Financial investment between the United States and China: current scope and future potential
While direct investment and venture capital flows between the United States and China have declined since 2016, “passive” investments in stocks and debt have increased. The inclusion of Chinese stocks in international bond and equity indices points to further growth, but political headwinds are blowing strong on both sides of the Pacific. Recent decisions by the U.S. administration, including an executive order banning U.S. investment in companies linked to the Chinese military and the forced delisting of some Chinese companies from U.S. stock exchanges, demonstrate that U.S. policymakers consider financial investment restrictions as part of their toolkit to reset the United States. -Economic relations with China. Beijing allows greater foreign participation in domestic financial markets, but only within tightly controlled parameters, and maintains strict controls on exits. The abrupt decision to cancel Ant Group’s Hong Kong IPO shows that political interventions extend to offshore financial markets. As policymakers navigate the complex issues around bilateral financial investments, it is important for them to have reliable and comprehensive data on cross-border holdings. This report, written by Rhodium Group for the National Committee on U.S.-China Relations (NCUSCR), clarifies the scope and patterns of bilateral financial investments in equities and debt securities and addresses key policy issues on both sides. The conclusions are:
China is a latecomer to financial globalization, but cross-border holdings of bonds and stocks are growing faster than traditional capital flows. Beijing lags behind major economies in global financial integration due to its reluctance to liberalize short-term capital flows. However, China’s financial ties to the world have grown rapidly from a weak base over the past decade as investors have found creative ways to control capital and Beijing has begun to gradually liberalize some channels. Official statistics do not accurately capture the full extent of China’s outward financial investment.
The United States is China’s largest financial counterpart, with the exception of Hong Kong. US markets have been key to raising cash for Chinese companies, and America is where government and household savers are looking to reinvest surpluses and savings. We estimate that there was up to $3.3 trillion in stocks and bonds back and forth between the US and China (including securities held in central bank reserves) at the end of 2020, nearly double the official figure of $1.8 trillion. Official under-reporting reflects the complex, multimodal structures that are often used for international securities investments and the difficulties that statistical agencies encounter in determining the nationality of issuers and owners of securities.
US holdings of Chinese securities approached $1.2 trillion at the end of 2020. We estimate that US investors held $1.1 trillion in equities and $100 billion in debt securities issued by Chinese entities at the end of 2020. That’s about five times the holdings captured in official US data, which show $211 billion in equity and $29 billion in debt. holdings in September 2020. Most of the disparity is due to Chinese companies using complex legal structures to issue shares out of tax havens that trade on US exchanges. These practices continue despite legal peril in China and U.S. regulatory pressure: In 2020, Chinese equity issuance on U.S. stock exchanges was higher than in any year except 2014. U.S. holdings of Chinese debt securities are smaller but growing rapidly thanks to China’s efforts to improve access to its onshore bond market and widening interest rate differentials between the United States and China.
Chinese holdings of US securities reached as high as $2.1 trillion. We estimate that Chinese investors held $700 billion in equities and $1.4 trillion in debt securities issued by U.S. entities at the end of 2020. By comparison, official U.S. data shows $240 billion in equities and $1.3 trillion in debt securities as of September 2020. Most of this The difference is explained by equity investments misclassified in official sources due to investors’ efforts to circumvent capital controls from Beijing or China. the use of Hong Kong as an investment intermediary. Debt securities represent the bulk of Chinese holdings. These are mainly US Treasury securities and agency bonds held by China’s central bank as reserves. While US investors tended to prefer ownership of Chinese equities (and were rewarded with higher relative returns), Chinese investors in US securities preferred to lend to the US government and US companies at rates of relatively low interest. They represent a small portion of foreign ownership of US stocks.
US-China financial integration is still in its infancy, but faces strong headwinds. Under normal conditions, there would be room for trillions of dollars of additional financial investment between the United States and China before balances reach levels typical of advanced economy pairs. A few years ago, such an expansion seemed likely, but the policy hurdles are mounting. Measures have multiplied on both sides which, if current trends continue, could significantly reduce growth prospects. Beijing has declared its preference for greater financial openness to the world, but needs to implement far-reaching reforms before it can truly open its capital account without safeguards. Washington has traditionally taken a very liberal approach to financial globalization, but a new era of “strategic competition” with China has led to redrawing the borders of national security, including in the economic and financial space. A new US administration is unlikely to completely reverse this change, but it could strike a better balance between mitigating national security risks, incentivizing good financial governance, and preserving the benefits of benign ties.
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