26 May 2007

China's Foreign Reserves

The People's Republic of China is sitting on cash. It is holding foreign-exchange reserves of more than $1 trillion (pronounce that "t"!). That is twice the amount of the PRC's reserves just two years ago.

According to The Economist, that $1 trillion is enough money to buy all the gold in all the vaults of the central banks of the world.

Such games-playing with numbers is fun, but there would be operational problems with the gold-buying spree as a policy. Might the money be used for infrastructure projects -- roads, bridges, water treatment plants? The problem is that by employing such money domestically China would inflict upon itself an inflationary spiral (inflation, remember, is too much money chasing too few goods).

China wants to invest its reserves in the rest of the world, and has decided to do something more adventurous than just buying U.S. Treasury bonds. In recent days, it announced that it's buying billions of dollars worth of non-voting equity in a US based private-equity firm, The Blackstone Group LP. Its important to note that this isn't an investment into one of the funds that Blackstone manages, but an investment in the management firm itself. (Its like buying stock in a bank rather than simply opening an account there.)

The easiest observation to make about all this is that a country still formally Communist in doctrine is now investing in a quintessentially capitalist institution. But of course the PRC's devotion to communism has been mostly lip service now for a long time, so this surprises no one.

A more speculative line of thought: what now happens to the market for US Treasuries? It's been my impression that China's enormous appetite for the stuff has been a large part of the market demand, and that this market demand is what has allowed the US government to deficit-spend itself silly in recent years with no real detrimental consequences. But what if China doesn't want the IOUs from Uncle Sam anymore? Who else will?

That's not a very pressing concern, though, because China's foreign reserve is plenty large enough to absorb those IOUs and leave a stray three billion on the side for the Blackstone deal, too. But if its a straw in the wind, then the wind could be troubling.

We should also say that China and Blackstone were both very careful, in the announcement of the deal, to specify that these were non-voting shares. The PRC thereby avoids the diplomatic consequences of appearing to 'take over' an important US based company. It learned this lesson, I'm guessing, from the recent Dubai port-management imbroglio.

It'll be nearly 10% of Blackstone's equity, though. So, whatever the formalities of voting, I suspect that the Chinese agency involved will have a seat at the table when important decisions are made.

This is a fascinating straw, at the intersection of a lot of different winds. The integration of the economy of the PRC into that of the rest of the world might prove to be the big economic/financial story for decades to come.

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Knowledge is warranted belief -- it is the body of belief that we build up because, while living in this world, we've developed good reasons for believing it. What we know, then, is what works -- and it is, necessarily, what has worked for us, each of us individually, as a first approximation. For my other blog, on the struggles for control in the corporate suites, see www.proxypartisans.blogspot.com.