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Mises Economics Blog

China to Move Ahead with Forex Plan

March 24, 2007 8:26 PM by Robert Blumen (Archive)

I have been covering the emerging trend of central banks "investing" their accumulated forex reserves in equity markets. In the last few weeks it has become clear that this idea appears to have moved from a proposal to a reality. This story is getting relatively little coverage in the press, yet it has the potential to be hugely disruptive of the functioning of capital markets, for reasons I have outlined in my other writings (1 2 3 4). Some recent articles on this topic are:

The problem with this proposal, that no one seems to have picked up on, is that the assets they will be investing in -- equities in particular -- are not mechanical black boxes that for some reason generate a certain return. The return on the assets cannot be separated from their role in allocating capital by private property owners, something that central banks cannot do. While it would be possible for a small state-run agency of a small nation to "free ride" on the reasonably efficient prices of securities generated by private investors in the market, say by purchasing broad-based indexes of all of the companies on a particular exchange, to the extent that these exchanges come to be dominated by state-run agencies, they no longer function as markets.

Robert Bradfoot, a management consultant quoted by the AP, did begin to point out some of the public choice problems that will occur when this plan is implemented:

    The company will have to cope with political obstacles stemming from its government ties, said Broadfoot.

    He pointed to Temasek's experience in Thailand, where it is embroiled in controversy over its purchase of a controlling stake in a telecoms firm, and state-owned Chinese oil company CNOOC Ltd., which dropped a bid to buy U.S. oil and gas producer Unocal Corp. after criticism by American politicians.

    "The controversies will come when they get this body and it tries to behave like a private financial institution but one that is government-owned," Broadfoot said. "Its reception could be cool in a lot of the places that it tries to do business."

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Comments (6)

  • Person

    I feel kinda bad. I buy equity index funds. Now I feel like I'm disrupting the global economy :-/

    Published: March 24, 2007 11:13 PM

  • Bill

    I disagree. If the Chinese government wants to invest in riskier securities then go right on ahead. I emphatically disagree if I own the securities they are investing in. The previous owners of Unocal were in this position and lost the opportunity to make (in the terms of the old show) MO MONEY! MO MONEY! MO MONEY!

    I agree that the concept of a central bank investing money instead of millions of Chinese citizens is a bad idea for the citizens and the country. But the evil is not the central bank buying securities and taking risk. The REAL evil is is in the institution of a central bank in the first place. If the Chinese had say a gold currency then this point would be moot. The billions pointlessly stored by the central bank at horribly low rates of return would be in the hands of entrepeneurs in the economy trying to satisfy the billions of consumers in and out of China.

    Published: March 25, 2007 8:54 AM

  • Tom Burger

    I agree with Mr. Blumen. As Mises showed in the Socialist Calculation debate, factors of production will be incorrectly valued and priced unless they are owned privately and freely exchanged.

    The central banks already distort market prices through their monetary policies. This plan will add another distorting layer to central bank behavior and take us further away from a capitalist economy.

    Published: March 26, 2007 7:48 AM

  • Person

    Sorry if I was too flippant before, but I don't see the difference on the capital market side between a central bank buying up foreign equities to maximize return is much different from e.g. a pension fund or hedge fund, or even a bunch of individuals. To be sure, the Chinese central bank may victimize the Chinese people, but how is it fundamentally different, in terms of capital allocation, from other groups buying up equities? Am I distorting markets as a passive buyer of equity indices?

    Published: March 26, 2007 10:19 AM

  • Tom Burger

    Person,

    We don't know that China will buy indices, for one thing. If they do not, then government bureaucrats will be influencing relative prices, with no telling what criteria, motivation, or insight.

    Furthermore, China's dollar-denominated demand will be measured in the hundreds of billions of dollars. Just guessing ... that may be as much as three orders of magnitude greater than your resources? :-)

    Published: March 26, 2007 11:54 AM

  • Person

    Tom_Burger:

    1) We don't know China won't buy indices either.
    2) The fact that they bought indices rather than specially selected stocks would not make their purchase more or less significant.
    3) I guarantee you that people with stupidity rivaling any government bureaucrat currently buy stocks in amounts well above what China would spend. As long as active traders "bid away" excessive valuations -- which they do -- it won't influence prices much, just shift one passive owner class to another.
    4) Even if they do take an active role, they're still profit-maximizing like any other shareholder. This isn't like buying domestic equities -- China can't pass laws favorable to the companies it holds, except for their Chinese investments, which it's trying to diversify away from.
    5) Vanguard alone manages over $1 trillion. ExxonMobil is valued at somewhere between 3 and 5 hundred billion dollars.

    Published: March 26, 2007 12:23 PM

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