Your Latest China Reserve Diversification Story

♠ Posted by Emmanuel in , at 7/21/2009 09:18:00 PM
The PRC meets a very skeptical audience when it keeps saying that it will diversify away from holding US Treasuries but doesn't appear to do so--or at least not yet. This latest round of bellyaching by Premier Wen Jiabao makes it appear as if the PRC will make strategic investments instead of fattening official holdings of increasingly dubious value. The general logic behind holding equity stakes--should they indeed come to pass (and I have my doubts)--was explained by Nouriel Roubini a long time ago in light of US protectionism over an Emerati company operating US ports and China's state-owned enterprise CNOOC attempting to acquire Unocal:
But, increasingly, foreigners are starting to realize that exchanging their goods and services for lousy low-return IOUs of the US government is a most lousy deal for them. Why to hold Treasuries that give you a mediocre 4.5% return over 30 years when you can instead buy higher return capital such as US corporation, US factories, ports, real estate and any other asset currently owned by American in this great land of ours?
In more recent times, you can count the US shooting down a legitimate bid by Chinese telecoms firm Huawei to buy parts of 3Com. Recall too that Chinese annoyance over these incidents has resulted in China returning the favor by blocking Coca-Cola's bid to buy Chinese juice maker Huiyuan in an act of juice protectionism. But hey, if CNOOC and Huawei were dissuaded over specious "national security" grounds, who's to say that OJ isn't a national security objective?

This brings me to Wen's latest statement. It may merit more attention coming from the Chinese leader himself. Also, it comes hot on the heels of a former vice-premier calling for more surveillance of countries issuing reserve currencies. What the news article below seems to neglect though is that China can prop up the dollar by buying American debt or equity to help make up for gargantuan US external imbalances. That is, China can instead buy stakes in American companies, although these would not qualify as traditional reserve assets. It would certainly cheer me up if the Chinese stopped purchasing dollar-denominated reserves in such large quantities or bought more equity in US firms instead. However, we need to consider a number of possibilities:
  1. Perhaps this is yet another shot across America's bow without real follow-through;
  2. China wants to test Treasury Secretary Geithner's assertion recently offered to Middle East states that the US will not discriminate so blatantly against foreign investors over "national security" grounds;
  3. China is sending a signal that it's more willing to let the yuan find a market-determined price by concentrating on purchasing international assets with strategic value. This of course assumes that targets outside the US won't invoke "national security" grounds against official PRC buyers.
Until proven wrong--and I so want to be proven wrong--the first answer is the default, with the second being rather unlikely and the third very unlikely. From the Financial Times:
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. Mr Wen said Beijing also wanted Chinese companies to increase its share of global exports.

The “going out” strategy is a slogan for encouraging investment and acquisitions abroad, particularly by big state-owned industrial groups such as PetroChina, Chinalco, China Telecom and Bank of China.

Qu Hongbin, chief China economist at HSBC, said: “This is the first time we have heard an official articulation of this policy ... to directly support corporations to buy offshore assets.” China’s outbound non-financial direct investment rose to $40.7bn last year from just $143m in 2002.

Mr Wen did not elaborate on how much of the $2,132bn of reserves would be channelled to Chinese enterprises but Mr Qu said this was part of a strategy to reduce its reliance on the US dollar as a reserve currency. “This is reserve diversification in a broader sense. Instead of accumulating foreign exchange reserves and short-term financial assets, the government wants the nation to accumulate more long-term corporate real assets.”

State-owned groups, particularly in the oil and natural resources sectors, have stepped up their hunt for overseas companies and assets on sale because of the global crisis. China Investment Corp, the $200bn sovereign wealth fund, has been buying stakes in overseas resources companies and has taken a 1.1 per cent stake in Diageo, the British distiller.

In an interview published in state-controlled media, the chairman of China Development Bank said Chinese outbound investment would accelerate but should focus on resource-rich developing economies. “Everyone is saying we should go to the western markets to scoop up [underpriced assets],” said Chen Yuan. “I think we should not go to America’s Wall Street, but should look more to places with natural and energy resources.”
Why anyone wants to buy IOUs of an entity projected to run up a tab of approximately $100 trillion once its unfunded liabilities are added up is beyond me. At the same time, it may not be very realistic to assume that these purported "bargains" elsewhere in the world will stand idly by while China, Inc. flexes its muscles.