- Global Watch
China diversifying into
equities and into gold?
Gold Forecaster snippet
Jun 4, 2007
- Below is a snippet from the
latest weekly issue from www.GoldForecaster.com
Last year the Chinese government
decided to change its policy on the composition of its reserves
to reflect the composition of its trading partners. This was
an effort to hold currencies sufficient to cover 'rainy days'
with these partners. But as reserves are at levels way above
those needed for a 'rainy day', the Chinese government finds
itself holding well over a $ trillion more than it needs and
this amount is rising by $250 billion a year and sure to rise.
So what can they do with these
'excess' funds? They can't enter the foreign exchange market
to sell the U.S.$ component of these reserves, as they would
certainly hammer the value of the $ itself and probably start
a run against it, so that's out.
Investment in Gold?
Will they invest in
gold? We believe they will, but the sheer size of their reserves
makes it impossible for them to go into the open market to buy
gold, after all a tonne of gold only cost $20 million, 50 tonnes
a $billion. What will be easy for them to do is to buy gold for
their reserves via the purchase of local production, now around
250 tonnes a year [a mere $5 billion], but this will be paid
for with Yuan. The Chinese want to keep the surplus away from
the Chinese economy and avoid increasing the inflationary printing
of money, so they will be cautious when doing this. Such caution
will, of course, be tempered by a continuous expansion of the
local money supply to accommodate the larger economy and its
consequential demand for more money. So the purchase of local
gold is certainly on the table of choices in front of the Bank
A more appropriate way to ensure
that there is gold in China is to expand the size of the local
Chinese gold market through the widening of the gold market and
direct encouragement to the Chinese citizens to buy gold and
we believe they want to do this. After all the holding of gold
by its citizens, still leaves that gold within its reach.
Investment in other Assets - The U.S.
$ & Treasuries.
To date they have parked
their dollars in U.S. Treasuries, as most international surplus
funds are parked in there, a sound situation it seems on the
surface and from a risk point of view. Yes, that's correct, if
they're holding reasonable and not excessive amounts of the $,
as this is the most liquid of markets in the world. They are
under no illusions though, as all they have in their hand is
a set of U.S. government I.O.U.s in very large quantities. This
is not wise, as tensions arise against China from the States,
who watch from a distance as China's cheaper prices and goods
are sapping U.S. global economic power. Indeed, China must realize
that the U.S. government has the capability of exerting control
over its paper and there's little they can do about it. The States
can retain control over this paper by even imposing Capital Controls
such as the following: -
- They can impose controls over
the excessive selling of these instruments much as other nations
[e.g. South Africa] did in the past when they placed a moratorium
over the repayment of debt, when there was a run on the Rand.
- They can even institute a
dual currency system [as did Britain in 1971] whereby capital
had a different rate on the foreign exchange markets to that
given to commercial transactions. This ensured investors suffered
if they withdrew their capital from the country and rewarded
those who introduced new capital to the country, thereafter.
Either way the States can keep
a grip on China's and all other $ investors money, justifying
it in the national interests of the U.S. China's immediate problem
is that it is stuck with a currency that is likely to fall and
vulnerable to government control, if the $ system is rattled.
What other options are open?
So what options are
left to China? China has to move away from their excess dollars
and its derivatives, so as to lower the risk from these holdings.
There is one certain way, which
has worked in the past, but could meet obstacles [if the politicians
got excited - a near certainty on this matter]. It is to convert
the currency and their derivatives into assets. This means China
must move its money out of the 'parking bay' in Treasuries and
buy equities [and more solid assets as well].
No, not across the board to
be minor shareholders in a sound well spread equity portfolio!
That would see China immersed in the U.S. economy under the control
of the U.S. authorities still, but a worse situation than before,
when they held Treasuries. In the position of non-controlling
equity holders they would now find they faced far greater risks,
ones that no Central Bank could countenance. China would have
to buy majority positions in companies or even in their entirety,
so that they controlled them.
Ideally strategic companies
would be the targets too, who could help China develop itself,
as well as retain value and grow inside the States. Expect huge
development contracts to go to companies with a majority Chinese
shareholding, enhancing their value even more. Such companies
can be in the U.S. companies or even foreign ones so long
as the Chinese paid for them with their U.S. dollars.
Such a policy would pose no
risk to the $ exchange rate [even foreigners will be happy to
be paid in the U.S. $ at present] and China would then find itself
under the same legislated protections as U.S. companies are now
inside the States and free from U.S. influence in the case of
foreign companies in whom they bought majority stakes.
The damage caused by the flight
from Treasuries would be ameliorated by the actions of the Fed
to some extent and be more than compensated by the potential
increasing value of their new equity investments. After all if
U.S. Treasury rates rose strongly they would pull the U.S. equity
market down and cheapen the purchase prices of the shares the
Chinese sought - a fair quid pro quo?
Such policies would be the
'spoils' of the economic battle the Chinese are winning. Their
selective conquest of the U.S. economy and its expertise would
thereby enhance Chinese growth and ease its way into the position
as the top global economy?
What would be the first step
on such a road? Buy into a company that will get you the majority
positions in your target companies. Last week saw the announcement
of China's intention to use $3 billion of its foreign exchange
reserves to buy a 9.9% stake in Blackstone, the U.S. buyout fund.
The investment will coincide
with Blackstone's landmark $40 billion stock market listing,
expected in the next few months. Quite rightly, Stephen Schwarzman,
Blackstone's chief executive, hailed the deal as an "historic
event that changes the paradigm in global capital flows."
Cleverly, under the terms of the deal, the Chinese government
has given up its voting rights associated with the stake in Blackstone.
Wisely, the move is aimed at defusing any U.S. political opposition
to the deal. In its prospectus, Blackstone warned that its priority
was to return cash to the private investors in its funds, rather
than to pay dividends to shareholders. After all the Chinese
want more valuable assets not dividends.
The investment will come through
a new Chinese agency charged with managing part of the country's
$1,200 billion in foreign reserves. The price of the stake to
be sold to Beijing will be at a slight discount to the one paid
by investors in the initial public offering. It is understood
that China's foreign reserve agency has agreed not to invest
in rival private equity groups for 12 months. We are sure Blackstone
had to pay a heavy price [looking after China's interests?] to
get this 'monopoly'.
This is the start of a new
and likely perspicacious policy by Beijing. The first obstacle
in its way will be when politicians see the buyouts as a threat
to the U.S. This could be well down the road.
And now Saudi Arabia diversifies from
the $ into assets.
For similar motives,
Riyadh-based chemicals company Saudi Basic Industries Corp. is
in the lead to buy General Electric Co.'s plastics business.
It looks like bidding for the business would approach $11 billion.
But the Saudi government is under the thumb of the U.S. and would
never pose a threat to the U.S. as they are wholly dependent
upon the U.S. for its power. The Chinese are not under the influence
of the U.S. Such a takeover would be seen as tame foreign direct
investment into the U.S.
GE, the world's second-largest
company by market capitalization behind Exxon Mobil Corp., has
close ties to the Saudi government. In December and January alone
the company received about $2 billion in orders for Saudi infrastructure
China is to follow this thinking,
but with $1.2 trillion to spend, so far, they are able to impact
on the U.S. economy heavily. This will make the companies it
buys extremely attractive, as they will be backed by the Chinese
government with a whole nation to develop.
But don't be naïve enough
to think that the U.S. economy is going to benefit, as a whole.
The purpose of the investments will be to benefit the
Chinese economy first. Any U.S. benefit will be incidental!
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Jun 1, 2007