[Viewpoint] China uber alles

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[Viewpoint] China uber alles

Reading Bill Gross’ latest musings makes one nostalgic for the days when words from big bond-fund managers actually mattered.

We in the media like to point out that Gross runs the biggest bond fund at Pacific Investment Management Co. He did, until China created a portfolio of sorts totaling $2.5 trillion. As the assets of China’s State Administration of Foreign Exchange, or SAFE, grow, it’s making Pimco’s $239 billion Total Return Fund look like chump change.

It’s a SAFE world; we just live in it. Expect SAFE’s mushrooming influence to create new jobs around the globe. Remember the Federal Reserve watchers who got so much ink in the 1980s and 1990s? Welcome to the world of the SAFE watcher.

Cracking the thinking inside the world’s biggest bond portfolio isn’t easy. How, when and where China invests its vast savings is a closely held state secret. And global markets will never be the same as debt-sellers bypass the likes of Gross and go right to the source: China.

It’s the latest unintended side effect of China’s embarrassment of riches. The first was creating a monster China can scarcely control. It must continually add to its reserves, or diversify them smartly, lest billions of dollars of state money be lost. In a sense, China is trapped, making its currency collection more a weakness than a strength.

The newest wrinkle is how governments in Asia and elsewhere are clamoring for China’s support. Japan, for example, has been gleefully announcing Chinese purchases of its bonds. Seoul traders were cheered by news that China more than doubled its South Korean debt holdings this year.

Last week, the Malaysian ringgit was added to a small group of currencies that can be traded directly against the yuan. An incremental step, yes, but one that could accelerate China’s reserve diversification process.

You can’t blame China. As of June, it was stuck with $844 billion of dollar assets at a time when the Fed is on the hot seat to pump even more liquidity into the U.S. economy.

Global debt markets are hanging in the balance as China shifts its wealth around. The advantage here goes to those nations that built the deepest bond markets over the past decade. The last thing China wants is money locked up in a market it can’t exit if things go awry in the global economy.

Is this arrangement really a good thing? The rise of state capitalism, driven largely by sovereign wealth funds, has been widely expected and explored. Yet the amount of bond-market power being concentrated in Beijing raises questions about where the nature of markets is heading.

If I were a recent college graduate in Beijing I’d be scrambling to open a road-show business. It’s not hard to envision a future in which Indonesian and Vietnamese debt issuers bypass New York, London and Tokyo and head right to Beijing - where the real deep pockets are.

By managing a multitrillion-dollar portfolio, China is at ground zero of a kind of nationalization beyond borders.

Admittedly, it’s been a disorienting few years for enthusiasts of laissez-faire capitalism. It was quite a novelty to see Wall Street giants, entities that long abhorred government involvement, lining up for bailouts.

Now we’re faced with governments amassing ever-growing piles of currencies that need to be parked somewhere. Never mind how unproductive a practice this is. China, for example, could be using large chunks of that money to create better social-safety nets or invest in clean energy sources.

Asia’s foreign-exchange fetish is short-sighted. It’s partly about walling off economies in case global markets crash anew. It’s mostly about holding down currencies to keep exports competitive. That delays Asia’s process of becoming more about ideas and services than factory jobs.

China’s trajectory comes with a few underappreciated risks. One is that its currency stockpile is a bubble all its own. Reducing its reserves would scare markets into a massive sell-off, leaving China with huge losses. So, for better or worse, it just keeps adding and adding.

Another is what happens if China hits a wall. While hard to envision today, China could slide into crisis in the next few years. If so, it will need to convert its bond holdings to cash. That unwinding process could hit Asia hard. If Gross is right that the U.S. faces a “new normal” of negligible growth, a double-dip global recession is entirely possible.

China’s geopolitical leverage also is worth considering. The U.S. government paid for the massive tax cuts of the early 2000s by borrowing money from China. It’s not hard to envision Asian leaders making political decisions based on how they might affect China’s support for their debt.

If you’re Spain or the Phillipines and you are selling debt, you’ll care about wooing the Grosses of the world. You will care far more about how bureaucrats in Beijing view your economy. Welcome to the bond market’s new normal.

*The writer is a Bloomberg News columnist.

By William Pesek
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