China on Wall Street: Buy? Yes. Lend? No.
The financial aid program of $700 billion to the beleaguered US financial industry that has been passed by the Senate, though House passage is anything but a given, raises at least one very interesting question: Whence the cash?
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Zhou Jiangong
2 October 2008
The financial aid program of $700 billion to the beleaguered US financial industry that has been passed by the Senate, though House passage is anything but a given, raises at least one very interesting question: Whence the cash?
Why, from the central banks of other countries, of course, is the expected answer. US government bond issues are going to be the major source of funds. The U.S. government plans to raise the statutory national debt limit from the present $10.6 trillion to $11.3 trillion. And with the Treasury Department having taken over Fannie Mae and Freddie Mac, along with various and sundry other debt arrangements, the debt issuance for the relief program will far exceed $700 billion.
At present, of the Treasury’s $9.5 trillion of government bonds issued, 27.9% are held by foreign governments and investors. In early 2003, foreign investors held less than 20%, and the ratio increased by 3.2% just from June last year to June this year. From an incremental point of view, the contribution of foreign investors is even more alarming. Over the same period, the balance of U.S. Treasury bonds increased by 624.3 billion dollars, 72.7% of which went to foreign investors, compared to the previous year’s 47.8%.
China holds the second largest stash of US Treasury bonds. The rapid increase of China’s trade surplus with the US in the past few years saw Beijing’s total US bond holdings reach $503.8 billion by the end of June this year, 5.3% of the total balance and up 0.9 percentage points from a year ago. In 2003, China held less than 2%. Of the total balance of Treasury bonds held by foreign investors, China’s share is 19.4 %. In July this year, Treasury bonds held by China increased to $518.7 billion, not far behind Japan’s $593.4 billion.
China’s foreign exchange reserves have now reached nearly $2 trillion. Last year, China set up a sovereign wealth fund, China Investment Corporation, with a stake of $200 billion. The rest of China’s foreign exchange reserves are held by the State Administration of Foreign Exchange (SAFE), which is conducting low-profile, small-scale equity investment around the world.
One obvious fact is that with a spreading financial crisis dragging the global economy into possible recession, those countries with ample foreign exchange reserves, particularly China, must take action, but the question of exactly what to do is a dilemma. Should it lend even more money to the US government? Or should it put its money into buying stakes in Wall Street financial institutions? In a larger sense, should China become a stakeholder in the United States, or should it just remain a creditor?
If the world’s sovereign wealth funds all fold their arms, the U.S. government only has two measures to save its financial system: the US Federal Reserve can print dollars or the government can issue bonds. Both solutions bring long-term depreciation pressure on the dollar leading to further lessening of the value of foreign countries’ dollar reserves, and China, with its ocean of dollar reserves, will be a titanic loser.
A better solution would be for foreign exchange reserves to invest in Wall Street financial institutions and assume an intermediary role in the capital cycle. Let the current account surpluses of East Asian exporting economies and the Middle East oil exporters re-circulate to the United States, to support consumer borrowing and the real estate market. The best way to do that is not to increase US liabilities but to let foreign exchange reserves finance Wall Street institutions through equity purchase, re-strengthening Wall Street as an international financial center, while foreign countries cooperate with the United States in financial supervision.
However, this is difficult politically both for China and the United States.
Chinese financial enterprises’ attempts at foreign investment have run cold and hot. China Investment Corporation’s (CIC) investments in both Blackstone and Morgan Stanley are under criticism because of huge losses. China Development Bank wanted to invest in Citigroup shares but was stymied by a last minute veto by the State Council. Ping An Insurance Company’s investment in European insurer-banker Fortis has lost 10.5 billion yuan. At the same time, China Development Bank’s acquisition of shares in Barclays Bank have increased and the bank has been allowed one seat on Barclays’ board. And CIC has lately taken a more flexible approach, allowing foreign operators to manage its assets. A partnership fund established by CIC and J.C.Flowers will first acquire assets impaired through the financial crisis, and then restructure and sell them.
Chinese institutions have generally been cautious in their investments. The State Administration of Foreign Exchange (SAFE) has laid down 40 investments in European secondary markets, holding around 1% of the shares of strategic companies in Europe.
The United States, on the other hand, might be at ease with investment from the sovereign wealth funds of Norway, Singapore and the Middle East, but it worries about those of Chinese and Russian funds. The United States, together with Europe, has called for the casting of investment rules. China at first strongly opposed this, but later stated a willingness to participate in the rule-making.
Once the rules are set, the best choice for China is bold acquiring of stakes in financial institutions on Wall Street rather than continuing to lend money to the US government. Although the US remains the world’s most powerful country economically and financially, why should China help the US to issue debt without end in the belief that the national credit of the US can expand without limit? At present, China should realize that it should develop its own or a regional bond market and reorder in a diversified way its foreign exchange reserves and foreign bonds.
Should China invest the Wall Street? Of course it should, because China believes that Wall Street belongs not only to the United States, but also to the whole world. China’s 2 trillion dollars foreign exchange reserves will be used for international payments and the acquisition of dollar-denominated assets. China should not only buy into investment banks on Wall Street, and should be actively involved in international cooperation in monitoring.
(Zhou Jiangong is the editor of Chinastakes.com)