2010-09-01 16:15

China now sits atop $2.4 trillion in foreign exchange reserves, the largest held by a country (Japan is second with $1 trillion). But this bounty comes with one big headache: where should Chinese officials park all that money?

International bankers estimate that roughly two-thirds of the Chinese reserves have been invested in dollar assets. In other words, China owns a huge chunk of America's ballooning debt. Chinese reserves invested in these conservative financial instruments are relatively safe, but they yield little return.

The moment of truth is looming over both sides of this co-dependent, and ultimately dysfunctional, economic relationship. First, there are limits to how many trillions of dollars China can, and should, put into US Treasury bills.

After all, should the dollar depreciate, China does not want to have too many eggs in the US basket. Investors should diversify their risk, and so must China.

But with so much capital, the options are limited. Until the euro weakened recently, Chinese bankers had been buying more euro-denominated assets, no doubt recognizing that, despite the frailty of the European Union's (UN) economy, Chinese exporters also need European consumers to keep buying their goods.

But the reality is that neither the euro nor the yen is capable of soaking up China's growing foreign exchange reserves.

It is hardly surprising then that Chinese officials have begun seeking more diverse and profitable investment possibilities across the world. We are far less acquainted with other kinds of Chinese investments, including outright acquisitions of foreign companies.

Here the US has not yet shown itself to be a particularly hospitable environment for Chinese investment. This has been especially true when Chinese State-owned enterprises (SOEs) have aspired to buy, or buy into, iconic US corporations that have a blush of national-security significance about them.

Things got off to a poor start in 2005, when the China National Off-Shore Oil Corporation tried to buy Unocal. Even though almost all of the oil produced by Unocal would have ended up on world markets rather than back in China, the US Congress's skittishness assured that Unocal was sold to homegrown Chevron.

Although Chinese investors have since made numerous lower-visibility plays in US markets, the failed Unocal deal has left a legacy of bitterness. So it is hardly surprising that gun-shy (and miffed) Chinese investors are wary about making further major efforts in the US. Huawei's recent failed bids for 2Wire and Motorola would only have rekindled this bitterness.

Indeed, a case similar to Unocal arose this summer. The Anshan Iron and Steel Group, a Chinese SOE, tried to buy a 20 percent interest in Mississippi-based Steel Development in the hope of setting up a re-bar plant in the US.

News of the pending deal prompted 50 Congress Representatives from the US steel caucus to write a letter to Treasury Secretary Timothy Geithner, calling for an investigation into the threat the deal posed to US national security and American jobs.

Nonetheless, the latest spurning of Chinese efforts to invest in the US comes when capital-poor and job-scarce America (where unemployment is more than 10 percent) could truly benefit from more receptivity to investment from capital-rich China.

One might think the US government would be actively courting Chinese investment, not scaring it away unnecessarily. If American officials do not begin to recognize the realities of today's globalized world, the US may unwittingly (and self-destructively) find itself cut off from the kinds of new foreign investment flows that are sorely needed to revitalize its manufacturing and infrastructure sectors.

The bitter new reality is that the US and "old Europe" have recently edged closer to becoming "developing countries". Indeed, it may be a painful recognition, but America's share of worldwide foreign direct investment is now half of what it was two decades ago.

If the Barack Obama administration and EU officials cannot figure out the proper mix between economic engagement and protecting national security, investment capital from China will go elsewhere. That is a strategy that will leave the US and the EU weaker, not stronger.

The author is director of the Center on US-China Relations at the Asia Society.