Did you know China has more than $1 trillion in foreign currency reserves
after posting huge trade surpluses year after year !! Add to that China’s reserves is growing at $20 billion every month
!! For China, that is simply spectacular, for U.S. well…sigh*
So what does China do with the 1$ trillion ? Right now they have invested approximately 75% in low-yielding U.S. Treasury securities and other dollar-denominated assets. The rest in euros and a small amount in yen. Returns on this investment has been less than 3% last year. Not quite exciting. But that is going to change….
Need a Change
China now plans to make better use of their reserves and reap in more profits. One way to do that is create an investment company, and that is exactly what they are upto. China will soon create one of the world’s largest investment funds, with diversification in global stocks, bonds and commodities markets. It is estimated that they will allocate somewhere between $200 to $400 billion to this new venture. The company named Lianhui will buy 20-25% of forex reserves from the central bank for investment.
Why the Change ?
China wants to invest its reserves to support an economy that grew 10.7 % last year, without causing large swings in global markets. The trade gap has increased driving reserves to a record. The surplus and China’s foreign-currency holdings have left the economy awash with cash, making it difficult for the government to slow lending and investment to curb asset bubbles. The nation is trying to slow investment and lending to curb inflationary pressures and asset bubbles in property and stock markets. The surge in money flooding in, forces the central bank to drain billions of dollars from the economy every month by selling bonds in order to reduce inflationary pressures.
China intends to follow the model of Singapore’s Temasek Holdings, which manages nearly $90 billion in government pension funds and other assets. Temasek Holdings average returns has been 18%. China would love to cash in on such returns.
Where to Invest ?
Chinese economists 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. Energy firms such as China National Offshore Oil Corp, China Petroleum & Chemical might be good investment grounds too.
Is there a problem for U.S. ?
The U.S. Treasury who is responsible for the revenue of the U.S. government will take a hit if China plans to shift its investment strategy. A hit could be in the form of less assistance to finance multi-billion budget deficits and perhaps led to higher interest rates. Is this something U.S. needs to be concerned about ?
Probably not…with $20 billion a month in growing reserves, China can afford to keep buying U.S. government bonds while also channel a part into new investments. Analyst believe China is unlikely to diversify massively away from U.S. Treasuries to prevent the yuan from strengthening. The central bank buys dollars to prevent the value of the Chinese currency from rising from the inflows of export earnings. Diversifying away from U.S. Treasuries would mean selling dollars. They have a policy that they will allow gradual appreciation of the yuan, but no more than that. They don’t want to see the dollar crash.
Conclusion: China is one unstoppable dragon. With $20 billion in growing reserves every month, they could diversify without affecting their investments in U.S. Treasury. By following the Temasek’s model their returns will be in double digits. That just adds more to their cash reserves. However what is still unclear is what portion of their reserves will be diversified and what kind of adverse effects that would have on U.S. markets ? Any takers ?
Stocks/ETFs to watch: CNOOC (CEO), PetroChina (PTR), China Petroleum & Chemical (SNP) ETFs: iShares Trust FTSE-Xinhua China 25 Index Fund (FXI), PowerShares Golden Dragon Halter USX China Portfolio (PGJ). Bonds: iShares Lehman Aggregate Bond (AGG), iShares Lehman 1-3 Year Treasury Bond (SHY), iShares Lehman 7-10 Year Treasury (IEF), iShares Lehman 20+ Year Treas Bond (TLT), iShares Lehman TIPS Bond (TIP). Currency: PowerShares DB G10 Currency Harvest Fund (DBV), Euro Currency Trust (FXE)
(Source: Seeking Alpha, Bloomberg, ShanghaiDaily.com)