It can’t be used to fund current domestic pension fund liabilities. We are talking about bills that come due between 10-30 years, at which time CIC can sell its holdings which will be worth a lot more than they are now. What CIC buys today in dollars could very well be sold for RMB in twenty years.

bsetser: and the complicated reshuffling you mention where the CIC generates equity profits that are dedicated to one set of needs while the MinFin takes large currency losses that it absorbs to free up the CIC’s profits for other uses frankly makes little sense to me.

It’s a management thing. CIC is a for-profit entity with a balance sheet. Ministry of Finance is a government entity without one. By creating a money fund, CIC can be managed in much the same way (and perhaps by the same people) that manage Calpers or the state pension funds in the United States.

If you don’t split off the CIC, then you can’t use any portfolio managers to manage the holdings. At that point, it’s unclear how you manage the state’s stock holdings to maximize investment return.

I disagree with you that China gets a pass because it is a poor country. it is now one of the world’s largest exporters, probably the largest extra-regional exporter (i.e. us sells a lot to canada and mexico, Germany to the EU and so on). it is the largest single global investor. It may be poor, but its size makes it a global player — and creates global responsibilities.

Summers position is consistent with a fear that absent fiscal stimulus, the US really might just stop borrowing, cold turkey. that would be a shock to both the us and to china. the oversupply of dollar reserves (see US treasury pricing) opens up policy opportunities. I suspect that Summers still believes in the need for gradual adjustment but is worried about the prospect of an abrupt adjustment.

2fish — you are right about capital controls. in effect, restrictions on what china’s government can buy are a form of controls. if china maintains an exchange rate regime that effectively gives China’s government a monopoly on outward flows, i suspect that is where we are headed.

i still don’t quite get your pension fund point. the CIC’s external assets cannot be used to meet domestic pension fund liabiltiies any more than they can be used to fund domestic infrastructure investment. Until China adjusts is exchange rate and starts running a current account deficit, it will need to add to its external assets.

and the complicated reshuffling you mention where the CIC generates equity profits that are dedicated to one set of needs while the MinFin takes large currency losses that it absorbs to free up the CIC’s profits for other uses frankly makes little sense to me.

Sure this goes against twenty years of stated US policy, but its no worse than the US screaming at China for not floating its currency, after spending the 1990′s trying to argue that a fixed currency was essential to economic growth, that emerging countries had to defend currency values even in the face of economic hardship…. Blah… Blah…. Blah….

David Chiang rails against self-serving inconsistency and hypocrisy. I don’t because I’ve gotten used to it. People will argue whatever helps them at that moment, and if it happens to be 100% different from what they argued five years ago. Oh well… Too bad…..

Self-serving inconsistency is what will keep the US from doing what it takes to stem the flow of foreign money. Sure the US could prohibit Chinese investment in US banks, but at that point, you end up with lots of angry people without jobs, whereas I can’t think of a single person who will lose their job or lose money if the deal does go through.

In exchange for providing start up capital, the Chinese government gets 100% equity ownership of CIC. Part of the cost of forming CIC was buying out Huijin. It’s really important to keep in mind that these are separate companies. They are 100% owned by the Chinese government, but they are not part of the Chinese government.

bsetser: money. let’s say it pays 4% in usd to the minfin. let’s say it earns 8%, getting a 4% margin .. not bad at all, really.

CIC doesn’t have any liabilities to the Chinese government. In exchange for providing $200 billion to CIC, the Chinese government now owns 100% of CIC stock. The money that was used to start CIC is counted as shareholder equity, which the Chinese government can cash out if it wants to.

bsetser: That margin is then handed over to the state pension system?

No. CIC is the reserve insurance fund for the state pension system. If a provincial or local government is unable to meet its pension requirements (which is almost certainly going to happen in ten years), CIC will sell its stock and then pay out the pensions.

One reason for centralizing stock investments is that local governments have proven horrible at stock investments. When CIC the State Council can take a look at CIC and see that they are doing rational things and more importantly, that they aren’t stealing from the till. If you let each province or local official invest in stock, you get a huge mess.

bsetser: let’s then say the minfin loses 4% a year over ten years (a 40% plus counting compounding cumulative appreciation, which i think is conservative) on the fx risk. the net result is effectively a transfer from the fin min to the pension system,

Yes. But getting to the “net result” is not easy. One criticism I have about neo-classical economics is that things “magically” happen. Supply magically matches demand. Rational investors “magically” select the investment with the highest return. Things don’t “magically” happen, and there are a lot of gears and pulleys that investors ignore.

bsetser: with a lot of funky intermediation and i-banking fees thrown in. the minfin picks up the fx loss that allows the cic to show a profit. I honestly don’t get it.

The part you are missing is that by having CIC act as a pension fund manager, the total losses that the Chinese state will encounter are going to be smaller than what they would have been had CIC not been spun off.

The amount that the Chinese government is going to lose via FX isn’t going to change no matter what CIC does, but by having CIC around the total bill to the Chinese government is going to be smaller, since by having professional money managers, the return on CIC is going to be bigger than it otherwise would have been.

Once the Chinese government takes out the currency risk, you can find a set of money managers, tell them to maximize risk-adjusted return, and just check on them from time to time, and you can tell whether they are doing their jobs, and you can tell when you should fire them and hire new people.

If you try to put everything in one pot, it’s not clear what the managers of CIC are supposed to do, and more importantly, it’s not clear whether they are doing their jobs or not, because it’s not clear exactly what their job is.

Suppose the reference index goes up 10%, and the portfolio managers at CIC have a portfolio that goes down 5%, At that point, they will get fired for not doing their jobs. If you don’t remove currency risk, then it is unclear what you should do if CIC assets go up 5% or down 5%, especially since the managers at CIC have no control over exchange rates or monetary policy.

bsetser: the balance sheet risk i drone on and on about has long been there.

What’s changed is that the limits of sterilization are being reached, and the current situation is turning into Chinese inflation. The fiscal stimulus package everyone is talking about right now is just going to make things worse.

I would make a number of points:

- correlation between the US current account deficit and the Chinese current account surplus is low. The bulk of the widening in the US current account deficit, measured as a three-year change, came in the period 2000-2003. The Chinese current account surplus has only widened substantially in the last few years when the US deficit was already at record levels.

- no-one denies that the Chinese surplus is currently an important source of finance for the US current account deficit. But most econometric studies i.e. Warnock and Warnock have struggled to place the value of stepped up central bank purchases of US debt at more than a 100bp; significant but not decisive. The key to the US housing bubble and the attendant over-absorption that it produced was the explosion in ARM mortgages produced by the Federal Reserve putting in place and then sustaining the lowest ex-ante Federal Funds rate since the early 1970s between 2002-2004.

- the strident (shrill?) criticism of China’s monetary arrangements seems to imply that China should not be allowed to choose the monetary arrangements that it considers best because, despite the fact that it is still an incredibly poor country, it now has global responsibilities. I find this a tough sell. More generally, is it really the case that the choice of a fixed or semi-fixed exchange rate regime is now essentially unacceptable in the 21st century? Must all trading economies be forced to accommodate the US’s loose money policies of the last 5-10 years or else they are impeding global adjustment? Is this really the point we have arrived at? As a Chinese policy maker recently remarked, aren’t rumours of a 25% devaluation in the $ shocking!

- blaming China for the US profligacy seems to be on par with my excuse for running up an unfeasibly large student overdraft now nearly 15 years ago. For those of who can’t work it out, I blamed the bank manager for my indebtedness on the basis that he had lent me the money. Given that like the US consumer I could resist everything apart from temptation at that tender age, it was clearly his fault! Looking at my expensive suit my bank manager had a rather different perspective and found my accusations of predatory lending on his part baffling.

- I also find odd that China and the oil exporters are roundly criticized for ‘impeding global adjustment’ when the US is seemingly granted absolute impunity to pursue whatever policies it desires that clearly perpetuate imbalances. Is it not a little rich that former Treasury Secretary Larry Summers, who has vocally spent the last few years fretting about the US deficit and the ‘global balance of financial terror’ immediately becomes a cheerleader for US fiscal easing the moment it appears US growth might slow below 2% per annum? The current account deficit is a product of excess absorption produced by over-valued asset prices. But living standards and the US deficit it appears must be preserved if it looks like adjustment will begin to cause anything other than a modicum of economic discomfort. In this world view, I’m afraid it seems ‘adjustment’ is something foreigners must do. Whatever happened to the old ‘rules of the game’ when it was the deficit country’s obligation to deflate its economy? How about a few posts on how US policy makers are impeding global adjustment to level up the playing field?? How exactly does the current combination of loose fiscal policy and ultra-loose monetary policy in the US help global rebalancing? A substantial gas tax hike bringing the US energy taxation levels more into line with those of Europe would be a useful contribution to global rebalancing. And if all these Arabs buying up Wall St is such a bad thing perhaps the President tonight should help global adjustment by advocating wearing more woolen outer garments to cut back energy consumption like Jimmy Carter did nearly 30 years ago?

- finally, could we have some commentary on the savage downward revisions to Chinese GDP measured on a PPP basis recently unveiled by the World Bank? The large wedge between Chinese GDP measured at market prices and estimates of PPP GDP has frequently been adduced as strong evidence of RMB undervaluation. Doesn’t a 40% cut in PPP GDP dent the case for a faster pace of RMB appreciation?

Korea is a case study for my point, after the won appreciated in 04/05, korea’s overall current account started to adjust. the yen is evidence that exchange rates matter as well– yen weakness v the euro seems correlated with the rise in japanese exports to europe.

2fish — i don’t quite get your point.

the cic gets $. it presumably borrows them from the minfin, and has to pay a $ interest rate back — or something. otherwise it is free money, with the minfin taking on the fx risk and paying the coupon on the borrowed money. let’s say it pays 4% in usd to the minfin. let’s say it earns 8%, getting a 4% margin .. not bad at all, really. That margin is then handed over to the state pension system?

let’s then say the minfin loses 4% a year over ten years (a 40% plus counting compounding cumulative appreciation, which i think is conservative) on the fx risk. the net result is effectively a transfer from the fin min to the pension system, with a lot of funky intermediation and i-banking fees thrown in. the minfin picks up the fx loss that allows the cic to show a profit. I honestly don’t get it.

agree tho with your point about importing us monetary policy being the main force pushing china to change; the balance sheet risk i drone on and on about has long been there.

You have been complained about CIC’s state role for so long that your blame on CIC’s acts like a typical private player in this post seems a little bit ironic.

But the fact remains that this is China’s stance, not the rest of the world’s.

The trend in the Chinese side is for faster revaluation. The problem isn’t the trade surplus per-se but rather that a peg forces China to attach its monetary policy to that of the United States.

One why of thinking about it is that if you keep trading goods for paper, then eventually the value of the paper is going to drop, and I’m pretty sure that China is going close to the edge of where it can keep subsidizing the United States get back paper dollars. Basically the national decision that the US has to make is whether the US wants to maintain its standard of living by selling off assets in US companies rather than paper.

My suspicion is that the decision is going to be that selling off assets is going to be more attractive than reducing living standards…..

However, the reason SWF’s are interesting is what happens *after* the RMB adjusts. After the RMB adjusts, the PRC is going to take a one time 10-20% currency hit, but it will still have $1.2-1.5 trillion dollars which will then be looking after assets that are relatively cheap. I think that after the RMB adjustment, the US is going to still maintain a large trade deficit with respect to China, but it is going to be financed by sales of US assets. This is sustainable of the growth in asset value is more than the trade deficit.