News Release: Finance and Economics, International, Law

Sep. 22,  2009

Do China's Growing Overseas Investments Signal a Global Power Shift?

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On July 20, Chinese Premier Wen Jiabao announced that the country intended to invest some of its record-breaking $2 trillion foreign exchange reserve to accelerate China’s overseas investments in natural resources and resource-extraction companies.

Although Chinese officials have refused to specify how much of their reserve they plan to reinvest, and some experts cite practical reasons China’s foreign currency reserve should be kept intact, on September 1 the country’s state-controlled lender, China Development Bank, formed a $5.1 billion investment fund that will be used in part to help Chinese companies acquire essential natural resources abroad.

Regardless of the ultimate dollar value of China’s overseas investment plans, professors at Emory University and its Goizueta Business School see these moves as the latest signs that China is increasingly in the driver’s seat of the world economy.

The tactical move Wen announced is part a larger strategic shift that China is making to transform itself from an export-driven economy and toward an economy fueled mostly by Chinese consumers, according to Jagdish Sheth, a chaired professor of marketing at Emory University's Goizueta Business School and author of the book Chindia Rising: How China and India Will Benefit Your Business (Tata-McGraw Hill, 2007).

Building a huge consumer market in China makes good strategic sense, Sheth says—and it’s similar to a shift the U.S. economy made in the late 19th century.

But why would a strong domestic economy entail buying commodities and assets outside China? The reason is that unlike the U.S., which had abundant resources but needed technology to harvest them, China has technology but limited resources. “In order to achieve its vision, its biggest challenge is going to be access to natural resources, including agricultural resources,” Sheth says. “China has great human talent, but it does not have sufficient natural resources within its own geographical boundaries,” he says.

Wen’s announcement is far from the first sign of the country’s plans to diversify the economy. Over the past six years, China’s overseas investments have risen geometrically, from $143 million in 2002 to $40.7 billion in 2008, according to Chinese government statistics, and up over 63% in 2007 alone.

In search of energy and other natural resources, the Chinese have been reshaping the face of Africa. Some authorities estimate that there are now more than 750,000 Chinese expatriates at work throughout the continent, many involved in developing mines and oil fields. Now they are reportedly looking farther afield, particularly to natural resources and resource companies in South America.

Although China has been criticized for its involvement with unsavory regimes such as the government of Sudan, Robert Ahdieh, a professor at Emory School of Law who has a specialty in international trade law, doesn’t see an ideological agenda involved in these investments. The Chinese are in such places, he says, mainly because assets in more stable and desirable spots were bought up long ago by Western companies. “The Chinese didn’t randomly say we only want to buy oil from rogue states,” he explains. “It’s just that the rogue states are the only ones on the table.”

Why the obsession with commodities? China’s reasoning, Ahdieh believes, is that getting hold of commodities in 10 years’ time could be difficult if India and China continue to grow as quickly as they have lately. “If their growth rates and industrialization pace continue, the level of demand for commodities is going to look very different in 10 and 20 years than it does today,” Ahdieh says.

The decision to cut down its foreign exchange reserve might seem like an internal matter for China, but it has significant implications for the U.S. In June, China, currently the largest holder of U.S. Treasury securities, reduced its holdings of U.S. Treasury debt by 3.1%, the largest percentage drop in eight years, according to Reuters and a Treasury Department report issued on August 17. In addition to the clear hint that China’s leaders may be tiring of the dubious privilege of serving as America’s largest creditor, the presence of a new competitor in the scramble for natural resources heightens geopolitical rivalries in an arena once dominated primarily by U.S. and European companies.

If China were to reduce its foreign exchange reserve, it could have a huge impact on federal borrowing costs and interest rates generally, since many of China’s foreign exchange assets are thought to be kept in U.S. Treasury bonds. (China does not divulge the exact breakdown of its foreign currency stockpiles.) “At the worst, if they really stopped buying they could throw America into a recession because they are now a major purchaser of the Treasury securities we have to sell in order to finance the government deficit,” explains Jeffrey Rosensweig, a professor of international finance at Goizueta and director of Emory’s Global Perspectives Program.

But Rosensweig and other professors don’t anticipate China making this move, except perhaps in a gradual way over time. It’s not in China’s interest to see the dollar go down or to see its best customers out of work, says Rosensweig.

“They may move some of the money they hold in foreign exchange reserves into some of those investments, but I don’t expect them to move a very significant part of it,” agrees Narasimhan Jegadeesh, a chaired professor of finance at Goizueta.

Levent Bulut, a visiting assistant professor of economics at Emory, is also of the mind that China will instead “gradually try to invest in profitable areas in the real market, in the real economy.”

The question remains if the Chinese can’t get away with a large-scale diversification right away, what is the meaning of Wen’s announcement? Rosensweig says we should read Wen’s announcement partly as a warning to the U.S., “reminding us that we’re now in a very vulnerable position. We can no longer just call the tune and lord it over other economies; part of it is saying, `you better respect us, because we could break you.’”

At the moment, it may be only a threat. Although the Chinese seem stuck in what both Chinese and American economists call “the dollar trap,” Emory scholars don’t appear optimistic that they will stay in that trap for good. When they finally escape, Americans could have a major adjustment ahead.

Although the U.S. has dealt with competition before, such as with Germany and Japan, Sheth argues that the competition with China will be different. “The scale economy of the domestic market China has is much larger and that gives it enormous advantages, both in making products but also in sourcing raw materials because you become such a big buyer,” he says.

The volumes demanded by a market of 1.3 billion could create a “Wal-Mart effect,” in Sheth’s view, in which China becomes the dominant buyer of a number of commodities, giving it a built-in cost advantage over other markets.

If that happens, Israeli business strategist Eli Goldratt has quipped, in ten years, the U.S. will have moved from the world’s number one power to “an island of 300 million, six weeks from China.”

Sheth argues that the rise of China to economic superpower isn’t at all far-fetched. Already, the U.S.’s position in the world has changed profoundly, he says. “Think about it—ten years ago, who would have ever imagined that China would become the biggest lender to America?”

While some critics point to the many challenges China faces—the need to feed and employ an enormous population; a government that lacks an electoral mandate; huge gaps between rich and poor—others see, as does Sheth, a country that has made precious few missteps on its way to economic power and is unlikely to start now. “In my view, they’ve done everything right,” Sheth says.

On the other hand, U.S. policy has few defenders among the faculty, some of whom see a much less important future ahead for the U.S.

“It’s our own bloody fault,” says Rosensweig. “We’ve run deficits for so long and had to borrow to finance them, and our own people have not saved enough to buy the bonds themselves—we’ve dug ourselves a debt trap.”

Sheth sees one problem that looms even larger: The biggest problem in America is we are in a denial stage. We still don’t accept where the world is going and adapt accordingly.”

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