China: The New Global Hedge Fund
I have been covering the story of the sovereign governments' ongoing ventures into capital markets with their accumulated currency reserves (see: 1 2 3 4 5).
The Economist has done a great piece on this (The World's Most Expensive Club) providing statistics showing the size of the sovereign investment funds relative to the world's capital markets.
Until recently, China's holdings of dollar-denominated assets consisted primarily of US Treasury debt. Earlier this month, the Financial Times reported that China has agreed to place $3Bn (of its approximately $1Tn in foreign exchange), with Blackstone, a private equity financier.
The Financial Times reports (see:China to Take $3 Billion Gamble on Blackstone, Trickle of Chinese money could become investment flood, China to buy 10% stake in Blackstone while yielding voting rights ):
- The Chinese government is to use $3 billion of its vast foreign exchange reserves to buy a 9.9 percent stake in Blackstone, the US buyout fund, in an unprecedented move that underlines Beijing's desire to tap into the private equity boom.
The investment will coincide with Blackstone's landmark $40 billion stock market listing, expected in the next few months, and will allow the private equity group to nearly double its original target of raising $4 billion.
Stephen Schwarzman, Blackstone's chief executive, hailed the deal -- the first time Beijing has invested its foreign reserve in a commercial transaction -- as an "historic event that changes the paradigm in global capital flows."
I don't have a lot more of an analytical nature to say about this than what I have said in my previous posts. This venture of government money into private capital markets presents a problem raised by Mises in his critique of economic calculation under socialism: financial asset prices do their job of helping entrepreneurs allocate capital only in the context of a private property system of capital ownership. The return derived from the assets is a function of entrepreneurship, while the modern finance view tends to see assets as having certain historical returns related to their volatility, without providing a causal-genetic explanation for how those returns are achieved.
Comments (16)
Jonathan Bostwick
What happens if they dump the whole trillion? Does the dollar collapse?
Published: June 3, 2007 12:13 PM
Robert Blumen
It's my understanding that for the most part these fund are not overweight US markets. They are global in nature. The issue is not one of currency exchange rates, at least as I can see, though it will certainly impact exchange rates in ways that are difficult to foresee. The issue is one of the gradual absorption of private capital markets into government ownership.
Published: June 3, 2007 12:45 PM
Nick Bradley
I've thought about how they could go about dumping the whole trillion. In my estimation, they couldn't pull it off without causing their remaining holdings to plummet.
Also, China would have to dramatically appreciate its currency if it sold all of the T-bills off.
China keeps its currency down for a reason: it keeps disgruntled Chinese workers off the protests lines and in the export industry. China already has a major unemployment problem -- their actual unemployment is anywhere from 15 - 25%. A stronger yuan would kill the expoer industry.
Published: June 3, 2007 2:13 PM
Jean Paul
I REALLY don't understand what you guys are talking about... where's the best place to begin with all this?
Published: June 3, 2007 2:42 PM
qwert
As far as i could reason, i would have to believe that no, this one transaction doesnt affect the dollar's exchange rate much at all, but i dont think that is the point as it represents something like .3% of China's reserves
I see the reason this is a HUGE story, is that China is now showing that they have an agency set up to specifically exchange dollars for assets and their willing to use it. Given their tremendous losses simply holding dollars, this is a logical move to finally say "we've lost enough," and start selling.
If this process continues (which only makes sense) you will see more dollars that were formerly sitting idle starting to flood the world. Even worse, with so many dollars sitting around the world, why wouldnt others, in anticipation of this further future decline in the dollar, get rid of their dollars while the gettin' is good!
I realize this is an argument many have heard before, but i dont see where it is wrong. This sooner or later, is the only logical route.
What does everyone think?
Published: June 3, 2007 2:58 PM
qwert
Jean Paul, I quickly found this article but im sure you could find more by going into lewrockwell.com or somewhere else and doing searches. I think this is a huge issue that most definitely will be worth learning as much as you can about.
Mr. Blumen is referring to the issue of governments owning investment property which is a problem, but i think there is a bigger issue here in relation to the value of the dollar.
Good luck!
http://www.lewrockwell.com/north/north308.html
Published: June 3, 2007 3:16 PM
Mark Humphrey
I fail to understand why the dollar is supposedly on the verge of collapse against various foreign currencies. Purchasing power is the ultimate determinant of the dollar's value versus any particular foreign currency. If the dollar's purchasing power falls faster than, say, the Chinese renimbi's purchasing power, then in this case the dollar would fall against the renimbi.
To say that the dollar's purchasing power falls, of course, is to recognize that prices in the united States have risen, either because of monetary inflation, or because production falls, or both. So to say that the dollar's purchasing power falls faster than the renimbi's purchasing power, is to recognize that prices in the USA have risen more, or faster, than prices in China.
If prices in the United States rise more than in China, market forces act to reduce the exchange value of the dollar against the renimbi. American importers, seeing opportunity, exchange dollars for renimbi for the purpose of buying goods in China that, after the currency exchange, are cheaper than in the USA. The process of selling dollars for renimbi pushes up the exchange rate of renimbi and pushes down the exchange rate of dollars.
Have prices been rising faster in the USA than in China over, say the past ten years? My guess is yes. By what differential? I don't know. Two per cent a year? Three percent a year? If so, ten years cumulative differentials equals 20% to 30% overvaluation of the dollar against the renimbi.
However, we don't know if the renimbi was over valued or undervalued against the dollar ten years ago, or whenever the Chinese pegged their exchange rate against the dollar. If the peg overvalued the renimbi early on, there might not be a large value differential between the two currencies.
More fundamentally, the idea among gold bugs that the dollar is on the verge of major collapse is morean article of faith than a reasoned conclusion. The dollar fell relentlessly against foreign currencies in the seventies for good reason: our price inflation was raging far beyond inflation rates abroad. The dollar had to fall.
Today, our monetary policy is comparatively tight, and has been for about the last three years. In fact, the monetary base over the past 18 months has grown only anemically. Meanwhile, foreign central banks, including especially China, print money like drunken reds. If this differential were to continue, whereby our central bank remained tight while foreign central banks, in China, Japan, Europe, inflated their money at a faster rate (as has been the case for some time, now), the dollar could get stronger.
Of course, the wild card that keeps smart investors on their toes, is the huge quantity of dollars held abroad by virtue of the dollar's status as world's reserve currency. Events could transpire to erode and destroy this status.
Still, as long as our Fed keeps our money growth in check, often repeated claims that the dollar is about to plunge have an air , to me at least, of unreality.
Published: June 3, 2007 4:03 PM
Good for the payee.
I am glad the Chinese government is going into private equity markets. That is good news for US and Western equitites as they get new money. It is bad news for the US and Japanese governments as the Chinese will prop up their currency less to get better returns elsewhere.
As for the Chinese people, they get hosed. Their stupid government steals money from them by buying US currency and now it is going to use that money in one of two ways that governments manage money:
1. Free of RISK-they throw the money around like crazy people. Think of the Japanese in 1988.
2. 100% RISK. They will kill the bozos that lose money. Like their current issue.
Their best course of action is to let their currency rise in value as their consumers rise in wealth. Then the US will have to find someone else to suck up their government debt. Then this money will be in the hands of the citizens where they can spend it, invest it or store it at their array of risk preferences.
Published: June 3, 2007 5:31 PM
qwert
Regarding the Chinese Currency, they have been devaluing to keep pace with the dollar but against most other currencies and assets, the dollar has dropped like a rock (ie purchasing power has fallen.) Other major currencies are hitting 20-some year highs against the dollar and the US dollar index is near its all time low!
According to the way the USGov't calculated it in 1980, inflation is now over 10% and the fed money creation (m3) is at 12% and rising. (http://www.shadowstats.com/cgi-bin/sgs?)
The dollar is in high supply and low demand (central banks are selling or ceasing to buy dollars like its going out of style and anyone holding is bleeding losses and China has had enough).
The US Government, consumer, and companies have debt up to their eyeballs and that has been the only way this economy keeps going at its anemic rate (and getting more anemic by the day).
The rest of the world is starting to realize not only are they never getting payed back, but the point of stopping the party by not lending anymore is possibly a more attractive option.
As the economy slows (according to shadowstats.com GDP is already negative) and foreigners realize it, they will even more aggresively pull their money out of the US further lowering demand for the dollar.
We know there MUST be a recession and it seems we are getting closer every day. Bernanke's solution that he has made crystal clear: pump more money into the economy so that asset prices dont fall and then the economy will pick up again.
This is a disaster waiting to happen. I dont call myself a gold bug, but they cant print the shiny stuff on a printing press.
Published: June 3, 2007 6:06 PM
Contrarian Investors' Journal
@ qwert
You may want to read up this article:
China unwilling to hoard US dollars—what’s the implication?
Published: June 3, 2007 8:04 PM
Matt
What does the Austrian school say about equity prices? There is supply and demand in the market, but there is also intrinsic value. For instance, if the majority value Intel at $30, and they have a big deal with the Chinese, and the Chinese government begins buying Intel stock pushing the price to $50, they have to continue purchasing shares if investors still believe there is only $30 of intrinsic value.
Maybe the reason is so a company can use their increased share price to acquire other companies, but I don't see how governments can continue to influence markets unless they have a much larger source of funds (like if the government invested everyone's retirement funds in the stock market).
Also, where is the line to be drawn for socialism? In the U.S., we would never allow the government to nationalize Exxon, but what if China, Saudi Arabia, and Norway control 51% of it? The U.S. cannot bar the funds, because the entire market would suffer.
Published: June 4, 2007 10:17 AM
NAt
Matt, the U.S. did just that in 2005 when it prevented the Chinese government (CNOOC is 70% owned by the Chicoms) from buying Unocal, and again blocked the United Arab Emirates government (Dubai Ports World is owned by the UAE government) from buying up some U.S. ports.
And it's a good thing too. Either we are in favor of government owning the means of production or are against it.
Published: June 4, 2007 2:31 PM
Mark
What does the Austrian school say about equity prices? There is supply and demand in the market, but there is also intrinsic value. For instance, if the majority value Intel at $30, and they have a big deal with the Chinese, and the Chinese government begins buying Intel stock pushing the price to $50, they have to continue purchasing shares if investors still believe there is only $30 of intrinsic value.
Unless of course, they invest in selected companies which they offer preferences to with respect to trading in Chinese markets. In which case, the intrinsic value would rise to $50 or even $60 or more!
Published: June 4, 2007 3:05 PM
Free Money
NAT:
We can not tell any government what to do with their money and shouldn't because we ONLY HURT OUR OWN ASSET HOLDERS. If a foreign government pays big money for US asset then is the OWNERS perogitive to sell it. If the US government wants to be involved the let them own the asset.
Think what happened when billions in wealth from Japan poured into the US. Quite a few equity holders became big time wealthy all at Japanese expense. Then the crash hit and the Japanese got hosed. AND THE JAPANESE WERE QUASI-GOVERNMENTAL. Think how much US equity holders can make/steal from FULLY-GOVERNMENTAL investors.
Published: June 4, 2007 4:53 PM
Vanmind
Mark, I could be mistaken, but I think the Austrian School rejects the notion of intrinsic value. There is subjective valuation, which might lead to human action, which might affect price levels and therefore also the subsequent subjective valuations of others (which might lead them to take different actions, and so on).
Don't quote me. I'm Mr. Dense.
Published: June 4, 2007 11:12 PM
Tom Rapheal
I agree with Vanmind. Nothing has intrisic value
Published: June 5, 2007 9:22 PM