China's El Crappo Investment Record

China has a mind-boggling $1.33 trillion in foreign exchange reserves. A lot of blood, sweat, and tears have gone into accumulating that sum--the environmental, labor, and social issues that you can enumerate that have been associated with China's rise are plentiful and need little reminding. It is rather unfortunate, then, that state managers have not exactly been the sharpest investors of this towering pile. To begin with, a lot of these reserves have been invested in low-yielding US Treasuries denominated in rapidly devaluing dollars. For this reason, China decided to "diversify" by buying more mortgage-backed securities from US housing agencies like Fannie Mae and Freddie Mac and others. However, its decision to do so was near the peak of the US housing bubble. While China typically buys the highest rated of these securities, there is no telling how severe the US subprime will be and may creep upwards.

Then, the Chinese decided to "diversify" yet again by taking out a stake in Blackstone, the private equity firm which recently had its IPO. Unfortunately again for China, it bought its stake at the top of the private equity craze. With global liquidity tightening up again as risk reenters the financial lexicon, Blackstone's stock has tanked. I am of two minds about China's dubious investment record. Sometimes I am dismissive with more than a little schadenfreude that this result is just desserts for China's efforts to try to game the global economic system by using beggar-thy-neighbor strategies: "My grandma could design a better portfolio than the Chinese!" Other times I too sympathize with Chinese citizens who see this endowment put to such poor use. What can I say? My persona is large; I contain a multitude of conflicting emotions. From the International Herald Tribune comes a story with many intriguing elements including (rather unusually) local political activism, blogging, censorship, and xenophobia:

The first purchase by the Chinese government's new overseas investment fund, a $3 billion stake in the Blackstone Group, has backfired badly and produced an unusual public backlash within China.

Blackstone shares have fallen steeply since the company went public June 22, pushing down the value of the government's investment by more than $500 million in just six weeks. Bloggers and even some Chinese financial media have frequently mentioned the dwindling value of the government's stake, and some have been highly critical.

"O senior officials of the Chinese government, please do not be fooled by sweet-talking wolves dressed in human skin," said one of several Internet postings compiled by an anonymous blogger on Sina.com, a Chinese Web site. "The foreign reserves are the product of the sweat and blood of the people of China, please invest them with more care!"

In a sign that the Chinese government may be censoring criticism on the sensitive issue of government investment losses, the blogger's entry was visible on the Web site on Thursday afternoon but had disappeared by Thursday night. Other entries by the same blogger were blocked, but milder criticisms of the Blackstone investment could still be found.

"It is really alarming the speed with which the Chinese government entered into this investment," said another posting, signed as "anonymous person 586215," that remained on Sina.com through Thursday night.

For many years, China's central bank followed the example of most central banks by investing the bulk of its assets in Treasury bonds and other government bonds. But as China's foreign reserves have soared to $1.3 trillion, the government has started chasing higher returns - and is now learning that this involves greater risk and sometimes losses.

Over the last several years, the People's Bank of China has led the way among central banks in buying U.S. mortgage-backed securities, accumulating an estimated $100 billion worth of them, according to people with knowledge of the central bank's trading. The People's Bank of China has long chosen some of the most creditworthy tranches of these securities.

But with the malaise in the U.S. housing market, even the value of some previously creditworthy mortgage investments is starting to erode. The Chinese central bank abruptly halted purchases of U.S. mortgage-backed securities in May, although it does not appear to be liquidating existing holdings, said one person who follows the bank's trading practices closely.

This person insisted on anonymity because of the central bank's policy of banning transactions with any individual or institution that discloses information about it.

China's loss of appetite for U.S. mortgage-backed securities and its indigestion from the Blackstone deal do not mean that China has lost interest in overseas investments. The China Development Bank, a state-owned institution, agreed last week to invest €2.2 billion in Barclays, the British bank, and to invest another €7.6 billion if Barclays won the ongoing bidding for ABN AMRO.

With China running a trade surplus that hit $26.91 billion in June, the central bank is issuing torrents of yuan and frantically buying dollars to prevent the yuan from rising quickly against the dollar in currency markets. The government's large purchases of dollars, and of other currencies to a lesser extent, has created a big problem of how to invest the money.

The government's latest solution is to begin creating a so-called sovereign wealth fund: a government-owned investment company that issues yuan-denominated bonds in China and uses the proceeds to buy dollars for overseas acquisitions...

As credit markets began to deteriorate this spring and pressure grew for higher taxes on private equity funds, Blackstone's leaders shrewdly pulled forward the date of the company's initial public offering and priced it at $31 a share, the top of the planned range. The stock rose on June 22, the first day of trading, but has slumped steeply since then.

Blackstone shares recovered slightly on Thursday, rising 74 cents to $25.05 in afternoon trading in New York.

Foreign investments are particularly tricky for the Chinese government because of virulent nationalism, born of centuries of foreign invasions and occupations like the British capture of Hong Kong in 1841 and the Japanese capture of Manchuria in 1931.

The same online writer who warned of wolves in human skin also cautioned that, "These fierce wolves are similar to the foreign thieves who pillaged our forefathers, only they are all the more cunning and manipulative, but their goal of pillaging China does not change with the centuries..."