. From a tiny port with a population of 59,000 only 40 years ago, it has grown to be a super-regional financial, commercial and tourism centre with influence globally. The population today is 1.5 million - with 1.2 million ex-pats.
It is easy to overlook how influential Dubai has been in markets it targets. Emirates airline revolutionised long haul by providing a real alternative to national carriers like British Airways. The Dubai Airport hub facilitated massive growth in commerce and tourism between Europe and Austral-Asia. The hotels and mega-malls followed the airport until Dubai supplanted Florida as a top holiday destination. These four investments were part of a long term, joined up strategy that no boardroom in a private sector corporation can rival.
Now that Dubai and others are targeting investment in strategic assets in OECD countries, people are paying attention. They should. By owning influential stakes in stock exchanges, banks, ports and other key economic infrastructure, Dubai and other SWF stakeholders will determine the shape of financial and commercial intermediation going forward.
There is a long term, rational strategy behind the pattern of investments being made by SWF and state-owned corporations from the Gulf. There doesn’t appear to be any long term, rational consideration of the implications yet within Washington, Westminster or other political capitals that would inform a sensible policy framework for responding to the new shape of the geopolitical-financial landscape.
bsetser: The CIC is a case in point. It wants to sit on the boards of the companies it invests in.
First of all, it’s a bit early to try to say much about CIC’s investment policy, but it appears that they do want a diversified portfolio, otherwise there would be little point in mixing the holdings of NSSF, Huijin, and overseas investments corporations. Second in the cases that CIC has done new investments, they have *not* wanted to sit on the boards of corporations that they’ve invested in.
bsetser: But the US concept of globalization was always that the rest of the world would adopt the US model of market capitalism, not that the US might end up importing the rest of the world’s model of state capitalism.
1) Guess what. The term is globalization, not Americanization.
2) It actually seems to me that China is importing the US model of “state capitalism.” Pretty much everything involved with CIC seems pretty clearly modeled after US state pension funds like Calpers, which is actually quite a bit larger than CIC.
bsetser: Right now, though, China doesn’t seem particularly inclined to make the CIC as transparent at Norway’s government fund to try to ward US — and European — concerns.
I pretty strongly disagree with that. CIC has been as transparent as most funds in the developed world as far as their holdings, strategies, organizational structure etc. etc. How much do you really know about the New York State Teachers Pension fund?
Something that I find interesting is that for a “sovereign wealth fund” CIC is not particularly big
http://www.watsonwyatt.com/europe/research/pdf/PI_300_Analysis_2007.pdf
I find it interesting that the China Investment Corporation ends up with so much interest whereas no one seems to care about the Ontario Teachers Pension Fund.
The way I think the Chinese government will deal with public backlash is to make lots and lots of small investments that don’t involve control transactions. After the one hundredth news story about *my god, the Chinese are buying American companies!!!* even Fox News is going to lose interest in the story.
The other driving force behind Middle Eastern investments is that the people involved want to keep the gravy train going after the oil runs out in about 20 years.
I find it interesting that the China Investment Corporation ends up with so much interest whereas no one seems to care about the Ontario Teachers Pension Fund.
Perhaps that’s because Ontario Teachers, and Calpers, and Harvard, et al. didn’t garner their assets as a direct result of a) owning a printing press, and b) engaging in heavy purchases of foreign currencies while heavily restricting foreign purchases of their currency.
Something that I find interesting is that for a “sovereign wealth fund” CIC is not particularly big
It is the largest three week old sovereign wealth fund in history. But you’re right- it isn’t that big. In fact, it’s so small in relation to China’s population that it’s pretty clearly not worth the effort if maintained at current size. GIC in Singapore has assets of roughly US $85,000 per citizen. CIC isn’t going to get there any time soon, but it will almost certainly grow very substantially. At $5,000 per citizen (which would still be much smaller per capita than any other SWF), CIC would have assets in excess of $6 trillion. And that would make it very comfortably the largest investment fund on the planet.
I pretty strongly disagree with that. CIC has been as transparent as most funds in the developed world as far as their holdings, strategies, organizational structure etc. etc. How much do you really know about the New York State Teachers Pension fund?
If you know wher to look, you can get the investment performance of pretty much any US pension fund or endowment. SWF’s, on the other hand, do not tend to report their performance data, with the exception of Norway. Given the widely-held expectation from those very close to the situation that CIC is using GIC/Temasek as their model, the reasonable expectation is a high degree of inscrutability.
I am amazed by the general view of almost everyone that the chinese currency has to appreciate againt the USD and this process is one way, RMB will only go up against the USD! It seems that the absolute guaranteed easy way to make money nowdays is borrow USD and buy RMB!!!
What everyone seems to be neglecting, is political risk and stability in the future for the RMB. Anyone who has been to mainland China (other than big cities) knows very well what a brutal regime there is in China and what shaky foundation it has. Just wait till the end of Olympics next summer. The USD will make a come back, as it is the only plausible reserve currency without any alternatives today or in the foresseable future and with least political risk. Do not neglect political risk, events happen and take everyone by surprise, like alawys.
Macro man: CIC isn’t going to get there any time soon, but it will almost certainly grow very substantially.
Not necessarily. If they are using a Calpers model, then it is likely that the Chinese government is going to spin off new funds once the fund reaches a certain size.
Macro man: If you know wher to look, you can get the investment performance of pretty much any US pension fund or endowment. SWF’s, on the other hand, do not tend to report their performance data, with the exception of Norway
Temasek does. It has to in order to be able to get a bond rating from the agencies. I think that people are making judgments on CIC based on widely held assumptions which IMHO are wildly incorrect. Prediction here is that in six months, you’ll have a CIC website that will have as much information as that of Calpers. For now the National Social Security Fund website has a fairly large amount of information.
“Prediction here is that in six months, you’ll have a CIC website that will have as much information as that of Calpers.”
I’ll place a $10,000 bet against that contention.
Temasek — transparent (tho that is new), but makes concentrated bets/ seeks strategic stakes.
GIC — quite untransparent for a fund of its size.
The CIC has preemptively decided to start operating at Norwegian level of transparency either — though the people involved in the CIC certainly talk more than say ADIA does.
2fish. Various press reports yesterday suggested that the CIC wanted seats on the board but not “control.” That suggests that initially it isn’t going to just buy the index, but rather make specific bets. I was reacting to those reports.
And I think the CIC attracts attention because it will immediately become the largest fund in terms of flows — and if the initial allocation is repeated, it will quickly become among the largest in terms of stocks. $200b is close to SAMA’s foreign assets, tho a bit under. and that is what the CIC is starting with.
Given China’s underlying pace of foreign asset growth (roughly $500b a year, though China hasn’t been transparent about the sources of its reserve growth/ how the CIC is impacting the reserves data), there is little doubt that the CIC could become big fast.
The gulf is going to run out of oil in 20 years? That is news to me. Russia and Norway will, but I thought the Gulf was going to be the world’s oil station for a bit longer …
China will be at the same time both a major buyer/holder of US debt, and also an investor in broader US assets, e.g. equities. That’s a lot of market power, and I think it is clear that in this case the ‘left hand’ will definitely know what the ‘right hand’ is doing.
GIC & Temasek being transparent? Well…CIC is being modelled after them and I think the Koreans and Japanese are using them as case studies.
SWFs as name suggests, definitely have some veil of secrecy, definitely have some political agenda/subagenda, definitely bound to be met with some resistance rational/irrational and definitely bigger and influential than our expectations.
During their heydays, in the 1980s Golden Era, the Japanese conglomerates aggressive investment strategies (subjective)were rebuffed by the Westerners collectively. And those were commercial and private names (if the classification is any good).
As Brad has pointed out, as along as the West continues to open up, continues its free market rhetoric and democratic charade, there is a good chance that these SWFs will have a hard time.
If Temasek and GIC are any good examples, they have been rebuffed several times in theis acquisition or partnership attempts. Ports, Telcoms, Resources, Transportation, Banks, Financial, Satelite, Hi Tech, etc which sector isn’t politically sensitive? Call me a skeptic, but it ain’t gonna be pretty.
As long as
Macro Man “In fact, it’s so small in relation to China’s population that it’s pretty clearly not worth the effort if maintained at current size.”
Well Im not too sure if its any good measuring/quantifying/gauging the SWFs by assets per capita. I mean do you measure the Hedge funds by assets per manager? or Citibank’s return/assets per employee?
My guess on CIC is probably, its just the beginning, the prototype Mark I and we will begin to see more Chinese funds (perhaps modelled after some other setups)
Adiemuso, if soverign wealth funds are ostenisbly meant to be ‘guardians of the people’s wealth’ or some such, than I believe it is appropriate to see how much wealth per person is being managed.
Morover, for political and economic purposes it really doesn’t matter whether China’s SWF assets are concetrated in one fund or split amongst a hundred. If their assets are garnered via mercantilist currency policies, they are going to meet with significant protectionist pressures if and when they try to make “stategic” investments in developed-market companies/industries.
Expect G7 to mention the issue, possibly in the communique but definitely on the sidelines. Not that that matters any to China, Abu Dhabi, et al, but it is indicative of the level of push-back that CIC is already receiving….oen would think that is only going to move in one direction moving forwards.
From the Daily Telegraph:
China threatens ‘nuclear option’ of dollar sales
By Ambrose Evans-Pritchard
Last Updated: 8:39pm BST 10/08/2007
The Chinese government has begun a concerted campaign of economic threats against the United States, hinting that it may liquidate its vast holding of US treasuries if Washington imposes trade sanctions to force a yuan revaluation.
Based on the comments made by Lou (the new CIC chief), it looks like they will not be like hedge funds — they won’t seek profits from trading. They want to make long term investments. There are great targets in the financial service sector right now. Very cheap valuation because of liquidity concerns — but that is exactly the strength of CIC. Their best bets are to take large stakes in the best Western banks and financial service companies.
M. Wolf: “But interesting questions arise elsewhere: what would people feel about Chinese government ownership of a big media operator?”
B. Setser: “But the US concept of globalization was always that the rest of the world would adopt the US model of market capitalism, not that the US might end up importing the rest of the world’s model of state capitalism.”
this argument is impressive and challenging, and it also has implications that reach international politics. But I feel to kind of soften the tones of the discussion.
As far as I know, all the best “globalizers” of the last ages (Spaniard conquistadores after the discovery of America, the British in the 18th century and USA in the 20th) gaied control of foreign territories also thanks to their military supremacy.
To cut it short, USA still holds a position of supremacy on the world chessboard. Hence, I think it still has the power a) to let un-welcome people out of their key centres of affairs and/or b) let the Western rule-of-law be respected for some years again.
So I don’t think that a few acquisitions by China could provoke by itself a major changing of the way globalization works. Other things (such as probably wars) should come into play before we could see the Chinese (or Russians) as the new “globalizers”.
A chinese guy ruling a TV channel (not FOX, nor the CNN ) might be peculiar at first, but after a while we will all get used to it. And it will also add a bit of differentiation to today’s financial world (dominated by the Americans and British). Should we all be really worried about it?
Best
If the US tries to shut China out of our equity market, what then? One result might be immense pressure of shareholders on the US government to open up so they can rake in the cash. Or China might react in some way to punish us? What would that be likely to be?
How easy would it be for CIC to operate through fronts, say in the Cayman Islands, so that its large purchases of US equities would be disguised? Could such fronts be easily penetrated?
“Should we all be really worried about it?”
Good question. I suspect that if globalization meant private Chinese purchases of US assets, the answer would be no — but if globalization means state purchases of US assets (on a potentially significant scale; China has half a trillion $ to place) the answer to many American is different. The scale of the flows associated with the “Chimerican” world — where Chinese savings finance US investment bothered me even when the flows were bonds, so it isn’t a total surprise that certain kinds of equity flows also raise questions to me — but that may reflect my concerns about the system as much as any specific concerns about chinese state equity investment.
I would note that if China buys a US pharma, it would have a big interest in a host of domestic US policy decisions (medicare reimbursement, patent protection, etc) and thus an interest in the outcome of the US political process. Chinese owned firms presumably would lobby to protect their interests … and well, that strikes me as leading down some pretty slippery slopes.
The CIC wouldn’t need to use fronts. It could just use equity derivatives. UBS (or another bank) buys a lot of US stocks and sells a derivative giving the CIC the upside. Some gulf funds use these structures. it also avoids formal control. When Dubai funds have used these structures though, they have still wanted a close — tho informal — relationship with the firm’s management.
And how would the CIC respond to restrictions? good question. One response would be to buy more european stocks. but that puts pressure on the dollar — and might drive the rmb down as well. I am not sure China wants to add to the dollar’s pressure through its asset allocation. Or it could adjust its portfolio so it buys more of those assets the US has been wiling to sell. This is what Dubai did — it ended up with a chunk of vegas real estate rather than the right to operate a set of US ports. Or it could just end up buying bonds.
So long as China manages its XR v the $ and doesn’t want to add to the existing pressures on the $, I personally suspect that China is kind of boxed in.
but that is a guess.
The Chinese CIC isn’t going to operate through fronts, and isn’t going to make hostile takeovers of US Corporations. They will more than likely take minority stakes of foreign corporations with the friendly support of the company’s board of directors. In the same strategy of state-owned CNOOC that took a minority 10% stake in the Australian natural gas consortium that exports to China, the Chinese CIC will take strategic minority stakes of global natural resource producers. The Chinese would like to have some stabilizing influence on the natural resource suppliers to their booming economy. For Western Corporations, having the Chinese state-owned CIC is actually a plus, since the Chinese are long term investors that are not very concerned about short term shareholder profitability. Capital intensive natural resource and high-technology corporations should welcome Chinese investment which also significantly increases their access into the booming China market.
Brad: “Chinese owned firms presumably would lobby to protect their interests … and well, that strikes me as leading down some pretty slippery slopes.”
…suggestive, we will see (I am truly not skeptical, it is just that I still imagine the Americans as those with the major bargaining power. Probably but I should seriously start changing my current view).
Brad: “So long as China manages its XR v the $ and doesn’t want to add to the existing pressures on the $, I personally suspect that China is kind of boxed in.”
I too think this. But this leads me to think that China’s bargaining power is probably less than we suppose. As you say, it has $1 trillion-odds-worth of FX, but its real value (i.e. their value if you account for all the implied and unavoidable devaluation the $ has to face), it might be less.
I think another important question is: “What is the real bargaining/purchasing power of China given its amount of FX and given its range of manouvre (which, as you point out is a bit limited)?”
Best
“…Deng has recently become a director and chief strategist for the holding company that licences the MySpace brand and technology to MySpace China, her first formal involvement in the media business since she left her job as a Vice President of News Corporation’s STAR TV in Hong Kong in the late 1990s.[citation needed] She married Rupert Murdoch… on June 25, 1999. The couple… live in Manhattan.” http://en.wikipedia.org/wiki/Wendi_Deng
Aren’t these problems that a world of increasingly integrated capital flows faces anyway? Apart from the additional effect of large current account surpluses? - Although the size of China’s surplus and state conduits for recycling it add to the complexity of the policy problem for the US.
“…When Li is not busy pulling off deals worth billions of dollars, he is actively involved in a myriad of non-governmental organizations. Li acts as the Governor of the World Economic Forum for Information Technologies and Telecommunications. He also is an active member of… the Global Information Infrastructure Commission, and the United Nations Information and Communication Technology Advisory Group… 2007 looks like the year in which Richard Li becomes a newspaper publisher and maybe this is merely the precursor to Li becoming a media baron rivaling Rupert Murdoch…” http://ca.askmen.com/specials/2006_top_49/richard-li-40.html
Brad - one could see that America’s own SWF is in the form of the financial and political clout being exerted by US private insitutions and organizations on Washington and military power stationed around the globe all following a similar laissez-faire model (in aggregate) as bigger and more domineering to the ROW than CIC at its infant stage — it’s way too soon to “Cry Wolf” unless Asia and Middle East become in its own right an econmic and military region to keep Good Old USA in check.
From Neo-liberalism advocates especially Thomas Friedman, I am really sick and tired of hearing the biased political arguments - the comparison of American private corporations equating to heaven, and Chinese state-owned corporations equating to hell on earth. Far from being broken and dysfunctional, the major Chinese state-owned corporations are highly profitable and rapidly expanding their global reach especially in the developing world markets. The soaring share prices on the Shanghai and Hong Kong stock exchanges reflect this economic reality.
Aito “Should we all be really worried about it?”
For me Im all for a free globalised market. I akin it to game theory, think you did an excellent piece the last time round, best outcomes are when both decisions are similar. In this case, since the Chinese has begun to open up albeit slowly in some aspects, the best outcome would be a similar stance being reciprocated.
However, I remember some old politician remarks, think its Lee Kuan Yew, who mentioned that ” if you allow vandalism in the neighbourhood, soon you will have broken house windows, and left unchecked, ultimately you will see robberies and break ins. And so, to prevent all these, we nip the bud of the problem. Might not be 100% but it will definitely prevent a host lot more.”
Especially, when CIC or SWFs are long term investors, it is very difficult not to have any reservations/barriers/outcries against these powerful entities. Put it in extreme angle, I don’t think anyone would like to have a Chinese Trojan Horse in their backyard. Political Realism overrules economics I suppose.
Brad mentioned about the indirect ownership or influence through derivatives, i think these are very different from physical ownership. Personally, I don’t think the SWFs are so keen in some optimal callables positions or covered trading strategies.
“What is the real bargaining/purchasing power of China given its amount of FX and given its range of manouvre (which, as you point out is a bit limited)?”
Guess as long as the world is still pretty much dominated and denominated in USD, theres always avenues (african,east asian,eastern europe,latin america) for these USD, though maybe depreciating, to be used for strategic allocations and acquisitions. Unless, USD is no longer the “legal tender” the Chinese is still pretty muched measured in the same breadth as everyone else.
Dave “The soaring share prices on the Shanghai and Hong Kong stock exchanges reflect this economic reality.”
I got to agree to disagree. True. Hang Seng, H shares, Shanghai are all in stratosphere, but in terms of basic measurements, their P.Es are skyhigh.
Matured indices paled beside these Chinese, but it doesn’t reflect the REAL worth of the stocks or the undelying companies.
In fact, I view that this Chinese Bubble is one of the biggest problems for China and the World.
Sequence 1 - US debts infect the financial planet: A century after the « Russian loans”, meet the “American debts”!
Sequence 2 - Stock market collapse, in Asia and the US mainly: between - 60% and -30% in two years according to the regions
Sequence 3 - Bursting of global housing bubbles: UK, Spain, France and emerging countries
Sequence 4 - Monetary storm: Volatility at the highest / USD at the lowest
Sequence 5 - Global economy in stagflation: Recessflation in the US, soft growth in Europe, recession
Sequence 6 - « Very Great Depression » in the US, social unrest and the militaries’ growing influence on public affairs
Sequence 7 - Major acceleration in world’s strategic rebuilding, attacks on Iran, Israel on the brink, Mid-eastern chaos, energy crisis
Guest: How easy would it be for CIC to operate through fronts, say in the Cayman Islands, so that its large purchases of US equities would be disguised?
Effectively impossible. Once you have a 5% stake in any US-public company, you are required to file a lot of paperwork stating who you are.
bsetser: I would note that if China buys a US pharma, it would have a big interest in a host of domestic US policy decisions (medicare reimbursement, patent protection, etc) and thus an interest in the outcome of the US political process. Chinese owned firms presumably would lobby to protect their interests …
But I don’t see any reason why Chinese owned big pharma would act fundamentally differently than US-owned big pharma or Saudi-owned big pharma. There is this Fu-Manchu-ish idea that the Chinese government is this vast centralized mindless machine. In fact what is likely to happen (and what has happened in the case of big oil) is that Chinese-owned companies figure out what their corporate interests are, and lobby for them.
I personally think that the oil price increases have actually allowed the financial asset bubble to survive another year, by providing yet another source of easy financing: revenues from oil exports have extracted more money from households around the world; in the West, as that spending is basically compulsory, it has to a large extent been financed by increasing debt levels; meanwhile, those huge inflows could not be all spent in the oil producing countries, and had to be recycled in the financial markets.
By financing their customers on easy terms, the oil producers have worsened the already massive global financial imbalances - and have acquired funds large enough to make them players in our markets - buying, via their Sovereign Wealth Funds, companies and assets and not just State debt. Right now, we’re selling jewellery to pay for our fix.
But the price is still not high enough to make us stop. It seems that until we actually have to sell the house, we won’t even slow down our craving for the black stuff. And $100 still won’t be enough.
DC: The soaring share prices on the Shanghai and Hong Kong stock exchanges reflect this economic reality.
No they don’t, at least in Shanghai. The thing that makes Shanghai obviously a bubble is that if you take the *EXACTLY THE SAME COMPANY* and look at the share price in New York and Hong Kong, they are far less than they are on Shanghai. The soaring share prices on Shanghai is a sign of a dysfunctional market, and it is something that the Chinese government is trying to fix.
DC: Far from being broken and dysfunctional, the major Chinese state-owned corporations are highly profitable and rapidly expanding their global reach especially in the developing world markets.
The irony here is that the big SOE’s are profitable because the Chinese government adopted parts of the “Washington consensus.” What has happened is that the SOE’s were suffering from the “GM disease.” Most of them were losing money because they had lifetime employment and were responsible for pensions, health care, housing, etc. etc.
In the late-1990’s the government closed the bad SOE’s, and the good SOE’s they freed from this social obligations. Which means that lots of people were fired, the government paid a lot of lump sum unemployment benefits, houses were given to the employees, etc. etc. The good news is that this means that the surviving Chinese state companies are now making huge amounts of money. The bad news is that this means that the Chinese government is now responsible for pensions and health care that used to be the SOE’s responsibility, and they are scrambling to piece together a health care system and reconstruct a pension system before everyone grows old.
The thing that makes me optimistic is that no one in a policy making position is thinking “ha!!! ha!!!! you stupid Americans!!!! we superior Chinese have figured out a better system!!!!!” People from the Chinese government, I’ve talked to at conferences are refreshingly open and candid about the huge problems that China is facing and no one is in a triumphant mood. Also, no one is against adopting anything just because it was invented in the United States. China didn’t adopted the Washington consensus or Chicago school wholesale, but there are certainly parts of it that it did adopt.
bsetser: The CIC wouldn’t need to use fronts. It could just use equity derivatives. UBS (or another bank) buys a lot of US stocks and sells a derivative giving the CIC the upside. Some gulf funds use these structures. it also avoids formal control.
US$200 billion is much too large to invest using synthetic “access equities.” You can easily invest a billion or so with them, but any position much larger than that, and it’s just too big.
The other problem is that if CIC wants to buy and hold, then you end up with a US bank with a long term position in a US corporation and the control rights to that corporation. This probably would violate US banking laws.
M setser
Hang seng is reaching new highs while DJ is suffering, china growth is still unbeatable, do you think that a sustainable very high price of oil could be a sign of decoupling ?
If China wanted to punish the US for awarding a medal to, say, the Dalai Lama, would it find restrictions on US ownership of Chinese stocks and assets an effective means? It could tell Citicorp for instance to reduce its ownership of a Chinese bank to 3% or less, etc. Restricting investment in China would be painful for US companies wanting into that market and China hardly needs US investment anyway. I would think it might consider such moves.
A single foreign bank cannot hold more than a 20-percent stake in a Chinese bank.
How about reducing that to 5% for US banks?
juijeng — you are right; oil’s rally as the US has slowed is the best evidence around of decoupling.
I worry a bit that the hang seng is now a bubble though, and if it bursts (and its bursting hurts Chinese demand growth — as Pettis but not Xie expects) before the US has worked its way through its housing troubles, decoupling may not last. But so far, so good.
one other qualification (A bit off topic) is that china hasn’t decoupled from external demand; it just currently is riding a surge in exports to europe and the commodity exporters rather than a surge in exports to the US.
A single foreign bank cannot hold more than a 20-percent stake in a Chinese bank.
How about reducing that to 5% for US banks?
Or how about allowing the US/French government to print some dollars/euros, exchange them for RMB, and using the proceeds to purchase a 5% share in Chinese banks? That is the appropriate parallel here, and I somehow doubt that China would be terribly welcoming of this type of investment.
Guest: If China wanted to punish the US for awarding a medal to, say, the Dalai Lama, would it find restrictions on US ownership of Chinese stocks and assets an effective means?
No.
First of all, it’s rather large over reaction for something that doesn’t matter very much in the grand scheme of things. The Dalai Lama thing is one of those issues that will make the news for a few weeks and that everyone rapidly wants to forget. (Figuring out what really matters and what doesn’t is tricky sometimes, but I don’t think that this matters in the grand scheme of things.)
Second of all, it’s not effective policy. Congress is just not going to say *wow, now that you’ve threatened the banks in China, we’ll not give the medal*. The people who are handing the Dalai Lama the medals aren’t fans of China or the banks, and they’d react by giving the DL, ten medals. Also, by restricting bank ownership, you are hurting your friends, and your enemies will ignore you. Not a good thing.
Finally, in doing finance, what people care about is consistency. Buying and selling a bank is now something that you do in a day, and it is essentially in order to deal with this sort of investment that the rules don’t change day to day. US banks can deal with a restriction that says the ownership level is 0%, 5%, 15%, 20%, 50%, 100% since they can plan accordingly. They can deal with ownership levels being raise from X% to X+10% since this means that whatever level they were at is still legal. They can’t deal with things changing from day to day, since this makes strategic planning impossible.
I was wondering what people’s thoughts were on the use of SWF’s to influence individual currency valuation.
If SWF’s were to grow in significance (especially the CIC as it seems popular opinion would dictate), is it possible SWF’s and the BoP surpluses they represent could be seen as a new avenue for strategic currency manipulation in a managed floating exchange rate regime dominated by a weakening US dollar?
Thanks
Fair enough, Shanghai stock market is a bubble. My point only was that the Chinese state-owned sector is profitable with “real” earnings. The bi-yearly dividend checks that I receive from the Chinese energy, telecom, transportation and insurance sectors are money in the bank. Although there is a stock bubble, one can mark to market shares of PetroChina, CNOOC, Sinopec, China Mobile, Guangshen Railway, China Oil Field Services, etc. The balance sheet statements of Chinese state-owned companies are less opaque and more transparent than say the balance sheet statements of Goldman Sachs which retains $76 billion of Level 3 assets including subprime derivatives that are NOT marked to market, but marked to theoretical model based on what the management thinks. Goldman Sachs and major US money center banks utilize the same Enron creative accounting techniques by refusing to mark to market the majority of assets on the balance sheets. With a capital base of $32 billion matched against $76 billion of Level 3 assets of dubious value, it is even possible that Goldman Sachs, JP Morgan, Countrywide Mortgage, and Washington Mutual corporations would be bankrupt if federal regulators required all financial assets to be marked to market.
2fish:
I doubt the Chinese think the Dalai Lama business is trivial. Getting involved in that is the US meddling in their internal affairs and it would be foolish to minimize their anger; after all the Taiwan problem stems from the US getting involved in their internal affairs. Remember? And as for the people behind it paying no attention, I can’t agree with that either. The Congress is now backtracking on the Armenian genocide issue since Turkey has threatened to invade N. Iraq. What Turkey had to say about that the Congress heard loud and good. And do you think Wall Street would not scream to Washington if its silly policy of meddling in Chinese affairs damaged potential profits from China? It would scream as loud as Turkey has.
re: “Once you have a 5% stake in any US-public company, you are required to file a lot of paperwork stating who you are.”
["Morgan Stanley??"] has sold its 7.2% stake in The New York Times Company, ["people"] close to the matter said yesterday, bringing an end to a bitter fight between one of the bank’s asset managers and the company…” http://www.nytimes.com/2007/10/18/business/media/18paper.html?ref=business
“…A collapse in housing prices could have a harsh effect on the economy, given that 80% of urban homes are owned by private citizens. The value of housing loans awarded in China stands at nearly $450 billion so far this year. Yi Xianrong, a finance and banking researcher at the Chinese Academy of Social Sciences… worries that China’s subprime mortgage problem is worse than that in the United States because banking laws are still being written and a credit rating system doesn’t exist…” http://www.washingtonpost.com/wp-dyn/content/article/2007/10/17/AR2007101702217_2.html
“Almost all hedge funds are almost leveraged” ???
“Husky Energy Inc., a Canadian oil company controlled by Hong Kong billionaire Li Ka-shing, said third-quarter net income rose 12.8% to C$769 million ($789 million) on income from its newly acquired Ohio refinery… Including shares held by Li’s family and through at least one other company, the Chinese investor in shipping, real estate and mobile-telephone businesses owns about 71% of Husky…” http://www.bloomberg.com/apps/news?pid=20601082&sid=aKYPRj6G9CtE&refer=canada
The problem of state controlled investment is a direct function of foreign exchange intervention. The two together are a distortion of a basic model of free trade and free markets. US policy in response should control investment limits. This effectively is stealth depreciation in the real external value of the dollar because it limits upside returns on foreign holdings of dollar assets.
WACM — I agree with anonymous; SWFs and state investment are corollaries of fx intervention (and government control over oil revenue streams/ gov. hoarding of the resulting oil windfall — I would prefere more distribution of the oil windfall to the population through dividend checks and the like). Issuing local currency debt to finance the purchase of external assets by a SWF is analogous to sterilized intervention by the central bank; it is a means of limiting currency appreciation.
So yes, SWFs are a way of limiting appreciation. And for the oil exporters, they are a form of “fiscal sterilization” — so long as the oil revenue is held offshore, whether on deposit in $ in the central bank or through a SWF, it doesn’t result in an expansion of the money base.
BEIJING, Oct. 14 (Xinhua) - Spokesman Li Dongsheng for the 17th National Congress of the Communist Party of China (CPC) said Sunday that 1,554 private entrepreneurs joined the CPC last year, taking up 14.4 percent of the 10,773 members from new social strata… http://news.xinhuanet.com/english/2007-10/14/content_6880404.htm
DC
To suggest that the Shanghai/HK soaring stock prices reflect anything other than the global liquidity driven bubble is to disqualify yourself from the argument. surely you can’t be serious that 54x on Shanghai is fair value (NAsdaq at peak was 40x). Overlay the Index chart with Nasdaq 2000. Not saying the comaprable is perfect, but similiarities hard to ignore. interesting in light of arbitrage proposal that the Shanghai shares went DOWN.
if the US would abandon its self defeating and anachronistic dogma, we could get the game going. So far the whole China rising is the sound of one hand clapping. The US is awaking to this reality and my sense is China’s low hanging fruit is gone. State owned enterprises should be buying puts and “robbing” US companies before halftime. This game is going to change; who knows what the outcome looks like but a reversion to equal odds will be interesting. Americans are awaking to the reality that a cheap microwave isn’t worth the cost. That consensus will grow (what’s old is new).
The west + japan still represents 75% of GDP. Relative growth rates matter but the world is going absolute.
The world is selling America short prematurely, not withstanding the dollar (like gold for what its worth). it wasn;t the peripherals that built the US house (or KB thank goodness), rather the idea - I love the the duration of that trade/compitive window.
Foreign exchange intervention actually works with the free market. The market freely quotes prices for currency and government bonds, as well as for goods, services and other financial assets etc, and the intervening government buys enough of these, subject to what it wants and is allowed to buy, to fix its exchange rate against that currency at its chosen level. If the US supplied more of what China wanted and would sell it to China, China might not need to buy bonds or even financial assets at all.
Where China does restrict the market is in its own exchange and capital controls. Now this would suggest that the most appropriate US response would be to restrict China’s access to its capital market. But that would be like a heroin addict volunteering for cold turkey.
check out yu yongding’s comments…
http://blogs.ft.com/wolfforum/2007/10/china-inflation.html#comment-86684022
ASHINGTON (Thomson Financial) - US Internet search engines in China were being hijacked and directed to Chinese-owned Baidu, analysts said Wednesday, speculating that this may be retaliation for the White House award to exiled Tibetan leader the Dalai Lama.
Analysts at Search Engine Roundtable, a website focusing on Internet search, said Chinese users trying to search on Google, Yahoo and Microsoft websites were being directed to the Chinese search engine.
“It seems like China is fed up with the US, so as a way to fight back, they redirected virtually all search traffic from Google, Yahoo and Microsoft to Baidu, the Chinese based search engine,” the analysts wrote.
…surely you can’t be serious that 54x on Shanghai is fair value (NAsdaq at peak was 40x)….
But have you factored in the relative growth rates of China v. the US and the certainty that the yuan will rise in value?
If chine will re-route search traffic, you think they’ll use the SWF or political ends?
Imagine for a minute a foreign-born ideologe buying a US media company like CBS, or ABC… or FOX. Who then uses his power to remake the news to help put into power an equally ideological leadership that increases the debts, deficits, and makes the rest of the world hate us. Then to cement his position takes control of a major media business outlet like say.. the Wall Street Journal.
Naw. I don’t think a foreigner would ever so a thing like that.
Guest: I doubt the Chinese think the Dalai Lama business is trivial. Getting involved in that is the US meddling in their internal affairs and it would be foolish to minimize their anger; after all the Taiwan problem stems from the US getting involved in their internal affairs. Remember?
There is “internal affairs” and there is “internal affairs.” The press makes is often sound like Beijing is a spoiled kid ready to go to war over anything, but there are international law reasons for what it does. “Internal affairs” is a term of international law, and international law is set up so that if you don’t complain about something, then what you do imply agreement.
As it is, the United States has (quite intentionally) done nothing that implies that the Dalai Lama is a political leader rather than a spiritual leader. If Bush were to do something that would imply political recognition of the Dalai Lama, (like meeting him in the Oval Office) then you’d really have a big situation. There isn’t anything in this situation that would call for more than your standard level screaming.
In any case, China has had a long standing policy of not explicitly linking business to human right and diplomatic issues. Business is business. This isn’t from any moral belief, but rather that it turns out to be in Beijing’s interest not to link these issues.
Guest: And do you think Wall Street would not scream to Washington if its silly policy of meddling in Chinese affairs damaged potential profits from China?
Yes, but it would also scream to Beijing if Beijing did anything that would damage profits. Also the policy isn’t “silly”. Politicians (both American and Chinese) do things for “strange” reasons, but you need to take those reasons seriously.
DC: The balance sheet statements of Chinese state-owned companies are less opaque and more transparent than say the balance sheet statements of Goldman Sachs which retains $76 billion
That’s not true. The balance sheets of GS don’t fit with your theory of Wall Street corruption, but that’s not its problem. GS made a huge amount of money, basically taking positions against the other investment banks. So their gains are as “real” as other banks losses.
Macro Man: Or how about allowing the US/French government to print some dollars/euros, exchange them for RMB, and using the proceeds to purchase a 5% share in Chinese banks? That is the appropriate parallel here, and I somehow doubt that China would be terribly welcoming of this type of investment.
They actually are. It’s not Chinese versus US. The politics in Beijing are such so that you have banking regulators and foreign investors on one side and local banks on the other.
VennData: If chine will re-route search traffic, you think they’ll use the SWF or political ends?
I don’t see the connection. Especially since the people involved are different people.
The prime motivation of the Communist Party of China is to stay in power, and so if you look at SWF policy, the question becomes how does the Communist Party believe the SWF’s will help it stay in power. This means looking at the people running economic policy in China, understanding their world view and political constraints.
My sense in talking with these sorts of people at conferences is that they basically look at the world in the way that a Harvard MBA or Wall Street investment banker would look at it (in part because lots of these people have Harvard MBA’s and are former Wall Street investment bankers). This is why I think that China’s SWF are going to be modelled after US state-level pension funds since thats a model that the people making policy are familar with. There are a lot of Chinese working as portfolio managers on Wall Street that for a reasonable salary and a patriotic appeal, could be persuaded to work for CIC.
London Banker “There doesn’t appear to be any long term, rational consideration of the implications yet within Washington, Westminster or other political capitals that would inform a sensible policy framework for responding to the new shape of the geopolitical-financial landscape.”
check out The Financialization of Foreign Policy
http://www.nationalinterest.org/Article.aspx?id=15816
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