China forming company to invest huge reserves(reducing U.S. treasury bond holdings?)

Beijing is to create one of the world's biggest investing companies, with possible ramifications for global stock, bond and commodities markets, and might also affect how the US finances its huge budget deficits.

Chinese Finance Minister Jin Renqing said on Friday in Beijing on the sidelines of the ongoing National People's Congress session, that Beijing is trying to make more profitable use of its $1 trillion in foreign currency reserves. It is believed that most of the reserves are now parked in safe, but relatively low-yielding US Treasury securities and other dollar-denominated assets.

Chinese Finance Minister Jin Renqing gestures at a news conference during the annual session of the National People's Congress in Beijing March 9, 2007. [Reuters]

"We can achieve more profit from (wiser) investments (of the reserves)," Jin said at a news conference. "We are now in the stage of forming this new company."

The finance minister said China may follow the lead of Singapore's Temasek Holdings, which manages nearly $90 billion in government pension funds and other assets. It owns stakes in Singapore Airlines and Singapore Telecom, as well as in banks, real estate, shipping, energy and other industries in India, China, South Korea and elsewhere.

Analysts have speculated for some time that China would create an investment company, and officials have said repeatedly they want to make better use of the world's largest standing foreign currency reserves. Economists have suggested Beijing might allocate as much as $200-$400 billion to the new company, which could create one of the world's richest investment funds.

"They want to be more aggressive than what they do with current reserves," said economist Mingchun Sun at Lehman Brothers in Hong Kong.

"They could invest in higher-yield products - stocks, corporate bonds, maybe even commodities," Sun said. "Basically, the returns would be higher because the risk is higher."

A shift in China's investment strategy could change its purchases of foreign government debts, affecting a market that Washington relies on to help finance multibillion-dollar budget deficits, and might eventually push up US interest rates. But Lehman Brothers' Sun played down that risk. He said that with its reserves growing by as much as $20 billion a month, Beijing could afford to keep buying US government bonds while also channeling billions into new investments.

Even so, news of the Chinese announcement - along with an upbeat US jobs report, which reduced expectations the US Federal Reserve will cut its interest rates - came on the same day of a big drop in the price of the benchmark 10-year Treasury note on Friday. That pushed up its yield to 4.58 percent from 4.51 percent.

Jin gave no details of how the Cabinet-level company might invest the reserves, nor did he say what portion of the reserves might be channeled to the company or when it would start to operate. Spokespeople for Jin's ministry and China's central bank declined to give any other details.

US Treasury Secretary Henry Paulson, in an interview this week on the US television network ABC, rejected suggestions that changes in Chinese bond purchases could affect the United States economy. Paulson said Beijing's entire holdings of US Treasuries represent the equivalent of less than a single day's trading in Treasuries on global bond markets.

Chinese economists and media reports 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 domestically and reduce its dependence on exports.

The growth in China's reserves is driven by the rapid growth of its exports, which brings in dollars, euros and other foreign currencies, and by the billions of overseas investment dollars being poured into the country. The surge in money flooding in from abroad forces the central bank to drain billions of dollars from the economy every month by selling bonds in order to reduce inflationary pressures.

The precise composition of China's foreign currency reserves is a secret. But economists believe that as much as 75 percent is believed to be in US dollar-denominated instruments, mostly Treasuries, with the rest in euros and a small amount in yen.

Stephen Green, chief economist at Standard Chartered Bank in Shanghai, calculated that last year the central bank made a $29 billion profit on its Treasury holdings after paying interest on its own bonds and other expenses.

But even that represents a return of less than 3 percent on the $1 trillion in holdings. By contrast, Singapore's Temasek says it has averaged an 18 percent annual return since it was created in 1974.

Investment Themes

Since Temasek’s inception, our mandate has remained the same: to invest, manage and add value to our portfolio as an owner of our assets and investments. In 32 years our total portfolio value has grown from S$350 million, to S$129 billion. We operate on a flexible investment horizon, and have the option of taking concentrated risks, with the choice to remain in cash if the returns do not justify the risks. As a shareholder, we regularly monitor the performance of our existing portfolio companies and investments, and actively engage our stakeholders. We do not direct the commercial or operational decisions of our portfolio companies, except where shareholder approval is specifically required.
We continue to build our exposure to Asia through four investment themes:

Rising Asian Economies
Growing Middle Class
Deepening Comparative Advantages
Emerging Champions

Rising Asian Economies
As Asian economies grow and connect into the global market, we are looking at industry sectors that correlate with the economic transformation of the country, as well as companies that serve the growing middle class. Some of these sectors include financial, energy, infrastructure, entertainment and even primary industries. Our investments include China Construction Bank and Bank of China in China, Shrinigar Cinemas, Reliance Energy and Apollo Healthstreet in India, Japan’s i-Logistics Corporation, and Cargill’s oil palm plantations in Indonesia and Papua New Guinea. Additionally, to widen our exposure in emerging Asia, the Middle East and parts of Africa, we have acquired an 11.5% stake in Standard Chartered.

Growing Middle Class
As Asia develops, a growing middle class with increasing purchasing power will drive demand for services such as telecommunications, healthcare and consumer finance. In India, we built on the successful roll-out of Danamon Simpan Pinjam for Indonesia’s small savings and loan market by investing in First India Credit Corporation, which provides financing programmes for the growing segment of small and medium enterprises. In Russia and the former Soviet Union, we have partnered with Troika Dialog Asset Management to establish the Russia New Growth Fund LP for investments. We have also taken stakes in Vietnam’s leading confectionery maker Kinh Do.

Deepening Comparative Advantages
The Asian region offers both a competitive manufacturing base and a growing market for consumption. In this respect, Temasek has investments in bioscience, biotechnology, pharmaceutical and healthcare services, as well as energy and other resources. We joined a Rolls-Royce-led US$100 million consortium to fuel environmentally-friendly and fuel-efficient power generation. We also partnered with Zuellig and Quintiles to form a pharmaceutical sales and commercialization joint venture, Asia Pacific Pharmaceutical, which has representatives in 11 Asian economies. We have also committed to a venture capital fund, GSR Ventures, which will focus on wireless, Internet, new media, semiconductor and other technology-rich companies in China.

Emerging Champions
As Asia grows, certain Asian companies are emerging as regional or global leaders of their industry sectors. These include automobile makers Bajaj Auto and Mahindra & Mahindra in India, which are recognized as leaders in innovative design, engineering and best industry practices. These strengths are fueling their expansion into the rest of Asia and the world.

People, or universities, or in this case nations, when they get big enough, they create things called 'endowments' or some other holding company to hold the massive amounts of funds they maintain.

These endowments invest on a whole different level than your average bear. Much of it through what is called Private Equity.

Lets say for example Tigerlikesrooster is a complete genius and he wants to start a company, but he needs $100m to do so.

What you then do is create a company with a general partner (you) and limited partners (the investors).

For your $100m you won't generally get one investor (but its possible) [that by the way is called angel investing].

What you get is 5 different endowments to each give you 20 million. This is what is called 'syndication'. Instead of one person/group taking all the risk, they sydicate it out so they have their fingers in shares of a bunch of different companies or transactions.

The company is then funded, and the revenues from the investment are generally paid first to the investors, plus 8%, however they decided to compound it when you started.

Once they are paid off, which might take 2-5 years or whatever...then the revenue stream turns to the general partner (you).

The split is typically 80/20 them/you.

You then get paid out of current revenues, sometimes 92-100% of the revenue until you get your 20 million bucks for your piece of the equity.

After you get paid off then the revenues revert back to an 80/20 split between them/you.

In the mean time while all this is going on, you have been getting a 1-2% management fee for overhead and investing the money.

Even large corporations use private equity money. It just depends.

None the less in this case, China can create a pretty darn big holding company and endow it with a trillion bucks to do what is described above...

They are NOT investing IN stocks. They are CREATING new stocks.

Now lets say the $100m turns out to be a real go getter as a company and there is intrinsic value increase. Lets say over 10 years it turns to $1b in 'worth' and then you take it public or sell it. In either case you have your equity piece as do your investors.

As for how that post above about private equity relates...thats how China will most likely run their endowment.

They will devote pieces of it to various sectors (like oil), but they can do telecom or whatever.

Much, if not MOST of the FDI money that has been flowing into China for the last decade has been US and European private equity money.

Part of the reason we haven't pulled the plug yet is A) the investors have not been repaid yet, or B) its a cash cow for them.

You are talking about offending the very essence of money and those who have it.

A person might say "Wow $100 million bucks!" but when you are talking about endowments of $20 billion... $100 million is all relative. If you have 200 deals all $100m each and 50% of them do well I trust you will believe me when I say you come out on top.

Not to mention they will often check you and your plan out both (just a little bit /sarcasm) before giving you the money.

If you can convince people you know what you are doing its quite possible you will get rich.

I would see China creating not one endowment, but multiple ones that follow specific industries and seek to deploy the money in their feild.

I think they will go heavily into oil myself, offshore oil in various regions I mentioned above.

This concludes investing 101.

Any questions?

You bet it will.

How much?

A government that is committed to deficit spending *must* have a buyer for its bonds.

The deficit is a small % of our GDP. Much smaller than it was 4 years ago.

If it does not, it must raise interest rates till it finds such a buyer.

So what?

I'm waiting for the economic illiterates ........ to show up.

You're already here.

who say that a trade deficit is no big deal

The trade deficit is no big deal.

because the new economic model is for China to sell us stuff and for us to pay them back in treasuries

We pay them with dollars. You know, cash. What they do with those dollars is up to them. If they bought GM bonds would that be bad for America?

How much should they hold, considering the current money supply?

Toddsterpatriot, if I haven't mentioned it before, you ask excellent questions, and that is certainly a good question.

Historically, the current Federal Reserve holdings by themselves are not out of line in comparison to our GDP.

It's when I start aggregating what is held by other governments that I take pause. The Japanese are holding a lot of U.S. debt, as well as other governmental entities. The reason for some of these major holdings is not driven by a market desire for our treasury securities but as part of currency manipulation on the part of governments. This appears to me to be large enough to be very much along the traditional concerns of the moral hazard associated with simply printing money rather than borrowing it in the markets which impose market discipline via market interest rates and availability of credit.

[However, mitigating some of my philosophical concern about who is holding our debt is that in the case with the Japanese holdings it does make some market sense for the Japanese to extend this credit since they can borrow yen at a low interest rate, and engage in a carry trade by lending in dollars at a higher interest.]

Issue limit?

Yes, the Treasury Department is limited to issuing $300 million in U.S. notes:

United States Notes (characterized by a red seal and serial number) were the first national currency, authorized by the Legal Tender Act of 1862 and began circulating during the Civil War. The Treasury Department issued these notes directly into circulation, and they are obligations of the United States Government. The issuance of United States Notes is subject to limitations established by Congress. It established a statutory limitation of $300 million on the amount of United States Notes authorized to be outstanding and in circulation. While this was a significant figure in Civil War days, it is now a very small fraction of the total currency in circulation in the United States.
Both United States Notes and Federal Reserve Notes are parts of our national currency and both are legal tender. They circulate as money in the same way. However, the issuing authority for them comes from different statutes. United States Notes were redeemable in gold until 1933, when the United States abandoned the gold standard. Since then, both currencies have served essentially the same purpose, and have had the same value. Because United States Notes serve no function that is not already adequately served by Federal Reserve Notes, their issuance was discontinued, and none have been placed in to circulation since January 21, 1971.
The Federal Reserve Act of 1913 authorized the production and circulation of Federal Reserve notes. Although the Bureau of Engraving and Printing (BEP) prints these notes, they move into circulation through the Federal Reserve System. They are obligations of both the Federal Reserve System and the United States Government. On Federal Reserve notes, the seals and serial numbers appear in green. United States notes serve no function that is not already adequately served by Federal Reserve notes. As a result, the Treasury Department stopped issuing United States notes, and none have been placed into circulation since January 21, 1971.

From the U.S. Treasury's FAQs: Currency LEGAL TENDER STATUS at http://www.treas.gov/education/faq/currency/legal-tender.shtml

Historically, the current Federal Reserve holdings by themselves are not out of line in comparison to our GDP.

I agree.

It's when I start aggregating what is held by other governments that I take pause.

But one can almost be considered "monetizing the debt" and the other can't.

So why bother to borrow dollars at 5% interest rather than just have the Treasury issue them for free?

You believe there is a big difference between the cost of each?

Toddsterpatriot, if I haven't mentioned it before, you ask excellent questions, and that is certainly a good question.

Thanks, I try.

But one can almost be considered "monetizing the debt" and the other can't.

Yes, that's the crux of my point, and perhaps it is flawed. My question is: Why can't it? It seems to me that any government providing low interest loans for non-market reasons provides the same concerns about monetizing the debt that the Federal Reserve doing the same. Do you see this differently?

You believe there is a big difference between the cost of each?

It is true that any profit that the Federal Reserve system takes in goes either to the Treasury or to its 6% dividends paid to the banks who own stock in the Federal Reserve system, so it is reasonable to point out that some of this nets out. (I don't think that that dividend is considered a preferred stock dividend; however, if it is, then that dividend would actually be considered an expense rather than shared profit from the Fed's viewpoint. That's something of a distinction without difference, though, since the Fed doesn't pay income taxes and the dividend is paid tax-free.)

However, for each dollar that we borrow from the Federal Reserve we do currently pay circa 5% each year that requires taxes from the taxpayer that would not have to be imposed if the Treasury had created the original note. (Well, I guess we could decide to pay our interest to the Federal Reserve in newly minted U.S. notes rather than collecting taxes to pay them. ;-)

Yes, that's the crux of my point, and perhaps it is flawed. My question is: Why can't it?

Monetizing debt is bad. Why? Because running the printing press to pay the bills is inflationary. If Japan buys our Treasuries with existing dollars, that is not inflationary.

Excellent! I've asked conspiracy nutbags before (obviously, you're not one of them), just how much "profit" the evil foreign controllers of the Federal Reserve earn each year in dividends. They never answer. I'm not sure if it's because they can't find the amount of the dividends or if they found the amount and it's too tiny to confirm the evil conspiracy they decry. Have you ever seen the dividend figure? What is it? A fixed amount or does it grow every year?

How much of the 5% gets sent back to the Treasury? There is not a big difference between free money and the net cost now.

Monetizing debt is bad. Why? Because running the printing press to pay the bills is inflationary. If Japan buys our Treasuries with existing dollars, that is not inflationary.

Your point is correct: yes, we aren't running the presses to create those dollars --- in point of fact, those dollars were purchased on the open market in order to push the yen down and prop up the dollar against the yen.

My point is that there is still moral hazard from those dollars then being brought back to buy Treasury-issued debt since I see those purchases as essentially non-market driven.

Since the Treasury is getting non-market impetus in that borrowing, I think it is close enough to the moral hazard induced by straight monetization of the debt. However, your point that it is not in fact monetization is certainly correct, and indeed inflation is the result that one most fears from the lack of market discipline introduced by monetization of the debt.

However, overborrowing due to lower interest rates and availability of easy credit is another worry to my lights. (Fortunately, our tax revenues lately have been climbing due to our increased economic activity which I think is a direct result of the very wise tax cuts that the Bush administration pushed through. Our need to borrow new money has been lessened quite a bit recently --- I would very much like to see enough progress on that front that we could start reducing some of our debt.)

The dividends are like dividends paid on preferred stock in that they pay a flat 6% on the face amount of the stock owned by a member bank. (To be a bit more precise, I think that the stocks are like cumulative preferred stock since if the Fed were to miss a dividend payment, that deficit would accumulate to be paid later. But I believe that I have read somewhere that they are considered a common stock. (Perhaps because of voting rights? Or my memory may be off, and perhaps they are just considered a cumulative preferred stock.))

The amount of stock by any one banking institution is not a significant figure --- I believe that you can determine the exact number of shares held by each institution by looking at the text of the current laws in effect with regard to the Federal Reserve Act --- but it's not going to be a huge number of shares per institution since preventing such accumulation was one of the concerns of the designers of the system.

Since the Treasury is getting non-market impetus in that borrowing,

I'm not sure what "non-market impetus" is supposed to mean.

I think it is close enough to the moral hazard induced by straight monetization of the debt.

Monetization hazard would be, "this currency is going down, they print it to pay the bills". Like Russia in the early 90s. This hazard is, "this currency is going up, the Japanese keep buying it". I'm not sure they're equivalent.

However, overborrowing due to lower interest rates and availability of easy credit is another worry to my lights.

I see your point, but if you think our congresscritters sit around and say, "If only the Japanese would buy more of our debt, we could pass more wasteful spending".....

Our need to borrow new money has been lessened quite a bit recently --- I would very much like to see enough progress on that front that we could start reducing some of our debt.)

Me too, as long as the surpluses were the result of increased growth and reduced spending, not higher taxes.

The dividends are like dividends paid on preferred stock in that they pay a flat 6% on the face amount of the stock owned by a member bank.

That's what I thought.

The amount of stock by any one banking institution is not a significant figure

That's what I thought. I had one clown, recently, who claimed that the Fed somehow took all the gold owned by the US government, sold it and split the profits with their evil foreign overlords.

That person obviously thought the Fed pays capital gains instead of dividends to the shareholders. But then again, he isn't too bright.

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