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CiteI found the Times’ article (hat tip, SWF Radar) on the China’s plans to invest abroad to be somewhat confusing.
The article’s headline claimed “Plans are are afoot to diversify its [China's] holdings of reserves without causing political rows.”
But what are those plans? Well, the CIC “will help [China's] state-owned companies to expand overseas in a shift of strategy” and specifically will “assist inexperienced Chinese companies in financing, foreign-exchange risk management and handling trade barriers.” Yet it isn’t at all obvious — at least to me — that using a sovereign fund to assist state firms is a strategy for avoiding political rows.
The article jumps between three very different ways China’s government is looking to gain equity market exposure abroad:
1) Supporting Chinese firms — Haier, Baosteel, no doubt others — looking to expand expanding abroad;
2) Handing funds over to private equity funds and other external managers;
3) Buying equities in the public market.
These are conceptually different different activities, and raise different policy issues. The CIC seems to be doing all three. SAFE doing the last two — though the foreign exchange it has placed with the state banks is also available to support Chinese state firms.
Much of the confusion in the Times article comes because it starts by indicating that Beijing has decided to use the CIC/ SAFE to support Chinese state firms and then jumps to a list of the various investments the CIC and SAFE have made without really explaining how these investments relate to this new reported strategy. And best I can tell, there is no connection. China has plenty of funds to commit to all three strategies.
The Times article does include some useful new information though. Caijing apparently has reported that the State Council has authorized SAFE to invest up to 5% of its portfolio in equities.
However, the magazine [Caijing] quoted a former official as saying the state council had authorised spending 5% of the $1.7 trillion reserves on shares in foreign companies.
SAFE likely now has more than $1.7 trillion — the last data point we have is for end-April, and we aren’t far from the end of June. 5% of $2 trillion is $100 billion, enough to make SAFE one of the largest sovereign equity investors in the world even though it technically isn’t a sovereign fund. The distinction between a sovereign fund and the investment portfolios of some over-reserved central banks is often very thin.
The fact that China is looking to encourage its state firms to expand abroad shouldn’t be a huge surprise. After World War 2, the US ran significant current account surpluses, which combined with capital inflows from central banks needing to build up their dollar reserves — that in an economic sense financed foreign direct investment by US companies. China is in a similar position. It now has a large — roughly $400 billion — current account surplus that could be used to finance direct investment abroad. It has successful domestic firms but those firms have a fairly small global footprint.
The outward expansion of private US firms after World War 2 generated plenty of controversy though. I would guess the outward expansion of Chinese firms will generate at least as much.
And there is a critical difference between the US then and China now.
After World War 2, the dollar was strong, which facilitated private investment abroad by US firms. By contrast, China’s currency is weak. A profit maximizing Chinese firm wouldn’t want to finance investment abroad with RMB. The outward expansion of Chinese state firms consequently hinges on the willingness of China’s state to make the dollars it is accumulating to hold its currency down available to Chinese state firms — and then making sure those firms do not use the dollars they have received from China’s state to buy RMB.
The state’s large role in the process strikes me as a major additional source of friction — hence my surprise that the Times would indicate that a plan based on supporting Chinese state firms was part of a strategy of avoiding political rows. If China wants to diversify into equities without causing political rows, the obvious strategy is to invest in equity index funds. And to disclose its equity exposure, in much the same way the Swiss do. China clearly hasn’t opted for this strategy.
This again demonstrates the futility of attempts at internationally regulating (and multilaterally as well) practices by focusing on the tools used. Eeverything Stigler once wrote about regulation applies to this type of nonsense a fortiori. However, politically it makes sense to show effort and apparently the mission is inherently impossible, so it can be harmless, use up time and constrain no one.
It may sound a bit realistic, but my chief interest in political economy is to study the ways in which politicians in relatively small countries (China is getting to big apparently) with weak or nonexistent democratic (democratic meaning inter alia. equipped with nagging media, ambitious troublemakers and an institutional framework that lets these people have their say, even drag the country down with them or bother about globl rsponsibilities) try to defy attempts of what opponents tend to call a neoliberal order to make them behave instead of free ride, blackmail, corrupt and generally behave as if the world is a zero sum game and the gvt has a licence to steal from foreigners -no, a duty. My favorite example remains the ROK.
This seems again the “neoliberal order” (as said a label used by opponents, but I have no equivalen) trying to deal with an outgrowth of what it tolerated earlier: (non-democratic) states monopolizing energy resources and (non democratic states) industrializing completely against the principles of free trade and not being punished (how). Now these may finally start to refer to these same (free trade, even formal, WTO principles although own behavior may be quite delinquent) principles to use their ill-gotten gains (who said they should sell plasmas to Walmart cheaply) in a market that more than any other, needs to be free and unregulated (well?), finance . Fortunately we know that financial market regulation, even in a single country is too difficult to have any other effect than to make politicians look good and game theorists hyperactive. Where would investment banks and hedge funds be if there were no well intended idiots indirectly causing predictable market disturbances.
But for the spectator sport of international financial politics (i.e. what most of us do) this promises to be an interesting match with as main ingredients: weak definitions, open ended rules, voluntarism (which constrains the good and unleashes the bad) and no enforcement, as well as a nice little bureaucracy that the culprits generously award to Washington.
But two serious things:
1. to what extent can this make life more difficult for a possibly more protectionist incoming US administration
2. this looks like a classic soft budget constraints game on an international scale (unlike anything the Bretton Woods institutions ever did or were supposed to do). Should regulating SWF investment (thus condoning crazy reserve growth) not be extremely inflationary? I would prefer a move on the part of the OECD countries (1) physically capping (with the assistance of a pigovian tax wherever that does not exist yet) energy imports from outside the area (a nice one, and so easy) and (b) quarantaining all official reserves, state firm balances of large exporters whose nonimal domestic factor costs are far below their PPP ones, until these costs have been realigned with OECD costs. Simultaneously, selected Koran etc bureaucrats should be invited to real OECD countries (right, the ROK must be expelled first, but, lo and behold they re not a surplus maker and their prices are OK; a Malaysian then) direct the investment of the quarantained funds in reindustralization of he OECD, funds to be repaid to the original owners if and when the industries in question generate sufficient cash flow. Come to think of it, that would mainly affect China..
As you see, you do not have to organize a barbecue in Jeddah to solve the world’s problems rationally and equitably.
My apologies for the typo in the above comments, “Koran” should of course be “Korean”.
Why shouldn’t the China CIC support expansion programs of BaoSteel, Chalco, CNOOC, or PetroChina. From Bloomberg, Chinese State-owned BaoSteel to build new $5.2 billion Steel Mill to supply Toyota and Honda corporations. China’s BaoSteel will meet the very strict quality control requirements of Japan’s Toyota and Honda. Contrary to the US media BS that state-owned Chinese corporations can’t do anything right, China BaoSteel should be commended for meeting the highest quality standards for the global automotive industry.
China BaoSteel to build new $5.2 billion Steel Mill to supply Toyota and Honda
http://www.bloomberg.com/apps/news?pid=20601080&refer=asia&sid=ab44C6PJbW0o
June 23 (Bloomberg) — Baosteel Group Corp., China’s biggest steelmaker, and two rivals in the southern province of Guangdong agreed to form a 35.9 billion yuan ($5.2 billion) venture to help build a 60 billion yuan steel plant for the 10 million-metric-ton-a-year. The new Zhanjiang plant will supply Toyota Motor Corp. and Honda Motor Co.
From British Brigadier-General James Ellery,
Iraq War was fought by US to stop “the tide of Easternisation”
http://www.counterpunch.com/
To speak bluntly, the United States opposes the emergence of China and India as threatening its desire for unilateral global hegemony. And bluntly is just how British Brigadier-General James Ellery CBE spoke on April 22 at the School of Oriental & African Studies (SOAS) in London. He described the U.S.-British Iraq War as having been fought to stop “the tide of Easternisation” – a shift in global political and economic power toward China and India, which together import some “two thirds of the Middle East’s oil.”
The emergence of India, China and Pakistan as economic and even military powers (at least for defensive purposes), as well as Russia and Central Asia, already has led to creation of the Shanghai Cooperation Organization, which Iran already has joined. The world is becoming multi-polar, if only as a defensive response to U.S. attempts to give NATO a post-Cold-War role by extending it into the Middle East, Indian and Pacific regions.
General Ellery is in a position to know. He was the Foreign Office’s Senior Adviser to the Coalition Provisional Authority in Baghdad after 2003.
DC — the case against CIC co-financing is independent of Baosteel’s quality. It is the same as the case against having the US government finance exxon mobile’s overseas expansion, or microsofts …
and I am not sure how a war financed by borrowing from China is a very effective counter to “Easternization”; it actually seems to have had the effect of speeding the eastern shift of the global economy up.
Trade deficits at any particular time for any given country can be beneficial or harmful; can represent economic strength or weakness. In the period before Worlds War I the U.S. had mostly trade deficits. We were a debtor country – and we thrived. Foreign investments accelerated our economic development and our standard of living rose faster as a consequence.
By the end of World War I the U.S. was a creditor nation, but we refused to act like one. We opted for tariffs and other restrictions on imports, rather than free trade. Capped by the sky-high Hawley-Smoot tariff of 1931, U.S. trade policy was an important contributor to the world wide depression of the 1930’s. By 1933 there was not a single major nation on the gold standard except the U.S.
The situation was further exacerbated when Roosevelt and his Treasury Secretary, Morgenthau, exercising the crisis powers delegated to the executive branch by Congress, took the U.S. off the gold standard in April, 1933 by making the dollar inconvertible into gold at a fixed price. And to make matters worse they periodically kept raising the price of gold from $20.67 per ounce to a final price in Dec. 1933 of $35. This had the effect of depreciating the exchange value of the dollar. All of this was done by a creditor nation operating with a chronic surplus in its balance of payments.
The Bretton Woods Agreement of 1944 established, among other things, the International Monetary Fund and confirmed the previous international status of the dollar, that an ounce of gold was equal to $35 and that all dollars were to be freely convertible into gold bullion at that price to foreign and confirmed the previous international status of the dollar, that an ounce of gold was equal to $35 and that all dollars were to be freely convertible into gold bullion at that price to foreigners but not to U.S. nationals.
In 1949, the U.S. dollar was not only as “good as gold”, but it was also preferred over gold. There were not enough dollars to finance the legitimate needs of the world economy. So, the chronic balance of payments deficits which began in 1950 were for a number of years beneficial to the world economy and to the U.S. Because of our large and chronic balance of payments surpluses after World War II, foreigners were unable to accumulate sufficient dollar balances to efficiently finance world trade. These balances were desperately needed because of the total dominance of the dollar as the reserve custodian, standard of value and transactions currency of the world.
By the mid 1960’s foreigners found themselves in possession of excessive dollar balances (foreign exchange reserves — FOREX reserves), excessive in terms of the needs of trade. Some of these excess dollars came to be used as “prudential” reserves in the formation and growth of the Euro-dollar banking system. This unregulated system (no legal reserves, only “prudential” or liquidity reserves) has been allowed by the governments and central bankers of the world to create in excess of ??? trillion new international units of account largely denominated in E-dollars. This deluge of international money has imposed excessive inflationary pressures on prices. I.e., the volume of E-Ds directly impacts U.S. prices.
We have observed, given the situation of this country in the 19th century, (its people government and undeveloped resources) that it was advantageous both to lenders and borrowers for the U.S. to run a trade deficit.
Conversely it is also economically advantageous for creditor nations, and for the world economy, if creditor nations operate with trade deficits: deficits proportionate to their creditor status. That is, the deficits should be large enough to enable the nationals of debtor nations to acquire a sufficient amount of foreign exchange to enable them to serve their international debts.
Since the U.S. is no longer an economically undeveloped nation, but is increasingly an international debtor, what evaluation should be places on our huge trade and current account deficits? For the very short run these deficits keep prices and interest rates lower than they otherwise would be and they subsidize our standard of living. But the deficits also are inexorably forcing the dollar down in terms of its foreign exchange value—and no consortium of central bankers, treasury secretaries, et al. can stop the process.
flow5, your approach of including the stocks of debt is of course correct. Sooner or later such a currency (ceteris paribus, e.g. : no sudden source of enormous and costless exports about o come on strm)
But what about the case of the Kiwi (the NZD(: enormous deficit, large debt, weak export structure: 5year trend vs USD and Yen : up, vs Euro and AUD: level. Pse explain..
DC: compliments for your impeccable sources. Small correction, Brig Ellery merely stated that he prefered the curren”source of stability” (i.e.not hegemony, quite difference) to one based on an as yet undefined east. He basically meant: the devil you know. No rational person can blame a general for saying that. Military 101.
Brad
not sure if this has been said before, sorry, bit of hiatus and have been too busy being amused at the markets to do much reading lately, laziness as always, but back to the topic. CIC has way too much on its plate, it has become a multi-purpose tool. As such, perhaps, it has become IB-asset management-infrastructure (at least in terms of chinese firms expansion abroad)focussed firm. the “focussed” part is probably debatable. The only possible link is, perhaps through equity purchase, it could gain some training ground for the management personnel /expertise it sorely lacks, and perhaps control over certain firms could allow expansion into sectors, be they resource firms or other industries.
DC- if Rien Huizer is right, well, let’s just say the military is where those who are not with you are against you, now why does that sound so familiar, at least Bush jr learnt something in the army, even if it was paranoia.
Rien Huizer, I am interested in Korean matters. I would like to know more of your thoughts. Please contact me at mitchtemporarily@hotmail.com if you are willing to share.
The outward expansion of Chinese state firms consequently hinges on the willingness of China’s state to make the dollars it is accumulating to hold its currency down available to Chinese state firms — and then making sure those firms down use the dollars they have received from China’s state to buy RMB.
huh? The first part, I do get, but the second part, why? wouldn’t that make the $ growth problem even more complicated? In a recent interview, an expert basically reiterated the official line- that raising bank reserve ratios and maintaining price stability (modus operandi unknown, guess; probably indirect subsidies of some form) are the main methods by which China aims to maintain economic and social stability(Dr Sun Lijing, can’t remember the university though)
Judy,
I believe it should say “…don’t use those dollars they have received…..to buy RMB”. In other words, lending the dollars to Chinese firms to invest abroad can provide another dollar investment to spread the load away from treasuries and agencies, like equity stakes and private equity etc. Providing those firms don’t decide that speculating on an appreciation of the renminbi does not provide a better bet, that is!
Rebel Economist is right; i meant to say “don’t use … “
Yeo: CIC has way too much on its plate, it has become a multi-purpose tool.
The term “political football” comes to mind. The one thing that we do know about CIC is that it is going to manage $200 billion in reserves. If you have $200 billion then there is not going to be a shortage of people with ideas on how you should use it.
DC: The world is becoming multi-polar,
Sure and the keyword here is multi-polar, and not bipolar.