This week, China revealed to the world what it already knew: China is using its foreign exchange reserves to fund foreign acquisitions by state-owned industrial giants. Premier Wen Jiabao said on Tuesday, "We should hasten the implementation of our ‘going out’ strategy and combine the utilization of foreign exchange reserves with the 'going out' of our enterprises." The "going out" refers to the efforts of large Chinese companies, such as Sinopec, Chinalco, and the Bank of China, to acquire foreign counterparts. However, the investment targets are no longer stakes in temporarily weakened western entities, but companies that will secure access to raw materials and energy.
Considering recent acquisitions (or acquisition attempts), this strategy has been obvious for quite some time. But it is a milestone to have a Chinese official publicly acknowledging the "going out" strategy for the first time. Jiabao's statements are also further recognition of China's dissatisfaction with the US dollar. This dissatisfaction has steadily increased and, over the past month, China has tried different avenues to address its reliance and vulnerability to the US dollar.
Early in July, China called for the G8 to discuss an alternative global reserve currency. Around this time, it also announced it would allow select Chinese companies to settle transactions in renminbi. A statement from the People's Bank of China stated, "Companies in China and neighbouring countries are facing relatively large risks of exchange-rate fluctuations because of big swings in the US dollar, the euro and other major currencies used for settlements." China's "going out" strategy is another way to address its reliance on the dollar. As the FT's John Authors pointed out in "the Short View" on July 23rd, China's strategy has shifted slightly from buying commodities to buying the companies that produce commodities. This is a good investment strategy as the rebound in commodity-based equities has far outstripped the rise in commodities. But there is also a strategic advantage: being a producer gives China more pricing power than being the biggest buyer. One interesting thing to watch in the future is what happens to the size of the "China premium", or the extra amount Chinese companies often have to pay to acquire foreign companies.
The "going out" strategy is also reflective of China's new geopolitical role. China's involvement abroad is based on trade rather than principles and politics. Its "going out" strategy means China will be a bigger player in places like Africa and Central Asia where there are abundant resources but less political opposition than places like Australia, where public opinion effectively blocked the 19.5bn Chinalco-Rio Tinto investment. In this sense, China is leveraging its currency differences in two ways. First, the low value of the renminbi drives export-oriented industries to China. Secondly, the suppressed renminbi supplies China with large reserves, which it now translates into real assets. The "going out" strategy, as well as China's efforts to have some Chinese companies use the renminbi, underscores that a weakening dollar will remain one of the strongest secular trends over the next decade. That is, unless there are stark structural changes in the US economy, which seems increasingly unlikely as appetite for reform is slowly seeping out of the political consciousness (best seen in the rising opposition to cap-and-trade and healthcare reform).
