Maybe the CIC isn’t motivated entirely by commercial gain …
The CIC claims it wants to be a commercial investor. Gao Xiqing is often quoted to the effect that the CIC “operates on commercial principles” and intends to only take passive stakes.
I have always found that those claims sit uncomfortably with the CIC’s current portfolio, which is dominated by stakes in China’s state commercial banks. Those state banks are used to support the government’s policy objectives. Right now, for example, they are being encouraged to hold dollars to help the central bank manage the unprecedented growth in China’s foreign assets. They also can be asked to lend to strategic sectors.
However, the CIC’s stake in the state banks can be viewed as a legacy of China’s 2003 decision to use foreign exchange reserves to recapitalize the state banking system. If they are in effect grandfathered in; the rest of the CIC’s portfolio could be determined by risk and return.
But it will be very hard for the CIC to make that argument if one of its mandates is to help finance the expansion of Chinese enterprises abroad. And apparently that is part of its mandate. Sender and Guerra of the FT reported, in a story about Haier’s potential bid for GE’s appliance division:
Executives at China Investment Corp say that one of their mandates is to help finance such moves abroad. Banks such as China Development Bank could also be tapped to help finance a bid and even take a slice of equity in any deal.
Supporting national champions is a separate mission from managing an external portfolio that maximizes risk-adjusted return.
For that matter, I suspect it will be hard for the CIC to argue that it is a purely commercial investor if the state banks that it owns aggressively support Chinese state enterprises as they expand abroad.
China isn’t Abu Dhabi. It has a competitive, growing domestic industrial sector – sometimes state-owned, sometimes privately owned — that wants to expand abroad. A company that wants to expand abroad could borrow RMB to buy dollars – and then use those dollars to expand abroad. But that leaves it exposed to the risk of future RMB appreciation. Far better to borrow some of the state’s dollars. As a result, there is pressure inside China to use the government’s foreign reserves to support Chinese firms. Cheng Siwei for example argues that China should be purchasing companies rather than Treasuries. He isn’t alone:
some national enterprises under State-owned Assets Supervision & Administration Commission have advocated that China’s foreign reserve should be invested in industrial and strategic resources.
But using government resources to finance the outward expansion of Chinese national champions sounds a lot like an extra-territorial industrial policy — something that that is bound to generate concerns outside China.
Right now, the CIC seems to have five missions:
– supporting China’s exchange rate regime by raising funds in RMB to buy foreign assets. It may also face limits on the extent it can diversify its external portfolio away from the dollar so long as China manages the RMB against the dollar. Massive dollar sales by the CIC that drove down the dollar might put unwelcome downward pressure on the RMB
– managing an inhouse portfolio of foreign securities
– selecting external fund managers to manage a portion of its investment portfolio (a process that assures the CIC will have friends abroad)
– managing China’s strategic equity stakes in the state commercial banks. It is a holding company for the state’s investment in the domestic financial sector.
– supporting Chinese state enterprises as they expand abroad, whether directly or through funds placed with the state banks
The first three arguably fit well together, though supporting China’s exchange rate regime could at times conflict with investing in ways that maximize return. But I am not sure that supporting Chinese firms and managing the state’s strategic stakes in the state banks fit well with the CIC’s other objectives.
As importantly, I suspect that the CIC was set up without full consensus inside China on what it should do. As a result, there is a constant battle between those who want the CIC to do more to support state firms, and those who want the CIC to focus on external investments.
Large losses on the CIC’s high profile investments abroad likely provide those who think the CIC should do more to support state firms with ammunition; they can argue that supporting Chinese firms expanding abroad may produce better returns than investing in say the US equity market – or a US investment bank.
The battle over what the CIC should do, in turn, means that its investment process risks being highly politicized. China’s top leadership gets drawn into the debate. It has to decide, for example, if the CIC should bid on Rio Tinto — or whether the CDB should finance a state firm looking to buy a stake in Rio Tinto. China’s top leadership likely will have to decide if the CIC should help finance Haier.
Back in May, the magazine “Emerging Markets” published an article — an oped really — where I laid out my concerns about the CIC’s complex mandate. It is now online as well. I touched on many of the these issues — and the tension between the CIC and SAFE — in my lengthy January paper on the growth of China’s foreign assets.
Brad,
I am worried that Haier will buy GE’s appliance division and then move remaining US production to China resulting in a loss of up to 300,000 US manufacturing jobs. China would be then be able to sell Chinese-made appliances using GE technology under the GE name through GE’s US distribution network, thus gaining GE’s share of the US market.
This is particularly a shame in that GE’s appliance division is still profitable and would be much more profitable in the growing market for appliances in China if China did not have the equivalent of an 80% tariff on US made goods that are exported to China.
By the way, my father, son, and I have a commentary just published yesterday in American Thinker. It’s called “Straight talk from Clinton’s trade negotiator.” The estimate that China has the equivalent of an 80% tariff on US imports comes from one of the paragraphs from Robert Cassidy, quoted in that article.
If you want to read it, go to:
http://www.americanthinker.com/2008/06/straight_talk_from_clintons_tr_1.html
Howard Richman
http://www.trade-wars.blogspot.com
Brad,
I appreciate you tackling this one in greater detail and I agree that the absence of a full consensus on what CIC should do has led to institutional tensions beyond those that might have been expected when MoF were handed responsibility for the new toy.
I’m not certain that the quote from the FT - “Executives at China Investment Corp say that one of their mandates is to help finance such moves abroad.” - stands up to close inspection. I’m not knocking the FT - they may well know something no-one else does. However, there doesn’t appear to be any English or Chinese-language quote from any CIC official available on the web which supports their allegation, while there are dozens denying it. I also wonder why, if the FT obtained such a quote, it wasn’t a headline piece for the reporter somewhere, as it would have been one of the best CIC “gets” of the past year…
There are, as you suggest, any number of companies and organisations within China who hold strong views about what CIC ought to be doing with its money. Many of them, unsurprisingly, feel it ought to be spent to their benefit.
While it’s early days and there isn’t a long record of behaviour to judge from, I think we can make some preliminary observations about CIC’s behgaviour with regard to its domestic bank investments: they haven’t lifted a finger to support any SOE or other organisation with their own funds; CBD has stopped making loans on non-commerical terms, if not wholly on a non-commercial basis; CDB/ABC/the more visibile Huijin components are making more articulate statements about their restructuring/listing plans.
CDB may well finance - alone or in concert with other lenders - a Haier bid. I would predict that no CIC house money will be involved and that CDB’s terms will be every bit as commercial as the next bank’s. I think you’re reasonable - and correct - to state that CIC is starting with an odd and not-purely-commercial set of assets. I’m not sure the same weight of evidence supports the argument that CIC - or its subsidiaries - are or want to be less than purely commerical in their ambitions.
Perhaps you can clarify something for me: i understand that China cannot spend dollars in China; my question: can China spend the $1,7 T AT ALL? i.e. a Chinese firm exchanges it’s dollars at the PB of C for rmb; what if the firm wants the dollars back?
Brad
Was wondering if the apparent confusion/complication stems from the fact that political power and money are rarely divorced, or at least not on amicable terms, after all, the funds CIC is given access to are deemed almost as pooled wealth of the nation. That asset carries with it political responsibility. In contrast, not being a de facto government agency, it has no political power of its own and yet is subject to political influences/pressures from various aides. Neither is it a bank nor the central bank, yet it has to worry about its effect on rates and exchange rates. Frankly, it just sounds very confused about its own identity. What I would wonder about is who is effectively (not nominally) responsible for oversight.
This is off-topic but hate to be bugged by these niggling questions. In a previous comment you said that negative real rates encourage investment, that makes sense from a theoretical aspect but does it really work in practice, when rates are negative (by which, I assume you mean inflation-nominal rates= negative real rates, i.e. inflation> nominal rates. ) the rates of return on investment tend to be on the decline? And what would you make of the situation in Brazil? (considering their interest rates are at least 12%).
Brad
Sorry, train of thought interrupted. Perhaps, the CIC was set up as an investment fund but somehow became a multi-purpose tool/agency. BTW, meant “sides” not “aides” , just before anyone accuses one of being a political gossiper!
Oh please Brad,
If we take for instance, the state-owned NJ government employees pension fund investing several billion dollars of its capital into the bailout of Wall Street’s Lehman as reported, is that not directly supporting a local US business enterprise? This is especially alarming considering that private equity investors are increasingly unwilling to invest in Lehman given its serious balance sheet problems, and the NJ state taxpayers will have to cover any financial pension losses if Lehman were to file for bankruptcy protection. The US federal government under the state-owned Import-Export Bank also provides billions of dollars in financing for Boeing Aircraft to IBM supercomputers. So naturally, all state-owned corporations of every respective nation will support their domestic industrial base. The China CIC should support Chinese state enterprises as they expand abroad while also making a profit and providing a social pension benefit to Chinese society. To argue otherwise, it is merely represents more of the same US hypocrisy in financial affairs.
The myth proposed by Bernanke that some sort of “Chinese savings glut” was responsible for the US housing boom. This is of course complete nonsense. It is impossible to have “too much savings”. Two weeks into the Federal Reserve job, Bernanke testified before Congress that it was a “positive” that the nation’s homeownership rate had reached nearly 70 percent, in part because of subprime loans.
Since then Bernanke has reversed course and is now blaming the “Chinese savings glut” for the US housing bubble. Greenspan, in interviews is blaming the fall of the Berlin Wall while backtracking on his endorsement of ARMs and derivatives.
Neither is willing to say what is obvious to the entire rest of the world: The Fed, in a foolish attempt to bail out its banking buddies from bad dotcom and foreign loans, took a mildly bad situation and made an international disaster out of it.
http://globaleconomicanalysis.blogspot.com
I’m also pretty skeptical about the quote. It’s not clear from the context whether someone told the reporter specifically that CIC was going to financial Haier, or it was part of “everyone knows that CIC is going to do stuff like this.”
To Richman: He is actually wrong about this. China got rid of most of the preferential treatment of foreign companies doing business in China since too many domestic companies were complaining. One interesting quirk of international trade rules is that there is no rule forbidding a nation from treating foreign companies better than local ones, and so the trade benefits that China gives to American companies who invest in China has never been subject to WTO rules or negotiations.
One other point here is that Haier has been opening up plants in the United States
http://www.appliancemagazine.com/editorial.php
This is why the “trade debate” is much more complex than it was in the 1980’s. It’s not necessarily the case that a company will be nicer to workers from the same country than a foreign company.
Here is the link about the tax change, it was quite big news.
http://www.huliq.com/14140/china-tax-reform-means-foreign-and-local-companies-equal
MMcM –
I am much less convinced that the CDB is a purely commercial lender. The loans to finance Chinalco’s bid for Rio, for example, seem motivated by a desire to support policy objectives (giving China a say in Aussie iron industry). And given that the CIC plunked a ton of $ into CDB (and CDB can borrow $ from the central bank), I would be hard pressed to think that any CDB bid isn’t ultimately financed by one of those two pools of fx. I’ll grant that the line is very blurred, but when a state-owned policy (or even commercial) bank lends to another SOE to support a government policy goal (going forth) it strikes me as very strategic.
As for the CIC, well, my core point is that its governance structure leaves it open to these pressures — and the decision to bring the SCBs under its fold gives it multiple avenues to support SOEs. If China wants the CIC to be perceived as apolitical fund manager, I deeply believe it needs a difference governance structure and to divest from its domestic portfolio. There are credible rumors that China’s leadership wanted to get “credit” in the SED for buying a stake in Blackstone, which hardly suggests an apolitical investment process (even for foreign stakes).
And I agree that the FT downplayed the CIC quote — presumably b/c they didn’t recognize its political significance and instead ran it as a pure “deals” story — i.e. will Haier bid or not.
qingdao — if a Chinese firm borrowed $ and then converted the $ into RMB, that is a capital inflow and it would undo the purpose of the CIC, which is to raise rmb domestically to buy foreign assets (or to lend to Chinese companies that buy foreign assets). They are aware of this (or at least SAFE is) and no doubt there are checks in place. How effective these checks are is anyone’s guess. But it does highlight one of the problems with financing Chinese firms going forth — the easiest way for a Chinese firm to make a profit is not to go forth but rather to take any dollars it gets and convert those $ into RMB.
Judy — I think your basic point is right. the CIC is the pooled wealth of the nation (or at least the state/ the group that rules the state). and there is a real debate within that group over what the CIC should do, and for that matter how the pooled fx should be used. there are lots of ways of supporting Chinese firms going forth that don’t involve the CIC.
DC — I am also worried by the loans Australia’s superannuation fund supposedly is making to cash strapped Aussie banks. Sounds like policy rather than commercial lending to me. The temptation to use government controlled pots of money for policy rather than commercial purposes isn’t limited to China.
If you really want to see Chinese state-owned investment, travel to the African continent. Chinese FDI into the US is a drop in the bucket in comparison. Everywhere in Africa, multi-billion dollars Chinese state investment for commodities are fueling the continent’s economic revival from Angolan offshore oil, Tarzania corn farms, to Zaire copper mines. Economic growth today in Africa is the fastest in several decades. Instead of Neo-colonialism, attempting to steal Iraqi energy reserves, at least the Chinese negotiate for economic African joint ventures.
China’s Haier is investing another $150 million in South Carolina creating 1000 new jobs.
http://www.businessweek.com/globalbiz/blog/eyeonasia/archives/2006/04/haier_invests_i.html
The leading contender for GE Appliance is Korea’s Goldstar corporation according to published reports.
Why the fuss about a new vehicle in the Chinese state financial institutions family? It will do what it is supposed to do until someone with enough power tells it to do something else, unless it becomes a public embarassment, then someone will neutralize it, give it a wholesome role and start a new one. Or am I a bit too cynical about the Middle kingdom’ current incarnation?
Entirely different subject: what is this story about “Australia’s superannuation fund” making loans to “cash strapped Australian banks”? (1) what “Australia’s superannuation fund”? not the Future Fund I guess, that is not a superannuation fund; (2) Loans or deposits? Where else would you park Aussie dollars? Are they subordinated, cheap or just arms length. Nothing about that in the Aussie press.
sorry, I meant the future fund. superannuation is in new zealand.
here is the story:
http://www.swfradar.com/past/2008/6/12/australia_banks_turning_to_sovereign/
bsetser: is a capital inflow and it would undo the purpose of the CIC, which is to raise rmb domestically to buy foreign assets
I’m not sure that this is the purpose of CIC.
bsetser: I’ll grant that the line is very blurred, but when a state-owned policy (or even commercial) bank lends to another SOE to support a government policy goal (going forth) it strikes me as very strategic.
One important point here is that neither Chinalco nor Haier are technically SOE’s.
Chinalco is thirty percent privately owned, one third is owned by banks, and that state holding company only owns one third of the company. Alcoa owned about ten percent until recently.
Haier is a collectively owned company, whose major owner is the city of Qingdao. Traditionally, city and provincially owned companies didn’t get preferential credit from SOE’s.
I don’t think that there is a contradiction between “being strategic” and “being commercial.” One reason I’m skeptical that the Chinese government is going to give massive amounts of subsidies to Chinese companies, is that the experience has been that doing that kills the company.
2fish — what then is the purpose of the CIC? presumably it primarily exists as an alternative mechanism for managing the fx china has to accumulate to avoid RMB appreciation, the increase in the CIC’s foreign assets (financed by bond sales) reducing the PBoC’s need to accumulate reserves and issue sterilization bills …
Twofish - I don’t think that there is a contradiction between “being strategic” and “being commercial.”
This is a strawman. Sometimes “strategic” and “commercial” objectives will be complementary, sometimes contradictory. When they contradict each other, it is a problem. It is not necessary they have to contradict each other all the time for it to be a problem.
For e.g. a state owned investor might prefer to shut down a more productive factory abroad to keep a less productive factory in China. The lost productivity can be made up by not having to pay out unemployment insurance or other jobless benefits.
bsetser: what then is the purpose of the CIC?
I’m not sure, and I don’t think anyone in Beijing is quite sure either. It seems to change every three months.
bsetser: presumably it primarily exists as an alternative mechanism for managing the fx china has to accumulate to avoid RMB appreciation
I don’t think that the China Rail or Huijin accquisitions make any sense if that is the primary goal.
observer: Sometimes “strategic” and “commercial” objectives will be complementary, sometimes contradictory.
It really depends on how broadly you look at things. One thing that appears to be the case is that large scale subsidies to industries causes huge problems. China has just gone through two decades of very painfully restructuring its industrial infrastructure, and it will be a while before it tries some things that just don’t work.
observer: For e.g. a state owned investor might prefer to shut down a more productive factory abroad to keep a less productive factory in China. The lost productivity can be made up by not having to pay out unemployment insurance or other jobless benefits.
Wouldn’t it make more sense to shut down the less productive factory, tax the more productive factory, and then use that it pay for the unemployment benefits of the less productive factory? If you don’t structure the incentives to promote productivity, then what happens is that you end up with an non-productive industrial infrastructure that looks like China-1975, which is what people have been trying to move away from.
There are ways of dealing with this problem, one of which is the make the the people who determine what factories get shut down, a different set of people than the people that pay out unemployment.
The problem with CIC using political rather than commercial criteria to do strategic investments is that it just doesn’t work to create world class companies. If you look at the efforts to create parastatals in Latin-America, you end up with these incredible messes, that end up being a drain on the economy.
If it did work, I wouldn’t object to it. If having centralized state-owned companies did succeed in creating powerful competitive companies, and all of the fears of China Inc. taking over the world were valid, then China should go ahead and do it, and then the US should respond by ditching this free market thing and nationalize its industries to compete.
I don’t care what the color of the cat is.
observer: For e.g. a state owned investor might prefer to shut down a more productive factory abroad to keep a less productive factory in China. The lost productivity can be made up by not having to pay out unemployment insurance or other jobless benefits.
Twofish - Wouldn’t it make more sense to shut down the less productive factory, tax the more productive factory, and then use that it pay for the unemployment benefits of the less productive factory?
How do you plan to tax a factory that is located overseas?? I think you’ll understand Brad’s (and mine) concerns better if you reflect on that a bit more.
observer: How do you plan to tax a factory that is located overseas??
You impose a corporate tax on profits of the company that owns the overseas factory. If there is money left over after the taxes, you can have a shareholders meeting and have the company issue a dividend to the state.
You can also negotiate a double taxation treaty with the other country.
(I should point out here that it is crucial for this to work that state be a large shareholder. Otherwise, the company can reincorporate in a tax haven. On the other hand, that’s not a trick that only China can play. If Calipers prevents an American corporation from relocating to Bermuda to avoid paying US tax, that’s a good thing….. Say…..)
http://www.treasurer.ca.gov/news/releases/2002/11182002calpers.pdf
observer: I think you’ll understand Brad’s (and mine) concerns better if you reflect on that a bit more.
I still don’t quite see the problem with respect to Chinese SOE’s. I can see why you wouldn’t want the Chinese government owning Lockheed-Martin or Boeing, but suppose companies ultimately answering to the state council own 75% of the washing machine factories in the US. What is the bad thing here?
I should point out that I’m a believer in markets and letting managers manage. If Wen Jiao-Bao starts micromanaging washing machine factories, he’ll end up running those factories into the ground, they’ll lose sales to better run competitor and the Chinese government will lose money.
But suppose I’m wrong and central planning does work, and in the process of running everything from Beijing we find that the economic structures that Beijing has invented do work. Well thing, shouldn’t the nations of the world adopt them?
Twofish - You impose a corporate tax on profits of the company that owns the overseas factory.
… and rapidly run foul of the WTO. Also taxes by themselves are not going to keep the unemployed masses under control. In the real world it is much simpler just to shutter the productive foreign factory and keep the jobs in China even if they are unproductive.
Twofish - I should point out that I’m a believer in markets and letting managers manage. If Wen Jiao-Bao starts micromanaging washing machine factories, he’ll end up running those factories into the ground, they’ll lose sales to better run competitor and the Chinese government will lose money.
This is a false dichotomy. What are the biggest centrally planned organizations in the planet today? Wal-Mart Corporation, UPS, Pepsi-Cola etc, these easily dwarf any Chinese state-owned factory.
Twofish - suppose companies ultimately answering to the state council own 75% of the washing machine factories in the US. What is the bad thing here?
People who work in washing machine factories in the US would be concerned about their jobs. Vendors who supply to these companies would be worried about whether their contracts will be outsourced to Chinese firms. Communities where these factories are located would be concerned about whether businesses will continue to grow and pay taxes.
observer: You impose a corporate tax on profits of the company that owns the overseas factory.
There’s nothing in WTO that prevents China from taxing Chinese companies that own factories in the United States. There’s also nothing in the WTO that prevents China from taxing US companies that own factories in China as long as they are taxed at the same rate as domestic factories.
observer: Also taxes by themselves are not going to keep the unemployed masses under control.
Give them unemployment benefits to tie them over, and then use the money that you are making from the overseas factory to start a new business.
observer: In the real world it is much simpler just to shutter the productive foreign factory and keep the jobs in China even if they are unproductive.
The overseas factory is making money. The Chinese factory is not. The incentives are such that you are better off shuttering the local factory, even if you are paying a lump sum of cash. Once you close the overseas factory, then where are you going to get the money to pay your workers?
In any case, you can see the behavior of Chinese companies in China. It went through a rather painful period of industrial restructuring. Also the situation of local versus foreign is relevant in the Chinese situation where many of the factories are owned by provincial governments.
observer: People who work in washing machine factories in the US would be concerned about their jobs. Vendors who supply to these companies would be worried about whether their contracts will be outsourced to Chinese firms.
There really is no particular reason to think that a Chinese owned company would be more or less friendly to American workers than an American company.
In particular, it seems like an enormous waste of money for a Chinese company to buy an American company and then shut down the American factories and move the jobs to China, since they already have factories in China.
http://seattletimes.nwsource.com/html/businesstechnology/2004425504_chinainvest20.html
Twofish - There’s nothing in WTO that prevents China from taxing Chinese companies that own factories in the United States.
This is getting too hypothetical but the very purpose of the WTO is to remove this sort of tariff on foreign produced goods.
Twofish - There really is no particular reason to think that a Chinese owned company would be more or less friendly to American workers than an American company.
Yes but what about a Chinese-GOVT owned company. A Chinese private citizen may not care about unemployment in Shanghai but the Chinese government sure as hell cares.
As threatened in Xinhua online this week and in Asia Times by former prime minister of Singapore last week, China will make any country that messes up the Olympics pay and pay big. Is the CIC the instrument through which they will punish protesters/boycotters?
[...] this story is true, the debate over whether the CIC’s mandate includes supporting the outward expansion of Chinese firms would be [...]