Posted on Saturday, September 20th, 2008 by bsetser
The reporting from Asia on Friday suggested limits to the CIC’s interest in Morgan Stanley. Restrictions on the ability of foreign banks to participate in the “TARP” (the current acronym for the bailout) might be another.
But the Wall Street Journal’s reporting (see Lucchetti, Enrich and Sidel) suggests that discussions are ongoing:
“Wall Street firm Morgan Stanley and Wachovia Corp. plowed ahead with merger talks Friday, even though announcement of the U.S. government’s crisis-fighting plan eased the pressure to race into a deal, people familiar with the matter said. Morgan Stanley’s board was expected over the weekend to discuss a deal, which may take an interesting twist. In one scenario being contemplated in New York, China Investment Corp. would take a significant stake in the combined company.In one scenario being contemplated in New York, China investment corp would take a significant stake in the combined company. … CIC’s interest might be contingent on Wachovia being able to offload some of its mortgage assets. So far, the CIC discussions has been preliminary and hasn’t been broached with Wachovia’s board.”
This sounds like a scenario that would need to be contemplated in Washington and Beijing as well as New York. Moving risky assets over to the books of the US taxpayer to create a “good bank” that appeals to the investment arm of China’s state council (an accurate, if undiplomatic, description of the CIC) would be a significant move – even in a week marked by a host of significant moves. The US government would effectively be a party in the deal.
I can see how say a voter in Ohio that – correctly – believes that China’s neo-mercantilist policy of accumulating foreign assets to hold its exchange rate down and support China’s export sector has contributed to the difficulties segments of US manufacturing have faced over the past few years might not look favorably on a deal that requires the taxpayer to assume downside risk and gives China’s government the upside. The US Congress has bulked at increasing China’s IMF quota because they haven’t wanted to reward China for intervening in the currency markets. The ideas that Morgan Stanley seems to be considering would seemingly require rather direct bit of US government assistance for a agency that helps to manage foreign assets that the US government doesn’t think China should be accumulating in the first place.
Yes, a CIC investment could help the banks raise needed equity capital and thus offers a potential alternative to an even bigger investment by US taxpayers. But a large CIC stake would also start to raise issues about who should provide the government backstop for the combined institution: China or the US? Bailing out US banks is one thing. Bailout out a Chinese-government-owned US bank is another.
That question hasn’t come up in the past because governments generally haven’t owned financial institutions with large operations outside their home markets. Singapore I guess is a partial exception; Temasek has large stakes in a lot of financial institutions. But it is at least worth starting to consider who has responsibility for such an institution in the new world of state capitalism.
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Posted on Thursday, September 18th, 2008 by bsetser
Reuters is reporting that Morgan Stanley has approached the China Investment Corporation (CIC) for additional capital; it isn’t just talking to Wachovia.
It order to get the equity it needs, the CIC’s stake would need to be quite large. Bloomberg reports:
“Morgan Stanley pared its loss on the New York Stock Exchange after the person said China’s state-controlled fund may buy as much as 49 percent of the New York-based investment bank. The person declined to be identified because the talks aren’t public and may end in no agreement.”
This kind of investment (some might say “risky bet”) would have to be approved by China’s State Council. And I would have to say that the CIC has yet to demonstrate a track record of apolitical, transparent management of its external assets — in part because it hasn’t been around for very long and in part because it hasn’t been very transparent.
It also is obviously something that the US regulators would need to approve — and especially in light of the Fed’s recent decision to exempt the CIC from the requirements of the Bank Holding Company act.
UPDATE: The FT’s alphaville has more.
CIC, the Chinese sovereign wealth fund which already owns 9.9 per cent of Morgan Stanley, is definitely talking to the investment bank.
The President of CIC even travelled to the US on Tuesday accompanied by Morgan Stanley’s China CEO.
CIC was previously part of the Bank of America-led consortium that was considering a takeover bid for Lehman Brothers, alongside JC Flowers & Co.
Christopher Flowers manages about $3.2bn of CIC’s money in a fund dedicated to taking stakes in financial institutions.
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Posted on Tuesday, September 16th, 2008 by bsetser
It is hard to focus on data from over a month ago when a large emerging economy’s stock market is down double digits and the Fed is debating whether or not to extend a lifeline to the largest US insurance company. But the TIC data is stunning in its own right.
It tells a simple story: demand for risky US assets disappeared in the month of July. That continues a long-standing trend. But that trend intensified significantly. And I suspect its intensity increased even more in August.
Among other things, the TIC data challenges the common argument that sovereign investors have been a stabilizing presence in the market. Best I can tell, sovereign investors joined private investors in retreating from all risky US assets in July, and thus added to the underlying distress in the market. I don’t fault sovereigns for limiting their risk. It has proved to be a sound financial choice. But I also find it hard to square their (inferred) actions in the market with many claims about their behavior.
The TIC for July pains a very clear picture: Treasuries were the only US asset foreign investors were willing to buy. Foreigners bought $34.3b of long-term Treasuries, while selling $57.7b of Agencies, $4.2b of corporate bonds and $5.2b of equities. On net, foreigners sold about $25b of long-term US assets.*
That would normally make it hard to sustain a large current account deficit. The US still needs roughly $60b a month in net inflows to cover its external deficit. Net sales of foreign assets of $32b provided some financing — but not nearly enough to cover the outflow of short-term funds. $75b in net outflows isn’t exactly a good sign, even if the dollar’s rebound suggest more flows (perhaps from large US sales of foreign assets) in August.
The same basic trend is apparent in the data for the 12ms through July 2008, which can easily be compared to the 12ms through July 2007 — think pre-crisis and post-crisis.
After the crisis, foreigners have bought roughly:
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Posted on Thursday, September 11th, 2008 by bsetser
The Financial Times seems to have found an obviously non-commercial investment by a sovereign state. And it didn’t come from a sovereign fund.
China’s State Administration of Foreign Exchange seems to have discovered that generating diplomatic returns is easier than generating financial returns. Jamil Anderlini of the FT:
In January this year Safe bought $150m in US dollar-denominated bonds from the government of Costa Rica as part of an agreement signed last year under which the Central American nation cut diplomatic ties with Taiwan (after 63 years) and established relations with the People’s Republic of China. The agreement …. explicitly links the foreign policy switch to China’s purchase of $300m in government bonds and a grant of $130m. In an exchange of letters from January this year between Fang Shangpu, Safe’s deputy administrator, and Costa Rica’s finance minister, Safe promised to buy government bonds under the terms of the 2007 agreement, but included a clause demanding Costa Rica take “necessary measures to prevent the disclosure of the financial terms of this operation and of Safe as a purchaser of these bonds to the public”.
China has long been willing to assist countries that refused to recognize Taiwan. But it generally hasn’t used its central bank reserves to do so. But if a country already has way more reserves than it really needs, well, it has new options. Anderlini:
“The purchase of US-denominated Costa Rican government bonds by China’s State Administration of Foreign Exchange (Safe) is the clearest proof yet that Beijing regards its $1,800bn in foreign reserves – the world’s biggest – as a tool to advance its foreign policy goals, as well as a potential source of income.’
I was particularly interested in the FT’s story for two reasons:
One, it suggests that SAFE is now something more than a traditional reserve manager. Investing in Costa Rican bonds and investing in equities (I suspect SAFE has a US equity portfolio, not just a British and Australian portfolio) are both signs that China believes it has more liquid reserve assets than it really needs.
Two, evidence that the world’s biggest creditor country is throwing its financial weight around should increase interest in my new Council on Foreign Relations Special Report which examines – or tries to — the strategic implications of the world’s changing balance of financial power.
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Posted on Tuesday, September 9th, 2008 by bsetser
A few months ago, Chinalco — using funds borrowed from China’s Development Bank, which itself had recently received an infusion of foreign exchange from the CIC as part of its recapitalization — bought a large stake in Rio Tinto. At the time, Richard McGregor of the FT argued:
“Chinalco’s purchase was funded by the China Development Bank, a state policy bank, a shareholder of which is the country’s sovereign wealth fund, the China Investment Corporation. The sovereign fund, further, owns the largest Chinese investment bank, which is advising Chinalco. The ambitious CDB itself is no stranger to doing the state’s business offshore. It has been given crucial government mandates, most importantly to fund the expansion of local companies in Africa, primarily for resource projects.
In short, you do not have to be a rabid conspiracy theorist to conclude that Chinalco is a front for China Inc. …. Geoffrey Cheng, of Daiwa Institute of Research in Hong Kong, told Reuters. “You’re not going against a corporation. You’re going against a nation.””*
Norway, by contrast, has decided it doesn’t want to hold Rio Tinto. (hat tip SWF Radar)
China’s quest for resources meets Norway’s socially-conscious investing.
Maybe Norway’s government fund should offer China its mining portfolio in one big block trade? Norway can avoid owning polluting mines, and China, inc could increase its resources exposure …
* McGregor’s argument is worth reading in full; he also believes that the relationship between various Chinese state firms is complicated — and different firms compete as often as they coordinate.
Posted in China, Sovereign Wealth Funds | 17 Comments »
Posted on Sunday, September 7th, 2008 by bsetser
Floyd Norris in the New York Times:
Remarkably, the country that prides itself on being the beacon of free enterprise finds itself with a financial system that needs government money to finance the most important asset most Americans will ever own. There have been bailouts before, but none that seemed more crucial than that of Fannie and Freddie. The housing boom and bust have left them virtually the only sources of large amounts of money for home loans in the country.
That isn’t the half of it. The US doesn’t just need US government money to support the US housing market: It needs money from foreign governments as well.
And no one more than China. China’s central bank borrows RMB from the state banks (whether by selling sterilization bills or by hiking the reserve requirement) and then uses those funds to buy large quantities of Agencies. The flow of Chinese savings into the US housing market is entirely a government flow. From June 2007 to June 2008, the foreign assets of China’s central bank increased by $681b. That is hard number — no fancy adjustments are required. I just added the central banks “other foreign assets” (the foreign exchange the state banks have deposited with the central bank) to its stated reserves. Adjust for valuation gains, and that works out to $620 billion or so. That is a low-end estimate for China’s foreign asset growth. It leaves out the funds shifted to the CIC, and the funds used to recap the China Development Bank. A lot of this went into Agencies. A lot more than the $70 billion in Agency purchases that shows up in the TIC data.* If that is true, then China also has more than $465 billion in short and long-term Agencies as well.
Over the past few years, the Agencies were central to the process that brought the emerging world’s savings to the US housing market. And governments were involved every step of the way. When the world’s central banks (and other big bond investors) decided that the implicit US government backing for the Agencies wasn’t enough, the US government had to make the backing explicit.
The New York Times reports:
Most worrisome, the companies’ cost of borrowing was growing more expensive, and central banks in Asia and Russia were scaling back their purchases of the companies’ debt
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Posted on Friday, September 5th, 2008 by bsetser
One of my usual laugh lines is that the CIC isn’t a sovereign wealth fund; it is a sovereign loss-minimization fund.
After all, selling debt denominated in an appreciating currency (and one that, given China’s current account surplus, should face ongoing pressure to appreciate) to buy assets denominated in a depreciating currency is generally a good way to lose money. All the more so if the interest rate on the appreciating currency is higher than the interest rate on the depreciating currency.
The PBoC has long faced the same problem. Consequently, Keith Bradsher’s story in today’s New York Times shouldn’t be a surprise. Some analysts warned China rather publicly back in 2004 (and 2005) that it would eventually face large currency losses on its reserves. The IMF wrote a paper noting that a central bank that takes capital losses from currency moves risks losing a bit of independence, as it could end up needing a capital infusion from the Finance Ministry.
China’s policy of holding the RMB down to support its exports produced highly front-loaded benefits (fast export growth, jobs in the export sector) and highly back-loaded costs (the bill for the losses on all the dollars and euros the central bank has had to buy to keep China’s currency from appreciating). The benefits are now shrinking — Chinese export growth to the US has stalled — while the costs becoming more visible.
But the fact that the PBoC is seeking a capital injection is still interesting.
“the People’s Bank of China has begun discussions with the finance ministry on ways to shore up its capital, said three people familiar with the discussions who insisted on anonymity because the subject is delicate in China.”
I guess falling US interest rates are starting to bite. Remember, the government of China is by far the United States’ largest creditor. China’s combined Treasury and Agency portfolio exceeds the total US holdings of the government of Japan.
Keith Bradsher is absolutely right to note that China has been pouring an enormous share of its GDP into US debt purchases and that its efforts to pass the costs of this policy onto the state banks and ultimately China’s depositors are an enormous subsidy from China’s savers to America’s borrowers:
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Posted on Wednesday, September 3rd, 2008 by bsetser
Rose Yu and Amy Or’s Wall Street Journal story on China’s reduced appetite for Agency bonds is loaded with interesting detail. And not just about the fall in Chinese state banks’ holdings of Agencies.
The fact that the Chinese state banks only held $23 billion or so of the $463 billion* or so of Agency bonds that China holds, according to the US data, confirms what I suspect was more or less known: the State Administration of Foreign Exchange holds the lion’s share of China’s Agency bonds. Remember too that the US data almost certainly understates China’s true holdings of Agencies.
Two other details in the story were more interesting, at least to me:
One: The big state commercial banks have $459 billion in “overseas” assets. That is way more than the CIC.
“China’s banks have significant overseas funds to deploy. Bank of China had $240 billion of overseas assets at the end of June, while the other three big lenders had a combined total of $219 billion.”
That sum exceeds the foreign exchange reserves of all but three central banks (China, Japan and Russia) and (in all probability) all but one sovereign wealth fund (ADIA). The state banks foreign portfolio is way larger than the CIC’s external portfolio.** Though, given that the CIC formally owns the state banks, it may well make more sense to add the state banks’ $460 billion or so to the $100 billion held by the CIC. That would imply that the CIC already could give ADIA a run for its money — as recent statements by the al-Nahyan family suggest ADIA doesn’t have the $800 billion commonly claimed.
Two: China’s state banks haven’t exactly been a stabilizing presence in global markets over the past year.
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Posted on Monday, August 25th, 2008 by bsetser
I was on CNBC on Thursday – and the planned segment on the role non-democratic governments play in financing US deficits morphed into a discussion of Chinese and Russian Agency holdings. The segment was hyped as “Do America’s creditors own the US” but the actual discussion swerved the other way: America’s creditors now depend on the US government to bail them out of their bad investment in Agency bonds. The implication seemed to be that the US still held the upper hand.
Count me unconvinced.
No doubt any large debtor does have leverage over its creditors.
Moreover, many countries finance the US not because they like US financial assets but rather because they want to hold their exchange rates down in order to support their export sectors.* They certainly haven’t done so for the returns. That gives the US a bit of room to maneuver: the US was able to attract central bank financing even as it cut US interest rates and the dollar slid.
Finally, the sheer scale of the surpluses in the oil-exporting economies and China limits their options. China and the oil-exporters will combine to run a $1 trillion dollar surplus. That implies a $ 1 trillion deficit elsewhere in the global economy. India’s $1 trillion economy cannot support a $1 trillion deficit. Realistically, that kind of surplus has to be offset by a large deficit in the US and Europe. There is a reason why the Gulf’s purchases of US assets almost certainly rose after Dubai Ports World, and CNOOC/ Unocal didn’t stop China from financing the US. Sovereign wealth funds options are a bit more limited that is sometimes claimed — at least at a macro level.
The alternative to large-scale purchases of US financial assets is even larger scale purchases of European financial assets, or policy changes that reduce the surplus of the oil-exporting economies and China.
But the United States isn’t in a position where it can disregard its creditors either. The US now relies heavily on central bank purchases of Treasury and Agency bonds – what I have called the quiet bailout – to sustain its current account deficit. Without that flow, the US couldn’t run a counter-cyclical fiscal policy – and the Agencies couldn’t step up their purchases of mortgages to offset a collapse in the market for “private” mortgage backed securities. America’s creditors couldn’t stop financing the US without provoking a sharp fall in US demand that would damage their export sectors – but the US also cannot avoid a far large contraction that has happened to date without ongoing central bank financing.
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Posted in China, central bank reserves, housing | 47 Comments »
Posted on Wednesday, August 20th, 2008 by bsetser
The IMF seems to be having a bit of a row over how to do exchange rate surveillance.
Why is that good news?
Because it suggests that the IMF actually is trying to do exchange rate surveillance.
That is something of a change. A good one, too.
For too long, the IMF generally took the view that all exchange rate regimes, and all exchange rates, were above average. Or at least above criticism from the IMF.
Any exchange rate regime, or any exchange rate, could be made to work with appropriate supporting policies.
If Argentina wanted to peg — back in the 1998 to 2001 period — to an appreciating dollar even as commodity prices fell and Brazil allowed the real to depreciate, no problem. Tight fiscal policy could produce the real depreciation needed to bring Argentina’s real exchange rate back into balance, or at least restore investor confidence in Argentine bonds, allowing Argentina to finance the deficits associated with its appreciated real exchange rate. If Saudi Arabia wants to peg to a depreciating dollar and have low rates of inflation, it can — so long as it tightens fiscal policy. No matter that fiscal tightening would push up Saudi Arabia’s surplus, and thus impede global adjustment. And no matter that fiscal tightening would have significant implications for the distribution of the gains from higher oil prices internally, as it cuts off a key channel for broadly sharing the oil windfall. Those with fixed riyal salaries have seen their real external, and in some cases domestic, purchasing power fall.* But raising salaries with a deeply depreciated exchange rate would be inflationary.
So long as the IMF focused on the policies — usually fiscal tightening — the IMF thought necessary to make a country’s chosen exchange rate work, it could avoid getting into a fight over whether a country’s chosen regime was appropriate for its circumstances or, perhaps more importantly, an impediment to global adjustment. That left the IMF in its comfort zone (making recommendations about fiscal policy). But it also meant that the IMF more or less stood on the sidelines as a set of countries pegged to a depreciating dollar despite large and often growing external surpluses.
The IMF is now looking more closely at exchange rates. That makes some uncomfortable. And — as is often the case — matters of great importance get reduced to matters of process. In this case, the IMF’s process for doing exchange rate surveillance.
After spending a bit of time trying to read between the lines of the IMF’s latest report on exchange rate surveillance, I would bet that there is disagreement on at least four points.
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