It would be fascinating to see what Mao Zedong would make of China’s $3 billion (Rs12,300 crore) investment in the Blackstone Group.
Here you have the world’s most-watched communist nation investing in perhaps the most capitalist of Wall Street vehicles: a private-equity (PE) firm. China is doing so with foreign exchange reserves, which it uses to ensure employment for its 1.3 billion people.
For Asia’s No. 2 economy, “The Blackstone investment represents a supreme business irony,” Donald Straszheim, chairman of Newport Beach, California-based Roth Capital Partners, told clients in a report.
China’s embrace of the PE movement, which the country’s regulators have long viewed with suspicion, is about expediency. Officials in Beijing have $1.2 trillion of reserves they want to invest more profitably than in US treasuries. They lack the expertise to do it themselves and don’t want to pay money managers millions in fees.
Enter New York-based Blackstone, an institution with the expertise that Chinese bureaucrats lack: running globally competitive companies. For Blackstone, the deal is a way of improving PE’s image in Beijing.
It’s a marriage seemingly made in investment heaven. That is, until you consider that it could also be the bonding of the world’s most obvious bubbles.
Lots of bubbles
China, of course, has at least a couple of bubbles on its hands. One is the equivalent of Spain’s annual gross domestic product (GDP) in reserves. The other is the irrationally exuberant surge in Chinese stocks, which Li Ka-shing, Asia’s richest man, says “must be a bubble”.
Then there’s the PE bubble. Banks are helping fund a record pace of mergers this year, with the value of announced leveraged buyouts soaring 40% to $188 billion in the first quarter alone. Last week, US Federal Reserve chairman Ben S. Bernanke said PE financing carries “significant risks” for banks, and the Fed is reviewing the issue.
“It’s very important for banks to be quite aware of the risks that are associated with working with private-equity firms,” Bernanke said. “We’re beginning to look at that.”
Bernanke didn’t use the word “bubble”, yet when it comes to Fedspeak, there’s a strong suggestion that the central banker senses one. It’s worth noting that New York Fed president Timothy Geithner also said officials are “looking carefully” at the loans that finance leveraged buyouts.
Geithner will be the guy left picking up the pieces if a PE-related meltdown shakes up markets the way the 1998 implosion of US hedge fund long-term capital management did. None of this means the PE phenomenon will go bad, though this is a case where regulators are moving too slowly to assess the risks to the global financial system.
The budding relationship between China and PE dovetails with a report this week from the Organization for Economic Cooperation and Development (OECD). It said the boom in buyouts is due to excess liquidity and low yields caused by distortions in the global system—mainly in China and Japan.
These transactions are facilitated when either borrowing costs or exchange rates are held too low. “Two major prices in the world economy worth noting in this respect are the near-zero interest rates in Japan and the fixed exchange rate for the renminbi,” OECD said.
Forces of change
PE firms are forces of change in the global markets and they can create new efficiencies. Yet their activities respond directly to the cost of global credit. At the moment, China’s currency policy, together with Japan’s ultra-low interest rates, is a key source of the liquidity feeding bubbles.
“We have actually now bubbles everywhere,” Marc Faber, who oversees $300 million in assets at Marc Faber Ltd, had said on 21 May. “We have bubbles in real estate, in equities, in bonds, in commodities, in art prices and totally useless collectibles. So, this bubble is huge and includes just about any asset in the world.” Faber is hardly alone in this view, and perhaps all the liquidity seeping out of China and Japan explains why.
If there are bubbles across asset classes, could they really be happening coincidentally? It may be that the sideeffects of two dynamics thought to be benefiting investors—Chinese growth and cheap loans from Japan—are setting the stage for a global swoon.
Opposition from lawmakers
The linking of China and companies such as Blackstone won’t please some US lawmakers. Blackstone aims to raise as much as $7.75 billion selling stock to the public and to China in the biggest share offering by a PE firm.
On the one hand, it’s a creative way for China to put some reserves in US assets without being accused of manipulating its currency. On the other, it means two issues that lawmakers hope to exploit in next year’s elections are becoming more complex.
Mao, who died in 1976, would hardly recognize the China of 2007. Then again, few would have predicted the changes that have taken place in his homeland.
Comments are welcome at email@example.com