Chapter 8
Is China a New Financial Superpower?
China’s growing production and export power enhances its financial strength as well. This is natural. However, compared to its sensational emergence as a leading manufacturing and trading nation, the process of its ascending to the position of a major financial power is more fragmentary and complicated.
China has by far the largest foreign exchange reserves in the world, about three times as large as Japan, which is number two. It is also rapidly emerging as the leading international lender. In contrast, China’s role as a foreign direct and portfolio investor is still considerably smaller than that of America, major European countries, and Japan.
For the time being, the story of China’s growing financial clout is, first and foremost, the story of the unprecedented increase of the financial power of the Chinese state.
As of the end of 2010, China’s total overseas gross financial assets were estimated at $4,126 billion. Its major portion: $2,914.2 billion or 71 percent, was accounted for by foreign exchange reserves, compared to $310.8 billion or 7 percent for the outstanding balance of outward foreign direct investment (FDI); $257.1 billion or 6 percent for portfolio investment, and $643.9 billion or 16 percent for other foreign investment: mainly financial and trade loans, and deposits (Searchina 2011).
Due to its exceptionally high foreign reserves, as of the end of 2010, China’s total net foreign assets (gross foreign assets less gross foreign liabilities) have become the second-largest in the world after Japan’s: $1,791 billion (Searchina 2011) and $3,085 billion (Ministry of Finance Japan 2011) respectively. For comparison, Germany’s net foreign assets were about $1,049 billion (Bundesbank 2011), and the United States had negative foreign assets of minus $2,865.8 billion as its gross foreign liabilities are larger than its assets (Bureau of Economic Analysis 2011b). So, technically today China is the world’s second-largest net creditor nation.
On the contrary, its gross foreign assets are much smaller than those of the United States: $4,126 billion and $18,379 billion respectively. They are also considerably smaller than Japan’s (about $6.9 trillion) and Germany’s (about $7.2 trillion).
$3 Trillion-Plus Foreign Reserves: Implications for China and for the West
In March 2011, China’s foreign exchange reserves exceeded the $3 trillion mark.
This tremendous amount stems from the status of the country’s balance of payments. Maintaining a huge foreign trade surplus and, consequently, a current account surplus, it also has a comfortable and usually quite substantial surplus in the capital and financial account, as foreigners invest in China much more than the Chinese overseas (in most countries the current account balance and the capital and financial account balance have opposite signs, which means that the current account surplus is somewhat offset by the capital account deficit or vice versa).
Unprecedented growth of China’s foreign reserves has two major implications for the West and for the whole world.
The most important one is Beijing’s position as the largest foreign creditor of the American government. China holds about 14 percent of all U.S. Treasury Bonds. Whether one likes it or not, it gives the Chinese government a strong leverage to push its interests on a wide range of economic, political, and security issues. Currently, China’s role as a creditor is becoming increasingly noticeable on the European continent as well, and will apparently increase further as public debt problems in a growing number of the EU countries are becoming critical.
The second implication is China’s ability to pursue foreign acquisitions and other strategic overseas investment in a buy-whatever-the-price fashion. In other words, the Chinese buy foreign assets they consider important even when their prices reach the levels that would be prohibitive for a private Western investor. While Western governments can block transactions of this kind in their own countries, and they often do, they can do little to prevent China from using its foreign reserves as a tool to boost its political and economic clout in the Third World. We will explore this issue more in detail later on.
On the other hand, soaring foreign reserves are posing challenges for China itself. The central bank governor Zhou Xiaochuan is clearly saying that foreign reserves have exceeded the reasonable level and are becoming difficult to manage (Schneider 2011).
In 2006, the China Investment Corporation (CIC) was established to manage a very small portion of the total: $200 billion. Today it is the largest Sovereign Wealth Fund in the world.
However, it is often noted that, overall, the reserves could be managed in a much more efficient manner and bring higher returns. The yields from U.S. Treasury bonds are very low. Some other investments, like the one into Merrill Lynch, ended in a substantial loss.
Next, also on the negative side, a dramatic increase of foreign reserves is accompanied by rising inflationary pressures. The reason is that, basically, the foreign currency accumulating in the People’s Bank of China is exchanged for the national currency, which is injected into the national economy. It amplifies inflationary trends and elevates the risk of an asset bubble. (Inflationary pressures are significantly increasing also due to soaring global prices for food, fuel, and mineral resources, and the legacy of the 4 trillion yuan economic stimulus of 2008.) There is a risk of a chain reaction of the increase of foreign reserves, growing liquidity injections into the economy, rising inflation, monetary policy tightening, and the fall of economic growth rates.
To sterilize dollars, the central bank makes the country’s major banks turn over their foreign exchange in return for its interest-bearing securities. The scale of such sterilization may exceed $12 billion a week. It helps to contain inflationary trends, but locks up capital, as this money cannot be lent or invested (Schneider 2011).
To tackle the excessive liquidity injection problem, China needs much larger outflows of capital (see further on). In other words, the Chinese have to invest much more overseas. It could also open new business opportunities for domestic companies, financial institutions, and individual investors.
The Chinese government has introduced some policy measures supporting outbound investment, but they are still too weak and fragmentary, while restrictions are still strong. Also, it is often argued that it is not relevant for China as a developing country to export much capital.
In our view, for China with its exceptionally large foreign exchange reserves this is not necessarily the case. However, it cannot be denied that the key issue is whether or not these reserves can be used more actively and efficiently for the country’s own development.
Though some attempts in this direction have been made, the situation remains unclear.
For instance, the Finance Ministry bought $106 billion of foreign currency from the central bank and used it for the recapitalization of the Big Four banks and the Development Bank of China. However, it turned out to be only an accounting detour, as, after all, the central bank repurchased the foreign exchange involved (Truman 2010).
In a new development, the CIC has announced plans to invest the foreign exchange it manages into the shares of Chinese companies listed overseas in order to boost technologically intensive industries.
Nevertheless, it would be safe to say that the accumulation of such huge foreign reserves by a country where many regions are still underdeveloped and a lot of people live below poverty level looks somewhat unnatural. Basically, countries with large foreign reserves are in the best position to become major international donors. However, China is a developing country itself. Thus, logically, it looks relevant to utilize part of its reserves, which after all manifest the state’s wealth, for official development assistance to its own provinces, villages, and townships to build infrastructure and houses for the poor, protect environment, improve livelihood, and so on. The problem lies in the monetary field: You cannot use accumulated foreign currencies directly for investing in projects at home.
However, apparently, Beijing would not turn down proposals about development aid for the purposes mentioned if they came from overseas (and, actually, it still gets some development funding from the World Bank, the Asian Development Bank, and so on). Today there cannot be too many proposals of this kind because China itself has a lot of foreign currency, but perhaps the Chinese government could use some of the foreign reserves for “domestic official development aid” for imports of the equipment, materials, services, and so on needed to launch development and livelihood improvement projects in the country’s less-developed regions.
This could ease the financial burden of provincial administrations whose debts are beginning to cause concern, and also contribute to balancing the trade between China and its Western counterparts in a way that is beneficial for both sides. After all, it is quite simple: The West has a lot of things to sell to China that could make the life of the Chinese people, especially poor people, better, and the Chinese government has the money to buy them. Only political will and a bit of creativity and imagination are needed to make it a win-win game.
China Has Become the Largest International Lender for Developing Countries
China is rapidly emerging as one of the world’s leading lender nations.
At the end of the previous decade it became the largest international lender for developing countries, surpassing the World Bank. According to the research by the Financial Times, in 2009–2010 the China Development Bank and China Export-Import Bank extended loans of at least $110 billion, while the World Bank’s loans between mid-2008 and mid-2010 hit its own record of $100.3 billion (Dyer, Anderlin, and Sender 2011).
In terms of assets, Chinese commercial banks, especially the Big Four (Industrial and Commercial Bank of China, Bank of China, China Construction Bank, and Agricultural Bank of China), are rapidly approaching the world’s top 10.
In 2010, the Industrial and Commercial Bank of China rose to the eleventh position in the world with assets of $1,726 billion, which almost equaled those of Citigroup ($1,857 billion) and comprised 58.2 percent of the assets of the leader, France’s BNP Paribas: $2,965 billion (Alexander 2011).
Chinese commercial banks are becoming increasingly important lenders for Western companies.
China’s Outbound Foreign Investment: Accelerating, but the Lag Remains
Until recently, China was not on the list of the world’s major foreign direct investor nations. An important breakthrough came in 2008. According to the National Bureau of Statistics, outbound FDI increased dramatically to $55,907 million from $26,506 million in the previous year (flow; FDI by financial institutions is not included). In 2009, it rose further to $56,529 million (National Bureau of Statistics 2010) and in 2010, according to the Commerce Ministry of China, it hit $59 billion.
In 2009, China entered the list of the world’s top five foreign direct investor countries, but the scale of its FDI was only about one-seventh that of the United States, one-third of France, and two-thirds of Japan (Table 8.1).
Table 8.1 Outbound Foreign Direct Investment by Country ($ millions)
Source: UNCTAD. World Investment Report 2010.
| 2008 | 2009 | |
| United States | 330,491 | 248,074 |
| France | 161,071 | 147,161 |
| Germany | 134,592 | 62,705 |
| UK | 161,056 | 18,463 |
| Japan | 128,019 | 74,699 |
| China* | 52,150 | 48,000 |
| Italy | 43,839 | 43,918 |
| Russia | 56,091 | 46,057 |
| World | 1,928,799 | 1,100,933 |
*Data for China differs slightly from the one presented by the Chinese National Bureau of Statistics.
The gap will turn even more significant if we take into account that Chinese FDI remains biased toward Hong Kong, which in 2009 accounted for as much as $35,601 billion or 63.0 percent of the total. It was followed by the Cayman Islands ($5,366 million and 9.5 percent respectively). The next-most-important recipient was Australia ($2,436 million and 4.3 percent)—first of all, its mining industry. The FDI to all European countries combined (including Russia, which was the largest recipient) was $3,353 million and 5.9 percent and to the United States $908 million and 1.6 percent (National Bureau of Statistics 2010).
So, overall, if you exclude the FDI to Hong Kong, China’s total outbound FDI would be around $20 billion, which means that, in spite of the recent gains, its role as a foreign direct investor nation remains very limited—even though Chinese acquisitions of well-known Western companies have become a hot topic around the world.
Acquisitions account for around 40 percent of China’s total FDI. The major targets are mining industry, high-tech manufacturing firms, and well-known but usually ailing companies possessing famous brands. Such acquisitions are usually carried out with the backing of the government, mostly by state-owned companies.
On the other hand, Chinese companies, especially the private ones, are gradually increasing FDI of quite a conventional character. They are investing in India, North Korea, Vietnam, Myanmar, and elsewhere in the developing world seeking lower production costs or better access to local markets. Also, more and more often, they are coming to the West entirely on their own initiative (without the government’s backing), attracted by markets, technologies, and high-skilled human resources. In these cases Chinese investors act basically the same way and pursue the same goals as investors from any other country, whether America, a European state, or Japan.
China’s overseas portfolio investment is also noticeably increasing.
In 2009 it was $57.0 billion—almost three times as much as in 2000: $20.7 billion (National Bureau of Statistics 2010), but still significantly smaller than America’s $208.2 billion (U.S. Census Bureau 2011a) and Japan’s $170.0 billion (Ministry of Internal Affairs and Communications 2011) or Germany’s 148.7 billion euro (Bundesbank 2010).
Chinese Households’ Financial Assets: Still Tiny
In relative terms, the Chinese save much more than Westerners. It is a well-known and frequently mentioned fact. In the 2000s, households’ net savings in China stood at 20–25 percent of their disposable income (Wang & Wen 2011). As for major Western economies, in 2008 the ratio was 11.6 percent in France, 11.2 percent in Germany, 8.6 percent in Italy, 2.7 percent in the United States, and minus 4.5 percent in the United Kingdom. The average for the EU-27 was 5.8 percent. In Japan, as of 2007, the net savings rate was 3.8 percent (OECD 2010). (We will discuss Western countries’ savings more in detail in Part Two.)
Much less frequently mentioned is the fact that in absolute terms, total families’ savings in China are still considerably smaller than in the United States or Japan.
As of the end of 2009, Chinese households were estimated to hold around 26,077 billion yuan, or about $3,818 billion (National Bureau of Statistics 2010) in their savings accounts as opposed to $6,130 billion held by American households (U.S. Census Bureau 2011a).
Overall, according to the latest estimates of the Daiwa Institute of Research, households’ total gross financial assets in China have exceeded $5 trillion (DIR 2010), which is still not comparable with America’s $45.5 trillion as of the end of the first quarter of 2010 (the data for the United States includes financial assets of nonprofit organizations).
Comparative cross-country data for the end of 2009 is presented in Table 8.2.
Table 8.2 Households’ Financial Assets (end of 2009)
Source: Allianz Global Wealth Report 2010.
| Total ($ Billion) | Per Capita ($) | |
| United States | 41,591 | 132,178 |
| Japan | 14,643 | 115,159 |
| Germany | 6,068 | 73,850 |
| UK | 6,065 | 98,511 |
| France | 4,975 | 79,801 |
| Italy | 4,576 | 76,434 |
| China | 4,407 | 3,769 |
By the absolute amount of households’ financial assets, China stood only at number seven, its total comprising a little more than one-tenth that of the United States and a little less than one-third of Japan. As for the financial assets per capita, Chinese families’ average wealth accounts for only about one-twentieth to one-thirtieth of that of the households in the developed countries.
At this point China’s strength as a global financial power does not stem from the wealth accumulated by Chinese people. It is rather the opposite: State coffers overfilled with cash on the one hand and mostly not-so-wealthy, if not poor, households on the other. This situation may be socially explosive.
Is China a New Financial Superpower? Yes and No
Is China already a new major financial power? Yes, definitely yes. However, it is a financial superpower of a very special kind.
Its financial strength does not stem from the wealth of the vast majority of its citizens. First and foremost, it reflects the might of the state, which, due to soaring exports and inward investment, accumulated a tremendous amount of foreign currency reserves.
The Chinese ruling elite feels very comfortable on the international arena using this financial might as big leverage to win concessions from its counterparts and push its own interests and priorities.
This is one of the major reasons why it is not that eager to reduce the country’s trade surplus and to speed up the appreciation of yuan. The weak yuan is a political choice whose main goal is to strengthen the system of Communist Party rule.
China is rapidly emerging as a leading international lender. Its major state-owned banks are feeling more and more confident as major players in the global banking community.
In other important respects—effectively all the respects unrelated to the state and state-owned financial entities—today’s China is not a financial superpower in the true meaning of the word.
The role of its companies (not to say its individuals) as international investors remains comparatively small, though it is growing. Most companies are still lacking international experience and expertise. Besides, for many of them incentives to go abroad often appear to be weak as there is a lot of investment opportunity at home.
China’s domestic financial market is heavily regulated and offers only a narrow range of financial instruments. The country does not play any noticeable role as an exporter of financial services either. With the exception of bank lending, their global market is dominated by the West, and there are no noticeable signs of Chinese financial institutions being ready to join the leaders’ ranks.
Demand for the yuan as an international currency remains comparatively small, and the probability of it playing the role comparable to that of the dollar or the euro in the foreseeable future is close to none.
In the coming decade, Western governments, starting from the United States, will become increasingly dependent on China as a creditor. Chinese state-owned banks will establish a key position among the world’s major lenders to clients not only in the developing, but also in the developed world. A relatively narrow circle of big companies, especially state-owned ones, will rapidly develop as important foreign direct investors.
On the other hand, the formation of a wider range of strong Chinese multinationals, including private firms—a range comparable to the one in the major countries of the West—will take a longer period of time, as well as the emergence of a cohort of Chinese large-scale investors into securities around the world. In these areas, competition from China is still relatively weak.
First, China’s nominal GDP has just become the second largest in the world. From now on, the world economy will be rapidly adopting a two-towers-dominated shape: with the United States and Chinese towers much taller than all other buildings. Moreover, the Chinese tower will continue growing much faster than the American and overtake it, most likely, in the first half of this century.
Within this U.S.-China duopoly, China will first of all further strengthen its position as the leading manufacturing nation, while America will be the number one services nation. At the same time, China will be gradually becoming a stronger competitor in services as well. On their part, America and the West have opportunities in manufacturing, but will have to work hard not to miss them.
Second, “China as the number one producer” has become an international standard for most manufacturing industries and products. As a rule, gaps between China and the followers are increasing. The circle of industries and goods whose top producer is another nation (in most cases, it is the United States) is becoming more and more narrow. By and large, it is already limited to several materials-producing sectors.
Third, China’s drive to the number one position in merchandise exports, mostly in manufacturing, was even faster than in manufacturing production. In the electronics/electrical products and the light industry consumer goods sectors it is becoming not just a leading, but a dominant exporter. However, in other industries, China’s growing lead in production does not necessarily translate into the lead in exports, as most of its production increment is absorbed by the domestic market. In these industries China often emerges as a big net importer. Especially, growth of China’s manufacturing production and exports is accompanied by a rapid increase of the imports of production inputs. The key point is what countries and companies will succeed in tapping China’s capital goods market. Up till now, in this regard East Asia has been doing much better than the West.
Fourth, Chinese producers have become the world’s dominant players in the production and exports of low-tech–low-end–mass products and are rapidly expanding their presence in the high-tech–low-end–mass products segment. Their global presence in the low-end–differentiated-products segment and especially in the high-end products segments is much weaker, though increasing. At the domestic market they are rapidly occupying the latter two niches as well.
Fifth, China’s manufacturing production/export offensive drastically changes the global rules of the game and the status of Western manufacturers. For the West, it is getting increasingly difficult, if not meaningless, to protect traditional local industries from the inflow of cheap made-in-China products by imposing punitive tariffs or other import restrictions. The notion of local industry itself is changing.
Because China-West production cost differentials are enormous, Western factories are doomed to lose in the low-tech–low-end mass-products segment and, more and more, also in the segment of high-tech–low-end mass products. In these two segments, globalization and the Chinese offensive deprive them of the economic rationale to continue operating. It is a new globalized world, and it is high time to change the mentality. In a way, it is very simple. Here is the world—your world—and if you want to manufacturer a particular item, find the place in this world where you can make it most efficiently and the markets where it will sell well. If you stick to a different way of thinking and want, by all means, to produce in your home country (it is understandable: In spite of globalization, many people, perhaps the majority, would still prefer to live and work in their homeland), then you have to find an answer to the key question: What particular products does it make sense to manufacture there and why?
Basically, today’s Western factories have no other rational option but to drift to the segments of low-end–differentiated products and, especially, high-end products—in other words, to aggressively differentiate their products raising nonprice competitiveness. This drive has to be accompanied by the increase in exports, especially to the most dynamic Chinese and other Third World markets. Governments have to do much more for exports promotion. Exportability of the product—its acceptance by consumers around the world—is becoming the major criterion of whether or not it should be manufactured in this or that particular place.
The number of West-based manufacturers is and will be declining, and only “excellent producers” capable of differentiating their products and competing on their quality and uniqueness will feel good at home. Others will either have to move to China and the like to produce mass products or continue a bitter fight for survival.
Sixth, though China is becoming an increasingly important player in the global market of services as well, it is not a strong service economy. To become one, it lacks tradition, committed and skilled human resources, and know-how. Too many Chinese service workers still do not understand the basic concept of services just as the main hero of Rainman, brilliantly played by Dustin Hoffman, did not understand the concept of money. In the services sector the West has a substantial competitive edge, and it should not miss its chance. Currently, its exports of services to China are too small.
Seventh, China has become one of the world’s leading financial powers and, technically, the number two creditor nation, but its financial might first and foremost reflects the strength of the Chinese state. The major manifestation of this strength is the unprecedented amount of foreign exchange reserves. They are working as a very important factor in global politics, letting China set terms on a wide range of issues. On the other hand, they are bringing very modest returns and are not used efficiently enough to solve China’s development problems and raise the living standards of its people.
As far as household wealth is concerned, China is not, by far, a financial superpower. Though Chinese families’ saving rates are exceptionally high, the absolute volume of their financial assets is still insignificant by international standards. China is a rich state with people who are far from rich.