It now appears China's leaders are acting upon their frequently expressed concerns about the continuing viability of the U.S. dollar. On 23 November 2009, the Economic Observer News, an independent weekly newspaper distributed in major cities throughout China, published a story suggesting Beijing's sovereign wealth fund is preparing to almost double in size. According to the Economic Observer News, the China Investment Corporation (CIC) is rumored to be preparing a request for an infusion of an additional $200 billion. The money would be shifted from China's ever-expanding foreign exchange reserves ($2.27 trillion as of September) into the hands of investors charged with earning a maximum return on the Chinese taxpayers' hard won gains.
This is great news for the Chinese citizenry...the purported "victims" of Beijing's strict monetary policies...and bad news for the average American. Allow me to explain this conclusion by running a few numbers by the reader. I'll start with the official Treasury figures for China's ownership of our growing national debt. On 17 November, Washington released its latest report on "Major Foreign Holders of Treasury Securities." Here's what the U.S. Treasury has to say about Beijing's spending habits over the last seven months. In March 2009, China held $767.9 billion in U.S. Treasury securities. In April that figure was $763.5 billion. In May it was $801.5 billion. In June, $776.4 billion. In July, $800.5 billion. In August, 797.1 billion. And in September--the last month for which data is available--$798.9 billion. Quite simply, over the last seven months China's investment in our debt has been essentially static.
Now let's turn to China's foreign exchange reserves over the same time period. According to Chinabilty, a website that has reliably provided the most current news and statistics on China's economy, in March 2009 Beijing's foreign exchange reserves stood at $1,952.7 trillion. In April that figure was $2,008.9 trillion. In May, $2,089.5 trillion. In June, $2,131.6 trillion. In July, $2,174.6 trillion. In August, $2,210.8 trillion. And in September, $2,272.6 trillion. My point in reciting this data--during the same period that China's foreign exchange reserves grew by approximately $320 billion, Beijing's interest in funding Washington's extravagance flat-lined.
Please note, I am not arguing that the Chinese are preparing to flee U.S. Treasury securities. Such a move would be devastating for Beijing and Washington. Rather, I am increasingly convinced the evidence points to a Chinese decision to diversify their holdings. A logical move--and one we can actually track by monitoring the China Investment Corporation.
Officially established in September 2007, the China Investment Corporation is responsible for managing Beijing's official sovereign wealth fund. (The U.S. Treasury defines a sovereign wealth fund as a government investment account, typically established using foreign currency reserves, but managed separately from those reserves.) Initially provided a pool of $200 billion, CIC was tasked with supporting the rise of China's largest banks and seeking off-shore opportunities. The approximately $100 billion CIC's managers allocated for the first task has paid significant dividends--as of August 2009 this investment has risen in value by an estimated $98 billion. The initial offshore investments were not so lucrative. In fact, the China Investment Corporation took significant hits on forays into Morgan Stanley and Blackstone.
These losses were an object lesson for Beijing. Unlike Washington--where bailing out the bankers and large insurance firms became a mantra of the moment--Beijing decided its taxpayers' funds were best kept locked up at home. This caution is now to be lauded. As a result of keeping 87.4% of its holdings in cash and only risking 3.2% in equities and 9% in fixed-income securities, CIC lost a scant 2.1% of its value in 2008. During the same time period Harvard and Yale's endowment funds--the reputed investment champions--declined in value by 22% and 13%, respectively.
Guess what, the Chinese are now ready to invest...in apparently anything but more U.S. T-notes. In March 2009, the China Investment Corporation deputy general manager declared "the current international situation gives the CIC a good opportunity." (OK, now go back and look at when China's interest in U.S. Treasury securities essentially flat lined...I'm thinking this is not coincidental.) So where is the money going? To long term investments that serve Beijing's national interests--read, economic growth--and earn a respectable return for the Chinese taxpayer.
A case in point, commodities. In July 2009, CIC announced its first foray into the natural resources sector--a 17.2% stake in the Canadian mining company Teck Resources Limited. The purchase price--$1.5 billion. In September, CIC bought an 11% stake in Kazakhstan's state-run energy company for $939 million. This move came only a week after CIC purchased $1.9 billion in debt from Indonesia's biggest coal producer. In October, CIC spent $700 million on a Mongolia-focused mining firm. And in November the China Investment Corporation sunk $400 million in China's largest wind-power producer and $1.58 in a Virginia-based power-plant developer. All told, over $5 billion now spent on energy and resource industries in less than 6 months.
The story does not stop there. In August, CIC bailed out the heavily indebted majority owner of London's Canary Wharf real estate development--taking a 19% share in the British firm. In September, China Investment Corporation mangers began talking with private-equity funds in the U.S. about acquiring distressed real estate assets--including mortgages and physical property--in the United States.
Has CIC been successful? Beijing seems to think so. The Economic Observer News reports the China Investment Corporation has now reached an agreement with the Chinese Communist Party such that it no longer has to treat its original $200 billion allotment as a debt, but rather as an asset. This means CIC will no longer have to make scheduled interest payments to the Ministry of Finance. Instead, CIC will now pay the state--Chinese taxpayers--dividends. This is a development policy makers in Washington can only dream about. I, for one, am certainly not expecting a similar outcome with our "investment" in AIG or GM.
My bottom line, Beijing has seen the light--further investment in Washington's debt does not appear a wise expenditure of Chinese taxpayers' money. We can speculate what this might mean in the long run...an even weaker dollar and higher interest rates...but should be more concerned about ensuring Mr. Geithner and company get the message. Rather than speculating on the potential of a brighter tomorrow, Washington needs to talk about taking fiscal responsibility seriously, today. The Chinese are not going to be impressed with a blue-ribbon panel that banally offers platitudes concerning the scope of our financial problems. Beijing is only going to be assuaged when Capitol Hill decides it too should be looking to this nation's long-term best interests. Until that happens I suspect the best gauge of Beijing's faith in the dollar's prospects will be measured by where the China Investment Corporation turns next.