THE BLOG
07/06/2010 05:16 pm ET Updated May 25, 2011

Coping with China's Financial Power

Chinese executives think they are not wanted as investors in the United States and they may be right. Ever since the 2005 public relations campaign that successfully ended China National Oil Company's attempt to buy Unocal, Chinese decision makers have concluded that the deck is stacked against them. U.S. citizens believe that China's state-owned business are instruments of the State and hence the Communist Party. And they blame China for the loss of jobs here even given evidence to the contrary.

It is true that China's approach to economic development has turned that country into a lopsided giant, an export juggernaut with one huge financial arm. At the end of 2009, it held $2.4 trillion worth of foreign exchange, the largest amount of foreign exchange owned by any central bank in the world.

Never before has China had this much financial might, and it is now experimenting with how best to use it in its relations with other states. Although China sometimes sounds ambitious, it is being prudent. For now, its financial foreign policy rests on two simple strategies: accumulating foreign currency reserves and sending money abroad--in the form of direct investment, aid, assistance, and loans--in order to secure the raw materials, new technologies, managerial know-how, and distribution networks that will bolster domestic growth and the Chinese Communist Party's legitimacy.

China's use of its foreign reserves in the international currency markets is aimed at managing the value of the renminbi--a normal part of any country's monetary policy. Beijing's open-market activity, the buying and selling of billions of dollars of financial instruments, has put it in close contact with the other major players in the multitrillion-dollar foreign exchange market. And these daily financial flows have lowered interest rates while increasing the liquidity and stability of international financial markets.

Having set the stage for economic growth through its financial policies, Beijing tries, in its direct dealings with other governments, to create jobs and secure the inputs it believes will stimulate domestic growth. But, in its bilateral foreign policy, Beijing prefers the somewhat blunt tools of direct investment, outright grants, and so-called concessional loans, loans with terms far more generous than those available on the market.

The Chinese government began to encourage "foreign direct investment" (FDI) from Chinese businesses in 1999, but this "go out" policy got off to a very slow start. As the need for energy and raw materials to feed China's booming economy grew however, the search for resources spread worldwide.

Still, there is less Chinese FDI than one might expect, and very little of it is being invested here or in other developed economies. During 2009, Chinese companies invested only $48 billion overseas, around one percent of Chinese GDP. This is partly a result of various barriers to Chinese investment outside the mainland. In addition to popular resistance to acquisitions of U.S. firms by Chinese, language and cultural barriers are a consideration.

Partly because of these dynamics, the Chinese government decided early on that it could not rely exclusively on state-owned enterprises and private-sector entrepreneurs to invest overseas. In 2007, it set up a sovereign wealth fund, the China Investment Corporation, now with a capitalization of over $300 billion.

As China invests more and more savings abroad, it will likely project its financial power differently. Down the road, Beijing may become less intent on using aid, grants, and concessional loans abroad so directly in the service of China's domestic economy. But this is not certain. No one knows, for instance, whether the Chinese government would allow capital to move in and out of the country without government involvement. Such liberalization would be a drastic change in China's financial foreign policy.

So far, China's financial foreign policy has been good for other countries and less beneficial for China itself than first meets the eye. China is buying U.S. debt. It is helping make orderly markets. Its FDI is helping it learn about the outside world. As for Beijing's aid and assistance to developing countries, the amounts involved are relatively small, and the Chinese government is generating a fair bit of resentment. Its mercantilist approach will not give the government any more real security over sources of supply than if it bought them at international prices on the open market, and in the fullness of time, as the Chinese government recognizes this, it is likely to shift its tack without external pressure.

For now, China would be well advised to stick to closely-held company acquisitions and to straight lending. Policymakers in the United States should remember that China emerged as a financial power less than ten years ago. It's too bad China announced only $5 billion of investments in the U.S. last year. With a better understanding of China's domestic imperatives, Washington can encourage Chinese firms to invest here in ways that increase their involvement in the global economy while helping us grow our businesses and job opportunities.

Ken Miller is CEO and President of the merchant banking firm Ken Miller Capital LLC, Director of the USA Pavilion at the 2010 Shanghai World Expo, and a member of the U.S. State Department's Advisory Committee on International Economic Policy. A longer version of this article is published in the July/August issue of Foreign Affairs.