There is historically no precedent for China’s export growth or for its rate of foreign exchange accumulation. In 2007, China will surpass the US as the world’s second-largest exporter, and in 2008, it will surpass Germany, the largest. By the end of September, China had exported nearly US$900 billion in goods.
Just 30 years ago, China was entirely disengaged from the global trading system, as Japan was flexing its trade muscles, accumulating foreign exchange and avidly shopping the world for things to buy. We are reminded that a lot can happen in a generation.
Critical changes began to occur in China’s export trade in the second half of 2004, with a sharp decrease in imports from Asian neighbors while exports continued to grow. On the forex front, between October 2006 and June 2007, China’s reserves soared US$330 billion to reach US$1.33 trillion, and now stand at nearly US$1.5 trillion.
As export growth rate reached 28%, the current account surplus expanded to a heady 9% of GDP. The financial impact gained more weight with an increase in foreign-funded acquisitions, both commercial and informal. The central bank’s practice of soaking up incoming forex to suppress the value of the yuan, capital conversion barriers and currency controls fueled a money supply surge, which in turn drove domestic spending higher in defiance of global trends.
End of the road
Simple arithmetic tells us this can’t go on much longer. The pressure in China is growing, both to drain liquidity from the domestic economy and find more profitable uses for its forex reserves.
Rising domestic consumption and imports are not a viable short-term solution, although it remains a policy goal. Large-scale outbound investment is required to address the imbalances: China must shift its exports from goods to capital.
The China Investment Corporation (CIC), formally launched October 1 with US$200 billion in assets, is the most formal and visible but not the only example of China’s entry into the sovereign fund club. It will follow in the footsteps of Singapore’s two sovereign funds and also learn from the experiences of other domestic entities like China Development Bank (CDB) and the CITIC conglomerate. CDB invested in Barclays, and CITIC is reported to have reached agreement for a large investment in Bear Stearns.
Central Huijin, the central bank’s own investment arm and main owner of China’s four biggest banks, stepped in while CIC was being formalized to invest US$3 billion in Blackstone on the sovereign fund’s behalf. CIC then bought Central Huijin from the central bank for a reported US$67 billion.
There is a powerful synergy as well as a powerful irony in these developments. For synergy, China’s moves come at a time of increasing global concern over capital shortages and credit crunches in major consumer markets, so the money speaks loudly now. CDB was brought in to bolster the Barclays bid for ABN AMRO and, even though this bid was eventually withdrawn, the partnership revealed the enormous potential of combining the resources of a Chinese sovereign investor with the savvy of a foreign financial player.
For irony, the last several years of vigorous private equity growth set the stage for the emergence of powerful sovereign funds. Private equity has been an ultimate example of capitalist free market instruments in action yet it has attracted strong interest in China. Its influence can be seen in the strategies of CIC, CITIC and CDB.
Over the last year, public and governmental concerns grew over the transparency, practices and controls that exist in private equity. These concerns are the forerunner of other ones that will be even more robustly expressed in the West regarding large sovereign financial players – after all, these Chinese funds are foreign, governmental and fundamentally secretive.
The huge forex reserves and the sovereign entities created to deploy them raise a curious question. There is a broad consensus that government owned economies (call them “socialist”) fared relatively poorly in the 20th century, and privatization became the key process to unlock economic growth from London to Beijing.
Is the global economy now witnessing the birth of a new mechanism to buy some of the world’s major economic players back into the hands of government owners?
DeWoskin is senior advisor to PriceWaterhouseCoopers and professor emeritus at the University of Michigan