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Did SAFE really buy that many US (and global) equities?

by Brad Setser
March 19, 2009

Jamil Anderlini’s Monday FT story — which obviously drew heavily on my work — attracted a fair amount of attention. Particularly in China. Americans are more focused on AIG’s losses than China’s equity market exposure.

Two specific questions have come up a lot, both in the comments section here and in various other conversations, namely, why is it likely that SAFE holds most of China’s US equity portfolio, and why did I assume that SAFE’s non-US equity portfolio was roughly equal in size to its US equity portfolio?

Both are fair questions.

The evidence that SAFE accounts for the majority of China’s US purchases is overwhelming. SAFE own data on China’s net international investment position shows that at the end of 2007, private Chinese investors held less than $20 billion of foreign equities. And that would include private Chinese holdings of non-US equities. Chinese portfolio equity purchases — according to the China’s balance of payments data — in the first half of 2008 were also modest. Consequently, it is hard to see how private Chinese investors could account for most of the $100 billion Chinese portfolio in the US survey data.

Moreover, we know from the US balance of payments data that private Chinese investors have been selling US securities other than Treasuries for the last two years. Private Chinese investors (i.e. the state banks) were significant buyers of US securities other than Treasuries (likely various US corporate bonds and some agencies) in 2005 and 2006, but they started selling after the subprime crisis.

Graph

The BEA’s data is here.

Now it is possible that private Chinese investors were selling large quantities of US corporate bonds and Agencies while buying a lot of equities, but that seems unlikely.

That leaves official investors — and well, I believe the CIC when it says that it remained mostly in cash. That leaves SAFE.

What then is China’s exposure to non-US equities. Here the evidence is more circumstantial. There are various hints that SAFE’s Hong Kong branch was buying into nearly all markets, not the US market. The Telegraph reported in mid September that China held at least 9 billion pounds of British equities, and it hinted, I think correctly, that its methodology for counting China’s holdings likely understated the full extent of China’s portfolio. The Telegraph reported last September:

An analysis by The Sunday Telegraph reveals today that the People’s Bank of China, the country’s central bank, owns shares in many of Britain’s household corporate names, including Cadbury, HSBC, the London Stock Exchange, Marks & Spencer and Tesco. These previously secret investments are in addition to known stakes in BG Group and Drax Group, the energy companies, and Legal & General, Old Mutual and Prudential, the insurers. In total, the stakes held by the People’s Bank are valued at about £9bn, according to the share prices of the companies concerned last week. Many of the shareholdings are held through nominee accounts registered in locations including Hong Kong and are technically held by State Administration of Foreign Exchange (SAFE), the body which sits within the central bank and has the responsibility of managing the forex reserves accumulated from China’s decades-long exports boom.

A number of other FTSE100 companies say privately they believe the People’s Bank of China to be an investor but have not established the paper trail which leads to the shares’ ultimate owners. …. Even allowing for the investments which can be established, however, China’s central bank is now a common name among the ranks of ‘institutional’ investors, like the giant pension funds, fund managers and hedge funds, which litter the FTSE. At £9bn, SAFE is now thought to rank among the top 25 investors in the London stock market, underlining China’s status as a global economic powerhouse

SAFE also clearly was buying stakes in various Australian and European companies. Anderlini reported back in September that SAFE’s equity holdings topped the $90 billion the CIC had to invest abroad:

“Before CIC came into existence, however, the State Administration of Foreign Exchange (Safe), the regulator in charge of managing the world’s largest foreign exchange reserves, was already dipping its toe into global equity markets, secretly buying small stakes in large-cap listed western companies. After CIC was founded, Safe … rapidly but stealthily expanded its programme of building small positions in some of the world’s largest companies. That meant taking a stake in companies such as BP and Total, as well as at least three Australian banks.

According to Chinese media reports that officials in Beijing confirmed as largely accurate, Safe has also used a shadowy Hong Kong subsidiary to build stakes of less than 1 per cent in numerous companies listed in the UK, including BHP Billiton, Rio Tinto, Unilever, Tesco, British Gas, Cadbury, Royal Bank of Scotland and Barclays Bank, as well as in other markets. While some western politicians worried about the transparency and strategic and political intentions of CIC, Safe was building offshore equity positions that now exceed the $90bn (€65bn, £51bn) total that CIC has to spend abroad, according to estimates by people in Beijing familiar with Safe’s operations.”

Prior to the most recent US survey, there actually was more solid evidence that SAFE was buying European and Australian equities than that it was buying US equities; the US data only showed a suspicious surge in equities purchased through Hong Kong. That said, I cannot point to an official data release to back my estimate that SAFE had invested a significant sum in non-US equities. An estimated portfolio is just that. Any calculations for the likely mark-to-market losses on SAFE’s equity portfolio are equally a function of that estimate.

One last point: The fact that the US data shows over $400 billion in Chinese official purchases over the last four quarters is rather shocking. And that is the unrevised data. When the results of the last survey are worked in, China’s purchases from mid-07 to mid-08 will be revised up a bit. That said, China’s recorded purchases of US assets are now about equal to its current account surplus. They aren’t likely to get much bigger than they are now unless China’s external surplus rises. And that is the last thing anyone should want.

21 Comments

  • Posted by jonathan

    How do you produce this high level of blog material nearly every day?

    “Rather shocking” indeed. It’s difficult in my head to pull apart the loop of China’s stakes in the US. Example: the decline in the dollar’s value following the Fed’s not so slender announcement of yesterday.

  • Posted by Bernardo A

    jonathan: “How do you produce this high level of blog material nearly every day?” … and how can he do it even twice or three times a day?

    by the way, the response to yesterday’s FED’s move has been quite schizophrenic. I suspect the Dollar decline of may have been due to expectations of higher inflation in the future (i.e. successful QE) and thus projected USD depreciation. Treasurys on the other hand have rallied for obvious reasons. I don’t think this outcome is any good for China, overall, and therefore I would be hesitating before saying that there was a lot of China behind yesterday’s developments. Maybe Brad has something more to say about this.

  • Posted by Rien Huizer

    Brad,

    Would not it be simply a case of buying the index? Looks like SAFE has a diversified portfolio. One may wonder about the timing (buying a diversified [portfolio in one shot is not wise) and about the technicalities of the diversificationstrategy. But there -on the surface- seems to be no reason for accusing SAFE of the sin of stock picking or other irrational investment strategies. Right?

  • Posted by bsetser

    Rien my loss calculations assume that China held a portfolio that mimics the index. Partially that is because I don’t have any reason to believe that they deviated that far from an index, and partially that is because that simplifies the calculation enormously.

    The main issue is one of timing, namely China bought in retrospect at the top. And I think that the scale of China’s purchases could have been one reason why the subprime crisis initially didn’t have more of an impact on the equity market. but that is just a conjecture.

  • Posted by Rien Huizer

    Brad,

    Right, they may have done the right thing in the wrong way. But i doubt their buying had an impact on the market. Anyway..

  • Posted by Simon

    China buying US equities seems odd to me. Unfortunately there is nothing stopping people in Charge of billions of dollars making bad decisions any more than people with mere thousands.

    To me the most perplexing things about macro economics are that a) the current models don’t actually provide a viable framework for understanding and controlling the world economy and b) The people participating in the process are just that, people, and totally prone to the same emotions that get everyone else into trouble. Fear and Greed.

    Lets have that world central bank that controls all international currency movements through its own currency. The one Keynes that advocated. It’s needed badly.

    Oh and it would probably be best if the directors were academics or monks or something and not permitted to participate in the markets or talk to the participants.

  • Posted by don

    “They aren’t likely to get much bigger than they are now unless China’s external surplus rises. And that is the last thing anyone should want.”
    But China’s official purchases are a policy variable, not an endogenously determined one (unless you think they are constrained to keep the yuan at a fixed level). People should understand that $400 billion of dollar purchases will offset $400 billion of U.S. fiscal stimulus. And stil we have Hilarious calling for more of the same.

  • Posted by Curious

    Brad-

    read your posts a few days ago, are you still 100% confident (as is Obama) that the U.S. won’t default on it’s debt over the next 5 years?

    I find your confidence as one with high national pride, yet a spring breeze of slight arrogance. Without listing names, I’m not so sure that all members within the Council itself share your view.

  • Posted by Curious

    btw sorry for off topic comment. if not a default i guess your bet is deflationary collapse followed by hyperinflation.

    that’s likely more logical…

  • Posted by Twofish

    The counterarguments for SAFE having such a large fraction are as follows:

    1) it is implausable that SAFE could amass $90 billion in equities without massive hiring of portfolio managers, large scale market disruption, or triggering mandatory reporting requirements. The known purchases of SAFE are consistent with a $10-20 billion portfolio

    2) There are other likely Chinese holders of global equities, namely state owned enterprises. Something to note is that CIC and SAFE investment corporations have the same legal status as SOE’s, so any statistics that would miss CIC and SAFE investments would also miss investments by state owned enterprises.

    3) There are lots of conduits by which you could have Chinese investment that is missed by the BOP data, namely moving capital into Hong Kong subsidaries or purchases by a holding company established in the BVI. Basically, anything that SAFE could do, any other state owned enterprise could do.

    4) Finally, it is just implausible from a Chinese bureaucratic perspective that SAFE would be allowed to hold much larger holdings than CIC and other SOE’s and even more implausible that CIC and other SOE’s wouldn’t complain especially if SAFE messed up in a big way. Chinese practice in these sorts of things would be to divide the pie evenly, and obvious that CIC has been restricted as far as equity purchases. It is implausible that SAFE would be allowed to make much larger investments than CIC.

  • Posted by Twofish

    bsetser: And I think that the scale of China’s purchases could have been one reason why the subprime crisis initially didn’t have more of an impact on the equity market. but that is just a conjecture.

    A $100 billion capital infusion is enough to get a lot of notice, but it is not nearly enough to affect the equities markets. When and why the equities markets tanked is very well known, after Lehman fell, hedge funds and mutual fund investors got scared and moved to cash.

  • Posted by Simpson

    Twofish – SAFE has plenty of portfolio managers. It is just that they are not on payroll and do not work in China. 400 bn is still less than 1/3 of their overall portfolio and in the parlance of the pre-Lehman era a 1/3 equities – 2/3 bonds portfolio is highly conservative.

  • Posted by Twofish

    Also the flaw in all of this is to assume that SAFE and CIC are the only sovereign wealth fund in China, and it ignores the fact that China has dozens of SWF’s. Every province and many local governments have an ITIC (international trust and investment corporation) as well as a pension fund, and that’s not including insurance companies and mutual funds. So the logic that China has $100 billiion in US equities that must be controlled by SAFE because no one else is around is fatally flawed.

    In fact, the existence of so many ITIC’s and SWF’s within China is one reason why I don’t think that SAFE could get away with running a $100 billion equities fund. The problem is that SAFE has a conflict of interest. People need its permission to do any foreign exchange, but it wants to run its own equity fund. If SAFE started using its regulatory power to block other parts of the Chinese government from starting their equity funds, it would soon find itself in a bureaucratic turf war that it couldn’t win.

    What I think is more likely than SAFE running a $100 billion equities fund is that it wanted to run a $10-20 billion equities fund, and in order to run a $10-20 billion equities fund it has to let a lot of other entities within the Chinese government run their $10-20 billion equities fund.

    It seems reasonable to believe that entities affliated with the Chinese government control $100 billion in US equities, with the caveat that almost every major economic entity in mainland China is affliated with the Chinese government in some way.

    What I cannot believe is that *SAFE* controls $100 billion in US equities, rather than control being divided among several dozen different entities, in part because I just can’t imagine the State Council or the Chinese bureaucracy in generally allowing any one agency to have that much power.

  • Posted by Twofish

    Simpson: SAFE has plenty of portfolio managers.

    Not enough. A rough rule of thumb is that it takes one person to manage $10 million. So managing $10 billion takes about 1000 people. A trillion about 100000 people, and $100 billion about 10000 people. I don’t see 10000 employees working for SAFE.

    You can also get a rough guess of assets under management by looking at office space. If SAFE really was managing $100 billion, it would have a major office building in HK.

    Simpson: It is just that they are not on payroll and do not work in China.

    It’s on someone’s payroll. You can outsource fund management, but other than TPG, no one has come up saying that they manage SAFE’s money. Any portfolio manager that is working for SAFE would be an idiot for not screaming that from the hilltops. If you work for SAFE, then you can use that fact to generate more China related business.

    Simpson: 400 bn is still less than 1/3 of their overall portfolio and in the parlance of the pre-Lehman era a 1/3 equities – 2/3 bonds portfolio is highly conservative.

    Not for foreign exchange reserves. The purpose of foreign exchange reserves is to save your rear end when everything goes bad, so you don’t have to beg and plead for money from the IMF loan sharks. Putting any foreign exchange *reserve* money in equities is highly risky and more than a little stupid.

  • Posted by Twofish

    Those numbers were for a diversified equity fund. If you just want to put all your money in treasuries, you can get by with a lot fewer people.

  • Posted by RebelEconomist

    Twofish: “Any portfolio manager that is working for SAFE would be an idiot for not screaming that from the hilltops. If you work for SAFE, then you can use that fact to generate more China related business.”

    False. Secrecy is the cultural default for foreign exchange reserves managers (the main reason I use a nom de plume here even though I am no longer involved), and to let out something as sensitive as this would probably disqualify the firm involved from doing any business with the public sector in China for a long time.

  • Posted by DJC

    China PBoC Backs Russia on replacing US Dollar as world’s reserve currency
    http://www.reuters.com/article/usdollarrpt/iduslj93633020090319

    MOSCOW, March 19 (Reuters) – China and other emerging nations back Russia’s call for a discussion on how to replace the dollar as the world’s primary reserve currency, a senior Russian government source said on Thursday. Russia has proposed the creation of a new reserve currency, to be issued by international financial institutions, among other measures in the text of its proposals to the April G20 summit published last Monday.

    Calls for a rethink of the dollar’s status as world’s sole benchmark currency come amid concerns about its long-term value as the U.S. Federal Reserve moved to pump more than a trillion dollars of new cash into the ailing economy late Wednesday.

    Russia met representatives of China, India and Brazil ahead of the G20 finance ministers meeting last week, as the big emerging powers seek to up their influence on decisionmaking globally. Their first ever joint communique did not mention a new currency but the source said the issue was discussed.

  • Posted by bsetser

    Rebel is right — if you talk about SAFE, you lose its business. That is the deal. It doesn’t want any institution to trade off its name, or to allow others to see the flows it is generating.

    As for China’s equity portfolio, a couple of points in response to 2fish:

    a) The telegraph did find 9b GBP of SAFE equity investments in the UK in Sept, which suggests your $10b estimate is a bit low. anderlini also reported — citing sources in beijing — that SAFE has a $100b plus equity portfolio back. And Caijing and others reported in 07 that SAFE had authorization to put 5% or so of its portfolio into equities.

    b) portfolio equity investments in the US by Chinese SOEs would show up in the Chinese BoP data as private outflows and as private holdings and neither shows up significantly. That also would show up as private flows in the US data. I think provincial investment funds would also be counted as private flows in the US data.

    I am happy to be persuaded that institutions other than SAFE hold a large US portfolio — I just want someone to show me who, and show that they have a large equity portfolio invested abroad (and buying Chinese firms listed on HK doesn’t count).

  • Posted by Twofish

    bsetser: b) portfolio equity investments in the US by Chinese SOEs would show up in the Chinese BoP data as private outflows and as private holdings and neither shows up significantly

    Why? It’s not clear to me at all why an investment by Citic Pacific or the Guangdong province pension fund would be considered any more or less “private” than an investment by SAFE.

    bsetser: I am happy to be persuaded that institutions other than SAFE hold a large US portfolio

    There is no need to have large portfolios, a lot of institutions with small portfolios will add up to $100 billlion.

  • Posted by don

    2fish: “Not for foreign exchange reserves. The purpose of foreign exchange reserves is to save your rear end when everything goes bad, so you don’t have to beg and plead for money from the IMF loan sharks. Putting any foreign exchange *reserve* money in equities is highly risky and more than a little stupid.”
    But China’s reserves are far, far beyond that need.

  • Posted by Rien Huizer

    Looking at the debate above, and previous experience, I think it is “plausible” that SAFE (still) owns a diversified portfolio of equities, and that these (except exceptions) are purely passive portfolio investments.

    CIC started later and took a few very public strategic stakes, though its main portfolio is domestic.

    Overseas Chinese, HK and Taiwanese family conglomerates tend to have one or more non-listed vehicles (often BVI based, bravo Twofish) at the top of their pyramid. Temasek plays a similar role in Singapore’s version of state capitalism and probably CIC the same in China.

    Given the fact that there are several established PRC entities like CITIC and most large SOEs (take for instance Chinalco’s stake in Rio Tinto) who own very large stakes of listed non-chinese companies, it is hard to see a slot for CIC’s foreign investment activities between (a) SAFE’s (now probably frozen) passive portfolio investments and (b) the highly strategic stakes of CITIC etc.

    The only rational (from a Chinese bureacratic perspective) for CIC would be to participate in foreign SOE investments and keep an eye on what the decentralized boys are doing. That would be in keeping with the way a proper Chinese conglomerate goes about keeping the family wealth out of the hands of undeserving employees and outsiders.

    But if this analogy holds, it would be impossible for outsiders to get a decent picture of “Chinese state” investment in foreign equities. No one knows where the state begins and where it stops and probably, they like it that way.

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