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SAFE seems to have started buying US equities in the spring of 2007, and didn’t stop until July 2008 …

by Brad Setser
March 15, 2009

Jamil Anderlini of the FT has picked up on one of the surprises of the latest survey of foreign portfolio investment in the US: the $70 billion rise in China’s holdings of US equities between June 2007 and June 2008. Roughly $10 billion of that can be linked to China’s direct purchases of US equities – the kind that show up in the monthly TIC data. But $60 billion was initially bought by investors in other countries and thus didn’t show up in the monthly TIC data

After spending a bit more time looking at the TIC data, I didn’t have much trouble inferring that most of China’s equity purchases were routed through Hong Kong.

The US survey data reduced Hong Kong’s equity holdings (relative to those implied by summing up the monthly flows) by $44b even as it increased China’s holdings by around $60 billion. The pattern in the US data also fits well with the revelation last year that SAFE’s Hong Kong subsidiary had bought stakes in Australian banks and a host of British firms. Anderlini:

“Safe uses a Hong Kong subsidiary when investing in offshore equities in the US and other countries, including the UK, where this subsidiary took small stakes last year in dozens of UK companies including Rio Tinto, Royal Dutch Shell, BP, Barclays, Tesco and RBS. As part of its diversification in early 2008, Safe also gave some money to private equity firms such as TPG and to hedge funds on a managed account basis. This gave the Chinese government ultimate approval for how its money was invested, according to people who have worked with Safe.

It all sort of makes sense; China usually leaves traces of its activity in the TIC data once you know where to look.

The monthly TIC data suggests that China started to buy large quantities of US equities through Hong Kong in the spring of 2007. The big rise in China’s equity holdings in the June 2007 survey (equities rose from $4 billion in June 2006 to $29 billion in June 2007) offered the first hint of this shift in strategy. The Hong Kong flows suggest that China kept on buying through the first stage of the subprime crisis. Large purchases through Hong Kong didn’t come to an end until July 2008.

That, of course, implies that China bough a lot of equities just before the market fell sharply. Bad timing.

Anderlini reports that SAFE may have had as much as 15% of its portfolio in global equities and corporate bonds at one point last year:

“By that point Safe had moved well over 15 per cent of the country’s $1,800bn reserves into riskier assets, including equities and corporate bonds, according to people familiar with its strategy.”

15% in global equities and corporate bonds is high for a traditional central bank reserve manager. 15% of $1.8 trillion (China’s end-June reserves) is also $270 billion. If most of that was in equities, only ADIA would have had a larger equity portfolio.

The survey data also implies that SAFE has suffered far larger aggregate losses on its equity portfolio – should that portfolio ever be marked to market – than the CIC suffered on its investments in Blackstone and Morgan Stanley. The CIC put $3 billion into Blackstone and $5 billion into Morgan Stanley, far less than SAFE put into a more diversified equity portfolio.

Not surprisingly, SAFE is now investing much more conservatively. Anderlini:

“”They are a lot more cautious and risk-averse now and have basically returned to buying government bonds,” said someone who works with Safe. “

Anderlini though hints that the CIC has been a bit more active recently:

Analysts and Beijing insiders say CIC has learnt from Safe that transparency and openness do not pay and the way to avoid criticism is to avoid outside scrutiny. “CIC has turned to stealth mode; it is doing transactions and is looking at lots of resource-related deals all over the world but it is trying to hide its involvement,” said someone familiar with the fund’s strategy.

Presumably the CIC isn’t the only sovereign fund that isn’t all that keen on transparency right now. I suspect that a host of sovereign investors took on more risk just before the market for risky assets crashed.

—-

A couple of additional asides on the way China purchases its foreign assets. In addition to buying equities through Hong Kong, China also seems to buy some of its Agency portfolio through Hong Kong. The survey revised China’s Agency holdings up by $90 billion while reducing Hong Kong’s holdings by about $30 billion and the UK’s holdings by about $115 billion. China also seems to be behind a decent share of all the Agencies sold to the UK.

China may also buy some corporate bonds through Hong Kong data. But it also buys a fair number directly.

China’s corporate bond purchases – bizarrely – show up in the monthly TIC data for China but NOT in the survey. The last two survey’s have produced large downward revisions to China’s corporate bond portfolio. That is the exactly the opposite of the pattern for equities. There China’s purchases show up in the survey but not the monthly TIC data. China likely uses a non-US custodian for its corporate bonds. I don’t think China stopped buying US corporate bonds before the Lehman crisis.

And for what it is worth, China seems to buy Treasuries both directly and through London – if SAFE London or SAFE Beijing buys a Treasury from a bank based in the UK, it doesn’t show up in the US data. What tends to show up instead is the purchase of US Treasuries by banks based in the UK who build up inventory in anticipation of Chinese demand.

UPDATE: I edited the post to make it clearer that not all of the 15% of its total portfolio that SAFE supposedly invested in equities and corporate bonds would not all have been invested in US equities.

35 Comments

  • Posted by Eduardo Guelman

    Brad, just to pick on you a bit (with all the respect…), but when you quote someone that is quoting you, it really looks very awkward (just like the chinese corp. bonds showing up in the tic data..).
    Anyway, never mind the bollock, keep up the great work!
    Best

  • Posted by DOR

    Remember the late 1980s panic over Japan’s trade surplus with the US? And, then Mitsubishi bought the Rockefeller Center for a record price, at the top of the market? And, then the yen soared? Cost the buyer billions.

    Here we go again: but up depreciating assets with an appreciating currency, and watch that wealth get transferred back to the US.

  • Posted by DOR

    Here we go again: BUY up . . .

  • Posted by bsetser

    eduardo — You are right, I should have edited the anderlini quotes more carefully. He obviously drew on some of my work, but he also got some useful color from folks in beijing that i wanted to highlight. I went back and edited out the self-quote.

  • Posted by bsetser

    eduardo and yes, your broader point stands — but i also wanted to highlight some additional detail from some work i have done since the survey came out.

  • Posted by anonymous

    Granted SAFE held 15% equities in its portfolio at its peak, why it must be US equities? From what was disclosed previously, China has bought shares in UK, France(holding in Total), Australia. And the popular strategy until mid last year was to buy EM equities, just check Harvard portfolio. So why it must be US equities?

    Also, I read and reread FT article. It’s obvious to me the main source of that article is your estimates, Brad, and “people familiar with Safe’s operations”. Don’t know it’s “from folks in beijing”, could be someone in HongKong, London, or anywhere who likes to brag.

  • Posted by bsetser

    Anonymous — You are right. Anderlini is based in Beijing, but he clearly doesn’t just talk to folks in Beijing. There are people familiar with SAFE or who work with SAFE in a host of places. And yes, I obviously was one of Anderlini’s sources — though really i was just a conduit for reporting the results of the Treasury survey.

    The US data shows $100 billion in Chinese equity holdings at the end of June 2008. China may have more — the US data doesn’t pick up any funds managed by third parties. But let’s assume that provides an upper bound for SAFE’s US equity portfolio. Not all the $100b is SAFE’s money, but SAFE likely has some equity investments in teh US that don’t show up as well. $100b would be just over 5% of SAFE’s portfolio at the end of june 2008. So if Anderlini’s source is right and SAFE had 15% of its portfolio in equities at its peak, the majority of SAFE’s equity investments could have been outside the US.

    That though isn’t great news for SAFE, as non-US equity markets generally have done worse than the US market since June …

  • Posted by bsetser

    p.s. I should note that the $80b loss estimate is based on a $160b equity portfolio in June 2008 (2x SAFE’s estimated $80b in US equities based on the $100b in the TIC data). It thus is implicitly based on a global equity portfolio that was under 10% of SAFE’s total reserves at its peaks. If SAFE really had 15% of its reserves in equities back in June 2008, its losses would be larger.

  • Posted by bsetser

    moreover, the estimates that SAFE held 15% in risk assets includes its holdings of corp bonds. If safe really held close to 10% its reserves in equities in june 08, i wouldn’t at all be surprised if 15% of its portfolio was in risk assets of various kinds.

    China’s state banks also likely hold some US corp. bonds.

  • Posted by Qingdao

    Is there some good reason WHY China (CIC,SAFE) buys Treasuries in London and stocks in Hong Kong?

  • Posted by astropolitik

    Brad,

    I’ve noticed you are being quoted more in the financial press, and that this blog is being linked to by traders interested in a macro view. I’ve enjoyed your posts for a while – this blog alone refutes the skepticism shown by the Obama administration on the value of blogs in exploring nuanced public policy.

    Thanks for your excellent and timely research, and congratulations on your growing fame!

  • Posted by Indian Investor

    @Brad: In a slightly wider context, I’d be interested to know the feasibility of some countries holding dollar assets while China offloads its dollar assets. My understanding is that this is the recommendation from your Sovereign Wealth paper. i.e. some close Allies should be encouraged to hold dollar assets, while China is “discouraged” to do that. I think we understand well enough what we’re talking enough. After the Ides of March, who’re Caesar’s true Allies?
    A German built high-speed Sapsan train arrived at Leningradsky station in Moscow today, completing its first test run from St. Petersburg. Deccan Herald, a regional Indian newspaper carries a photograph of the train in Leningradsky.

  • Posted by DJC

    BEIJING – While much hope is focused on China and its still-growing economy as a rare bright spot in the current financial gloom, the country’s leaders are drawing a line on global expectations, reminding the world that for them China’s priorities come first.

    This was underlined by Premier Wen Jiabao on Friday when speaking to the press at the closing of the annual meeting of the nation’s legislature in the Great Hall of the People in Beijing, he said that in managing the country’s foreign exchange reserves, “our first consideration is the national interest”.

    http://www.atimes.com/atimes/China_Business/KC17Cb01.html

  • Posted by Simpson

    Brad – Indeed, SAFE uses a non-US custodian or more correctly several non-US custodians.

  • Posted by DJC.

    Crony capitalism at its best. Does the Fed and US Treasury regulate Goldman Sachs or is the reverse true?

    Politically-connected Goldman Sachs biggest recipient of US taxpayer bailout of AIG
    http://biz.yahoo.com/ap/090316/aig_bailout.html

    The biggest recipient of the AIG money was Goldman Sachs at $12.9 billion. The taxpayer dollars went to banks to cover their losses on complex mortgage investments, as well as for collateral needed for other transactions.

  • Posted by Bob_in_MA

    It looks like their timing is about as good as the average corporate buy-back program. ;-)

    It would be interesting to follow the eventual sales, might be the time to buy…

  • Posted by MPM

    hey brad, how are you analyzing the Caribbean Treasury Holdings flow?
    It recently dropped by 10B, after a major spike. Any specific insight?

  • Posted by DJC.

    The Chinese aren’t going to bailout the Washington Consensus unipolar world order. The IMF Gestapo banksters have raped and pillaged one developing nation too many especially the destroyed Indonesian Economy under the authority of the former US Treasury’s Robert Rubin. It’s time for a new equitable world order……

    From Chinese President Hu Jintao,

    “Now many countries are saying that China is good and hope that China will emerge (to help them), but honestly we are still a developing country. Don’t over estimate the fact that we have almost 2 trillion dollar in our foreign exchange reserve. If you take that amount and divide it by 1.3 billion people, how much per head is that? Therefore, we truly need to conduct our own affairs well.”

  • Posted by Off the boil

    Caribbean Treasury Holdings flow?

    STANFORD

  • Posted by WStroupe

    Losing faith in financial Assets?

    The fact that China’s SAFE has suffered the degree of losses Brad has documented, and the fact that China’s CB is selling off almost everything in U.S. assets in favor of short-dated U.S. Treasuries, and the fact that China’s overall purchase of U.S. assets is significantly slowing, all combine to paint a picture of a gross loss of confidence in financial assets – particularly those denominated in the dollar.

    You get massively into short-dated Treasuries when you are afraid of the losses encountered as prices decline and yields rise. You sell off your agency and corp bonds in favor of the short-dated Treasuries because you don’t trust such financial assets anymore. You slow your overall purchases of U.S. financial assets when you see the danger of too great an exposure to the dollar. Also, the short-dated Treasuries afford you the opportunity to move fast – further out of financial assets and the dollar. It’s like getting up on your mark, get set, and ready to go – in a foot race.

    Financial Times today made the point that SAFE and CIC are in stealth mode and are moving faster toward hard assets (resource buys). See http://www.ft.com/cms/s/0/7a29cfde-1185-11de-87b1-0000779fd2ac.html where both Brad and Rachel are quoted.

    Step back, take in the bigger picture – deepening loss of confidence in financial assets, especially those of the U.S. This is spreading beyond just China, too. It has the potential to seriously harm Treasuries and the dollar, sooner rather than later, in my assessment.

  • Posted by Twofish

    Qingdao: Is there some good reason WHY China (CIC,SAFE) buys Treasuries in London and stocks in Hong Kong?

    Yes. Treasuries are very liquid and so you get a better price in London than in HK because the pool of buyers and sellers are larger. Stocks tend to be more distributed, and for a given stock, you can often get a better price if you go to a particular exchange such as HK.

  • Posted by Twofish

    I find it plausible that China bought $100 billion in equities in 2008. I find it totally implausible that SAFE controls more than about $20 billion in equities. If you add up known purchases by SAFE, you only get to about $10 billion.

    If you add together totally purchases of global equities by everyone then you can get up to $100 billion rather easily.

  • Posted by Twofish

    I might have to eat my words for saying this, but this looks like a classic example of rumors and misstatements creating a story that doesn’t exist.

    The reason there hasn’t been much criticism of SAFE losing huge amounts of money in equities, is that IMHO, SAFE hasn’t lost huge amounts of money in equities.

  • Posted by Twofish

    bsetser: I should note that the $80b loss estimate is based on a $160b equity portfolio in June 2008 (2x SAFE’s estimated $80b in US equities based on the $100b in the TIC data). It thus is implicitly based on a global equity portfolio that was under 10% of SAFE’s total reserves at its peaks. If SAFE really had 15% of its reserves in equities back in June 2008, its losses would be larger.

    I’m sorry but this makes absolutely no sense at all. If you start off with roughly $100 billion in Chinese equities holdings and then subtract the known equities holdings by people other than SAFE, you are going to end up with a much smaller number.

    If you just subtract QDII, you end removing the numbers by about $25 billion right there.

  • Posted by Twofish

    The numbers make sense, but I think the interpretation is wrong. From about mid-2007 to mid-2008, China’s main concern was to reduce the amount of hot money entering the country, so there were a number of programs intended to get money out of China, and part of this involved programs that loosened restrictions on SOE’s buying foreign equities as well as things like the QDII program.

    So I think it is plausible that China has invested about $100 billion in foreign equities. I find it totally implausible that *SAFE* has $100 billion invested in foreign equities. Also the number quoted was that SAFE had 15% in risker assets. It wouldn’t surprise me at all if SAFE had 15% in corporate bonds, but $100 billion in equities.

    No way…..

  • Posted by Twofish

    WStroupe: The fact that China’s SAFE has suffered the degree of losses Brad has documented.

    Let’s stop right there. Brad is guessing. It’s an informed guess, but it’s a guess that I personally think is completely wrong.

    WStroupe: the fact that China’s CB is selling off almost everything in U.S. assets in favor of short-dated U.S. Treasuries, and the fact that China’s overall purchase of U.S. assets is significantly slowing, all combine to paint a picture of a gross loss of confidence in financial assets – particularly those denominated in the dollar.

    China is behaving basically like everyone else in the world, and paradoxically the loss of confidence in financial assets benefits the dollar. What is going on here is that confidence is relative. When everything falls apart, confidence in the dollar and treasuries fall, but they fall less than everything else.

    WStoupe: Also, the short-dated Treasuries afford you the opportunity to move fast – further out of financial assets and the dollar. It’s like getting up on your mark, get set, and ready to go – in a foot race.

    Except that there is nowhere else to go. If you want to get out of the dollar, then get out of the dollar. The fact that people are moving into Treasuries illustrates that people *don’t* want to move out of the dollar.

    WStroupe: Financial Times today made the point that SAFE and CIC are in stealth mode and are moving faster toward hard assets (resource buys).

    And with due respect, I think that the FT is totally wrong about what SAFE and CIC want to do with their cash.

  • Posted by WStroupe

    Twofish,

    I agree that Brad’s estimate of China’s losses are just that – merely an estimate, and one that’s very likely to turn out significantly over-stated.

    I also agree that the dollar is benefiting from the global loss of confidence in financial assets. But that’s just my point – it’s benefiting only VERY TEMPORARILY, and ONLY AT A SURFACE DEPTH, because by-and-large those piling into Treasuries are piling into short-dated bills that they can exit from very quickly as soon as the stampede to the next bubble begins. The dollar isn’t getting the nod as a medium or long-term safe store of wealth.

    Investors are prudently positioned to be able to swiftly move to the next bubble, whatever it will be, and there most certainly will be one – there ALWAYS is “the next bubble”. My assessment is that it will be in the general category of “hard assets” as confidence in ALL financial assets, including Treasuries, gets progressively undermined in this global crisis. In this, China is blazing the trail via its “resource buys”, which encompass a lot of territory, but in general constitute a potent move into hard assets whose prices are now very, very attractive (buy low, sell high). This is a very good, prudent, forward-looking way to spend one’s dollars, thus decreasing exposure to the dollar.

    So, the idea that “there’s no place else to go but the dollar” is now changing, and China leads the way. I would expect investor psychology to embrace this to an increasing extent over the next several months – with obvious risks for the Treasuries bubble and the dollar itself.

  • Posted by bsetser

    2 fish –

    i stand by my analysis.

    QDII should appear in the bop data.

    at the end of 07 recorded Chinese portfolio equity inv. abroad was $18.9b

    http://www.safe.gov.cn/model_safe_en/tjsj_en/tjsj_detail_en.jsp?ID=30307000000000000,1&id=4

    i don’t have a reference on hand/ forget the distribution between h2 07 and h1 08 but do remember that total port. equity outflows during the h2 07 + h2 08 period in the bop data were in the $10-15b range. That puts an upper bound on non-official Chinese equity holdings abroad at around $30b at the end of june 08.

    the CIC has reported it has about $90b in cash. given all that we know about it, that implies it wasn’t a huge buyer of equities.

    and for what it is worth, my measure of treasury/ agency flows v chinese reserve growth started to show a large gap around in q2 07 … just when the flow thru HK spiked.

    it is all circumstantial, but i am pretty confident of this — otherwise I wouldn’t have talked to the FT.

    let’s see if SAFE denies having a significant equity portfolio.

    whether the losses are $50b or $80b I don’t know, but SAFE clearly bought a fair amount of equities from end q1 07 til end q2 08.

  • Posted by Qingdao

    Two-fish: thank you; sometimes it’s hard to get an answer to a simple question.

  • Posted by Twofish

    bsetser: i don’t have a reference on hand/ forget the distribution between h2 07 and h1 08 but do remember that total port. equity outflows during the h2 07 + h2 08 period in the bop data were in the $10-15b range. That puts an upper bound on non-official Chinese equity holdings abroad at around $30b at the end of june 08.

    No it doesn’t.

    It’s likely that a huge fraction of equities are owned by subsidaries of Mainland companies, and given that capital flows between HK and the Mainland are not very well tracked, you could very easily have tens of billions of dollars getting exchanged and moving into HK where they were used for equity purchases.

    And BoP doesn’t provide any limits, since if you add up all of the known purchases of equities in that time frame, you already exceed $10-$15b.

    The reason I think that SAFE doesn’t have very large holdings is:

    1) it’s very hard to hide that big of an elephant. To manage a fund that a large you either need to hire large numbers of people or else contract out portfolio management. Either of these would have been noticed, and in fact have been noticed. The amount of hiring that SAFE has consistent with $10 billion holdings and not $100 billion.

    Also $100 billion equity purchases would overwhelm the markets. You just can’t go to a broker and say “I want to purchase $1 billion in Exxon”.

    2) It makes no sense bureaucratically. SAFE is the agency that people love to hate, because it has control over foreign exchange transaction and therefore can and does block things just to annoy people.

    What this means is that I find it completely implausible that SAFE would be allowed to a larger foreign equity portfolio than CIC, or more importantly, if SAFE had lost $80 billion, everyone in Beijing would pull out the knives and trying to kick SAFE while it is down.

  • Posted by Twofish

    WStroupe: My assessment is that it will be in the general category of “hard assets” as confidence in ALL financial assets, including Treasuries, gets progressively undermined in this global crisis.

    I doubt it. People that put their money in oil and metals lost much, much more money that people that put their money in real estate. There are a lots of ethanol manufacturers that got themselves in big trouble.

    The problem with “hard assets” is that most of them are totally worthless if you have an economic crisis. If an economy collapses, then oil and steel are worthless.

    WStroupe: In this, China is blazing the trail via its “resource buys”, which encompass a lot of territory, but in general constitute a potent move into hard assets whose prices are now very, very attractive (buy low, sell high).

    It would be utterly stupid for China to do this, but that’s not what China is after. If you are looking at what China is doing with oil and minerals, it doesn’t care about the actual commodity. What China is after are *brains* and *technology*.

    There is no point in buying an Australian aluminum producer, except that now you have access to Australians that know how to produce aluminum, at which point you pull over the technology and the people.

  • Posted by WStroupe

    Twofish,

    China’s resource buys aren’t just to get the brains. They’re to get the resources, both physically and by virtue of increasing China’s control over their production and therefore their pricing as well. Such hard assets have had their prices beaten down very far and virtually have no place to go but up. No matter how bad the global economic crisis gets, it’s going to turn around, in some areas of the globe at least, someday soon. These hard assets have a real value. They are vital. I think you should study these resource buys more carefully before you make blanket statements as to their purpose and nature. Rachel Ziemba at RGE Monitor has some good analysis on the subject.

  • Posted by Twofish

    WStroupe: They’re to get the resources, both physically and by virtue of increasing China’s control over their production and therefore their pricing as well.

    You actually *don’t* get much control over assets if you sign one of these agreements. If you sign a deal for Australian aluminum, the aluminum is still in Australia, and if the Australian government doesn’t like the agreement, they can and will tear it up.

    WStroupe: Such hard assets have had their prices beaten down very far and virtually have no place to go but up.

    Lots of people have lost lots of money thinking that.

    WStroupe: These hard assets have a real value. They are vital.

    A barrel of oil has no more “real value” than a piece of green paper. Also, raw materials can often turn out to be not that vital. Oil is the only real commodity that can’t easily be substituted, and even there, it can be substituted with some difficulty.

    WStroupe: . I think you should study these resource buys more carefully before you make blanket statements as to their purpose and nature. Rachel Ziemba at RGE Monitor has some good analysis on the subject.

    I have, and I think that most people are missing the big picture about what China is doing and why. China’s resource buys are part of an effort to “go global” and end up with world class companies. China is not as much interested in owning oil as owning a company that can compete with Exxon-Mobil and Halliburton to get oil.

    The reason for this is that getting foreign technology and know how. China has huge aluminum deposits and unexploited deep water oil deposits. So why is China buying aluminum from Australia if it has plenty of aluminum deposits in China.

    Answer: They aren’t interested in the aluminum, they are really interested in the aluminum mining technology. If the US Navy or the Australia government wants to stop China from getting Australian aluminum, it can. However, if China has cutting edge technology, then it can exploit domestic sources of aluminum which are immune from blockade.

    Owning an Australian mining company makes Chinese mines more valuable.

    Also, I’m not afraid to disagree with analysis if I think it is dead wrong.

  • Posted by Twofish

    One other way, that you can make stock purchases that aren’t in the balance of payments data is if you are a HK company that is a subsidary of a Mainland company. If you have any profits that are made overseas, and you have permission not to convert them to RMB, you then have the incentive to play the stock market to make up for currency losses. You are willing to live with currency losses since most of these permissions are “use it or lose it” and if you can’t figure out how to use SAFE permission to hold overseas assets, you can rent out this permission to people that do.

    My believe is that this sort of thing (which is really quite common) far, far exceeds direct purchases by SAFE.

    Also, the analysis that what the Chinese government really is after is strategic investment to acquire technology and expertise is yet one more reason it makes no sense to me that SAFE would be allowed to operate a large index fund since unlike every single purchase in which the Chinese government has been known to make, you learn nothing from the experience.

  • Posted by AndyLG

    OK
    A simple and smart plan would work like this:
    Sell whole bunch of US bonds to the Chinese.
    But before buy a lot of cheap staff from China with american currency.
    Than Chinese have amassed apx 2 trillion billion dollars in US bond. Than DECREASE the value of dollar by borrowing another 500 billion followed shortly by another 700 billion and than you are wining the war against communism/chinese government.
    Very smart and inventive thinking.
    Chinese don’t realise they are holding the virtual currency of trust in US.

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