from Follow the Money

Commentary on the People’s Investment Company has been outsourced to Stephen Green

March 26, 2007

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Stephen Green of Standard Chartered has the best analysis I have seen of the bureaucratic politics behind the creation of China’s new state investment company, as well as the best analysis of the constraints on its operations.  

As Green notes, the management of a country’s reserves -- especially a large country's reserves -- is fundamentally about supporting a country’s exchange rate regime (“Running FX reserves is not like running an investment or hedge or even pension fund. It should not be about maximizing returns, but first about supporting the chosen exchange rate regime”).  A large state investment company probably faces similar constraints.  

Green writes in Business Week:

There are other issues which will complicate Beijing's pursuit of happiness. ….  First, with the dollar. Premier Wen Jiabao, answering questions at the National People's Congress, went out of his way to make this point, saying the new fund would not have any impact upon the dollar. And for its own part, China is still caught in what former U.S. Treasury Secretary Larry Summers once called "the balance of financial terror", since if they sell their dollar holdings, the value of their residual U.S. holdings will fall. If the markets ever caught wind of China diversifying its holdings, dollar-selling pressure would be immense—and Washington would have something to say, too. But this raises the question why start a new fund if you don't want to do anything differently? That creates incentives to be extremely conservative, diversifying quietly and gradually.

Second, consider the possible impact on the region. How would people react if Beijing bought large quantities of the equities and debt traded in Taipei? Or of those traded in Tokyo? If the fund does indeed turn out to be active in Asian equities, China's relationship with the region will get a lot more complicated. How would other investors feel if China FX Fund owned 5% of their company? Would they be assured that China was only holding a position for financial reasons?

There are also big operational questions. If the new fund went into buying control of ventures overseas—an Indonesian gas field, a failing U.S. corporate, a high-end German engineering venture—how would that entity be operated? Would it be handed over to a Chinese corporate with some experience in that area or would managers and/or directors be sent from the fund? These are immense challenges, and the potential for generating nothing more than dissatisfaction at home and unease overseas are significant. Money, in short, will likely not buy Beijing happiness, at least not easily.


One of the rumors about China's state investment company – reported by Green – is that it intends to invest heavily in emerging Asia.  I don’t quite see how, though, that will make China popular in the region.   Many other emerging Asian economies run current account surplus, so they don’t need the money.   Those with deficits generally are already attracting more money than they need, so they are adding to their reserves.  Big inflows from China would put more upward pressure on their exchange rates – or force their central banks to intervene more.   That shifts the dollar that China doesn’t want to hold over to another Asian central bank.  And I don’t think many Asian central banks are all that keen to add to their dollar holdings.  If China really does try to change its asset allocation, things could get interesting.

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