The Chinese economy is slowing rapidly. The latest estimates show declines of several percent in official Chinese growth rates, which might be indicative of an actual recession. The Chinese government, like many around the world, is responding with a large economic stimulus plan. Official estimates are that the plan will cost roughly 14 percent of one year of China’s GDP, or well more than double the relative size of the proposed plan in the U.S. While some of the proposed stimulus spending may be worth doing anyway, the idea of a stimulus plan is to spend and build more than is worth doing in an economic slowdown. In the rush to stimulate the economy, there will surely be some waste and investments undertaken that in retrospect may be worthless.
The risk of this stimulus strategy for China is the same risk that the U.S. and European countries face: that the government spending and transfers do not get the economy moving and instead provide a drag on future growth as bloated government deficits and debt levels lead to lower spending or higher taxes in the future. China has only to look across the sea at Japan for one of the world’s best examples of this terrible outcome. But there is a much better way to stimulate the Chinese economy while perhaps even improving the governments’ fiscal position.
The main cause of the Chinese slowdown is reduced exports, primarily to the U.S., but also to much of Europe. And the primary cause of the global slowdown in demand is the U.S. financial crisis and deep recession which has the U.S. and global markets battered. So the most direct solution for China is to address the problem at its roots, in U.S. markets.
Now I do not propose that the Chinese government send out stimulus payments to U.S. households. Instead, we need to turn to the history of the crisis. Like serving alcohol to an alcoholic, the Chinese government provided cheap credit to the debt-hungry U.S., fueling its consumerism. The Chinese government did this by purchasing U.S. Treasury debt, and now holds about ¾ of a trillion dollars in Treasury debt, an amount increased by recent appreciation as global investors have sought out safe investments. Unwinding this position would significantly worsen the crisis, increasing interest rates in the U.S. and putting downward pressure on the dollar, both further slowing Chinese exports.
So my proposal is that the Chinese start to sell Treasuries and buy a broad index of U.S. equities. For China, this has several advantages. First, this would raise the U.S. stock market, and help to cheer up the American consumer while increasing Chinese exports. Second, if this “stock market stimulus” starts a rally or spreads to the confidence of global investors, there may well be a multiplier effect to the global economy, helping Chinese exports to much of the world. Third, the yield on Treasury debt is very low, partly due to its convenience yield or liquidity. China does not need this liquidity, so why pay for it in terms of lower rates of return? Finally, the U.S. stock market is actually a pretty good buy right now – both Warren Buffet and myself have invested heavily based on the idea that returns will be strong just from the underlying dividends given such low prices.
Are there downsides or complications? Yes, I see two. First, the Chinese would increase their exposure to some U.S. risks. While holding Treasury debt exposes them to inflation risk, holding equities means their government wealth declines when the U.S. does poorly, which is exactly when China might need money to prop up its economy in the face of falling exports. Second, the U.S. could get nervous about the scale of foreign government control rights over its own corporations. This could probably be circumvented by buying index mutual funds, perhaps with special low fees, or worked out at high levels. On Saturday, Chinese President Hu and newly elected U.S. President Barack Obama spoke and reportedly discussed a coordinated response to the global slowdown. My advice to my new President is to try to sell President Hu some stocks.
Strengthening the ties between China and the U.S. by having the Chinese buy equities is a brilliant idea. However, why not let the Chinese buy U.S. companies? That would be the next logical step and allows them some control. I write about Sovereign Wealth Funds in my new book and see the U.S. becoming one with the government’s investment in autos and banks. The Chinese could help our economy by direct investment and in so doing, create jobs. At the end of the day, job creation is the most important aspect to increase confidence (by consumers and CEOs) and ultimately our economy.
Great point about the Chinese purchasing US companies. The idea of the Chinese buying equities was driven by the facts that 1) Treasuries have nowhere to go but down because everyone has run for the perceived safety and liquidity of US debt ; 2) China does not need either liquidity or safety, their only goal was (is?) to hold dollar denominated assets to prop the dollar up relative to the Yuan; 3) US equities are suffering because our financial institutions are reeling and not because we are about to enter the Great Depression II; and 4) China would prefer a slow adjustment to declining US imports from China and would benefit from a less severe US recession. But there is no economic reason why the Chinese cannot provide capital to start-ups and private equity instead of buying public equity. And small business may be suffering more capital shortages than large at this point in the US downturn. There might be more political issues however for private equity. Direct ownership of US companies by a foreign government may raise more concerns in Washington and so may be more risky for the foreign government, especially if that government is still weaning itself from communism and was not that long ago an adversary. But again, from an economic perspective, direct investment is a great idea.
China is currently America’s largest trading partner – the U.S. bought $338 billion worth of goods off of the communist country last year – and also America’s biggest creditor. China currently holds over $800 billion in U.S. debt. China has recently raised concerns over the U.S. budget deficit publicly, and U.S. policymakers have acquiesced, [promising to bring the budget under control. With that kind of sway over U.S. policy, it could be much sooner than expected that China surpasses the U.S. as the world top economy.
In a sign of the growing influence of the Asian nation, a Chinese company has completed the purchase of a unit of one of the world’s largest automotive parts manufacturers. Chinese-owned steelmaker Shougang Corp. has led a group of investors to purchase the Delphi brakes and suspension unit, according to the Associated Press.
Headquartered in Troy, Michigan, Delphi employs some 146,000 people worldwide and 19,000 people in the U.S. The brakes and suspensions unit employs 3,000 people in North America, Asia and Europe. The deal is reportedly worth $90 million and will be closed by November after being approved by the Committee on Foreign Investment in the United States.