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SAFE, state capitalist?

by Brad Setser
July 21, 2009

One of the questions raised by the expansion of sovereign wealth funds – back when sovereign funds were growing rapidly on the back of high oil prices and Asian countries’ increased willingness to take risks with the reserves – was whether sovereign funds should best be understood as a special breed of private investors motivated by (financial) returns or as policy instruments that could be used to serve a broader set of state goals. Like promoting economic development in their home country by linking their investments abroad to foreign companies investment in their home country. Or promoting (and perhaps subsidizing) the outward expansion of their home countries’ firms.

Perhaps that debate should be extended to reserve managers?

Jamil Anderlini of the FT reports that China now intends to use its reserves to support the outward expansion of Chinese firms. Anderlini:

Beijing will use its foreign exchange reserves, the largest in the world, to support and accelerate overseas expansion and acquisitions by Chinese companies, Wen Jiabao, the country’s premier, said in comments published on Tuesday. “We should hasten the implementation of our ‘going out’ strategy and combine the utilisation of foreign exchange reserves with the ‘going out’ of our enterprises,” he told Chinese diplomats late on Monday.

A number of countries have used their reserves to bailout key domestic firms – and banks – facing difficulties repaying their external debts. Fair enough. It makes sense to finance bailouts with assets rather than debt if you have a lot of assets.

But China is going a bit beyond using its reserves to bailout troubled firms. It is trying to help its state firms expand abroad The CIC has invested in the Hong Kong shares of Chinese firms, helping them raise funds abroad (in some sense). And now China looks set to use SAFE’s huge pool of foreign assets to support Chinese firms’ outward investment.

That of course is China’s right.* China clearly has more reserves than it really needs, and thus can take some risks with its reserves.

But it also has consequences. If Chinese firms are explicitly backed by China;s reserves, it gets harder to argue that their expansion reflects a purely commercial calculus. China’s government presumably will deploy its assets to pursue China’s strategic as well as its commercial goals.

In some sense it is surprising that China has decided to be so explicit about its new desire to use its reserves to support Chinese state firms. China’s government could have achieved the same result by quietly putting more foreign currency on deposit in the state banks, and having the state banks lend those funds out to firms looking to expand abroad. See Richard McGregor’s account of how Chinalco financed its initial purchase of Rio Tinto shares.

China’s announcement presumably was directed at a domestic audience – one that is increasingly uncomfortable with China’s growing exposure to the dollar, and one that wants China to use its foreign assets in ways that more obviously help China’s own citizens.

It nonetheless highlights that the state plays a larger role in the economy of the world’s leading creditor nation than in most of the economies that it is investing in. Even now, after the crisis. And China’s state plays an even bigger role in China’s outward investment than in China’s domestic economy. Thanks to China’s exchange rate regime, China’s state has a de facto monopoly on outward capital flows from China.

Creditor countries often end up exporting their own economic model. Or at least trying too.

China may be no different.

And the growing reach of China’s state capitalists, in turn, might end up changing corporate America’s view of China.

* China isn’t alone in using its reserves to support local firms.

30 Comments

  • Posted by DOR

    Something very odd about the CFR interface today.

  • Posted by ReformerRay

    Of course China will use its supply of dollars (or other U.S. financial assets) to assist Chinese firms export activities. What else would be consistent with their behavior for the last decade?

    The countries who are unwilling to act as though they are in competition for the ability to export to the global market have endured a decade of a large trade deficit (UK and US). Forget any theories about ideal world trade. Each nation must preserve its own ability to participate in the global economy on terms that benefit that nation – or at least, do no harm.

  • Posted by jonathan

    Interesting choice of topic; The Economist whilst you was away had that long piece about Texas vs. California. That highlighted the weird opposite of SAFE, etc., that the US engages in massive internal competition – much of it government subsidized – that doesn’t advance the overall economy but instead breaks down “losing” states. The idea seems to be ultra-market, that the competition (subsidized as it is) corrects high cost levels. That argument would be stronger if a) the friction in the correction was minimal, meaning the time frame didn’t cause massive disruption an b) the country as a whole weren’t facing external competitors who use their resources to fight external competition.

  • Posted by CapitalMonster

    More than 75% of China’s top 150 companies by market cap are state-owned or state-controlled. Of those remaining, about half are real estate developers dependent on state banks for their their capital (not to mention local govts for their land).

    Is it really possible that China has “cracked the code” on central planning?

  • Posted by investor

    it’s been several weeks (if not several months) since i read news about china government’s support for oversea expansion.

    instead of focusing on key words such as “communist”, “state-owned”, or “subsidized”, i just want to make a few other comments:

    * buying upstream supplier seems to be a very common business strategy to reduce cost and secure key resources. it might reduce business risk if sale grows in long term as expected. in the last two or three years, china has been heavily relied on us and other foreign countries consumers. if china trade surplus or export volume can’t presume in the long term, those stated-backed acquisition will turn out to be a waste of money.

    * on the other hand, china firms must be facing serious problem on cost controls, especially on raw materials. the price of iron ore, oil and other key resources have gone up so much. in fact, a few china media reports claim that china steel firms was overpaying 700 billion RMB for iron ore import every year, which is about twice the size of total profits of china steel industry. in us dollar, that will be equivalent to $100b at least.

  • Posted by WStroupe

    Well, the FT.com analysis reports also that China will decline on trying to scarf up U.S. financial assets and will go for real corporate assets and hard resources-based assets around the globe, especially in the emerging world.

    Sounds to me like China’s leaders are basically fed up with the endless objections they run into from the developed economies of the world and are overtly signaling to the emerging world that China is moving money in their direction. I think they’re going to be well received. So this is much more than placating a domestic Chinese audience.

    Just think of how rapidly China can now work to convert much more of its dollars into real assets, without having to worry much about triggering panic via any dollar sell-off on its part. I’ve said it before and I’ll say it again – China’s leaders are going to continue to surprise on the upside (for China) and catch most of the West on its heels.

    Maybe a little less gloating over how China is supposedly “stuck” with the U.S. and with the dollar for the foreseeable future and a little more humility and out-of-the-box thinking is in order here.

  • Posted by Brick

    My first thought would be does this put more dollars into circulation and will it affect dollar values? My second thought was this could be bad news for Europe and India in that China will seek cost reductions through consolidating its supply chain.

  • Posted by Rien Huizer

    Brad,

    Creditor countries often end up exporting their own economic model. Or at least trying too.

    What model? I cannot see a model, only an elite trying (so far, successfully) to cling to power and privilege. Of course the country is now more developed than it was under Mao and possibly also than a hypothetical counterfactual that couls be labelled “model India”. But I think that the model is still good old Xiaoping crossing his stream by feeling the stones…Not that difficult if you are authoritarian and govern an initially poor but socialized people that had not had decent government for six or seven generations. But not enough to continue.

  • Posted by DJC

    Why is this unexpected? Does the US Treasury really believe the Chinese will park their hard earned money into Treasury bonds yielding approximately 0%. Compared to fiat US Dollars printed in unlimited quantity by the Federal Reserve, natural resources will be increasingly limited.

    ———-

    “Beijing will use its foreign exchange reserves, the largest in the world, to support and accelerate overseas expansion and acquisitions by Chinese companies, Wen Jiabao, the country’s premier, said in comments published on Tuesday.”

    “We should hasten the implementation of our ‘going out’ strategy and combine the utilisation of foreign exchange reserves with the ‘going out’ of our enterprises,” he told Chinese diplomats late on Monday.

  • Posted by Rien Huizer

    DJC,

    “We should hasten the implementation of our ‘going out’ strategy and combine the utilisation of foreign exchange reserves with the ‘going out’ of our enterprises,” he told Chinese diplomats late on Monday.”

    Time to batten the hatches, the Chinese are coming! Not only boosting the real world economy but also pouring money into dodgy ventures and risky stocks! But lock up the family silver pse.

  • Posted by bsetser

    Rien — Chinese state plays a larger role in the ownership of Chinese firms than it does in most other economies. I would consider that — state control of the commanding heights of the economy — part of China’s current model. The US had (and still has) private int. oil companies, and had (and to a degree, though a much reduced one), private int. banks. Chinese companies are going forth as state owned firms. That is something of a change.

    WSTroupe — the sale of the right to extract resources to a firm, whether a private firm or a state owned firm — is often controversial. I suspect that China will encounter resistance in some developing countries, just as private US and European firms have. that said, a world where China’s surplus finances deficits in the rest of the emerging world isn’t all bad; if Chinese inflows pushed up the real exchange rates of some emerging economies, that would help to facilitate sustained adjustment in the US external deficit!

  • Posted by DJC.

    Brad: “Chinese companies are going forth as state owned firms.”

    DJC: While Chinese companies are majority state owned firms, they also need to be responsive to shareholders around the world. China CNOOC lists shares in Hong Kong, New York, and Shanghai. If CNOOC isn’t profitable and paying dividends, shareholders around the world will dump the stock. Chinese companies don’t just take orders from the government, they still must respond to the marketplace.

  • Posted by bsetser

    DJC — last I checked, the Chinese government controlled the majority of most firms stock, and appointed the management … I accept that there are offsetting pressures, but this certainly seems to be a case where one shareholder dominates.

  • Posted by DJC.

    bsetser, if China CNOOC loses billions and eliminates its dividend like General Motors, will the private shareholder hold their shares. Absolutely not. CNOOC stock price will collapse like Enron, Lehman, and GM.

  • Posted by Rien Huizer

    Brad,

    Right. But that means that an absence of property rights (because there is not really a “state” that runs the SOEs and enforces its own rights consistently) combined with an absence of space for institutions that could foster and protect properly structured property rights (for both state and private actors) and accompanying incentives, can be called “a model”. For me, a model would indicate something with lot more “positive” elements and a structure with a certain degree of rationality. What we have in China is a stalemate, where none of the actors has the power to subject everyone else. A bit like the warlord area but more peaceful. A gross exaggeration of course. But a model, no.

  • Posted by WStroupe

    bsetser,

    There might well be some mechanical-sort-of side-benefits to the US external deficits as China struts its economic and monetary influence onto the global stage, but what happens to these benefits as the scary (to the West) reality of a real strategic consolidation of control over vital resources production/pricing/access by China and its emerging market partners crystallizes? Also, the negative political/geopolitical implications for the West of this, and of the accelerating emergence of a new collective driver for global demand and growth (China and the emerging world) are not by any means inconsequential. Increasingly, the U.S. and the wider West do NOT control their own destinies. They really risk being “handled” by the rising East as they continue to forfeit their economic/financial independence in favor of dependence upon the East. That’s the big picture. How it affects the U.S. financial/economic position and the dollar’s position going forward is the real question. I think it’s net negative all around for the West.

  • Posted by BigBadBank

    An official announcement of very deep pockets seems like a way to ensure that China pays the highest possible price for anything they end up buying.

  • Posted by bsetser

    Rien — Models can take a lot of different forms. Chinese firms will be active globally before the tensions that you identify have been resolved, or to put it differently with a model for corp governance that has allowed int. expansion w/o resolving a set of questions about who has de facto control/ property rights. So what you take as a lack of model is in some sense a model …

    Certainly Chinese state firms are still different in some sense from privately owned firms in the us and europe (which have their own corp governance issues).

  • Posted by Dan Rosen

    See my freshly published Policy Brief at peterson institute on this:

    http://www.iie.com/publications/interstitial.cfm?ResearchID=1245

    Dan Rosen

  • Posted by WStroupe

    BigBadBank said, “An official announcement of very deep pockets seems like a way to ensure that China pays the highest possible price for anything they end up buying.”

    Not really, because China’s signaling to the rest of the world, especially the emerging economies, that if they want the big big benefits of diversifying toward the increasing Asian demand and markets to replace what’s being progressively lost in the West (by virtue of the continuing crisis centered there), then they can have it – but only at prices that are workable for the Big Creditors (like China) who want to finance their (the emerging markets) expansions into those big Asian markets. And China won’t be hassling its “going out” partners with irritating and domestically destabilizing issues like human rights, democracy and the like, as the U.S. and the wider West tend to do. It’s win-win for China and its partners.

    After making some big and painful investment (by CIC) and forex management blunders, China’s leaders are pretty quickly getting real smart. They’re playing the ‘lightning rod’ game with this high-profile announcement now. They want to take to themselves (progressively but still rather quickly) the economic and financial thunder the U.S. and the wider West traditionally reserved for themselves. China’s leaders are telling the emerging world to ‘look here now’, not to the West. So, they’re capitalizing very potently upon U.S./Western troubles. This will undoubtedly help China and its partners to accrue more and more clout in many ways, and that will be key down the road a little ways when they want to push through their global economic/financial agenda to transform the global order as they see fit, not as the U.S. would have it. So I see this as smart geopolitics, good chess.

  • Posted by Cedric Regula

    In a country where “rule of law” seems to be pretty much whatever the Party says it is, I don’t know why the Party needs state ownership of equity in companies to exert state influence. In other words, if you can execute CEOs you are not happy with, why bother voting your proxy?

    So it seems to me that it would be rather tempting as a part of the “coming out” to open up the financial side to world investment. With the excitement about Chinese stocks, the state could sell much of their ownership and probably a lot of dilutive secondary stock offerings as well.

    So that would add a lot more money to the already large warchest of excess reserve funds.

    Potentially they could eclipse Japan’s coming out. Similarly, when a company makes ROI calculations on new investments, almost anything looks good if your cost of funds is zero.

  • Posted by biofuel

    Cedric: “In other words, if you can execute CEOs you are not happy with, why bother voting your proxy?”

    The quality of this discussion just hit the dirt…

  • Posted by Rien Huizer

    biofuel:

    “Cedric: “In other words, if you can execute CEOs you are not happy with, why bother voting your proxy?”

    The quality of this discussion just hit the dirt…”

    Well, Cedric has bit of a point, although it is not the whole story. But there are comparable situations in the West: look at the disciplining options traditionally available to mafia leaders (at least in fiction) for disciplining managers of more legitimate businesses they control. Earthy, but true, if the fiction is true.

    I guess there are lots of validities in arguments pro and contra Chinese macroeconomic policy but there is no excuse for accepting state owned firms of the Chinese type as “private sector businesses” in the context of competition law, trade policy and securities regulation in other jurisdictions than the PRC. Except that it may not be rational to antagonize a player that can do a lot more damage if it is isolated, or totally different, antagonizing an irrational spender in our own store.

    Incidentally, look at the remarkable events around Temasek in Singapore…

  • Posted by Cedric Regula

    Rien:

    China does have a lot of what we would call regulators, and there are occasional news stories of them getting caught for taking bribes, and being shot as a result. Like the guy in charge of approving cat food for example. That’s why this came to mind, but if they don’t go after bribe givers, then maybe CEOs have nothing to worry about. So maybe I made a gaff, but I’m the guest blogger at CFR on space alien relations, so I’m not always up to speed with earth foreign relations.

    But that important point aside, I also meant to point out that I don’t see much reason that China wouldn’t sell out it’s state ownership and double its market capital. That happens all the time in developing countries that start a state owned biz, then if it becomes saleable, they privatize it.

  • Posted by biofuel

    According to the reports, no CEOs were physically harmed in Singapore…

    By the way, does it occur to you even a little bit that screaming “murder” and comparing Chinese to a mafia is a bit over the top? No sympathy here anyway: the fittest will adjust.

  • Posted by bsetser

    Rien – what is your take on Temasek?

  • Posted by Rien Huizer

    Brad,

    “Rien – what is your take on Temasek?”

    You ‘re expecting too much.. I guess Mr Goodyear should never have accepted this job, but that is another issue.

    Temasek is much more than just an investment corporation. It is a conglomerate with a distinctive role in the “Singaporean model” . In order to manage it, you have to subscribe to the type of developmentalism that informs Singapore’s leadership, because it is basically only a tool. But it is separate from regular government (difficult to raid in populist fashion).

    If you think you are going to run Templeton or, for that matter GE, when Spore hires you for Temasek, you are wrong. But I find it hard to believe that an experienced mining CEO would neglect his politics. So maybe there is something going on in Singapore that makes it hard to do business as usual and hard to do something else. And something that was not there five, six months ago. As I said, interesting

  • Posted by Rien Huizer

    biofuel,

    “According to the reports, no CEOs were physically harmed in Singapore…”

    What reports, what CEOs? Perhaps a very small CEO was harmed a little bit?

    Your other remark:

    “By the way, does it occur to you even a little bit that screaming “murder” and comparing Chinese to a mafia is a bit over the top? No sympathy here anyway: the fittest will adjust.”

    Hey, I am not screaming, and certainly not screaming murder. Agreeing with someone who believes (plausibly, because that is the local law) that the ultimate shareholder (the PRC) of SOEs has the death penalty in its repertoire, even for relatively mild cases of corruption, is hardly over the top. A propos the mafia: the comparison was with the fictitional mafia (you know, the godfather stuff etc), because that is the one that people know. I have no idea whether there is one in reality and what it does. And the fictitional mafia has a similar repertoire.

  • Posted by Rien Huizer

    Dan Rosen:

    “See my freshly published Policy Brief at peterson institute on this:”

    Yes.

  • Posted by Judy Yeo

    China’s government presumably will deploy its assets to pursue China’s strategic as well as its commercial goals

    How well that works one has to look to the contrasting fates of Japan and the USA . Japan’s aid diplomacy has few positive vresults -”buying friendship” has always had that danger. As for the USA, well, the biggest difference is that its commercial power has always had the shadow of military might backing it- what couldn’t be enticed by greed could always be scared off by guns and the like. To Americans, anyone who represents a threat to hegemony is a rival or enemy, hence the sinister overtones. To onlookers, American unease or the broader unease of the West reflects an ironic awareness of how western hegemony has looked to the rest of the world.

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