For years, analysts have argued that the U.S. dollar is overvalued and that the huge U.S. trade deficit is unsustainable. Investment flows from Europe and Japan that fund the deficit were bound to slow, they predicted, and the dollar would fall accordingly. These flows have slowed, but the dollar remains strong. Why? One reason is that the U.S. has a surprising new investment partner: China.
China's mighty manufacturing and export machine has filled its coffers with a mountain of foreign exchange. With all the relevant 2001 data now available, it turns out that last year, Beijing poured $51.8 billion into U.S. Treasuries, corporate bonds, and commercial paper, compared with just $15.5 billion in 2000. And that doesn't include Hong Kong, which invested $40.3 billion in U.S. securities in 2000 and 2001.
The flood of money from China came just in time. Europe's share of foreign-capital flows into the U.S. fell from roughly 66% in 2000 to 51% last year, according to a recent report by Joseph Quinlan and Rebecca McCaughrin of Morgan Stanley Dean Witter & Co. And while Japanese investment is still rising--from $51 billion in 2000 to $59 billion last year--its pace has slowed.
China is shipping its hoard to the U.S. for the same reason everyone else does: safe investments that can be counted on for a dependable return. Moreover, U.S. Treasuries, though at a low ebb now, still boast interest rates four times those offered by Chinese commercial banks. And China certainly has lots to invest. Its commercial banks held $107 billion in net foreign assets at the end of 2001, while official reserves include $209 billion more in foreign currency. In addition, Chinese companies and individuals hold $130 billion in local, dollar-denominated accounts. Says Andy Xie, Hong Kong-based regional economist for Morgan Stanley: "China is awash in U.S. dollars." In effect, China is recycling its trade surplus back to the U.S. Last year, the largest U.S. trade deficit, $83 billion, was once again with China, making up a large chunk of the $412 billion U.S. current-account deficit.
Will Chinese capital keep flowing across the Pacific? Quinlan, who is senior global economist at Morgan Stanley in New York, doesn't think so. Japan and Europe are mature economies, but China is a developing country that needs to put its money to work at home to fuel its growth. "If you're looking for a long-term source of funding for the U.S., I wouldn't bet on China," he says.
At least for now, Beijing has a strong incentive to keep the cash coming. Its banks need the profits to offset the write-offs they're forced to take on local nonperforming loans. And when interest rates start to rise in the U.S., China is likely to send still more capital America's way. "This is sustainable," says Francis Leung, chairman and managing director for Asia at Salomon Smith Barney in Hong Kong. "China will continue to build up its foreign reserves because of its trade surplus and the inflow of capital through foreign direct investment. And China will continue to invest in U.S. dollar assets. It's a cheap source of funds, so [the U.S.] should not object to huge trade deficits with China."
The U.S. always seems to find new sources to feed its thirst for foreign capital. And China is the country of the hour. By Frederik Balfour in Hong Kong