This is the second part of the series. First part here.
The Alternatives
Holding $2 trillion dollars, the Chinese authority has several options.
A Portfolio of US Treasury managed by PBoC
This is the status quo. Don’t think it is risk free return. Besides risk of inflation as I mentioned earlier, there is also exchange rate risk and a hard decision of short/long term allocations.
While the yield curve is influenced by the Fed, the possible reallocation of the Chinese reserve would inevitably move the yield due to the size of the portfolio. Out of curiosity, I would like some transparency of the current arrangement, or will I be asking for too much?
A Sovereign Fund
This one has also been carried out. China Investment Corp (CIC), is managing $200 billion financed by debt issued by Ministry of Finance. Ostensibly the risk is transferred to another entity, actually if CIC goes under the government would be footing the bill.
Again, some transparency would help. At lease have some press releases, as does the Abu Dhabi Investment Authority (ADIA).
Financial Investment by Citizens
This is to offer global investment options to local citizens in China - saving rate is high. Instead of limited local personal financial options, offer choices of international equities, bonds, commodities, REITs, etc.
It may partially solve the problem of dollar flood, but it sounds a bit dangerous, doesn’t it? Besides, it seems out of line of the current Forex management philosophy of the government. The consumer protection regulations may not be ready as well.
M&A by Corporations
We live in a global village. A large and uncultivated local market notwithstanding, Chinese corporations have to be global in scale to contribute to the global economy. Foreign merge and acquisitions or FDI sounds a natural step.
I am talking about strategic acquisitions and/or investment (vs. financial ones for financial gains). With global asset price depressed, it is never a better time.
The Chinese companies’ global footsteps have been intensifying, mostly in the resource acquisition area. Google it for more information. But I would like to stress the obstacles here, without an intension to be negative.
First, there is a huge historical, social, political, legal, cultural, linguistic gap. China has been a closed economy for a long time, seriously lacking experiences of global operations. Besides, we are commies. Chinese companies grew up under a different sets of rules and competitive environment. There are a lot to learn.
I have to point out one misconception: Chinese pundits like to distinguish mature market (i.e., developed economies) vs. immature market (developing economies) and insist that the later is more suitable for Chinese companies. The not-so-conventional wisdom makes less sense to me. The so-called mature market is called so for a reason – open market of greater size, well established infrastructure, a more complete legal environment – overall, a safer investment field in spite of competitive intensity. Why giving up?
Secondly, worthwhile competitive advantages have to be established. Chinese companies are perceived as low-cost producers - China’s nominal GDP per capita is $18k, while most developed countries are above $40k. Or you can look here.
However, cost leadership is an edge easy lost. sustainable global businesses require the emergence of some serious global brands, based on technology advance, management and operational capabilities. There are but few established examples.
Thirdly, it needs a capital market for financing needs – few companies can afford the bills by operation cash flows alone. Chinese banking system are nationalized and theoretically inefficient on capital allocation, not mentioning lacking international exposures.
Finally, it returns to the topic of exchange regime. RMB is appreciating at 5% per year, raising the bar of required rate of return.
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