"Buying up the US, Chinese-style"

Brad DeLong continues with the discussion on foreigners acquiring ownership of U.S. assets. How long before congress and the media realize what they should know already, that our "yawning external gap is inevitably financed only by selling off assets, which means that foreigners with money acquire ownership and control of US-based businesses," and what will happen when they figure it out?:

Buying up the US, Chinese-style, by J. Bradford DeLong, Project Syndicate: When China National Offshore Oil Company tried to buy ... UNOCAL two years ago, it set off a political firestorm in the US. When Dubai Ports World bought Britain's P&O Steam Navigation Company, the fact that P&O operated ports inside the US led to more controversy.

One would think that a country like the US, with a current account deficit of roughly $800 billion a year, would realize that such a yawning external gap is inevitably financed only by selling off assets, which means that foreigners with money acquire ownership and control of US-based businesses.

But the US -- or at least Congress and the media -- doesn't get it. Americans evidently hope for a world in which they have feckless deficit-generating fiscal policies, a very low private savings rate and a moderate rate of investment, all financed by foreign capital whose owners are happy to bear the risks yet have no control over their assets.

One might think that foreign investors would quake in terror at these terms... But this has not been the case. ...

Someday, of course, this will come to an end. Perhaps Asian real currency values will rise sharply as a result of a burst of inflation in Asia. Perhaps the dollar will collapse and there will be a burst of inflation in the US as the Federal Reserve Board decides that temporarily abandoning its price-level peg is a lesser evil than the unemployment fallout that will result from a dollar collapse and interest rate spike.

A government that buys political risk insurance by placing an ever-growing stock of reserve assets in dollar securities guards against some dangers. But ... US Treasury and high-grade corporate bonds ... that US politicians are comfortable having foreigners own ... are not well hedged against inflation.... Prudent foreign government and private investors would find some way to diversify.

But how? Buying other countries' bonds would mean abandoning the goal of keeping real currency values low against the dollar. Buying up whole enterprises triggers angry speeches in the US Congress. What are needed are intermediary organizations that will grant a measure of control to foreigners, allow diversification across a wider range of US-located assets, and yet still appear 100 percent American to US politicians.

Enter the Blackstone Group.

China's $3 billion investment in Blackstone, while insignificant relative to China's $1.3 trillion in reserve assets -- a sum ... likely to hit $2 trillion sometime in 2009 -- is but a toe dipped in the water, a test run. At the start..., China will have small and indirect ownership stakes in a great many US enterprises, and the odds are that the usual objections will be absent. China will gain a measure of risk diversification ... and avoid running into political trouble. ...

Some observers think that the US political backlash against foreigners "buying up America" is what will bring the current configuration of global imbalances to an end. Deals like China's investment in Blackstone postpone that backlash, but not for long: $3 billion is equivalent to what China accumulates in reserve in less than three working days.

The question following China's Blackstone investment is this: How far can this process go? And how much control will US investors ultimately realize they have given up?

[Discussion of related issues at: "The Right Way to Respond to China's Exploding Surpluses."]

Comments

[Tapen Sinha]

If you recall, in the 1980s, the Americans
were worried about the Japanese "buying up
America." In Australia, in the late 1980s,
the same fear swept through. However, the
fact that LOTS of Australian businesses
were owned by the Brits did not even register.

It has a clear racial dimension.

Tapen

[Winslow R.]

I think Brad is missing something important here..

But how? Buying other countries' bonds would mean abandoning the goal of keeping real currency values low against the dollar. Buying up whole enterprises triggers angry speeches in the US Congress.

Buying up whole U.S. enterprises also requires 'abandoning the goal of keep real currency values low against the dollar'. Switching from U.S. financial assets to U.S. nonfinancial assets is an abandonment of dollar support.

No wonder the U.S. Congress gets angry. I don't think they care what race you are as long as you willing to hold 'wealth' in the form of U.S. debt.

[calmo]

And maybe more accurately anti-China bashing (currently being groomed as our next Enemy, yes?)...wait while I catch up with my wrestling "racism" back to a specific country, Tapen. [The "maybe" is for me.] The Japanese have also been accused of some less obvious unfair economic practices (recently by The Big Lame Three who feel that it is not their hopelessly self indulgent executive practices but that fx business --that is the problem...the very same "problem" that generates such lucrative profits for GM et al in China, yes?), but generally the media absolves Japan, irreplaceable member of the carry trade which enables so much of Finance...which is so much of our growing (but now sputtering) economy.
Now recall that the Bomb was dropped on Nagasaki, not Berlin.
Ok, that duzzit, you were more accurate.

[James Kroeger]

So this is DeLong's "Yes, maybe we should be worried about China's huge trade surplus with the U.S." contribution? Where is the hard-nosed economist that he'd like us to believe he is?

There is actually no reason whatsoever for Americans to be concerned about the PBOC owning dollar-denominated paper assets. The dollars they receive when they sell Renminbi to American importers at the rate of exchange they desire stay in the U.S. and remain as much a part of the U.S. economy as any reserves held in U.S. owned banks. The dollars aren't taken out of the country. They aren't lent to Chinese citizens/firms or anyone else for that matter (unless the dollars that are borrowed are then spent in the U.S.). Effectively speaking, dollars obtained by the PBOC are guaranteed to stay in the U.S. as part of the U.S. money supply. To an economist, the fact that the dollars might be 'owned' by a foreign banker should be considered utterly irrelevant if those foreign bankers can be counted on to act with those dollars just like any domestically-owned bank.

Some like to exclaim, "Yeah, but they will be earning interest that will accrue to non-Americans, making them wealthier at our expense!" to which I respond, "Yeah, and what are they going to do with that interest income except keep it in the U.S. where it will continue to be a part of our money supply? They can't spend/lend those dollars in China, can they? How are we any better off if our government/firms/households owe money to U.S. banks instead of foreign banks, given that the money is going to stay in the U.S. no matter what?"

I would so love to hear DeLong respond to this, but I am so sure that he never will....

[reason]

JK...
You are ignoring the long term downward pressure on the buying power of USD. US Consumers will eventually have to pay more in real terms for imports, as the USD becomes chronically weak. The US will become poorer.

[James Kroeger]

You are ignoring the long term downward pressure on the buying power of USD.
I'm trying to figure out how the dollar would weaken vis-a-vis the Renminbi if the PBOC never demands more dollars per Renminbi?

Of course, the Chinese have said that they will allow a very gradual strengthening of their currency vs. the dollar, but won't everyone be celebrating the consequent gains in our competitiveness then?

[reason]

JK...
There is something else you are not thinking about. At present one of the explainations for Wall Street values rising at the same time as the US Economy is stalling, is that US Multinationals make half their income overseas. So at least on paper, large amounts of US income come from subsidiaries of US Multi-nationals. As US assets are sold, less of this income will come back to the US. The world is changing, and at minus 6-7% BOP it is changing fast.

[James Kroeger]

So at least on paper, large amounts of US income come from subsidiaries of US Multi-nationals.
One of the things that I think many in the business/economics community are not consciously aware of is that when U.S. firms build new factories, etc., in other countries, what they are actually doing is 'activating' unlent bank reserves in those countries. Those reserves could otherwise have been borrowed and spent by domestic borrowers, but were purchased/borrowed and spent by U.S. firms, instead. There is not actually any 'flow' of capital that leaves one country and ends up in another. What happens is foreign banks/firms/individuals get to buy 'ownership rights' of blocks of the other country's currency, which they will then use (spend) in that other country. So when U.S. firms earn income from overseas subsidiaries, that income will typically be spent/invested in those countries.

(Countries---like Japan and China---that choose to stimulate their economies and create jobs through export industries would not have to resort to this option if their own domestic rich people had the knowledge/inspiration to build domestic industries, themselves. The capital is there. No country actually has an excuse for high unemployment problems; it can always obtain the capital needed for growth through taxation or even inflation. The reason why poor countries remain poor is because the upper classes of those rich countries either do not care or do not know how to use their money to produce things of value.)

Of course, at certain times certain owners of foreign currency/assets will want to turn them into domestic currency. When that happens, banks involved in forex will---if demand for that currency is sufficient---demand more units of the currency in demand. Most economists who speak of money/capital markets and international capital flows exaggerate the significance of these transactions, which is why all the predictions of a weakening dollar over the past few decades have been wrong. They've been wrong because central banks that do not want to see their domestic currency appreciate have all the power they need to overcome the impact of speculators; their percentage of the total volume of currency transactions is far greater than that of individual speculators. They can simply sell as many units of their currency as foreign importers want at the same price they sold it the day before. They don't have to demand more of the foreign currency if they don't want to.

So much for the imagined 'efficient markets' thesis in international currency transactions. Once again, the analytical error is made by economists who want very much to believe that a "market" exists out there that is making all kinds of rational decisions. When speculation does move international currency markets dramatically, it is not individuals, but the banks themselves that are doing most of the speculating.

[calmo]

Generally nodding along with most of what James opines here, egThey've [most economists...the orthodoxic chronic toxic] been wrong because central banks that do not want to see their domestic currency appreciate have all the power they need to overcome the impact of speculators; their percentage of the total volume of currency transactions is far greater than that of individual speculators. and know this avoids sterilization issues and massive failures of smaller "emerging" economies.
But Japan as recently as 2003 announced that they were prepared to support the yen/$ with an astounding wad, an amount that was never used...making some of us believe that the gesture was as James outlines, keeping the currency speculators in line.
The volume of fx trade though makes even this Japanese wad look minuscule and it seems to me that the Japanese (and other fcbs) make this gesture/grandstand in desperation against the growing horde of private investors (the HFs).

[anon]

I did a very rough calc not long ago on another topic to see how much it would cost the Chinese to buy up 10% of the top 20 firms (by market cap) in the US. I came up with around 400 billion. Chinese have now over 1 trillion in dollar assets, so this would not exhaust them by any means. I would think buying 10% of a firm would create fewer waves than buying the whole firm, although some economic nationalists might still cry foul. I am not an economist, but if China were to sell US bonds to buy US stocks, I presume this would send rates up in the US. Or am I mistaken about this? China could also shift some money from US bonds into non-US stocks. But China is earning so many dollars on an ongoing basis that it probably would not need to sell anything. Just buy stocks (or real estate) instead of bonds with the inflow.

[reason]

JK...
which is why all the predictions of a weakening dollar over the past few decades have been wrong.
I can remember when a Euro was worth much less than a dollar! And it wasn't all that long ago!

[James Kroeger]

The volume of fx trade though makes even this Japanese wad look minuscule and it seems to me that the Japanese (and other fcbs) make this gesture/grandstand in desperation against the growing horde of private investors (the HFs).
I have to assume that the BOJ has the same unlimited resources that the Fed has when/if it wants to prevent the appreciation of its currency.

If speculators or importers or anyone else wants to increase their purchase of Renminbi with dollars in order to appreciate the Renminbi vs. the dollar, all the PBOC needs to do is create those Renminbi with a keystroke and transfer them to the purchasers. The only thing that will stop the PBOC from providing as much Renminbi as foreign importers of Chinese goods might want at the rate of exchange they've chosen is an unacceptable increase in their domestic inflation rate (assuming they don't want to issue more sterilization bonds to counter that threat).

I assume that the BOJ has the same power to create as many Yen as they might desire, and that the only reason why they announced that they were willing to spend a certain amount of Yen in order to prevent its appreciation was in order to hide the fact from the general public that the actual quantity of Yen available to them is not limited. (People participating in financial markets like to believe in the 'soundness' of the fiat money they use, which means they want to believe it is absolutely limited in quantity. The reality is quite different from the public perception.)

Preventing the depreciation of your currency is a different matter altogether. It requires that you have large reserves of the alternative currency that holders of your currency are trying to buy. This would not be a problem if the central banks of the countries that produce the alternative currency were willing to "print" enough of their currency in order to stablize the exchange rate of your own, but that is certainly not guaranteed.

[James Kroeger]

I can remember when a Euro was worth much less than a dollar! And it wasn't all that long ago!
Alright, alright... :)

Clearly, Reason, Europe's Central Bank has no intention---at this point, anyway---of intervening to prevent the appreciation of the euro vis-a-vis the dollar. You don't doubt that it could, do you? I imagine one reason why Europe's central bankers are more than happy to ask for more dollars/euro is because they have this insane fear of any 'overstimulation' of their economy. With such a mindset, it's always best to try to keep your currency strong, yes?

[James Kroeger]

...if China were to sell US bonds to buy US stocks, I presume this would send rates up in the US.
Answer: only if that is what the Fed wanted. If the Fed did not want rates to change from its target, it would simply buy the Treasuries that the Chinese would be selling. That's how they do it all the time...

[anon]

Of course not just the Euro has gained vs. the dollar, but also the Australian $, the Canadian $, the Brazilian real (? they keep changing the name), the Rouble, etc. I think even the Mexican peso has gained, but I would have to look to be sure. So the idea that the dollar has "weakened" is surely not wrong.

[anon]

Peso has declined vs. dollar over last five years. Over last two years it is slightly ahead. Very slightly.

[Winslow R.]

Jk wrote:"Answer: only if that is what the Fed wanted. If the Fed did not want rates to change from its target, it would simply buy the Treasuries that the Chinese would be selling. That's how they do it all the time... "

I agree with your mechanics. Just like to add that doing so would put cash into circulation likely causing inflation. This quandry of monetary policy could be remedied with a shift in fiscal policy by 'simply' raising tax rates, removing dollars from circulation with a fiscal surplus and thereby keeping inflation in check.

[paine]

tubby brad shows his tower remoteness
here

control ???

short of offering
to buy the company out right
as in the UNOCAL deal

hell you can buy huge chunks of stock
in a firm and have nothing
but a great big passive investment

BTW winslow
if "your"
CB currency value policy
is to neutralize any size trade gap's
possible effect on rates of exchange

thru active balancing on the payments level
portfolio investments in corporate bond vs uncle bonds
is a wash

dollar support wise china can also
just as easily buy
ny stock exchange index funds

brad's point:
stock purchases
without control of target firms
is a way to hedge against
a dollar dive
but its true only if the stock market
dosen't swoon along with the dollar

note :
the interaction on the one hand
of real plants
equipment and their stream of earnings
and on the other of

their market value
is a complex process
not well caught in brad's
fee simple algebra
and first tier first cut
deductions there from
stocks like real estate
can fail to properly register
the cumulative
level of " product market "inflation
for ten or more years
vide the dow circa 67-81

this piece by brad
has all the markings
of a wing job
done with his off hand

ie
its hack's wind bag
and our brad
ain't good enough to pull that off

what after all is he claiming here ??
beyond playing
a few trade model trade gap consequences
thru to each one's simple final tautology

[paine]

i note
two things in comments
a very sound sense
central banks acting in posse
can trump
"the moves of money market specs "

and one brain at a time attempts
to work thru the interactions of say a change in dollar policy
are dauntingly complex
networks of n independent CBs
like the real world
are
not tractable folks

possible hobbes states of all agin all obtain here
even though reduced to "only "
asset markets

best hope
a sense of
de facto co operation obtains
as now it does
among the bulk of the n CBs
enlightened self interest in maintaining
the systemic status quo

btw in this light
guys take it from a retired spec
never compare us v mex peso
to us v euro

[James Kroeger]

Just like to add that doing so would put cash into circulation likely causing inflation.
Considering all of the variables in the hypothetical situation, almost all of the inflation would occur within the stock market and within the upper classes, just like it did in the 1990's when the money supply grew so rapidly but the official measurement of inflation was quite tame.

As the Chinese are supposedly selling off their treasuries, [mostly] banks would be buying them, using up reserves that would otherwise be available for lending, driving up the interest rate. The Fed, however, would ultimately be purchasing them in order to maintain the interest rate at its target---if not from the Chinese, then from the banks, insurance companies, etc.---replenishing the loanable reserves that would otherwise have been depleated. So yes, inflation would be the result, but not the kind of inflation that rich people in general---and finance people in particular---mind.

[Winslow R.]

paine wrote: "thru active balancing on the payments level
portfolio investments in corporate bond vs uncle bonds
is a wash

**I agree

dollar support wise china can also
just as easily buy
ny stock exchange index funds

**I don't think China would, see below.

note :
the interaction on the one hand
of real plants
equipment and their stream of earnings
and on the other"

I've had this discussion on another web site about treating stock as a financial asset rather than a nonfinancial asset.

Who knows the quantity limits of ETF funds? Given that the quantity of stock can be manipulated almost as easily as the quantity of money, I'd tend to agree....

Except the current transactions of 'private equity' tend to purchase the whole company and take it private, exchanging cash for nonfinancial assets. In this case, previous owners of stock now hold cash possibly leading to inflation (at least in stock prices - as JK points out) if this happens too rapidly without an increase in domestic (or previous owners of stock) savings levels.

I don't think China would buy ETF funds.

[anon]

JK, well if the various eventualities that may occur if the Chinese were to shift to buying real assets instead of bonds are so benign or if they stopped buying bonds in the future or decreased their purchases and the US Treasury is so able to cope with anything that comes along, I wonder what all the fuss is about. You make it sound as if the US has absolutely nothing to worry about involving the trade deficit, ever. Is that your position? If so, why are others so worried? Do they not understand things as well as you do?

[James Kroeger]

You make it sound as if the US has absolutely nothing to worry about involving the trade deficit, ever. Is that your position?
Well, I don't think we have anything to worry about as far as the Chinese suddenly trying to dump their dollar-denominated assets. What I do worry about with respect to the trade deficit is the impact of job losses in the U.S. combined with a Congress that will not act to exploit the potential benefits of free trade.

Ideally, the outsourcing of jobs to other countries should provide the same kind of benefit that improvements in technology and productivity efficiency provide: both free up labor that could be used to produce other things of value that increase the amount of real wealth that Americans can consume. By real wealth I'm talking about enhancements in the quality of our lives.

That can be done while outsourcing goes on unchecked and immigration remains unrestricted. All it requires is that Congress increase the tax 'burden' of the wealthy and start spending the money it collects on every manner of public investment, from instructure modernization to investments in human capital (double or triple the number of teachers and classrooms) to pollution cleanup. If federal spending increases enough on these real economic investments, unemployment is eliminated and a modest labor shortage would begin to put upward pressure on wages.

The result: more real wealth produced and consumed, unemployment eliminated, a cleaner environment, higher quality of education, less congested highways, etc., and an elimination of the divisive issues of immigration and outsourcing. But just try to get any of the economists who profess to sympathize with working people to embrace this kind of economic agenda. The silence can be quite deafening.

(Why, you ask? They are afraid Wall Street wouldn't like it too much and they believe that we are all helpless before their almighty power over the economy. To paraphrase Brad DeLong...why oh why oh why can't we have some 'Democrat economists' who have the guts to stand up before their masters?)

[TECHY2468]

i am trying to understand how currency pegging works.

if china keeps all the dollars it receives for its exports as reserve, but instead it prints yuan/renminbi, will that not lead to massive inflation in china? if so is it occuring (i have not read anything about it).
does anyone know how china is managing all these?

on other hand india was also doing the same till jan 07, but after letting their currency appreciate by 10% they are again going to keep it fixed wrt to USD.

but in india it is a bit different since their interest rate is very high (around 7.5%).

[paine]

jk nice comment

give wall street the old one two

lower the relative dollar till we've
closed the trade gap

pump up the fiscal spending
till we hit
chock full employment

[Cassandra]

Slink,
isn't all this action -> talk -> reaction -> thermonuclear disintegration, reminiscent of erstwhile competitive devaluations ?? We seem to have achieved such a higher level of economic understanding since the last "big one", but yet, seem to be none the wiser for it.

As a metaphorical financial pacifist, I am aghast at the talk of "war" as the last financial resort, when it seems as if reasonable balance (of the sustainable sort) has been been achievable through our own policies mix and actions all along.

[James Kroeger]

if china keeps all the dollars it receives for its exports as reserve, but instead it prints yuan/renminbi, will that not lead to massive inflation in china?
From deductive reasoning I can tell you that China does not simply hold all the dollars it receives as reserve, but uses most of them to buy dollar-denominated, interest-bearing paper assets like Treasuries. It makes sense that they would do this.

One big reason why China is not experiencing high rates of inflation is because the PBOC issues 'sterilization bonds' that successfully remove exessive amounts of renminbi from the domestic economy. It's a great fine-tuning innovation that the U.S. would do well to copy, as an alternative to throwing the economy into yet another recession to drop the measured inflation rate down from 6% to 2.5%.

Another big reason, of course, is the high rate of growth of the Chinese economy. Yes, more renminbi are injected into the Chinese economy by foreign importers, but then more 'stuff' is being produced in China for domestic consumption, as well, including new highways and other infrastructure improvements.

[TECHY2468]

JK..

if i understand correctly....usa is going thru a slowdown....hence FED cannot reduce liquidity...but instead they keep injecting more to keep it going.

i am assuming that indian gov is also doing the same, removing liquidity from the system. even then asset prices over there have gone through the roof (thanks to a brief period of excess money at a low interest rate).

while i have your attention i will like to clarify few more questions.

1. GDP is made up of consumer consumption+business expenditure etc??
2. and GDP is the measure for the health of economy??
3. USA GDP is in declining trend, why??....is it because of declining consumption or declining business expediture (sorry i am clueless)

[James Kroeger]

USA GDP is in declining trend, why??....is it because of declining consumption or declining business expediture
I haven't looked at the recent breakdown, but typically the one category of spending that declines the most during recessions is business expenditure. In this particular slowdown, I suspect a drop in spending on housing by developers is a major factor...

[DOR]

TECHY2468 says...
if china keeps all the dollars it receives for its exports as reserve, but instead it prints yuan/renminbi, will that not lead to massive inflation in china? if so is it occuring (i have not read anything about it).

James Kroeger says... “One big reason why China is not experiencing high rates of inflation is because the PBOC issues 'sterilization bonds' that successfully remove exessive amounts of renminbi from the domestic economy. Another big reason, of course, is the high rate of growth of the Chinese economy. Yes, more renminbi are injected into the Chinese economy by foreign importers, but then more 'stuff' is being produced in China for domestic consumption, as well, including new highways and other infrastructure improvements.”

---Two more reasons: Soaring productivity gains and incredibly bad data. We don’t know if the Chinese economy is moving forward, fast-forward or backward. The data are garbage, and everyone knows GIGO.

= = = = = = = = = = = = = = = = = = = =

TECHY2468,

Demand side GDP is private consumption expenditure, government consumption expenditure, gross fixed capital formation, the change in inventories and exports, minus imports.

On the supply side, it is stuff you drag out of the ground (farming, mining, etc), stuff you smash together (manufacturing, construction) and “the remainder” (utilities and services).

Since the National Accounts System was established in the 1930s, it doesn't account for some of the more modern parts very well (banking, IT).

[paine]

cassandra
u hit some very high c notes here

the awe i feel is in the ruggedness of the system
given all the innovations
its difficult not to turn chicken little

but over the last 30 years
i've learned to hold my beating heart in my mouth
and speak not from my depths......i rely on my
toy models and lots of hot tar