WASHINGTON, Oct. 11
China's foreign exchange reserves have reached US$1.3 trillion US dollars, ranking first in the world. In the midst of discussions within and outside China as to how to manage this national wealth, the Chinese government has been gradually moving toward foreign exchange management reform. This year the pace of reforms suddenly speeded up. In March, a decision was made to found the China Investment Corp., under the State Council, not the Ministry of Finance.
Initially this company had US$200 billion as its founding capital. The total investment for the Three Gorges Dam was US$22 billion. This means the company could have funded nine such dams. The Three Gorges project faced huge opposition at the outset, and we have already seen a number of adverse consequences. However, it went through 40 years of discussion and a great deal of research before it was finally started.
In a sense, the risk of investing China's foreign exchange reserves is much higher than that of building the Three Gorges Dam, with nearly ten times the funds. Yet surprisingly, this huge, high-risk investment was decided quickly without any careful research.
The Chinese government is separating its foreign exchange reserves into two parts, which are managed by two bodies. One is the China Securities Regulatory Commission headed by Hu Xiaolian, deputy governor of the People's Bank of China. The other is China Investment Corp. headed by Lou Jiwei, deputy secretary general of the State Council.
Both the People's Bank of China and the Ministry of Finance wanted to control China Investment Corp. Zhou Xiaochuan, governor of the central bank, and Jin Renqing, minister of the Ministry of Finance, fought for control of this entity, but neither succeeded. Recently, Jin was suddenly dismissed from his ministerial position. Although there have been many rumors about the reasons for his dismissal, the main reason was this struggle between conflicting interest groups.
The initial capital of US$200 billion was obtained by issuing over 1,500 billion domestic bonds and then purchasing U.S. dollars from China's central bank at the official yuan exchange rate. Considering its capital costs -- the cost of issuing the bonds plus the appreciation of the yuan -- the China Investment Corp. must maintain around a 10-percent return in order not to lose out. It is not easy for such a huge company to achieve this, considering the poor capability of the Chinese officials compared to international standards.
Chinese officials have been known for making decisions hastily and irresponsibly. But the foreign exchange reserves are the people's hard-earned money and should not be abused. In my opinion, this is not the right time for the Chinese government to get involved in investing its foreign exchange reserves. This could be suicidal for those who don't understand how international capital markets operate. Even for those who know the market, unless they are highly talented financial investors they will be controlled and bullied by others.
International financial markets are extremely volatile. After 100 years' development, in a macroeconomic environment where global capital circulates smoothly, the four large markets -- the stock market, debt market, foreign exchange market and futures market -- are closely linked. In an extremely complex pattern, financial derivatives, commodities, stocks, securities, interest rates, foreign exchange rates, various political and economic factors and even climate factors are all entwined. If one element is changed, the whole body will be influenced. The strongest investment banks, hedge funds and private capital groups run the overall market.
Take hedge funds for example. Experts know that hedge fund operators are the behind-the-scenes manipulators of global stocks, debts, foreign exchange and futures markets. The presumed headquarters of the U.S. stock market is Wall Street in New York, but the real headquarters is in Greenwich, Connecticut, where the hedge fund operators gather. The operation of hedge funds is extremely bold, crazy and secret. It is very difficult for outsiders to learn the inside story. Since the main practice of hedge funds is to use extremely complex derivatives for high returns, this also contains great risk.
Transactions in derivatives are the most unfamiliar and most difficult market behavior for China's financial circle. Chinese financial experts may understand futures trading, but not the inside story of how it works. In recent years, China's great defeats by international financial tycoons in copper and crude oil are significant lessons.
Apart from a well-established system, an important factor in the function of international capital markets is trained and talented people, and this is what China lacks most. At present there are no world-class economists in mainland China; there are not even second-class ones. This is due to the country's very late start in the study of finance and management and the lack of top talent to be found.
None of the Chinese officials in charge of the large foreign exchange reserves have received a complete standard education in finance or had any real experience in overseas financial markets. Financial management is not yet a real science in China. The officials managing China's huge funds, therefore, are less than beginners.
Among the 10 most influential Chinese economists selected by the Chinese media, six have received doctoral degrees from prestigious Western universities. Although the rest do not hold foreign doctorates, they also graduated from the most prestigious universities in China, and two of them have done research at Harvard University. From the aspect of talent, these economists are superior to those officials in charge of managing the nation's foreign exchange funds.
Nevertheless, these top Chinese economists still cannot compare to their colleagues overseas. In the field of international finance, the most intelligent people are traders and analysts in investment companies. Many economists and professors at universities and research institutes are secondary talents and are not capable of or not suited to such jobs. Although there are also outstanding economists and professors, generally speaking their ability is not as high as the traders and analysts. In the field of finance, the top salaries go to the traders, then the analysts, then the economists and professors. According to Professor Ding Xueliang from Hong Kong Chinese University, China's best-known economists would not even qualify as master's degree students in the top 50 economics departments of universities in the world.
Lou Jiwei and the like can be counted as the top financial talents among high-level Chinese officials. But compared to those powerful, intelligent, well-educated, experienced, and cruel competitors in the field of international stocks, securities and futures markets, they may prove dangerously weak.
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(Li Xiaolu is teaching at George Washington University in Washington, D.C. in the United States. He has also worked at Shanghai Jiaotong University in China, Meiji University in Japan, Harvard University, Asia Weekly and Ming Pao Daily in Hong Kong and Voice of America. This article is edited and translated from the Chinese by UPI Asia Online; the original can be found at www.ncn.org. ©Copyright Li Xiaolu.)
http://www.upiasiaonline.com/economics/2007/10/11/commentary_chinas_suicidal_approach_to_international_investment/
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