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Tuesday, December 25, 2007

China controlling more of U.S. economy

I was talking with my friend Bob last Thursday at NYC, working with Major World one of the largest seconds car dealer. He was taking his breakfast in an American Diner and was saying that, the living costs of locals had remained the same whether the dollar is falling; the majority of the immigrants in US are suffering due to the depreciating Dollar. He had to switch his choice of diner from Indian restaurants for his breakfast, just because the costs of food is getting more in the Indian joint, where he used to take his breakfast for last 10 years.

Although considered unlikely, analysts say a more rapid decline of Greenbacks could prove disastrous. A global run on the dollar would force the Federal Reserve to hike interest rates to prop up the U.S. currency just as lower interest rates may be needed to stimulate the domestic economy.

There's a good reason schools across the country are scrambling to find people who can teach Chinese: It's quickly becoming business' second language as Wall Street seeks to tap China's $1.3 trillion in foreign reserves.

China has been making increasingly aggressive investments in some of the world's most prestigious financial companies in recent months — most of them American. Morgan Stanley, Bear Stearns, Blackstone Group, and Britain's Barclays have all negotiated major stakes by Chinese government-controlled investment funds. This is true that China’s economy is growing and generating huge money. See the video below.

Investment banks ailing from the subprime mortgage mess are looking for money to shore up their balance sheets. And China is leading a surge of strategic investments from Asia and the Middle East that so far have sunk about $25 billion into Wall Street banks.

That's just the start of what some believe is a dramatic reversal of financial power in the shadow of Wall Street's credit turmoil. Lower interest rates have caused the dollar to slide in value against other major currencies. And, for foreign governments, the devalued dollar makes investments in these financial institutions cheap.

In the 1980s, Japanese investors snapped up real estate and invested in businesses across a number of sectors. This new wave of foreign investment is different because Asian and Middle Eastern governments are taking stakes in financial institutions — a cornerstone of the U.S. economy.

China agreed to pay $5 billion for a 9.9 percent stake in Morgan Stanley, and those securities pay 9 percent a year until they convert to shares in 2010. That translates to a gain of about $450 million of cash next year.

But, for Morgan Stanley investors, the infusion of new stock two years from now will dilute their shares — and potentially make owning Morgan Stanley's securities less valuable. The same can be said about other banks that receive foreign investments.

The deals have been structured so that the sovereign funds are passive investors with no seat on the board, and this escapes regulatory scrutiny. This week President Bush said Thursday he was "fine" with foreign investors snapping up big stakes in U.S. banks and financial firms.

By keeping investments under 10 percent, it does not trip an automatic review by the government. Bush, and others, believe the injection of foreign capital helps keep the banks competitive and restores faith in an industry beaten down this year.

But, some banking analysts believe these government-sponsored funds might get more say than the banks are admitting.

"The Chinese are putting $5 billion into Morgan Stanley without there being some kind of quid pro quo of what they're going to get other than interest on their investment," said Dick Bove, an analyst with Punk Ziegler & Co. "It's part of a major shift in the worldwide financial system that I think will be very negative to the U.S."

He said these kind of investments are not over, and expects to see others surface next year. In some cases, investment banks that have already received investments might strike other deals to increase capital.

Next up? Speculation swept through Wall Street on Friday that Merrill Lynch & Co. is on the hunt for a foreign investment to help cushion what could be a huge fourth-quarter writedown in January.

"The whole situation has changed with financial power moving dramatically toward China and the Middle East, and that will have significant impact over time," Bove said.

In China, where the currency still trades on a narrow, government-controlled band linked to the dollar, authorities have resisted global pressure to allow its currency to appreciate faster. The Chinese currency has gained about 11 percent against the dollar since 2005. But by keeping the currency relatively weak, Chinese companies have managed to ride the weak-dollar export boom -- making their products even cheaper in countries where the greenback has sharply dropped.

But now, some in China are turning their noses up at the dollar. Lin Jing, a sales manager at Shanghai Shuangyuan Import & Export Co., which exports garlic oil, said the company has begun to demand euros from its overseas customers instead of dollars. "The use of euros enables us to shy away from losses caused by the conversion between the [Chinese currency] and the weakened dollar," he said.

Reference: MSNBC

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21 comments:

Surfer said...

hi its a nice post and usefull too i request you to submit your post in www.laadi.com also so that you can get more readers in your blog.

Jan Andreassen said...

Hi Dibyendu !

Not beeing a financial ecpert, i find it comforting that the chineese economy is growing, and should they be able to control parts of US economy by 2010, i'd say it's what you would pay for a mistake like the SubPrime mortgage disaster, which has influenced the entire global economy in a very negative way.

Maybe the fact that chineese capital eventually might control parts of US economy will keep them from doing such mistakes again, or at least minimize the consequences for the rest of the global economies.

Also, i think that the impact of chineese economy getting stronger will spawn more global consumers, and thereby maybe reduce the rate at which their economy grows and gain control over segments of forreign markets.

Merry Christmas and regards
Jan

Arun Aravindan said...

I am not sure whether its about control. The very fundamental premise in a market is that things will settle into an equilibrium and cannot be at an extreme. China or other countries may buy out some companies in the US but then it doesnt mean they would control the US economy. China or any other country cant do anything detrimental to US economy as it would have an effect on the valuations of the companies they have bought into. So in the interest of keeping their "interests" in the US alive they have to keep the economy rosy as any impact on the economy is an impact on the companies they have bought into. Plus the US is the largest consumer in the world so a dip in their consumer power would cause a dip in the fortunes of the rest of the world. In todays world, you have a global economy and an impact on one economy will have an impact across all.

K Shankar said...

Chinese Economy becoming stronger day by day is a fact but 2010 is too short a period to to lead US economy although it is certain that China, India and few more economies will imapct the behaviour of western economies is certain in the 21st Century.

K SHANKAR

Ray Miller said...

No matter whose economy is larger than the other's in 2010, the economic pendulum never swings in one direction too long. The US economy will grow vigorously again after W is out of the White House and many believe China cannot sustain their boom as they will run into one or many obstacles including severe shortages of trained workers.

Ankit Shrivastava said...

What many people don’t realize when they are talking about China and India overtaking the US economy that India and China to a great extent are service providers and Americans are consumers as well as “top management”. What will happen in the long term is America will very smartly emerge as the Top Management of the world economy, India its brain and China its cheap Labor. The world will assume that its using the Indian services and Chinese products, while the profits will continue to go to the top management based in America. So India and China in my opinion are two factories full of skilled people for a smart Capitalist called America.

Mark Parker said...

This is very insightful.

It is interesting to see the massive changes in the world economy and new players emerge, or re-emerge on the world stage.

One Part of the equation that is not stated here: How much of the manufacturing growth is due to U.S. investment in Chinese operations and how much of that capital gets paid back to the U.S. economy in the form of profits from operations? Might there be agreements in place on a macro level to keep the U.S. in its position of prominence?

Asking questions on Christmas morning. By God’s grace we are allowed the time to speculate!

Merry Christmas!

Michael Brittingham said...

Not even the best dreamer in China can imagine that prospect as a reality. The fact is that not only America, but many of the key countries of western Europe are actively engaged in the development of China, and are large, active investors in their primary areas of growth. This is the real wave of the future for countries to be pro-actively engaged in each other's development and to have common-interest-cooperation.

JC Brandon said...

Hi Dibyendu,

There are many factors to consider, including:

China is the 2nd-largest economy in the world after the US - although in per capita terms the country is still lower middle-income and 130 million Chinese fall below international poverty lines.

Economic development has generally been more rapid in coastal provinces than in the interior, and there are large disparities in per capita income between regions. The government has struggled to: (a) sustain adequate job growth for tens of millions of workers laid off from state-owned enterprises, migrants, and new entrants to the work force; (b) reduce corruption and other economic crimes; and (c) contain environmental damage and social strife related to the economy's rapid transformation.

From 100 million to 150 million surplus rural workers are adrift between the villages and the cities, many subsisting through part-time, low-paying jobs. One demographic consequence of the "one child" policy is that China is now one of the most rapidly aging countries in the world. Another long-term threat to growth is the deterioration in the environment - notably air pollution, soil erosion, and the steady fall of the water table, especially in the north.

China continues to lose arable land because of erosion and economic development. China has benefited from a huge expansion in computer Internet use, with more than 100 million users at the end of 2005. Foreign investment remains a strong element in China's remarkable expansion in world trade and has been an important factor in the growth of urban jobs.

Since July 2005, China revalued its currency by over 12% against the US dollar and moved to an exchange rate system that references a basket of currencies.

China had the largest current account surplus in the world - over $1.43 trillion. More power generating capacity came on line in 2006 as large scale investments were completed. Thirteen years in construction at a cost of $24 billion, the immense Three Gorges Dam across the Yangtze River was essentially completed in 2006 and will revolutionize electrification and flood control in the area.

The 11th Five-Year Program (2006-10), approved by the National People's Congress in March 2006, calls for a 20% reduction in energy consumption per unit of GDP by 2010 and an estimated 45% increase in GDP by 2010. The plan states that conserving resources and protecting the environment are basic goals, but it lacks details on the policies and reforms necessary to achieve these goals.

I don't see China passing the U.S. by 2010 but with almost 5 times the population - they will at some point.

JC Brandon

Robert De Loght said...

The only way to saveguard the value of dollar reserves in China, India and the Middle East is to invest the money in companies. The phenomenon is happening in Europe. Taking into account that the EURO is a strong currency and the USD is extremely weak, it seems probable that the same kind of investments are taking place in the US on a much larger scale. The impact will remain limited at first until a threshold is reached.

Nathan von Colditz said...

I have been reading many articles like this as the markets have tumbled with the subprime issues. The fact of the matter is, it is just a surface conversation about a much more complicated thing called the global economy.

A few basic things to consider; first off, China holds more US Treasury bonds than any other single investor in the world. If the American economy were to collapse, they would stand to lose trillions. The fact is, long term, China benefits from the American economy being successful and profitable and some of that comes from making investments in our big financial companies.

Right now, the American economy is having issues and thus we have to look outside of our own backyard for investment and we can’t rely on the same normal channels for investment. Long term this will be quite great and could lead to some more global stability. Something many do not point out is that if the Middle East has a vested interest in our success as a Nation, i.e. they own large chunks of our companies, treasury bonds, etc., they have less of a reason to attack us. Unless they can stand to lose their entire investment by tanking these companies, having cross investment acts as a check against terrorism, aggression, and promotes global stability.

Some time down the road, China or Brazil could have a dip and we will do the same. This did happen to Europe several years ago and American investors prospered as a result. As a nation, we are very used to being the one giving the bailout rather than being on the receiving end.

Ramesh Manghirmalani said...

Mr Choudhury:

Most of time people ask question or comments without understanding the the situations, America will remain Economy Power for at least t 29.8 years, China and India each have 1.1. billion people each, both economies as not even 8 Trillion Dollars, and America with 300 million people has economy of over 14.7 Trillion Dollars.

China and India have not see the inflation and variation in currency market, 85 percent of Fortune 100 companies are in America, the day America stops consuming goods Made in China and India's IT where do think these economies will go?

About four weeks ago, I spoke to Vikram that Abu Dhabi’s purchase of a stake in Citi group boded well for the American economy. It showed that American assets were finally cheap enough for foreigners to start buying in big chunks, and the dollar’s decline was probably flattening out. Now, as Eric Dash writes, that $7.5 billion investment has grown to $27 billion, with foreign buy-ins at Bear Stearns, Morgan Stanley, UBS and now Merrill Lynch.

The banks that lost big on sub prime mortgage securities are likely selling at a deeper discount than other American assets, so they’re the first in line to be bought. But these purchases still show that the dollar doesn’t have much farther to go. Moreover, integration of the American financial sector with economic interests in Asia, where most of the buyers originate, could be a stabilizing force in the long term. At the very least, some of the nightmare scenarios that conspiracy theorists like to tout - for example, a Chinese shutdown of the markets’ information technology infrastructure using secretly embedded software - would seem a lot more farfetched.

But is there any danger from foreign investments in major American financial institutions? Well, we’re still a long way from foreign control of the American banking sector. Even now, it’s not clear to me that the boards of these banks are acting in the national interest, nor that they should. And hey, if foreign board members did someday decide not to go along with a Federal Reserve plan to bail out some hedge fund, would that necessarily be a bad thing?

Who is catching up to whom in the global economy? Once upon a time, economists put groups of countries with similar size, geography and institutions together. They figured that the less-developed ones would copy from the leaders, growing faster until they achieved similar living standards. But the groups of countries with converging growth rates - the “convergence clubs” - are changing, as I wrote this week. Even fast-growing nations like China and India may not catch up to the United States, according to the experts.
William Baumol, the economic guru who coined the term back in 1989. He and Peter Howitt of Brown University outline some important factors for growth, factors that go deeper than simply the rule of law or free markets. I’d like to hear whether you, loyal readers, agree about their importance.

In addition to the material in the article, we discussed the problems of poor countries. There are so many ways to disrupt economic growth that it’s hard to classify many of them into groups. But worryingly, the further they fall behind the leaders, the harder it may be to catch up. Inequality has a way of perpetuating itself, as the powerful consolidate their advantages. Is it too late to turn this pattern around?

Consider China’s and India's enormous industrial capacity. Is it crazy to suggest that it might someday become an energy exporter, even to island nations like the Vietnam or Philippines?

Would it not then reap extraordinary benefits from also operating the grids in such countries? As I’ve written before, Russia’s Gazprom is trying to extend its tendrils through Europe at all levels of the energy market, for the same reason.

I think you should look at Russia as next economic power.

Best Regards

Ramesh Manghirmalani

Aneal said...

"The Circle is continuous, regaining connection when broken."

It is amazing that in foreign policy and influencing processes we continue to choose a single point of control as it is easily influenced (rather than dealing with the mess of democracies!) and provides short term and immediate gratification. The "Sovereign Government" proved a great ally to the capitalist governments and corporations. No labor unrest. No need to worry about pollution and safety as the sovereign government is taking care of it.

The politically correct term is "sovereign funds" fed by capitalist monies now boast fat bank balances. Now the capitalist countries must reap what they sowed, we have been able to prop-up our habit of consumptive, disposable society where a CD player costs less than an hours pay and it is not worth standing in line to return, leave alone repair! Drive megaton SUVs, shun public transport.

We cannot talk out of both ends, scream open markets and then when the "Sovereign Funds" come to invest cower and cry. All Dollars and Euros are equal, be they funds from Socialists, Communists or Dictators. We traded them as good tender, now we must support them when the 'sovereign funds' wield the financial power we have surrendered to them.

Coming back to the meal as a reflection of the economies: A wise man once said "there is no free lunch". Weellll guess what our lunch is being eaten by those whose philosophies we may dislike, but we choose to benefit them under the banner of free and open enterprise as well as higher corporate profits.

Finally what is the big deal about a sovereign fund investing in our countries. As the basic tenet of Economics goes: Free and open flow of capital (goods, services, human, financial) enriches all that participate. Let us welcome the newly wealthy into the "developed economies" group and discard the term "third world" forever.

We have yet to find other planets with aliens!!! Perhaps its time to abolish all borders and truly develop this "first world" of ours and then find other worlds to incorporate!

PEACE ON EARTH
&
GOODWILL TO ALL

Sanjay Negi said...

If China does overtake the west in economic development, it would become fashionable to have high cheekbones and slanting eys. Cosmetic surgeons would prosper giving people that oriental look. Chinese would call Europeans the red barbarians as they used to before the industrial revolution overturned the scales in favour of the whites.

If India also overtakes the west, we would employ sturdy caucasians as our "chowkidars" or watch guards as rich Indian merchants used to do with blue eyed central Asian Turks a few centuries back.

The higher strata of white society would send their children to Indian and Chinese universities to gain career advantage over normal folk.

The only thing which will be difficult to change would be the Indian preference for "Gori Bahu"....

Amit Agrawal said...

Dibyendu,

A couple of instances of money pouring (at opportune times) in the Banks/FIs based out of US dont necessarily mean China/ME taking over US. Please mind these are the world's biggest banks/ institutions and they originated in the US only. Imagine how difficult would it be acquire/ control bigger proportions of equity when 5-10% are attracting so much attention (though these are big investements) but I would see them more as investment opportunity as the valuations fell abmormally low. Also for CITI 4% was already held by a Middle east investor duirng Prince's tenure.

Investment by Middle East and China can also be reasoned- Middle East has always been cash rich region (oil based economy did not let debt markets develop there, so they operate differently than other economies) and China is the richest (though of late) in current account; so the two are clearly identifiable approachable regions capable of making investments to finance significant portions of world's leading institutions. Its quite logical for the banks/institutions to approach them than anyone else.

Now to control-
I see it very difficult to happen even in next one decade though we may see some countries growing up to challenge US in a few parameters. US has been no. 1 in almost all the aspects.
Mcap-India and China's aggregate MCap is less than $5 trillion, US's more than $123 trillion.
IPOs- Despite sheer size , US was no 2 in no of IPOs after China in 2006, though I agree China is growing fast.
US is the largest automobile market in the world, though Japan sells huge portion of its cars production to US and Toyota has become no. 1 seller (at least over last 2 months), Japan does not control US, it challenges latter in a lot of aspects and they are interdependent-one produces another consumes- both gain!

I guess an economy would need to have balance growth in almost all the aspects (employment, education- against literacy, health, reduced disparities of income/wealth, power, water, roads, GDP, pollution control, geographically balanced infrastructure growth, automobiles, no of people working etc.) to lead/control the world. Also as one grows bigger, it needs to balance itself before growing even bigger- thats a real challenge. As more economies get bigger, they become more interdependent and co-operative, single economy/ region control would gradually taper down to minimum .

In a lot of points I would concur with James(JCB) and Ramesh.

Amit

Liviu Siteanu said...

As someone pointed out before, China owns enough bonds, and overall US currency to have a vested interest in our economy. Granted. They own more US currency than they know what to do with it, and keep buying more. And we keep printing more. Common sense dictates that they would keep doing what's in their best financial interest. And I know that I am very much oversimplifying this- but:
Keeping in mind the level of currency owned by them, and companies that they would eventually own, is it that far-fetched to imagine a time when a foreign interest (China in this example) would be capable of exerting undue pressure on our economy, even in some cases against our own better judgement? What if we decide to take a course of action in the international arena that would prove unpopular or damaging to them... Is it hard to imagine them deciding to take the short-term financial hit and dump $1B, $2B (just an arbitrary figure) on the market to try to just "make a point"? (thus destabilizing our economy even more?)

Rod Bell said...

Hi Dibyendu,

Much ink can be spilled over such a huge topic; allow me to spill some here!

1. The good and promising thing about China and India's economies is that they are developing as diverse, "complete" economies, which means they will continue to cultivate multiple partnerships and agreements due to the multiple facets of their economies. Though the US may not always like it, it will be a good thing for economic power centers to be spread out among more nations, leading to a more "balance of power" world situation.

2. The US economy has always been relatively open, both on the labor side (lots of immigration) and investment side (foreigners can buy in, and people can take money dollars out). Many countries, including China at this stage, are not nearly so open in one or both of those respects. In my opinion, no national power center that tries to keep control of its economy to the extent of a) keeping labor out or b) preventing investment and/or profit-taking (including taking real money out), will become the equivalent of what America has been economically.

3. I worry about countries that try to leverage their strategic natural resources too greatly. As modern nations developed, naval blockades became defined as an act of war. Presumably this was because no modern nation could maintain its economy without sea access. Well, the same thing goes for oil today. It's one thing to take full advantage of your natural resources, but, depending on the resource, it could cause a world of trouble, to put it mildly, if such countries fail to recognize that they can't just do anything they please with their oil.

4. Finally, I wonder how the nationalism card will be played, if at all, during the rise of the economies of China and India. The US economy began as a kind of Europeanization of America, but during its growth the US forcibly imported a very large African contingent, and later attracted and absorbed very large contingents of South Americans and Chinese, not to mention large dollops of many other ethnicities. So the US has always been, as we say now, "multi-cultural". As much as its great natural resources--maybe more so--this transnational, open character has let the US take such a big economic/military lead over Europe up until now. So, my interest is in the question of how "nationalistic" China and India will be in developing their economies? For historic (including English colonization) and ethnic reasons, it seems to me, India will be able to grow in a very open way. China, I don't know--really, I don't know. My sense is that the leadership will opt for openness (on their terms, to be sure, but still in that direction), but will a billion people, historically steeped in rather xenophobic attitudes, resist the urge to declare that it's their turn, now, to dominate? No other circumstances exist, or have ever existed, as far as I know, for such a huge labor market of relative cultural and ethnic homogeneity existed at a capitalist take-off stage.

Best,
Rod

Andrew Scribner-MacLean said...

I agree with several posters that growth/size will eventually cause China to overtake US in size, but influence is another matter. California is often cited as the 8th largest economy in the world but it doesn't directly influence other nation's policies as a result.

Also, China needs extensive infrastructure investment - schools, hospitals, roads, etc. This will begin to drain external investments or lacking improvements likely cause social upheaval the chinese government has never encountered (Tianamen Square would be considered a small situation compared to a full revolution).
So, they are rising, but their supremacy is not yet guaranteed and as someone else mentioned, market equilibrium is in their self-interest.

Vinayak Parkhe said...

Interesting article.

Thanks!

Vinayak

Ken Altreuter said...

China is pursuing a very smart “win win” strategy that is propelling their modernization and facilitating rapid broad based economic growth with increasing percentages of large numbers of well educated middle class people. Their investing a portion of their $1.4 trillion in US equities doesn’t result in them controlling the US but being a real partner with them. Given their 1.1 billion population and the current percentage remaining in a peasant economy, I don’t see them passing the US by 2010 as some media commentators/writers have suggested. Being a partner in global stability, YES!!

China is at a take-off point (a la M. Rostow) to higher level industries and a more fully developed modern economy but will be limited by the vestiges of state control and lack of: transparency, full profit remittance, capital restrictions, personal freedoms and the like, that will discourage foreign investment in the next steps. Similarly, one can not just project their growth based on the current low base increases as indication of the future. There are some speed bumps and political corner turning that have to be handled before more complete modernization can really take place.

With the USD probably at a low relative to the Euro(at least on a PPP basis), this is a smart time for China to invest in undervalued US equities/properties where at the same time they can get incremental benefit of board positions and operating knowledge that would not otherwise be available. Pretty smart!!! Contrast China’s multi-faceted partnering approach with Russia’s commodity based economy taking obvious short term advantage of trading and foreign policy initiatives. Here is where one sees that longer term the goal of China is first development, then control as a real global partner.

It looks like the Sovereign Wealth funds and Petro dollars are starting to play the same global strategy as the world’s excess of USD reserve currencies are moving quickly from fixed income instruments to equities and assets!! See the Financial Times article below about China's approach to a Sovereign Wealth fund as an indicator of how they are using an international advisory board(just another indicator of their increasing understanding & willingness to be a part of how the real world works!!)

Robert S said...

Well known problems of government indicate that ownership and control are not the same. Three other considerations:

1) Careful management of invested assets, i.e., for highest return, requires ignoring nationalistic considerations in the exercise of control, even supposing exercise of control by mere corporate shareholders were possible.

2) Super-large scale investing is a lot like crawling into a roach motel. Your only option is to say yes when your investment comes to you for additional capital.

3) One day some private equity firm or the like (whatever they're calling themselves in half a decade) will come along and take these assets off the hands of the Chinese and other non-US investors for pennies on the dollar.

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