US-China Commission Report - Fatal System Error

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difference between temporary, though massive, intervention undertaken
by the U.S. government as a part of a rescue plan for the
floundering economy, and the sustained control of China’s economy
by China’s government.
China’s sovereign wealth fund portfolio also is unusual because
it is backed by the world’s largest pool of foreign currency holdings—nearly
$2 trillion and growing as much as $500 billion a
year.* 120 This vast sum is managed by an arm of the central bank,
the State Administration for Foreign Exchange (SAFE), that
quietly has been making its own investments, in apparent competition
with China’s official sovereign wealth fund. In fact, both SAFE
and CIC are just two parts of a complex web of state-owned banks,
state-owned businesses, and government-run pension funds, all of
which draw their money—and receive their directions—from the
central government and which promote a state-led development
agenda.
China’s methods of raising such a large amount of foreign exchange
also set its sovereign wealth fund apart from those of other
nations. Rather than being derived from sales of commodities such
as oil or minerals, the capital in China’s fund is the result of its
financial controls and its trade surplus in manufactured goods. CIC
is a ‘‘by-product of efforts to manage exchange reserves more aggressively’’
and was established because the government’s total
holdings of foreign exchange ‘‘exceed what conceivably could be
needed for prudent reasons,’’ according to Brad Setser, a Council on
Foreign Relations economist who testified at a February 2008 Commission
hearing on CIC. 121 Ultimately, the enormous pool of money
available for investment means CIC is likely to have ‘‘a major impact
on the composition of global capital flows . . . and could have
a particularly large impact on the United States.’’ 122
Controversy has continued to surround CIC and China’s foreign
reserves despite China’s official insistence that it intends nothing
more than to diversify its portfolio with sound investments devoid
of political or strategic considerations. In early 2008, the Financial
Times reported that SAFE, the official administrator of China’s foreign
exchange reserves, appeared to have surreptitiously made investments
through a Hong Kong company that is its subsidiary. 123
In September 2008, the Financial Times revealed that SAFE
money was used as part of an incentive package to persuade Costa
Rica to shift its diplomatic recognition from Taiwan to China last
year (see the portion of this section on SAFE for further discussion).
124 SAFE agreed to purchase Costa Rican government bonds
at a low rate of interest despite Beijing’s promises that it would not
use sovereign wealth fund investments to further its political goals.
It remains unclear whether SAFE created its own sovereign wealth
fund to vie with CIC in a secretive, high-stakes bureaucratic squabble
or whether the SAFE fund represents an effort to escape public
notice while offering CIC up to scrutiny.
The participation of a large, nonmarket economy raises a broader
issue: whether China’s investment is formally transacted by CIC,
* The People’s Bank of China, the central bank, has reported that China’s foreign exchange
reserves grew from $1.0685 trillion in 2006 to $1.528 trillion in 2007. By September 2008, the
reserves grew to $1.91 trillion and are expected to reach nearly $2 trillion by the end of 2008.
www.pbc.gov.cn/english/.