The shift toward sovereign wealth funds: the policy debate

Both the Financial Times and the Wall Street Journal have done a great job reporting on the rise of sovereign wealth funds.   Joanna Chung and Tony Tassel’s nuanced analysis of the impact of sovereign wealth funds on assets markets stands out (also check out Joanna Chung’s contribution to today’s special report), as does Henny Sender’s reporting on QIA and ADIA

For the outlines of the emerging policy debate, though, no one has matched the FT.

I liked Larry Summers’ note of caution better than John Gapper’s more ethusiastic line.  

The FT leader and Lex’s analysis of sovereign wealth funds also stood out.

Why?  Lex and the FT leader displayed a healthy outrage at China’s insistence on pegging to the dollar — a policy that has required that China adopt a series of other policies that have pushed its savings rate up to spectacularly high levels.   The editorials of the major US papers on China rarely strike a similar tone: they often seem to worry more about the risk that RMB appreciation might push up import prices than about the consequences of relying on China’s government to finance an awful lot of US investment.  

The FT and Lex also recognize that the US cannot realistically expect China to finance the US current account deficit by building up an undiversified portfolio that contains only the lowest-yielding of US assets forever.  Lex:

“In the short-term, it was all too tempting.   The savings of Asian and oil-exporting countries have helped to fuel the current boom.   Their purchases of Western government bonds have funded the external deficits created by profligate consumers and lower real interest rates, boosting asset prices.    But now the long-term consequences of the bargain are becoming clear.  … . Governments are moving from lending to the West to owning chunks of it.” 

Nicely put.  But purchasing companies raises a lot more concerns than purchasing bonds.  There clearly is a policy debate brewing over how the US and Europe should respond to the rise of sovereign wealth funds. 

Lex– rather surprisingly — chastises the UK Treasury for not showing a bit more concern about the consequences of the rise of state capitalism. 

“At the other end of the spectrum is the UK government, which appeared to welcome such deals yesterday.    This seems behind the curve.  If it is, as a matter of economic policy, fundamentally undesirable for the UK state to own UK businesses, it is unclear why the opposite should hold for foreign governments?”

Lex recommends encouraging sovereign funds to limit themselves to minority stakes in companies.  

“If sovereign funds simply behave as institutional investors that own minority stakes in companies, there is no basis for objection ….  Protectionism is not the solution but neither is widespread direct control of companies by governments, with the resulting potential for capital misallocation and inefficiency.”

However, Lex doesn’t quite specify what policy makers should do if governments decide that they want to own companies, not just take small minority stakes – or if they decide they want to be private equity firms, not just invest in private equity.

It is still early, but the China Investment Corporation seems to be modeled more on Singapore’s Temasek (which takes strategic stakes in companies) than Singapore’s Government investment company (GIC).  It seems to be acting more like Dubai International Capital (the private equity firm that invests the personal money of Dubai’s sheik) and Qatar’s Investment Authority (QIA, as Henny Sender reports, aspires to be a private equity firm, not just invest along side private equity firms) than the far larger and in some ways more conservative Abu Dhabi Investment Authority. 

But there is one obvious difference between China’s investment fund and the investment funds of Singapore and the smaller Gulf states: scale.  The CIC will be bigger than DIC, QIA, and Temasek by the end of the year.   Nothing like $200b in seed money.  The CIC will soon by about as big as Kuwait’s investment authority (around $200b in reported assets) and Singapore’s GIC (at least $100b, and rumored to be much bigger).

And if the CIC gets all of the $500b or so in foreign assets the Chinese state is currently accumulating every year going forward, well, it will surpass ADIA.    By the end of 2010, it could potentially have close to $1.7 trillion, even in the absence of any capital gains.  That worries the FT:

[It] is the potential scale of Chinese buying that causes concern. The vast foreign exchange reserves that China has accumulated defending its undervalued currency, the renminbi, are currently invested in US Treasury bonds. Buying shares such as Barclays could boost returns and reduce exposure to the dollar and US interest rates, but huge investments would be needed to make a difference.

China will struggle to copy state investment agencies such as those of Dubai and Singapore by taking large stakes abroad. Nobody is scared of those nations; they are afraid of China.  China would be better advised to invest its money quietly in hedge funds, private equity or funds that track an index.

If there are many more deals like the $3bn investment in US private equity group Blackstone by China’s new state investment agency, they will become a political issue of the highest order. China’s trade surplus and exchange rate policy are bad enough, but if it is seen to be buying up the world economy with the proceeds, it can only end in hearings before Congress, public demands for protectionism, and ever louder demands for a higher renminbi. That is the last thing that China needs.

The rise of sovereign wealth funds has drawn attention to five different issues –

1.   Reciprocity.    According to this view, sovereign wealth funds should be free to purchase controlling stakes in US and European companies so long as private US and European investors are free to purchases companies in China, in the Gulf and in any other country with a large fund.   Norway, Singapore and arguably Russia meet this standard. China does not: it is closed to most portfolio inflows.   And the Gulf may not either – its oil and gas firms are firmly controlled by the state.

2. Transparency.   Sovereign wealth funds should be free to invest in US and European markets so long as they disclose their broad portfolio and investment strategy.     Sure, this risks allowing private market players to try to front-run the big funds, but that is the price sovereign wealth funds have to pay for the ability to invest as they please.  They need to accept some restrictions on what they can try to do for the good of the market.   

Norway discloses its debt/ equity mix, the country composition of its portfolio, its returns and its outside managers (though not its derivative book … ).  It would meet this standard.   But Singapore’s GIC and the Gulf funds do not consistently disclose their debt/ equity mix, let alone more details about the country and currency mix of their portfolio.   That raises one obvious question:  are the US and Europe really prepared to tell ADIA and the GIC that they have to sell if they do not disclose more?  

3. Government control.   According to this view – articulated effectively by Willem Buiter — sovereign wealth funds should not do more than take small minority stakes.  Indeed Buiter would restrict sovereign wealth funds to non-voting shares.

SWFs should only be allowed to invest in equity that does not have control rights attached to it, that is, non-voting stocks and shares

Government control raises a host of concerns beyond the potential fall in economic efficiency.  Say China bought a big drug company.  It suddenly would have a large economic interest in certain US legislation – the Medicare prescription drug benefits, patents, corporate taxation and so on.   Dr. Summers identifies two other scenarios:

Apart from the question of what foreign stakes would mean for companies, there is the additional question of what they might mean for host governments. What about the day when a country joins some “coalition of the willing” and asks the US president to support a tax break for a company in which it has invested? Or when a decision has to be made about whether to bail out a company, much of whose debt is held by an ally’s central bank?

His recommendation: sovereign wealth funds should rely on outside intermediaries.

4. Leverage.  This hasn’t received as much attention, though Treasury assistant secretary Clay Lowery implicitly raised it in his remarks (“the funds’ counterparties and any creditors may simply assume a sovereign guarantee and fail to exercise market discipline”).  One way to enhance returns is to borrow money.    Some sovereign wealth funds already do.  Dubai international capital isn’t technically a sovereign wealth fund since it manages the sheik’s “private” money, but it clearly is leveraged.   QIA seems to be as well. 

In some ways, sovereigns with strong balance sheets are well positioned to compete with “private” private equity firms in the private equity business.  If their sovereign wealth funds borrowing has a de facto sovereign guarantee, they can gear up cheaply.  That might not make “private” private equity fund managers happy.  They have grown fat managing Gulf money.  But they may not want to compete with Gulf money 

5. Scale.   

According to this view, big sovereign wealth funds need to be held to a different standard than small funds.  Lower articulates a version of this argument to make the case why long-existing funds need to be more transparent.   But the point extends beyond transparency.

Small investments by the government funds of small city states are unlikely to change the character of the overall market.   They won’t change the market ecosystem.  Big investments by big states, by contrast, could change the market.    Henny Sender reported that QIA has $1 billion a week to place.  That seems a bit high – oil and gas flows would suggest an annual inflow of more like $20b a year not $50b a year.   Collectively the Gulf city states (Kuwait, Qatar, Abu Dhabi and Dubai) certainly have at least $1b a week to invest.    

That is a lot.  But it pales relative to the sums now available to China, which needs to place $2b every working day.  The Gulf is adding something like $60-80b to its sovereign wealth funds from its oil revenues (and the Saudis are adding another $50b to their reserves); China is on track to add $500b to its reserves/ the CIC this year.  If all of China’s funds were going into an (unleveraged) investment fund, it would need to do a Barclay’s sized deal every two weeks, year in and year out, for the next few years …  

My own view?

It is still a work in progress. 

Sovereign wealth funds and central banks certainly should be far more transparent than they are now.   More transparency would put me out of business – no one would want my estimates of the currency composition of China’s reserves if you could find that information on the PBoC’s web site.    But it would also help the markets function more efficiently.   Less time would be devoted to guessing what the big players are trying to do.

Transparency would also deter the managers of big sovereign funds from taking imprudent risks with the money they manage.   Call me old-fashioned, but I think the citizens of the countries with big funds should be able to know how their money is invested.   

At the same time, I wonder whether it will be possible to convince the big sovereign funds to act more transparently.   Is anyone prepared to kick ADIA out if it doesn’t disclose more.    That seems to me to be a big obstacle to Willem Buiter’s proposals.       

By contrast, I am not impressed by the argument for “reciprocity.”   In a world with large deficits and large surpluses, the flow of capital intrinsically lacks full reciprocity.   Surplus countries like China, Russia and the Gulf by definition are building up claims (in net) on the rest of the world.

Moreover, reciprocity implies liberalizing China’s capital account to portfolio inflows – and that is something that China cannot open up so long as it is intervening massively to hold the RMB down.  Keeping the RMB down doesn’t just make Chinese goods cheap.  It also, as Stephen Jen notes, keeps Chinese assets cheap.    There isn’t a constituency in China that favors selling off China on the cheap.  The nationalists don’t like it – they think foreigners already own enough Chinese assets and Chinese purchases are just redressing an existing imbalance.  And the last thing the PBoC wants is even large capital inflows –

Absent RMB appreciation, more private inflows into China just means faster reserve growth – and ultimately, an even bigger CIC. 

Nor am I convinced that the UK is willing to enforce such a standard.   The CDB’s investment in Barclays is arguably “reciprocal” given RBS’s investment in the Bank of China, but if a British company thinks it can raise money from China — or a British shareholder thinks it can sell at a higher price to China than to someone else– will Britain really say no, not unless your capital markets are as open as ours?

Finally, there is the issue of scale.   

China didn’t buy Treasuries in the expectation that it would always just hold Treasuries; US government debt is a fungible asset.   I suspect China could – if it move slowly and avoided taking controlling stakes – manage to put $200-400b of its existing in equities without disrupting the market very much.  But that doesn’t deal with the real issue: China’s portfolio is currently doubling every two years or so.   

$500b in late 2004 (q3 2004) became $1 trillion (a bit more actually) by the end of 2006.   $1 trillion will morph into $2 trillion by 2008.   Even if China takes policy actions to slow the growth of its current account surplus and Chinese foreign asset growth stabilizes at around $500b a year, its portfolio will continue to grow very, very rapidly.  $2 trillion in 2008 will become $4 trillion in 2012 even in the absence of any capital gains.

A credible commitment to bring down China’s current account surplus needs to be part of any deal that accompanies the shift in China’s state portfolio toward equities.  

I am not sure that the US has the leverage to make this happen.   If forced to choose between no Chinese financing and a 7% ten treasury interest rates and Chinese purchase of US equities on China’s terms, would the US tell China to take a hike?    Then again, the US may have a bit more leverage than it seems.  China hasn’t – at least to date – been willing to stop buying dollar assets and direct its enormous monthly flow into euros, pounds, and other currencies.   That would put pressure on the dollar … and so long as China basically pegs to the dollar, on the RMB.   Unless China is willing to drop its peg or it accept an even weaker RMB, it may find that it effectively forced to buy just those dollar assets that the US is wiling to sell.

And then there is the possibility that driving the RMB down v the euro might not do much to convince Europeans to warmly welcome Chinese-style state capitalism.

77 Responses to "The shift toward sovereign wealth funds: the policy debate"

  1. salvatorem   July 30, 2007 at 5:36 pm

    Looks like we have to make nice-nice with China for a long long time.

  2. Anonymous*   July 30, 2007 at 5:38 pm

    US asset protectionism seems like a rational and reasonable response to use against the threat of continued China trade protectionism (i.e. protection via the RMB export subsidy). Such a response would magnify the implicit risk of future dollar depreciation already faced by China – depreciation would be “compounded” by the continuation of inferior dollar investment returns and the denial of higher risk/return diversification. Deny China its point of inflection and opportunity in assets, unless it reverts to free trade standards on goods and services. Conversely, the US could offer free trade in assets in return for freer goods trade (i.e. by China committing to accelerated transition from the peg). This should help turn the tide on imbalances overall, and expand freedom of trade in goods and assets.

    In terms of asset trade, reciprocity seems too balanced an idea for a situation that is inherently one of imbalance – not a solution to the primary problem. Transparency should be up to the US domestic standard plus national considerations. But distinguish between the normal investor’s right to take risk under a legitimate proprietary (i.e. opaque to a degree) strategy, versus the public right to reign in inappropriate strategic consequences (e.g. national security; foreign government control). Control over leverage and scale issues should be subordinated to the larger issue of national strategic consequences.

  3. Twofish   July 30, 2007 at 5:57 pm

    As the PRC appreciates the value of its currency, it’s going to make overseas assets even cheaper.

    Also I strongly disagree that the RMB peg caused high Chinese savings. The high Chinese savings rates are due to retirement savings on the household side, and the success of state-owned enterprise reform on the corporate side. Neither of these two factors would have been changed by RMB valuations.

    In fact, I would argue that the causality is reversed. The massive savings allowed the PRC to maintain the peg for as long as it has. Without a pool of savings, the PBC couldn’t have issue sterilization bonds. Without sterilization bonds, maintaining the peg would have cause inflation.

    I’d argue that the natural flow of capital is from savings-rich areas like China to savings-poor areas like the United States. The peg and restrictions on capital outflows has made the PBC a proxy for this savings, but if both the peg and capital outflow restrictions are removed, you end up with the RMB being more or less where it is, and ownership of overseas companies going to individidual savers rather than the PBC.

  4. Twofish   July 30, 2007 at 6:09 pm

    The trouble with broad protectionist deals is that they are impossible to fine tune. There are all sorts of people who want asset protectionism on the US side for all sorts of different reasons, and there are all sorts of people who want different economic policies on China for all sorts of different reasons. This makes it difficult to say “if you do X, we do Y and if you stop doing X, we’ll stop doing Y” because there are people that want Y to happen regardless of whether China does X or not.

    If China does adopt a more flexible RMB policy in response to US trade protection, there will be people that would want to continue trade protection because of actions in Darfur, in Tibet, because they want China to build fewer subs, or because they want to keep auto parts or textile jobs in the US. Coming up with a set of incentives that can be credibly removed is difficult, and it is actually what is mostly being discussed in the Senate.

  5. Anonymous*   July 30, 2007 at 6:46 pm

    Asset protectionism is unavoidable to some degree – all countries have some kind of foreign investment review mechanism on the back burner at least. It’s necessary for national security reasons and related contingencies. The rules are a function of desired flexibility, which is why it’s a reasonable US response in the case of China. The quid pro quo for fewer asset restrictions for China would be speedier transition from the peg.

  6. Guest   July 30, 2007 at 9:00 pm

    Norway, from wikipedia:

    To reduce over-heating from oil-money, the uncertainty from the oil income volatility, and save money for an aging population, the Norwegian state started in 1995 to save petroleum income (taxes, dividends, licensing, sales) in a Sovereign wealth fund (“Government Pension Fund – Global”). This also reduces the boom and bust cycle associated with raw material production and the marginalization of non-oil industry (see also Dutch Disease).

    Because of its size the fund is invested in developed financial markets outside Norway. The budgetary rule (“Handlingsregelen”) is to spend no more than 4% of the fund each year (assumed to be the normal yield from the fund ). By January 2006, the Fund was at USD 200 billion, representing 70% of GDP in Norway. During the first half of 2007, the pension fund became the largest fund in Europe, totaling about USD 300 billion. Already (April 2007), Norway has the largest capital reserve per capita of any nation. Projections indicate that the Norwegian pension fund is set to become the largest capital fund in the world. Conservative estimates tell that the fund may reach USD 800-900 billion by 2017. Other natural resource-based economies (examples: Russia and Chile) are trying to learn from Norway by establishing similar funds.

    The future size of the fund is of course closely linked to the oil price and the developments in international financial markets in which the fund is invested.

    Where is the problem about private/public decissons?

    Woudn’t the US like to have something similar to that?

    Let’s go to the core of the matter!

  7. Twofish   July 30, 2007 at 9:08 pm

    Here’s the problem with that mechanism. Suppose the PRC wants to buy 51% of Lockheed-Martin. Of course that would be silly, and the US CFIUS would put a stop to that. OK now the PRC appreciates the currency. Should the US then me more flexible about PRC investment in Lockheed-Martin? Of course not, if there are good national security reasons not to allow PRC investment in Lockmart when the yuan is at 8:1, those are still valid at 7:1 or 6:1.

    The same considerations seem to be the case with every other reason I can think to allow or prevent SWF from investing in the US. Either the deal should go through, or it shouldn’t, and there aren’t too many situations were I can think of where the reasons why the deal should go through or not would could be used as any sort of quid-pro-quo for currency valuation.

    Personally, I think when people look at the issues, there aren’t going to be too many new things to worry about. The same laws and regulations that are used to keep the Rockefellers from controlling too much of the US economy are as far as I can see sufficient to keep China from controlling too much of the US economy.

    A more relevant worry is that China and the Middle East are going by accident do something with sovereign wealth funds to inadvertently destabilize the world economy, but I think this worry transcends SWF’s.

  8. Guest   July 30, 2007 at 9:39 pm

    The US and the West are going to have to come to terms with the fact that their day in the sun is coming to a close. China and Russia and the Gulf states have the money; the US has mainly debts. We are not used to being the “pushed around” rather than the pushers around. Now we’re going to find out what it has been like to be on the receiving end of power as has the rest of the world during the last century. Our turn to be the pushed arounds is at hand. Condign punishment?

  9. Anonymous*   July 30, 2007 at 9:55 pm

    The mechanism isn’t a simple binary decision that accepts or rejects control positions. There may be a scale of lower limits placed on certain kinds of foreign investment in public companies – 10 percent ownership limit, 20 percent, etc. A lot of potential equity investment can be released depending on how those kinds of limits are set, without necessarily ceding control positions. Given China’s surplus problem, it will be interested in equity returns however it can get them – China doesn’t exactly have the leverage at this stage to insist on US equity returns, but only with control positions. The US could increase investment limits gradually, perhaps including control positions in acceptable cases, depending on China’s progress in moving toward a freely floating currency.

  10. bsetser   July 30, 2007 at 9:58 pm

    Norway’s government fund will lag ADIA for a long time …

    and i suspect China, Russia and saudi Arabia have the potential to develop larger funds over time … just because they are larger. norway tho does save a remarkably high fraction of its national income. its mechanisms for external investment were designed to be transparent to Norwegians themselves, but as a result, they also arouse relatively little opposition abroad.

    twofish — disagree re: savings. I don’t think you can explain the rise in China’s savings (up roughly 15% of GDP) without linking to the exchange rate, and more importantly, the policies that support the exchange rate (a relatively restrictive fiscal policy, credit controls, and the like). i’ll cover this in more detail later in the week — eswar prasad’s paper is a good introduction to the issue.

    the point of RMB appreciation is two fold. One, it makes US assets more attractive to private chinese investors, which would reduce the concentration of chinese foreign assets in the hands of china’s central government. and two, over time, at least in my view, it would bring down China’s current account surplus and thus lower China’s pace of foreign asset accumulation.

  11. Guest   July 30, 2007 at 10:53 pm

    I find it amusing to see the mice scurrying for cover as the cat approaches and looms larger and larger. The US can do X or maybe Y or even Z for a while, but eventually the overwhelming power of an overwhelming amount of money will break through any resistance that can be offered. And if the US decides to destroy globalization in an attempt to defend itself, it will only be shooting itself in the foot, or worse. The world economy, she is a-changin’. Face it and adjust to it.

  12. bsetser   July 30, 2007 at 11:09 pm

    the world economy, she is a changin’. true.

    but where does the economy end and policy start? it seems to me that the biggest change in the economy is the decision by a number of governments to intervene (initially in the fx market but fx reserve accumulation necessitates buying other assets, so it influences a lot of other markets). A lot recent economic changes in my view reflect policy changes — symbolized by record official asset accumulation.

    face it and adjust to it?

    sounds good. but adjust to what? how should the world adjust to China’s unprecedented intervention in the fx market? does adjust means getting out of the way, specializing in non-tradables, and hoping that the disconnect between the united states growing external debt (a claim on tradeables output in the future) and its shrinking tradeable sector doesn’t cause problems? or does facing it mean pushing back, and arguing that china’s policy choices — initially done primarily for domestic reasons — now have such large external implications that china can no longer ignore the impact of its policies on the rest of the world (I recognize that many think this is a bit rich coming from any american, given america’s tendency to alternatively ignore the world and throw its weight around … but right now, the US isn’t an 800 pound economic gorilla …)

    face it and adjust could mean a lot of different things.

  13. Guest   July 31, 2007 at 5:47 am

    re: “US has the leverage”

    cut off the development aid

    “…Japan is the second-largest World Bank donor after the US…”

  14. Guest   July 31, 2007 at 6:19 am

    China tells Paulson it’s poor and poses no threat
    BEIJING (Reuters) – China on Tuesday deflected U.S. pressure for a faster rise in the yuan and bolder economic reforms by telling visiting Treasury Secretary Henry Paulson that it is still poor and poses no threat to anyone.

  15. Anonymous*   July 31, 2007 at 6:49 am

    The US has boxed itself in by promoting free trade while blithely absorbing the effects of the rest of world’s protectionism (i.e. cheap goods through XR and labor rates). It has assumed it is “ too big to fail“ in this regard. Now that it can’t correct its imbalance through trade, it must decide what asset categories are exportable. The credit card will never be repaid.

  16. Guest   July 31, 2007 at 7:00 am

    “Adjust” means that the US might as well stop trying to pressure China to do anything it doesn’t want to do, since the US no longer has the power to compel China to do anything. The pathetic scenario includes the many trips of Paulson to China to “pressure” them from which he returns empty handed and the many threats in the Congress to put tarifs on many Chinese imports, and then never doing so.

  17. Guest   July 31, 2007 at 7:35 am

    re: “purchases of Western government bonds have funded the external deficits created by profligate consumers”

    how can you/FT generate and repeat this and still expect to be treated seriously? what the purpose of this spin?

    is it possible for any entity to do a sizable, cross-border transaction through anything other than ‘Western’ intermediaries?

  18. Guest   July 31, 2007 at 7:40 am

    2007-07-31 07:00:59 – then, presumably, ‘China’ would have to stop pandering for, and accepting development aid and ask its own growing population of billionaires and millionaires to do a better job of redistributing their wealth.

  19. RN   July 31, 2007 at 7:43 am

    Brad, why do you believe it would be a benefit to increase the RMB specifically with regard to changing the mix of US assets held by private Chinese investors vs. the state? What do you see important about that mix? Freer markets?

    Because the US is politically incapable of solving its own major problems, the China trade/CA situation will not be solved domestically. Its effects are very little understood by Congress, and the “free-trade solves all problems” gang shout down any policy alternatives with fine-tuned propaganda.

    However, if things become more dire in the US because of a liquidity contraction, the housing market, oil prices, some combination or something else, policy makers will find it much easier to point the finger at China and take action. And frankly, currently they have every justification for doing so. 1/100 Americans understands what Blackstone is, but one or two big headline deals involving companies that involve some real or perceived threat and congress will shut them down overnight.

  20. RN   July 31, 2007 at 8:03 am

    “Guest” wrote:

    re: “purchases of Western government bonds have funded the external deficits created by profligate consumers”

    how can you/FT generate and repeat this and still expect to be treated seriously? what the purpose of this spin?”

    Hello? Anybody home?

    Looked at your interest rates over the last 5 years? Looked at lending practices? Looked at housing prices turning parabolic in the absence of any material change in underlying fundamentals? Looked in nearly any store anywhere in the US and seen where the goods are made?

    The sea of liquidity that has flowed over the US over the last few years that has cause so much careless “risk-free” investing is to a large extent the result of China’s mercantistic RMB policy.

  21. Guest   July 31, 2007 at 8:05 am

    re: “I recognize that many think this is a bit rich coming from any american” – and presumably a member of the community that is in the business of distributing American funded development aid to nations like China.

  22. Guest   July 31, 2007 at 8:15 am

    2007-07-31 08:03:00 – hello, but apart from consumer spending practices, there could be a few other factors, which for some reason are rarely, if every mentioned. And there is nothing in the examples you mention which scream ‘profligate consumers’ to me. If consumers are forced to take on huge amounts of debt to buy homes and cheap Chinese manufactured household essentials, how can you blame the consumer?

    so why would Western institutions even consider the possibility of allowing representatives of poor, developing countries to participate as directors of fortune 500 corporations, or take major stakes in Western firms when said representatives have yet to demonstrate that their own houses are in order?

  23. Guest   July 31, 2007 at 8:19 am

    And yes Brad, there is a typo in 2007-07-31 08:15:54, and I would correct it if I were able to do so.

  24. Guest   July 31, 2007 at 8:23 am

    Where’s the analysis of net foreign debt in the context of the much larger gross domestic debt?

    Foreign/domestic – what’s the difference in terms of the cost and risk implications? Why should we care?

  25. Dave Chiang   July 31, 2007 at 8:32 am

    Of course, the policy debate over Chinese purchasing shares in companies raises a lot more concerns than purchasing low yielding US T-bonds. But if anything, the Chinese are far more open to foreign direct investment than the United States. For instance, America’s Anheuser Busch, producers of the Budweiser beer, over the past decade purchased 100% of China’s Wuhan brewery and 30% of the Tsingtao brewery corporations. Can you imagine the xenophobic uproar from the mainstream US newsmedia if the situation were reversed? Certainly there would probably be violent riots in the streets over how the Chinese will contaminate the US beer supply. Never mind the millions of Chinese-built Apple Iphones sold over the past week, Businessweek magazine in its last issue, which claims that most Chinese products are dangerous and defective, would probably advocate a protectionist global trade war. And don’t forget the US newsmedia absurd nonsense over Chinese air pollution of the skies over Los Angeles and Santa Barbara, California.

  26. bsetser   July 31, 2007 at 8:40 am

    Frankly, this discussion has spun off track — it was meant to be focused on sovereign wealth funds, their investment styles and the policy issues associated with their rise. questions like:

    “Foreign/domestic – what’s the difference in terms of the cost and risk implications? Why should we care? ”

    are not helpful. I have discussed the difference between foreign debt (debt owned to non-residents, ultimately a claim on future tradable production) and domestic debt (debt owned between residents) at length in the past — and their inter-relationship is discussed at length in bailouts and bail-ins along with a paper I co-wrote with a host of folks from the IMF (inlcuding mark allen) in 2002 called the balance sheet approach.

    moreover, RN is right, at least in my view — equilibrium interest rates in the US and Europe have been influenced by Chinese policies, and that has induced more borrowing by consumers and firms (as well as reduced the costs of running fiscal deficits). that is a function of the fact that again in my view, China both has used government policy to push up the savings rate to sustain its exchange rate policy (martin wolf makes this argument persuasively), and moreover, maintaining the peg requires turning external equity inflows into demand for foreign debt, as China already haves as much as it needs (more) and any inflows from abroad have been used to build up central bank reserves. the net result is more demand for debt, though China acts more like a cross-border intermediary there.

    but again, that topic has been discussed in the past — and the focus of this post is on the implications of a shift in Chinese (and other) demand away from debt and toward equities. I would appreciate it if the discussion returned to those themes — we had a good and i thought informative discussion last week, one that got at the differences between pension funds and sovereign wealth funds.

    and I haven’t seen anyone comment on whether i identified the right set of issues — reciprocity, transparency, leverage, state-ownership and scale — when it comes to thinking about policy toward SWFs, or whether my argument that the british focus on reciprocity is a bit off is itself off.



  27. Guest   July 31, 2007 at 8:50 am

    with all due respect brad, the spin of at least some of your posts may invite unhelpful responses

  28. RebelEconomist   July 31, 2007 at 8:50 am

    For those who do not have an online subscription to the FT, a better link for John Gapper’s article that Brad refers to is:

  29. Twofish   July 31, 2007 at 8:58 am

    bsetser: disagree re: savings. I don’t think you can explain the rise in China’s savings (up roughly 15% of GDP) without linking to the exchange rate

    I think I can. The rise in corporate savings occurred largely because the state-owned enterprises were freed from their social-welfare obligations and hence became immensely profitable. Because the government did not (and has not) put together a dividend policy, this has created SOE’s with huge cash reserves that they can do nothing with except reinvest.

    This would have happened regardless of what the exchange rate was.

    bsetser: and more importantly, the policies that support the exchange rate (a relatively restrictive fiscal policy, credit controls, and the like).

    In each of these cases, the prime motivator was something other than the exchange rate. Fiscal policy was the results of a drive to increase efficiency in government and trim the bureaucracy. Credit controls were needed to recapitalize the banks.

    bsetser: i’ll cover this in more detail later in the week — eswar prasad’s paper is a good introduction to the issue.

    I disagree with almost everything Prasad says about the Chinese economy.

    Just to start off with. I strongly disagree that the Chinese economy is “unbalanced” and that there is too much investment overall. The reason I disagree is that if you look at return on capital, there is no sign that Chinese investment is being directed toward inefficient projects.

  30. Twofish   July 31, 2007 at 9:08 am

    I think the main focus of SWF is to think about how to prevent someone (government or otherwise) from destabilizing the global financial system.

    I really don’t think that reprocity is that important because if you define reprocity has an important trait, you’ll get into a situation where your countries policies are fair and those of other countries are unfair. What thing happens comes down to negotiating power, and this leaves poorer nations at a huge disadvantage.

    The other thing that hasn’t been talked about is how really poor nations (Angola or Uganda) could use SWF’s to meet their social welfare needs.

  31. Twofish   July 31, 2007 at 9:17 am

    Let’s step back and talk about what people are really worried about…..

    The basic issue here is that sovereign wealth funds make people in Kansas realize that they are dependent on decisions made in Beijing or Riyadh, and this scares people. Whether those decisions end up to be wise or not is not that relevant. Even if Beijing or Saudi Arabia makes decisions that benefit people in Kansas, the fact that those decisions are being made elsewhere scares people.

    The trouble here is that this is an inevitable consequence of globalization and third world development. Unless we want to live in a world that is permanently divided between haves and have-nots, as the have-nots start getting wealthy they are going to have power associated with that wealth, and what people in Beijing or Riyadh think start mattering.

  32. Guest   July 31, 2007 at 9:23 am

    2007-07-31 09:08:04 – you may disagree with Mr. Dizard’s statement, but isn’t China already investing in some of these countries?

    “…The Chinese don’t seem to worry about being considered vultures.”

    and I still have to wonder how a country can both receive and distribute development aid, or at least versions of it, at the same time.

  33. Guest   July 31, 2007 at 9:32 am

    One thing China might do to reduce the friction resulting from its accumulation of dollar assets would be to move from selling its vast industrial output to foreigners to selling more to its own citizens. US development in the early 20th century did not depend upon exports but rather on an expanding internal market, did it not? Perhaps Brad could talk about how China could shift to selling much more to its own citizens and why it is not doing this, as far as one can see.

  34. Guest   July 31, 2007 at 9:33 am

    re: “people in Kansas realize that they are dependent on decisions made in Beijing or Riyadh”

    do you really believe that – more so than the actions, inactions, or complicity of their own government?

    re: “RN is right” – still doesn’t answer my question about a statement you highlight at the beginning of the post.

  35. Macro Man   July 31, 2007 at 9:55 am

    Brad, I at least agree with your highlighting of the relevant issues, particularly reciprocity and transparency.

    High domestic savings in China is a product of a number of things, including but not limited to adminstrative diktat, the removal of socialized housing and, I believe, an artificial depression of the international purchasing power of Chinese firms and citizens via the weak RMB. Of these, the latter is not the most significant contributor but certainly among the most visible. It is also probably the easiest to alter, should the authorities wish.

    I personally think the US could use a SWF, but previous efforts to broaden the investment remit of the social security program have failed badly, and there appears to be little current appetite to re-open the discussion, badly as it may be needed.

    And the US is not totally against foreign ownership of domestic household names. SAB has already bought Miller Brewing Co., and of course Daimler bought Chrysler. The opposition, such as it has been, is a function of regional bias (anti-Middle East in the case of Dubai ports).

    Unease about foreign public agencies essentially “nationalizing” companies in the US and Europe is, I think, understandable. Lest we forget, of course, Japan has a long tradition of antipathy towards foreign and/or unsolicited takeovers, so it’s not as if the US or Europe is breaking new ground here.

  36. Dave Chiang   July 31, 2007 at 11:34 am

    When the Chinese government purchases unlimited quantities of low yielding US Treasury bonds, there is never any mention of any “National Security Threat” issue. Now that the Chinese government is diversifying equity investment into other Western nations, not the United States, senior U.S. officials are crying foul citing the National Security threat. Is there any hypocrisy of the IMF dictating to developing nations to open their markets to US investment while slamming the door permanently closed to any Chinese investment in Western economies? It appears that the Chinese can only be trusted to own US Treasury bonds, and “AAA” rated, sub-prime mortgage bonds.

    From Bloomberg,

    U.S. officials are pushing the International Monetary Fund and World Bank to set guidelines. Senator Jim Webb, a Democrat from Virginia, cite national security concerns; others say such investments raise the risks of disrupting the financial markets.

  37. Guest   July 31, 2007 at 11:43 am

    re: “the Chinese can only be trusted to own US Treasury bonds, and “AAA” rated, sub-prime mortgage bonds”

    interesting conclusion on your part, but until they resolve their own management and wealth disparity issues (largest rich poor gap in the world achieved while increasing their military spending) – you may be right about that.

  38. Twofish   July 31, 2007 at 11:51 am

    “largest rich poor gap in the world”

    Those statistics are IMHO highly misleading. If you look at the numbers (and walk on the streets), the intraregional wealth gap is actually low. China ends up with a huge Gini coefficient because parts of the country are third world and other parts are first world.

    My suspicion is the fact that the wealth gap is interregional means that the actual impact is overstated. Incomes in Yunnan are lower than Shanghai but so are costs.

    Also, one shouldn’t forget about the political motives behind those numbers. Part of Hu and Wen’s agenda (which I think is a good one) is to redress the gap between rich provinces and poor ones, and this means that a lot of the talk about rich and poor comes from the government, who are using it to get political support for their policies (which again I think are good ones). However, when the news gets to the West, it becomes “OHMYGOD, the Chinese government is about to collapse.”

    Finally, one reason I don’t think that reprocity is a good principle is that it treats free trade as some sort of gift, which isn’t a good way to think about it at all. Once you see open markets as a “gift” then its easy to say, “yes you can get the gift once you meet this impossible condition.”

  39. JSP   July 31, 2007 at 12:08 pm

    (Quote from Brad). At the same time, I wonder whether it will be possible to convince the big sovereign funds to act more transparently. Is anyone prepared to kick ADIA out if it doesn’t disclose more. That seems to me to be a big obstacle to Willem Buiter’s proposals.
    (Quote from Lenin). Typical of the old capitalism, when free competition held undivided sway, was the export of goods. Typical of the latest stage of capitalism, when monopolies rule, is the export of capital.
    In some way Lenin analysis also applies to China, a State Capitalist country. China exports both goods and capital, the latter increasingly so. In capitalist logic. China will move to control (corner) financial and commodity markets. It will be next to impossible to convince China to do otherwise.

  40. Twofish   July 31, 2007 at 12:10 pm

    The other thing that worries me a being is that we are following into the “news headline of the day” and missing tomorrow’s headlines. Chinese sovereign wealth funds are only a part of the story. Over the last five years, China has created a mutual fund and insurance industry that is on the verge of going overseas. There are also about 50-80 restructured state-owned enterprises that are about to “go global.”

    What I suspect is going to happen if we keep the focus on sovereign wealth funds is people are going to come up with policies narrowly tailored toward that, which completely misses the real issue which is unease at the massive shift in global economic power that is now occurring. Suppose China doesn’t invest US$300 billion using SWF’s, but instead invests US$2 trillion with mutual funds and insurance companies (which is likely to happen in the next five to ten years). I think you’d see the same amount of screaming and nervousness.

  41. Guest   July 31, 2007 at 12:21 pm

    We really have no way of knowing, except from the statements made by Chinese officials, who certainly make the situation look dire. But the wealth gap issue seems to be more internal than country to country.

    And given what seems to be decreasing transparency in the entire financial sector – most probably don’t know who or what ultimately owns their mortgage, or how their pension funds are invested, let alone know what China is doing with its SWF. Interesting that, to my knowledge, no one has tried placing the blame for the subprime situation on America’s wealthy Chinese clients. Or that there has been so little discussion about who or what owns the properties once held by those who are forced to walk as the next chapter unfolds.

    “…The new Distressed Sub-Prime fund will have some unusual features, including a defined investment period that ends in roughly two years. It will also take 20% of any profit, but Marathon will only get that fee once the investor gets the principal back… “There is a significant investment opportunity unfolding…”

  42. Dave Chiang   July 31, 2007 at 12:25 pm

    Comments by “Helicopter Commander” Ben Bernanke that he would stimulate the US Economy by, “dropping cash scattered from the sky to cure deflation”, don’t inspire confidence by the Chinese PBoC or other foreign investors to invest their hard earned capital into low yielding US Treasury bonds. Based on the Federal Reserve’s stated intention not to support the monetary purchasing power value of the US dollar, why shouldn’t the Chinese at least attempt to diversify investment into foreign equities. Ben Bernanke is on official record stating that, “he doesn’t care what the US dollar exchange value is”. And finally, Treasury Secretary Hank Paulson is back in Beijing demanding that the Chinese devalue the US dollar versus the yuan currency which should be alarming to any foreign investor holders of the US dollar. Dump the US dollar because the US Treasury Secretary say so.

  43. black swan   July 31, 2007 at 12:34 pm

    If the Chinese sovereign fund owned controlling interests in the US military industrial complex’s arm merchants, could it do much worse than the Iraq war, selling $20,000,000,000’s worth of weapons to Saudi Arabia and $30,000,000,000’s worth to Israel? Imagine if the fund owned controlling interests in US big pharma and its lobiests. It could be the biggest addictive drug cartel in America. Maybe we really have sold them to rope with which hang us. But, hey, look what we’re doing to ourselves without their control.

  44. Guest   July 31, 2007 at 12:38 pm

    “China ends up with a huge Gini coefficient because parts of the country are third world and other parts are first world.”

    According to the CIA China’s Gini is 44 compared to 45 for the USA. Wealth gap, it would seem, a bit less than ours.

  45. Guest   July 31, 2007 at 12:58 pm

    And many of the wealthier, if not wealthiest, ‘North Americans’ include Asian residents and NRs, however and wherever the funds were raised to finance their investments.

    “…In terms of sales and receipts… Indian Americans are on top at $2 billion in 2002, followed by $1.8 billion from Chinese American companies… Asian American-owned firms in the U.S. increased by 86% from 1992 to 2002…”

  46. bsetser   July 31, 2007 at 1:05 pm

    the increasingly unequal us is hardly a good baseline for international comparison. of all the aspects of us society that is the one i would least like to see china emulate.

    guest –the point on profligate consumers is a point that has been discussed in the past, and i didn’t feel it needed to be discussed again. with us household savings at close to zero, i think it is a fair point. the improvement in the us fiscal balance has been offset by a deterioration in the household balance (note real consumption growth of 4% in q4 06 and q1 07 … tho it was much lower in q2 07.

    twofish — at current exchange rates, it doesn’t make sense for Chinese financials to invest in dollar assets unless they are using money borrowed from the central bank. china has been desperately encouraging more private flows (if you call state financial institutions private) to offset the central banks reserve growth, with no success — hence the growth of PboC reserves/ SWFunds. I see no reason why that will change. basically, the only entity in china willing to take the XR risk associated with holding $ and euros right now is the chinese state. hence the rise of a large chinese sovereign wealth fund.

    balanced flows — us investors holding more chinese assets, chinese investors holding more global assets — make a lot of sense to me. call it portfolio diversification. that is how the US and Europe operate. but right now the world economy works on a very different basis. chinese savigns are very high. chinese savings are generally in rmb. the chinese state borrows in rmb, and then buys $ and euro assets in huge quantities. the scale of those purchases has increased every year recently, even with all of china’s efforts to encourage private outflows. I don’t think all this can be imagined away. unless something changes, i think we need to assume it continues.

    and i would also assume that the russians and the saudis will start operating their own funds.

    finally, if the same guest is posting repeatedly, it would help if that guest opted for a distinguishing name that still preserves anonymity — a discussion board where 1/2 the posts come from anonymous guests (who may or may not be many guests) isn’t working perfectly.

  47. Guest   July 31, 2007 at 1:14 pm

    “…Today, almost a third of Manhattan’s Chinatown residents live in poverty, including 40% of children and 35% of the elderly, census data show, and only about 7 percent of households receive public aid. At the other extreme, a 2004 study by the Spectrem Group of Chicago, financial consultants, found that Asians accounted for 5 percent of affluent households in the United States, up from 1 percent two years earlier; they had an average net worth of $2.9 million…”

  48. bsetser   July 31, 2007 at 1:33 pm

    the last comment is in my view off-topic; the topic here is sovereign wealth funds. i would again appreciate focusing the discussion on that topic.

    macro-man, jsp, two-fish — thanks for on topic comments.

    one question: is china likely to follow the Temasek/ QIA/ Dubai model (more of a private equity fund, with large stakes) or the GIC/ Norway government fund model (smaller dispersed stakes, more of an attempt to profit from broad market moves)? or a bit of both?

    another question: will the saudis set up their own SWF? The russians have already indicated that they will. and how will that fund be structured?

  49. Macro Man   July 31, 2007 at 2:02 pm

    To the best of my knowledge (i.e., from a pretty well-connected source who has connections with the people who matter), China will ultimately pursue both avenues, e.g. a PE type fund AND a more broad financial market fund. I had assumed that the latter would be constructed first, but it appears it is the former.

    It was announced that CIC took a small (£120 million or so) stake in British Gas this morning- which is literally a couple hours’ worth of reserve accumulation. It may be the case that Cazenove announced that they had executed the deal simply because it was China and they wanted to make waves….but when was the last time you heard about Norges taking a stake in a specific company? (The next time will be the first time, for me at least.)

  50. bsetser   July 31, 2007 at 2:14 pm

    Macroman — will both funds be housed under the same roof? i wasn’t sure there would be a PE type fund let alone that i would be built first … sp i was way off.

    Do you have any idea why the PE fund might have gotten rolling first? how the funds will be allocated between the two?

    agree that the CIC taking position info is different than how others operate — tho it does make more sense for china to own energy cos (for diversification) than for say Norges.

  51. LC   July 31, 2007 at 2:22 pm


    Good summary of the issues raised by others on SWF. However, I believe these issues are all political, not economic. Others have already commented on some of them, but I also don’t think the argument of scale makes much sense. Already, we have examples of markets-stock market, for instance-where large scale players make moves that affect the market. There are traders who base their moves on what the large instituational investors buy and sell. I don’t hear any calls to curtail the power of instituational investors in stock markets. So this argument seem rather subjective to me. Also, I think there is a wrong perception that markets composed of mainly small private players are more efficient. The Chinese food market is composed of many small private players and it’s far from efficient, when the main metric is safety and health.

    “balanced flows — us investors holding more chinese assets, chinese investors holding more global assets — make a lot of sense to me. call it portfolio diversification. that is how the US and Europe operate”

    Actually, the last sentence should be this is how US and WESTERN Europe operate. I think you hit the nail on the head: the rules currently set cover about 10% of the world’s population and close to 40% of world’s economic activity (at current exchange rates). Now do these rules need to be expanded to the other players coming on, e.g. Russia, Saudi Arabia and China or is this closed to new comers? That fundamentally is a political question. Frankly, this is what bugs me most about these debates: it reflects a mentality that fundamentally hedges against the rise of these new comers. Unless there is a change of attitude or vision, we will be stuck in these types of debates about many other things, a point alluded to by Twofish.

  52. gillies   July 31, 2007 at 2:25 pm

    it might help to return every so often to the most basic facts of the global situation. the earth, her resources and commodities are finite, and arable land and fossil fuel production beginning to contract. labour and potential labour is in massive surplus and the educated population and the global population expanding. in a globalised economy production is now shifting to workers who often break the henry ford principle – they are not earning enough to buy the model T that they are producing.
    the military industrial complex has nearly gone as far as it can, because if it gets any more aggressive it will simply collapse the way of life that it is supposed to be defending. destruction is also a finite resource.
    the corporations have nearly gone as far as they can, because the natural result of going on further with globalisation is that the fiat dollars come home to buy up america, thus shifting political support towards protectionism and aggression.
    so what happens ? no use having the answer – because who has the power to put the answer into effect ? time for all to recognise the limits of their power. countries like the soviet union and even japan, who centralise decision making, have done badly. imagine a united states post-coup military dictator able to impose policy on the entire world. what would he/she do for an economic policy ?
    i guess take over the canadian commodities, the cheap mexican labour, and convert the USAF to biodiesel. keep the rest of the world at arm’s length. sounds like a joke, but as a thought experiment, what would you do if all opposition were overawed ? why outsource manufacture to distant cultures if you could reduce your own underclass to chinese levels of subsistence policed by strict martial law ?
    china is still going to remain comparatively poor, per capita, but become rich in aggregate through sheer numbers. so we have the paradox of millions of poorly paid employees in a position to buy up, if allowed, strategic investments. when they buy out henry ford – or the current equivalent – they jointly own ford but they individually cannot afford the model T.
    say that again ?
    something’s got to give.
    i think that we will all enter upon a period of chaos, global economic contraction, fragmentation of decision making, with saving and austerity replacing borrowing and consumption, and a wholesale wipe-out of the over leveraged.
    the helicopters have flown already. the future is japan. childhood obesity will not be a plague for so much longer . . .

  53. Twofish   July 31, 2007 at 2:26 pm

    I think that the central government is going to do both private equity and strategic resource investments. Also local and provincial governments are likely to do something different with their pension and retirement funds. Part of the reason that I bring up Calipers, is that every provincial and local government in China has their pension fund, and all of those are preparing to invest overseas.

    One other interesting thing is that I suspect a huge amount of funds are going to “round trip” back to China. One of the big reasons for Chinese to invest in “overseas companies” is so that they can put their money in NYSE or Hong Kong listed shares of PRC companies. Something that I’m sure was part of the Blackstone deal was so that Blackstone could use its expertise in order to improve allocation of capital in China. China has a huge amount of money, but all of the skilled money managers are in New York or Hong Kong.

  54. bsetser   July 31, 2007 at 2:42 pm

    LC — I don’t think the old model for EM-US financial interactions was balanced. that model was more less FDI inflows (and some portfolio flows) offset by EM reserve buildup, with the reserve buildup generally smaller than the inflows (i.e. there were current account deficits) and the overall scale of the flows small. but there are a host of models that are different from the current model as well —
    a model based on large em sovereign financing of the private sector in the US and Europe is to my knowledge new.

    twofish –why are the provincial funds investing abroad rather than in china, given the XR risk?

    as for offshore intermediation, i am not convinced — by any measure, the amount of funds intermediated offshore is tiny relative to china’s $1.5 trillion (minimum) in domestic savings. lots more funds are intermediated via the banks, via the local equity market and via SOEs (who reinvest profits). and offshore portfolio managers face a lot of restrictions on the kind of chinese assets that they can buy.

  55. Twofish   July 31, 2007 at 2:42 pm

    gilles: it might help to return every so often to the most basic facts of the global situation. the earth, her resources and commodities are finite, and arable land and fossil fuel production beginning to contract.

    Personally, I’m an optimist, and I really think that you can get most of the world up to US/Europe standards of living with 100-150 years of effort.

    However, if I’m wrong then things really do look bleak. If it turns out that the world can’t support everyone at US/Europe standards of living, then there the problem is how to reduce the standard of living of US and Europe in an orderly way. Just from a point of view of economic fairness, there is no reason why someone growing up in Topeka, Kansas has the right to living better than someone growing up in Lagos, Nigeria, and with increasing technology and capital flows differences in standards of living are going to start disappearing.

    The American middle class cannot continue exist unless a global middle class is formed. Moreover if you accept a world of haves and have-nots as a permanent condition, that goes against the basic founding principles of the United States, and I don’t think the United States can continue to even exist as a nation in a world that is permanently divided into lords and peasants. All of the nervousness about sovereign wealth funds is I think that people are starting to realize this.

  56. Twofish   July 31, 2007 at 2:52 pm

    twofish –why are the provincial funds investing abroad rather than in china, given the XR risk?

    Because 1) there are no few good assets to invest in China and 2) because foreign assets are incredibly cheap by Chinese standards. Take two identical companies, one listed in Shanghai, the other in NYC. The NYC listing is going to be a third the price of the Shanghai listing.

    twofish: as for offshore intermediation, i am not convinced — by any measure, the amount of funds intermediated offshore is tiny relative to china’s $1.5 trillion (minimum) in domestic savings. lots more funds are intermediated via the banks, via the local equity market and via SOEs (who reinvest profits). and offshore portfolio managers face a lot of restrictions on the kind of chinese assets that they can buy.

    You are talking about the situation today and not the situation in two years. “Onshore” and “offshore” become very fuzzy concepts since all of the money is floating in cyberspace anyhow. What’s likely to happen is that both “onshore” and “offshore” accounts are going to be bookkeepping entries on a database server in Hong Kong.

    Also private equity is the one area where there aren’t too many restrictions on what offshore companies can purchase. As far as equity assets, Chinese companies find it a lot cheaper to raise cash in NY or HK than Shanghai.

  57. Dave Chiang   July 31, 2007 at 3:02 pm

    Just as the Chinese are buying back their ancient art treasures from the rest of the world, I think they also hope to buy back the New York listed shares of strategic PRC companies. There is no reason why more ADR shares of PetroChina should be traded on the NYSE than domestic shares on the Shanghai exchange. The ADR shares were listed on the NYSE when the Chinese economy was short on capital a decade ago, but that is no longer the case. Recently large state-owned Chinese corporations have been instructed not to IPO list overseas, but on the domestic Shenzhen and Shanghai stock exchanges to raise capital.

  58. Macro Man   July 31, 2007 at 3:06 pm

    Brad, my understanding is that there will eventually be two funds a la GIC and Temasek.

    Twofish, I would respectfully suggest that aversion to sovereign wealth funds, in the US at least, is philosophical in nature. To wit, the US has historically shown a marked aversion to governments getting into the investment management business, viz. the debate about ‘social security privatization’ or SS equity investment in the latter portion of the last decade. For some reason, it appears to be a assumed truth in the US political establishment that governments shouldn’t, by and large, participate in private sector markets- hence the preference for ‘moral suasion’ with China rather than outright intervention in, say, USD/JPY.

    I’d also suggest that the US political system has never, until relatively recently, been about ensuring equality of outcomes or preventing haves and have nots. Consider the deep-rooted opposition in many quarters to the New Deal, for instance, or the laissez-faire attitude taken by the Coolidge administration to Gulf Coast flooding.

    If the US political establishment cannot bear to see their own national retirement organization “invest” in markets other than Treasuries, I for one am not particularly surprised that there is opposition to foreign SWFs acquiring substantial stakes in publicly traded firms that the US equivalent eschews oh what I take to be philosophical grounds.

  59. Dave Chiang   July 31, 2007 at 3:13 pm

    The state-owned, US Federal Government employees pension fund also invests in domestic shares and foreign equity shares.

    The Top 10 foreign share holdings by the U.S. Government
    ( as of December 31, 2006 )

    HSBC Holdings (GB)
    Toyota Motor Corporation
    Vodafone Group
    Royal Dutch Petroleum Company
    Roche Holding AG

  60. bsetser   July 31, 2007 at 3:32 pm

    the TSP — the government pension fund DC described above — invests in index funds. it also offers an international index. i would bet the firms listed above are the ones with the biggest weight in the index (full disclosure: I have a TSP retirement account with some int. exposure from my time at the treasury). if china wanted to emulate the approach taken by the TSP (index funds, disclosure) i sincerely doubt there would be huge concerns, apart from the sheer scale of china’s holdings/ the risk that buying equities might take pressure off china to change its currency.

    LC — i wasn’t thinking about the difference in price between chinese firms onshore and offshore offerings — there you have a point, tho obviously if enough chinese money was going offshore to do the arbitrage the price difference would close. i was thinking much more of buying us assets (i.e. in $) not buying chinese assets listed offshore.

    I also think private equity funds face significant restrictions in china — one reason blackstone liked the cic deal was the hope it would get a bit more freedom of action in china.

    I second macroman’s point. we in the US privatized our uranium enrichment company for godssake. we really have a strong historical aversion – even relative to europe — to government ownership of companies/ most economic assets (setting aside public lands in the west … ).

    I do though think there is a bit stronger vein of equality in the us political tradition than macroman allows — not equality of outcome per se, but certainly equality of opportunity. homesteaders in Ks all got the same opportunity (160 acres), and at least at one time, the us had a better public education system than europe. that tradition has been allowed to erode, but it was there, once …. (sorry for going off-topic)

  61. LC   July 31, 2007 at 3:51 pm

    “LC — i wasn’t thinking about the difference in price between chinese firms onshore and offshore offerings — there you have a point, tho obviously if enough chinese money was going offshore to do the arbitrage the price difference would close. i was thinking much more of buying us assets (i.e. in $) not buying chinese assets listed offshore.”

    Acutally, that original comment wasn’t made by me. It was made by Twofish.

  62. RebelEconomist   July 31, 2007 at 4:32 pm

    I do not think that the fuss about SWF’s equity investment is justified:

    (1) If the acquired firm’s business is done largely outside the country of its existing owner, then a change to foreign ownership should not be a problem. If its business is largely domestic, then that firm’s success depends on the goodwill of its domestic customers, suppliers and workers. It would be commercial suicide to do anything to antagonise them.

    (2) Managerial control is worth nothing without the rule of law. If a foreign SWF uses its managerial control of a firm against the national interest, the law can be changed to stop them. A golden share is just a fancy way for a government to reserve that right. A SWF would be unwise to own most of a business in any remotely unwelcoming country – I imagine that it would be easy for a cynical government to devise some regulatory or legal change that has the effect of making any particular business worthless – as foreign investors in Russia, Venezuela, Zimbabwe etc have discovered. They are probably more exposed to such legal fleecing in equity than debt.

    (3) If countries like America and Britain are good places to start businesses, they should be able to build some more enterprises to replace those they sell to foreigners. Maybe their future lies in producing and selling financial capital assets like Germany and Japan excel at producing and selling physical capital assets.

  63. Twofish   July 31, 2007 at 4:46 pm

    [q]There is no reason why more ADR shares of PetroChina should be traded on the NYSE than domestic shares on the Shanghai exchange.[/q]

    There is a reason. If it is traded on the NYSE, then it means that it is subject to NYSE exchange rules, SEC supervision, and auditing with GAAP standards. People (including people in China) trust the US government to do these things better than the Chinese government.

    Also, there just are more people that know how to manage money in NYC and Hong Kong than in Shanghai.

    [q]The ADR shares were listed on the NYSE when the Chinese economy was short on capital a decade ago, but that is no longer the case.[/q]

    Capital is plentiful but trust in securities regulation isn’t.

    [q]Recently large state-owned Chinese corporations have been instructed not to IPO list overseas, but on the domestic Shenzhen and Shanghai stock exchanges to raise capital.[/q]

    This isn’t true. All of the big corporations have been dual listing on Shanghai (to get the RMB capital) and an off-Mainland exchange (to get credibility). This offshore exchange has tended to be Hong Kong more than NYSE recently because NY was hit hard by the Enron scandals and then by Sarbanes-Oxley which creating uncertain rules.

    The Chinese government has actually been encouraging large companies to list overseas because having the SEC say that you are honest makes it easier and cheaper for people to give you their money.

    Since all the money is in cyberspace anyhow, the costs of shipping money from Shanghai to NY and back again are basically nil.

  64. Twofish   July 31, 2007 at 4:58 pm

    Re: Private equity in China. There really are very few restrictions on private equity/venture capital in China. You can’t take large ownership in “strategic industries” but those aren’t of much interest to PE/VC firms anyhow.

  65. bsetser   July 31, 2007 at 5:06 pm

    twofish/ lc — my apologies.
    twofish — re cost of shipping money back and forth is virtually nil. dang maybe you can help me buy some pboc bills then … i would prefer them to ndfs, but my sense was that china’s controls made them hard to buy.

    and when you say few restrictions on private equity, do you mean few restrictions on local private equity firms or on foreigner setting up shop? and if you mean foreigners, how would i verify that data?

    rebel: isn’t financial capital ultimately a claim on a real cash flow? and if it is a cross border claim, isn’t it a claim on tradables? i am not sure the us sells ious/ companies germany sells goods argument works … ultimatley those ious need to be exchanged for future goods and services, or they aren’t worth much … and taking on external obligations to build domestic service businesses isn’t an obvious recipe for success.

    I agree with your point tho about changing the law = big threat to foreign equity. if all us pharmas were chinese, i suspect the us would change a lot of its patent laws/ medicare prescription benefit terms and the like (as noted in the post).

    what then can china buy w/o taking that risk?

  66. Twofish   July 31, 2007 at 5:16 pm

    The more I think about it, the more I’m surprised that everyone is surprised that China is going into equity funds. It’s not as if Hu Jintao woke up a month ago with a sudden idea to invest large amount of money in stocks.

    People on Wall Street have been suggesting that China invest in funds for years now, and there is been a huge amount of cooperation between the Chinese government and Wall Street to make Chinese corporations ready for “going global.” If you go to any China conference, you end up with a lot of bankers that are giddy at the deals that are about to happen.

    This makes me wonder about the “transparency” element here. No one has been particularly secretive about the ideas that the deals that are coming down the pipe.

    There’s also “isn’t this what you wanted?” I thought one of the major goals of US economic and political policy was to have China be an integral part of the world economic system. Having China be more influential is a consequence of this that I thought should have been obvious to everyone involved.

    The people that are shocked at the Blackstone deal are going to be in for some even larger surprises in the next few years. Blackstone is a small dry run.

  67. Guest   July 31, 2007 at 6:26 pm

    “…It may seem odd that a legal structure for handling failing companies would prompt CFOs to open their wallets… But experts temper their enthusiasm with caveats. No one knows how the law will stand up as cases work through China’s court system. A key feature of the law is that Chinese courts will have jurisdiction over a company’s assets even outside of China. But for US and European courts to respect this jurisdiction, China will have to affirm that its system is fair and not politically motivated..”

    “…In 2000, the crisis nations, plus China and Japan, met in Thailand… pledging regional economic cooperation to protect against future shocks. The group identified the creation of a regional bond market as key to the return to prosperity… Governments can support this by establishing uniform procedures of conduct, disclosure, and transparency. Here, too, progress has been meager… “A sense of complacency may bring about another crisis”… persistent political rivalries have contributed to this complacency…”

    “…The Asian Wall Street Journal went as far as to compare Hutchison to Enron, claiming in mid-February that Hutchison “sweeps billions in contingent liabilities under the rug.”…But Hutchison is guilty of the Journal’s broader charge that it does not give enough detail to explain its complicated finances. Although Hutchison’s annual report ranks as one of the best in Asia… When asked to rate the company’s investor relations, one analyst joked: “It’s improving – at a prehistoric rate…”

  68. bsetser   July 31, 2007 at 9:17 pm

    “I thought one of the major goals of US economic and political policy was to have China be an integral part of the world economic system.”


    i think the surprise is the way china is going about being a part of the world economic system. that includes the scale of chinese financing of the rest of the world ($500b in CIC/ PBoC foreign asset growth; $350b plus current account surplus). And it includes the extent to which the Chinese state is being a major financial actor — i.e. china acts as a big unitary player, not as a set of separate actors.

    I keep returning to $500b. that is going to be close to 1/2 of total state foreign asset growth. it is just a huge number.

    as for the CIC, i think the surprise is how aggressive it has been — per the discussion with macroman. I was expecting more index style investment — not participation in IPOs/ big strategic stakes.

  69. Anonymous   July 31, 2007 at 9:25 pm

    For better part of this decade, informed people have argued about the global adjustment needed to reflect savings differential between Asia and the West. And now we are finally seeing it happen as SWFs etc are looking to invest their money.

    But should the West resort to protectionism? Arent they the champions of free trade and globalization? Sadly enuff, the alternative to US is starker still. Disallow these SWFs from investing in the US, and see flight of money invested in US bonds to more attractive places (a la flight of financial engineering to The City of London from Wall Street). As someone noted on this blog, its time to kow-tow to China & Co., coz the US just owes too much to them.

  70. Twofish   July 31, 2007 at 11:16 pm

    Re: Private equity in China.

    Here is a summary of the 2003 Venture Capital regulations which basically allow the formation of foreign investment enterprises venture capital funds. These funds are subject to the same restrictions as all foreign investment.

    Here is a schedule of encouraged/restricted and prohibited industries.

    Also the Chinese state *is* going to act as a set of disparate actors. The thing thing about China is that it is so huge that even any one of those actors is going to be enormous. Over the next ten years, you are probably going to see $300 billion in SIC, $100 billion in private equity investment followed by maybe a trillion in mutual funds, insurance fund, provincial and local pension funds.

    BTW, *this* is why I think Paulson wants China to unpeg the RMB. With a peg in place, China has to maintain capital controls. To lift capital controls and maintain an independent monetary policy, China has to have a floating currency. Once you lift capital controls, you are going to see tens of billions in fees for investment banks.

  71. bsetser   July 31, 2007 at 11:21 pm

    please explain your first point —

    global imbalances certainly reflect savings differentials, along with exchange rate misalignments — but presumably adjustment implies reducing those savings differentials.

    the fact that china’s savings gets channeled into demand for equities rather than bonds doesn’t change the fact that china saves more than it invests, or the us less than it invests. and if china thinks the higher returns from the CIC can allow it to avoid making other policy changes — whether fiscal stimulus/ creating a social security system to reduce savings or letting the rmb appreciate, it certainly won’t facilitate global adjustment.

    i also to be honest find the protectionism argument over-stated. china is using its central bank to subsidize its exports in an exceptionally big way. that isn’t free trade — not if free trade is meant to imply the absence of government intervention. the question now is how the rest of the world responds to this policy. SWFs are part of that, since holding the rmb down means acquiring foreign assets

  72. bsetser   July 31, 2007 at 11:26 pm

    twofish – you might be right re paulson.

  73. RebelEconomist   August 1, 2007 at 2:41 am

    Brad, regarding selling companies rather than capital goods:

    It is important that the financial asset sold is equity, not an IOU, because when a company is sold, the seller has no further commitment to the buyer. This is what makes the sale of a company like the sale of a capital good generating a stream of output into the future. The stream of dividends from the stock sold may or may not be drawn from the country in which the business was originally domiciled. Private equity can specialise in this kind of thing, like the purchase and sale of Long Term Credit Bank of Japan by Ripplewood or Lone Star’s involvement with Korea Exchange Bank. The sale of IBM’s PC business to Lenovo provides a slightly different example. Obviously, such “enterprise farming” is not going to keep the US afloat on its own, but it can make a useful marginal contribution.

    Twofish: While I do not always share your optimism, I do appreciate your reasoned and factual comments on China, which provide food for thought and make a welcome change from the one-sided ranting of certain defenders of China who appear here.

  74. Guest   August 1, 2007 at 3:23 am

    To David Chiang:

    “For instance, America’s Anheuser Busch, producers of the Budweiser beer, over the past decade purchased 100% of China’s Wuhan brewery and 30% of the Tsingtao brewery corporations. Can you imagine the xenophobic uproar from the mainstream US newsmedia if the situation were reversed? Certainly there would probably be violent riots in the streets over how the Chinese will contaminate the US beer supply.”

    What a bizarre and offensive caricature of the US and it’s citizens Mr Chiang. There weren’t any riots over the recent pet food issue were there..? There is plenty of foreign ownership of major industries in the US that is barely noiticed including the Japanese owned Sony Pictures.

  75. Guest   August 1, 2007 at 5:56 am

    re: “the [u.s. saves] less than it invests”

    perhaps it’s just me, but are you saying ‘the problem’ is China’s, or the SWF nations’ saving – or the u.s.’s ‘investing’ – and what’s wrong with ‘borrowing’ to ‘invest’ if an entity has a proven capacity to allocate capital to assets that produce a superior return, especially when its’ management and technological know-how contributes to developing those assets? and isn’t that statement in conflict with the ‘profligate consumer’ rhetoric, which seems to imply the that money is ‘spent’ rather than ‘invested’ and place the ‘blame’ for global imbalances on those who may be victims?

    read your response on the FT forum and agree that each SWF has to be assessed differently. That Dr. Summers is a bit ahead of himself with recommendations which appear to lump SWFs together and place a great deal of faith – and power and prestige along with what would have to be a huge windfall in fees – in the fund managers to do the right thing – at least going from what must be a very brief summary of more in-depth recommendations.

    With the many frequent references to the savings in Norway’s SWF, thought the following was interesting: “…Other vulnerable economies include… Norway… Scandinavian households have particularly high levels of debt relative to their assets…”

    2007-08-01 03:23:41 – such statements are better ignored, although I do think it is to the detriment of the blog that brad actually encourages and defends someone who posts that kind of commentary through the use at least dual IDs to further confuse and obstruct constructive analysis.

    brad – the number of guest posts would be diminished if at least one regular commenter who signs on with a name was not also using, quite deliberately, the guest moniker as well. That type of abuse of the guest category also has to discourage comments from other who have something to contribute and don’t see the merit in the monikers, but do not want to be affiliated that type of commentary – or anyone who encourages it.

  76. Anonymous   August 8, 2007 at 2:53 pm

    The experience of Central Europe may be instructive.

    During the 1990’s, Central European countries privatized much of their state holdings, including those in telecommunications, banks, utilities and other companies which would be considered ‘strategic’. Ironically, many of these sales were to state-owned companies of western countries, notably in the utilities and telecomms sectors. For example, French and German state-owned utilities were typical acquirers of privatizing Central European utilities.

    In general, in my experience, Central European subsidiaries of state-owned companies acted as profit maximizers. The reason: the subsidiary lacked political clout in the parent company’s country. Laid off Czech workers do not vote in France. Therefore, in general, ownership by foreign state entities did not lead to politicized (or rent seeking) behavior.

    This assertion deserves two caveats:

    First, foreign state ownership does not mean that the portfolio company will not be subject to domestic political pressure. So, the Prime Minister of Hungary could ask the President of France to intercede with a French state-owned company to induce it to forego layoffs at the company’s Hungarian subsidiary. The French President might well comply as a political gesture.

    Second, because state-owned companies are typically not profit-maximizers (they maximize political acceptability subject to budget constraints), such companies tend to suffer principal-agent problems. In other words, state-owned companies are more likely to have corrupt management, in my experience. This, in turn, can affect the corporate culture or corporate governance of an otherwise profit-maximizing, foreign subsidiary. If management takes kickbacks at the parent company level, the subsidiary’s management may be emboldened (or indirectly encouraged) to mimic such behavior.

    So, the adverse effect of SWF’s in say, France, could be that they erode the corporate governance of the French portfolio company, on the one hand, and open the company to French government interference, on the other.

    While both are negative effects, neither rises to the level requiring financial protectionism, in my opinion.