The Great Uncoupling

There have been a number of intriguing developments in the last week that have potentially big implications for U.S.-China commercial, financial & trade relations.

Keen observers of China's banking scene may remember that a number of big western financial institutions, including Bank of America, Citigroup, UBS, Goldman Sachs, American Express and Royal Bank of Scotland have invested in various big Chinese banks a few years ago, primarily before those Chinese banks went public in western and/or the Hong Kong stock exchanges. At the time, these investments made plenty of sense for both sides. The western investors, of course, got to jump into -- even if a bit passively -- the Chinese banking markets. Those markets had been largely closed to their significant participation before China's accession to the WTO. After China became a member of the WTO, altho the banking market technically was partially opened, only a few foreign banks hopped over the border. Not that the Chinese government exactly made it particularly easy, but that's a story for another day. The one avenue where the gates swung wide open, altho the gatekeepers were still on duty, was equity investments in Chinese banks. With the prospects of the big four (Industrial & Commercial Bank of China, China Construction Bank, Bank of China, and Agricultural Bank of China) going public in the near future, the chance to jump in before the expected stampede for public shares was irresistible. For the Chinese side, there were big advantages. Looking forward to impending IPO's, the Chinese banks got a bit of legitimacy. If Bank of America buys shares in a bank, it must be a good investment. Or so the reasoning went at the time.
In addition, the then badly managed Chinese banks, in their rush towards legitimacy, could rightly claim that they had not only dumped a lot of their bad loans but they also were getting operational advice & counsel from their western brethren. In hindsight, we can all hope that they didn't learn too much.

Since those days in the not too distant past, the banking world has turned topsy-turvy. Those western pillars of the banking world turned out to have been infinitely more poorly managed than the big four Chinese banks. After the events of the last few months and the effective partial nationalization of many, if not all of those western banks, the scene has become truly surreal. Follow the logic. The big U.S. banks, with their significant ownership in major Chinese banks, are now largely owned by the U.S. Treasury. That means that the U.S. Government owns a chunk of the Big Four Chinese banks. Since the Big 4 are partially owned by the Chinese Governmentas well as the investing public, it means that the Chinese & U.S. Governments are, effectively, co-investors in the banking business. Mao Zedong & Ronald Reagan must both be squirming around in their graves, wondering what on earth could have happened.

But that's not the story. Now, in an effort to raise badly needed funds, Bank of America has sold off some of its Chinese bank stock for approx. $2.8 billion (for a profit of a bit more than $1.1 billion -- we're glad something has worked out for them, by the way). Analysts expect that B of A will be selling more stock (and they've got plenty left). In addition, other western banks are expected to begin to sell some of their Chinese bank holdings as well over the next few months as restrictions on stock sales expire.

So that's the first part of the story: Western banks begin divesting Chinese bank stocks.

The second and also intriguing development is this story, reported in the New York Times, among others:

China has bought more than $1 trillion of American debt, but as the global downturn has intensified, Beijing is starting to keep more of its money at home, a move that could have painful effects for American borrowers.

The declining Chinese appetite for United States debt, apparent in a series of hints from Chinese policy makers over the last two weeks, with official statistics due for release in the next few days, comes at an inconvenient time . . .

In the last five years, China has spent as much as one-seventh of its entire economic output buying foreign debt, mostly American. In September, it surpassed Japan as the largest overseas holder of Treasuries.

But now Beijing is seeking to pay for its own $600 billion stimulus — just as tax revenue is falling sharply as the Chinese economy slows. Regulators have ordered banks to lend more money to small and medium-size enterprises, many of which are struggling with lower exports, and to local governments to build new roads and other projects.

While this is not, in itself, striking news (it follows reports last year of China's national sovereign fund, The China Investment Corporation, coming under popular criticism in China after some of its less-than-stellar western investments began showing the strains of the times), it comes, as The Times notes, at a rather inconvenient time for the U.S. As mentioned previously in this blog and numerous other places, there's a lot of U.S. Treasury debt that must be rolled over soon and a big bill to be paid, financed by soon to be issued, crisp new Treasuries, for the first & second phases of the Big American Rescue Plan. That will mean that, in order to attract investors to the Treasury auctions, interest rates will need to be higher than they are now. Interest rates going up means Treasury prices go down. And the current Chinese holdings aren't immune to those market forces. It doesn't mean, of course, that Chinese bond buyers will entirely sit out upcoming U.S. Government bond auctions, but they can expect to demand higher returns. And we wouldn't be surprised if they bought less than they have in the past. And you can't blame them; you'd do the same thing.

Let the Great Uncoupling Begin!