Inflection Points In China’s Economic Development

When the economic history of China is written, it will show that, to date, there have been three major inflection points in the country’s economic development — events that have triggered major changes in the direction of the country.

First, of course, was the opening of China to the outside world under Deng Xiaoping in 1978. Attracting investment initially from overseas Chinese businessmen in Hong Kong and Taiwan, but then later from companies all over the world, Deng’s masterstroke unleashed a flow of capital into China and jump-started the country’s development as a major exporter.

China’s entrance into the World Trade Organization (WTO) in December, 2001 was a second pivotal event. By formally becoming a member of the global economic community, China signaled to the rest of the world that it would not turn back on the economic reforms begun by Deng. It also signaled to Chinese companies that they would no longer be protected, and would have to learn to compete with global companies anxious to win a share of the China market as well as their local competitors. From 2002 to 2007, exports quadrupled, China’s GDP grew by double-digit rates of growth annually, and money and investment capital poured into the country.

The period that we are now in — from roughly 2007 to the end of this year — will go down in history as the point in time when China became a major exporter of capital, adding yet another dimension to its impact on the rest of the world.

It all began at the top, with the Chinese government. As massive amounts of capital began to flow into China from foreign direct investment and export surpluses, the government chose to pull much of it out of its own economy, accumulating large amounts of foreign currency reserves in the process. China’s holdings of foreign currency reserves increased by one-third to approximately $800 billion in 2005; crossed the $1 trillion mark by the beginning of 2007 and has doubled since then.

Of the nearly $2 trillion in reserves currently held by China, approximately $700 billion is comprised of U.S government debt, making China the single largest investor in the United States economy. Government to government, the relationship is now such that Secretary of State Hillary Clinton felt compelled to turn bond salesman at the end of her recent trip to Beijing, urging China to continue buying U.S. Treasury bonds to help finance President Barack Obama’s stimulus plan. “We are truly going to rise or fall together,” she told the Chinese.

Apart from the government’s investments in U.S. Treasuries, efforts by Chinese companies to buy abroad got off to an inauspicious start in 2005 with CNOOC’s $18.5 billion bid for Unocal, a bid that ultimately failed after running into the buzz saw of U.S. protectionism.

The formation of China Investment Corporation (CIC), a sovereign wealth fund for China, in 2007 was seen by many as a way for China to diversify its holdings and to make passive, less politically offensive investments in businesses outside the country. CIC promptly bought a $3 billion stake in Blackstone Group in June, 2007, and a 9.9% stake in Morgan Stanley worth $5 billion at the end of 2007, investments that were welcomed as Blackstone went public and dark clouds gathered above Morgan Stanley and other U.S. financial institutions. Unfortunately, the timing of these investments was wrong for China as both companies have been severely impacted by the financial meltdown of recent months.

Given the short supply of credit in the global economy today, investments by Chinese companies are becoming even more welcome. In February, Chinalco, a large Chinese state owned company, announced its intention to invest $19 billion into Rio Tinto, ultimately taking a stake of up to 19 percent in the Australian miner and helping it to work out from a crushing burden of debt. While the Australian authorities are reviewing the proposed transaction, political opposition to the deal is nothing like that seen in Unocal.

The acquisition of overseas natural resource assets by Chinese companies, in fact, is a growing trend. Following the Rio Tinto announcement, Australia’s Fortescue Metals said that China’s Hunan Valin Iron and Steel Group had agreed to invest more than $650 million in the company, taking a stake of up to 16.5 percent stake in the iron ore miner.

Even the struggling global auto industry may benefit from China’s increasing aggressiveness overseas. Although Geely has since denied having any interest in buying Volvo, the Wall Street Journal reported earlier this month that the company was planning to make a bid for the Ford unit. Where there’s smoke, there’s fire, and Chery, Geely and other Chinese assemblers have been cautiously eying the foreign brands as they come up for auction.  Reports are now circulating that Chery has received government approval to acquire Volvo. Chery has reportedly received financing support from China Development Bank and the Export-Import Bank of China. My guess is that it won’t be long before China’s interest in buying industrial assets overseas extends well beyond natural resources.

Following the lead of the Chinese government and its industrial companies, Chinese individuals are now also getting into the act. Flush with cash, many are now hunting for bargains in the United States housing market.   As prices for U.S homes fall, home-buying tours to the U.S. to look for investment properties have become one of the most popular tour group packages in China.

China’s continued economic development made it all but inevitable that the cash the country is accumulating would begin to find its way back into the global economy. One of the outcomes of the global economic crisis may be the acceleration of this trend as Chinese companies and individuals are presented with once in a lifetime buying opportunities abroad.

China constantly changes, and yet again, the next chapter in the China story is now being written, right before our eyes.

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