For China, Is America the Best Investment?

Lend to Americans or Share among the Chinese?

Yi Gang, the Deputy President of the People’s Bank of China, recently announced that China will handle America’s national debt as a market investment action, and does not want to make this a political matter. But, as a responsible investor, one can certainly achieve a mutually beneficial result with this type of investment. China’s foreign exchange reserves have a huge amount of American debt, but the Sino-U.S. trade imbalance is fairly severe. Furthermore, after the financial crisis both countries have increased recessive barriers to safeguard their national industry and employment, causing the imbalance to further intensify.

The story the public often hears is “The Chinese people’s hard earned bank savings are lent to fund American’s extravagance, they accumulate large amounts of U.S. dollar reserves, and are faced with the devaluation of the dollar bringing about further loss.” This easily overlooks the fact that, in reality, China’s lending to America can cause increased American demand for Chinese goods, thereby promoting China’s industry and employment at the same time. Mutually beneficial policies can easily be skewed to sound unidirectional.

In fact, the profit rate from lending money to America over the past few years has continuously been quite good; even during the 2008 financial crisis, for a period of time China was adding, not reducing, U.S. Dollar reserves because they possessed a steady rate of profit. Of course the profit rate of U.S. national debt cannot be so good forever, as it is inseparably tied to the actual condition of the U.S. economy. However, the profitability of U.S. national debt was continuously increasing through the whole year of 2009, in a 10 year period has increased by a grand total of 17 percent, and in 2010 has maintained this trend of increasing.

The interesting part is, according to a disclosure from the Central Bank, while reducing dollar reserves, China is increasing Euro and gold reserves. While gold’s profit rate is probably around 20 percent, gains on the Euro are not at all as high as one would imagine. Because the Central Bank cannot disclose the proportions of its various investments, the total profit rate is also a mystery. No wonder Zhang Guobao, Vice Chairman of the National Development and Reform Commission, questioned in two meetings why earnings on $2 trillion are barely more than 60 billion RMB, a profit rate of not even one percent. Yi Gang argued that 68.3 billion RMB is interest specifically on 1.55 trillion RMB worth of national debt, but no matter how much money foreign exchange reserves make, the public is still not confident.

Supposing policymakers are reasonable, reducing dollar reserves implies that by reducing holdings they can obtain profits greater than the loss from the decreased holdings. Of course these profits are mainly indicating expected profits, and at the same time they consider the potential risk of holding dollars. For example, America’s unemployment rate remains high, which could cause their economy to sink deeper into recession, thereby pulling down confidence in the U.S. economy’s profit rate.

Now the essence of the issue is that China has money, and simply needs to decide to whom to give it. The Chinese government’s previous policy has been to give a large amount of it to the Americans; in times when the U.S. economy was thriving this might have been a good choice, because the marginal benefit was even higher. However, even if lending to America can still maintain as high a profit rate as before, the profits from lending to the Chinese people are not necessarily low. What causes uncertainty is China’s contradictory policies: on one hand it does not make profit margins on foreign exchange reserves public, and on the other hand it does not announce the specifics of foreign exchange reserve adjustments. Lacking this necessary understanding, the public can only “burn incense and pray to Buddha,” expecting the policymakers to invest in them and put the money in the place with the highest marginal benefit.

Just let us imagine one possible scenario: if money is lent to Chinese innovators in the business world and public society sector, how much future profit could we gain? Or what would it be like if the government followed the suggestion put forward by Zhang Weiying and other scholars, and divided a portion of the reserves among the common people? Policymakers have probably never considered this type of option, preferring rather to levy taxes, raise loans and borrow money from the public to give to nationalized departments with low market efficiency. But, to transform the economy to a pattern of growth, thereby revising the structure to grow domestic demand, it cannot hurt to first start by relaxing restrictions on the choosing of targets.