CHINA U.S. TRADE DEFICITS NEWS

Stock Market News - BEIJING 3/9/2007 - China Forming Fund to Invest Reserves
 

China will soon create one of the world's largest investment funds, with ramifications for global stock, bond and commodities markets and for how the U.S. finances its trade deficits.

Finance Minister Jin Renqing said on Friday the aim is to make more profitable use of its $1 trillion in foreign currency reserves that have piled up as it posted huge trade surpluses year after year. Most of those funds are now parked in safe, but relatively low-yielding U.S. Treasury securities and other dollar-denominated assets.

We can achieve more profit from the investments," Jin said at a news conference. "We are now preparing the organization of this new corporation."

Jin said Beijing may follow the lead of Singapore's Temasek Holdings, which manages nearly $90 billion in government pension funds and other assets. It owns stakes in Singapore Airlines and Singapore Telecom, as well as in banks, real estate, shipping, energy and other industries in India, China, South Korea and elsewhere.

Analysts have speculated for some time that China would create an investment company, and officials have said repeatedly they want to make better use of the country's reserves.

Economists have suggested Beijing might allocate as much as $200 billion to $400 billion to the new company, which in a single move could create one of the world's richest investment funds.

"They want to be more aggressive than what they do with current reserves," said economist Mingchun Sun at Lehman Brothers in Hong Kong.

"They could invest in higher-yield products -- stocks, corporate bonds, maybe even commodities," Sun said. "Basically, the returns would be higher because the risk is higher."

A shift in China's investment strategy could change its purchases of Treasuries, affecting a market that Washington relies on to help finance multibillion-dollar budget deficits, and perhaps eventually push up U.S. interest rates.

But Lehman Brothers' Sun played down that risk. He said that with its reserves growing by as much as $20 billion a month, Beijing could afford to keep buying U.S. government bonds while also channeling billions into new investments.

Even so, news of the Chinese announcement -- along with an upbeat jobs report, which reduced expectations the Federal Reserve will need to cut U.S. interest rates -- came on the same day of a big drop in the price of the benchmark 10-year Treasury note Friday. That pushed up its yield to 4.58 percent from 4.51 percent late Thursday.

The Commerce Department also reported on Friday that the U.S. trade deficit with China soared 12 percent to $21.3 billion, even as the overall gap between what America sells abroad and what it imports slimmed slightly in January to $59.1 billion from a December deficit of $61.5 billion.

Jin gave no details of how the Cabinet-level company might invest the reserves, nor did he say what portion of the reserves might be channeled through the company or when it would start to operate. Spokespeople for Jin's ministry and the central bank and foreign currency regulator declined to give any other details.

U.S. Treasury Secretary Henry Paulson, in an interview this week on the U.S. television network ABC, rejected suggestions that changes in Chinese bond purchases could affect the United States.

Paulson said Beijing's entire holdings represent the equivalent of less than a single day's trading in Treasuries on global bond markets.

Chinese economists and media reports have suggested China might adopt more unusual investment approaches, ranging from stockpiling oil and other raw materials to spending more on social programs in order to encourage Chinese consumers to spend more and reduce dependence on exports.

The growth in China's reserves is driven by the rapid growth of its exports, which brings in dollars, euros and other foreign currency, and by the billions of investment dollars being poured into the country.

The surge in money flooding in from abroad forces the central bank to drain billions of dollars from the economy every month by selling bonds in order to reduce inflationary pressures.

The precise composition of China's foreign currency reserves is a secret. But economists believe that as much as 75 percent is believed to be in U.S. dollar-denominated instruments, mostly Treasuries, with the rest in euros and a small amount in yen.

Stephen Green, chief economist at Standard Chartered Bank in Shanghai, calculated that last year the central bank made a $29 billion profit on its Treasury holdings after paying interest on its own bonds and other expenses.

But even that represents a return of less than 3 percent on the $1 trillion in holdings.

By contrast, Singapore's Temasek says it has averaged an 18 percent annual return since it was created in 1974.
Friday March 9, 2:24 pm ET By Joe Mcdonald, AP Business Writer
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Wang Jian, executive vice secretary of the China Society of Macroeconomics, an academic organization affiliated with the National Development and Reform Commission said, China should use its reserves to buy resources, like oil fields, mines and foreign technology, instead of investing them in overseas assets. "I don't recommend" the program "as a way to ease the growth of reserves," Wang said in an interview "The dollar is very unstable. If the U.S. is in trouble, Europe and Japan won't escape unscathed."
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An excerpt from Peter Navarro's recent testimony before Congress, though one would do well to read it in its entirety. Web Site http://www.peternavarro.com

The bottom line is that the Chinese already have control over the US economy via the bond market and will only increase that control in the future:

Stage Two in the projection of Chinese economic, financial, and political power is just now getting underway, and it involves what is likely to be a very aggressive move into U.S. equity markets. In this regard, a Bank of America analyst recently reported the expected formation of a new investment corporation in China that may be capitalized with as much as $200 billion, roughly one-fifth of China’s foreign currency reserves.[x] The purpose of this corporation will be to invest some of China’s reserves into equity holdings around the world, with much of the investment likely to be focused in the U.S.

On the surface, this seems like a good thing for the U.S. stock market as any infusion of capital into U.S. equity markets would be reflected in higher share prices. There are, however, several caution flags.

First, should China become as important a player in U.S. equity markets as it now is in the U.S. bond market, it would be able to destabilize not just the U.S. bond market but the equity markets as well. Second, China may begin to use its equity funds strategically to establish controlling interests in U.S. companies. In this way, China may effect decisions ranging from the offshoring of production or transfer of technology to China to lobbying against U.S. legislation designed to promote fair trade.

Third, there is no guarantee that China will always “go long” the U.S. market with its financial capital. Indeed, there may be times that China may want to short the broad U.S. market indices or major U.S. companies as a hedge against events it may either be anticipating – or, in the worst case, precipitate itself.

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