The financial relationship between the United States and China may be wider, but shallower, than previously known. Even as political tensions escalated, their respective portfolio stakes in each other swelled to some $3.3 trillion, or double official estimates, according to new research. The shift from direct investment to stocks and bonds portends a more volatile financial relationship.
Bilateral direct investment flows, including venture capital, have been on the decline since 2016. Such money tends to be longer-term, and involves active management, engagement with the local market and exposure to government policy. Rising diplomatic distrust has therefore translated into policy hostility, discouraging deployment of capital via this channel.
Compensatory efforts
China’s increasing comfort with foreigners trading more equity and debt issued by its companies has compensated somewhat. US investment in such securities neared $1.2 trillion by the end of 2020, per a Rhodium analysis released on Tuesday. That’s roughly five times what’s recorded by official US data, which the authors attribute to shares issued through tax havens.
Similarly, Chinese investors, including the country’s central bank, have accumulated $700 billion worth of stocks — nearly three times official U.S. estimates — plus $1.4 trillion of debt from the United States. That hidden equity stake may help explain how some New York-listed Chinese companies accused of fraud by short sellers, including GSX Techedu, experience mysterious short-squeezing rallies immediately after coming under attack.
‘Investing in your enemy’
It makes sense for Chinese fund managers to increase their relatively small overseas portfolios, to improve diversification and hedging. Ditto for American hedge funds and others seeking fast-growing companies in markets that do not perform in sync with the S&P 500 Index or track US Treasury yields. For this trend to grow even as long-term capital flows decline is worrying, however.
Such securities holdings may be passive, but they’re also fickle. When foreign funds flee en masse, as during the 1997 Asian financial crisis, they destabilise currencies and wreck economies — one reason Beijing has been wary of them. During a 2015 Chinese stock market crash, the country tightened its capital account and froze traders. In New York, Chinese companies are being excluded from indexes and face delisting. Investing in your enemy can be a dangerous game.