Diversifing the portfolio of Chinese U.S. dollar reserves seems like a good move.

Rather then accept a paltry sum on T-Bills and have the Federal Reserve of the U.S. increase the money supply rate far faster then the return on those T-Bills, why not take advantage of some of the U.S. asset price increases that will result form the Federal Reserve monetary pumping?

An excerpt from Peter Navarro’s recent testimony before Congress, though one would do well to read it in its entirety. The bottom line is that the Chinese already have control over the US economy via the bond market and will only increase that control in the future:

Stage Two in the projection of Chinese economic, financial, and political power is just now getting underway, and it involves what is likely to be a very aggressive move into U.S. equity markets. In this regard, a Bank of America analyst recently reported the expected formation of a new investment corporation in China that may be capitalized with as much as $200 billion, roughly one-fifth of China’s foreign currency reserves.[x] The purpose of this corporation will be to invest some of China’s reserves into equity holdings around the world, with much of the investment likely to be focused in the U.S.

On the surface, this seems like a good thing for the U.S. stock market as any infusion of capital into U.S. equity markets would be reflected in higher share prices. There are, however, several caution flags.

First, should China become as important a player in U.S. equity markets as it now is in the U.S. bond market, it would be able to destabilize not just the U.S. bond market but the equity markets as well. Second, China may begin to use its equity funds strategically to establish controlling interests in U.S. companies. In this way, China may effect decisions ranging from the offshoring of production or transfer of technology to China to lobbying against U.S. legislation designed to promote fair trade.

Third, there is no guarantee that China will always “go long” the U.S. market with its financial capital. Indeed, there may be times that China may want to short the broad U.S. market indices or major U.S. companies as a hedge against events it may either be anticipating – or, in the worst case, precipitate itself.

Wouldn’t investing more in U.S. equities vs U.S. T-Bills also increase the rate of return that the U.S. would have to offer on U.S. T-Bills?

In effect, the extent to which the Federal Reserve would be able to tax the outstanding debt of the government through monetary policy would be abrogated.

I haven’t yet read Mr. Blumen’s article about central bankers buying US stocks, an interesting prospect. However, I just finished his article about “Debt and Delusion”–the synthetic growth of financial markets and prices in the US.

Several major consequences flow from the creation of a gigantic species of artificial life, i.e. today’s bloated financial sector, by long-term Fed policy. One such consequence is that those who work in “finance” enjoy hugely exaggerated incomes. I’m not hostile to their earnings, but only note that this phenomena accounts for the scale of those earnings.

Because financial professionals enjoy a huge incomes, they are able to use cheap Fed borrowings to buy other assets, such as western ranches which are scarce when compared to this ocean of new borrowed money. In north central Montana, the price per acre of river breaks ranches has increased 1,000% since 1987.

But there exists another dimmension to this enormous misallocation of scarce resources into “finance”. Long term and extensive state intervention in the market, from central bank abuses to tax and regulatory and entitlements burdens, may today be eroding America’s ability to maintain its infrastructure of capital goods. Malinvestments–in finance and housing, for example, waste scarce and precious capital; regulatory and tax burdens reduce output and capital investment. Inflation and low interest rates encourage consumption, and reduce the returns from which subsequent savings (and investment) can be made. We may be in the process of moving from a stagnant to retrogressive economy, reflecting silent insidious capital consumption.

If we are consuming capital today, then this fact alters relative prices. Demand for producer goods declines, while greater portions of falling real incomes must be devoted to consumption. This increase in time preference weakens pricing among producer good manufactures. Such weaker prices mean that formerly profitable businesses no longer make much money–not after taking full account of the inflated costs of eventual capital replacement and the tax take on over-stated corporate income.

But if producer-goods manufacturing companies no longer really make much money–despite reported profits–then these companies will not be enthusiastic about expanding their production, or in venturing into related businesses. Such a reluctance to invest in bricks and mortar could account for A) the doubling of cash held by corporations as a percentage of their assets since 1982, and B) the takeover boom, wherein company A speculates in the resale value of company B, using borrowed money; and finally C) the ubiquitous proactice today of corporations buying back their own stock at relatively low earnings yields–a practive that has contracted the capitalization of the US market in recent years by 20%.

To wrap this all up succinctly, when the Fed holds the monetary base steady for a while–as in the last year–the risk grows of an unexpected financial markets crash. If levereaging works going up, it also works rapidly going down.

Any ideas where it may go. I dont think that government has any interest in buying U.S. real estate because of its illiquid and risky nature. I would wonder how much of this will go into “aid” and investment schemes in Africa while they secure resources.