February 26,2008

What the US Does (n't) Allow China to Buy?

By Ma Wenluo

When Chinese enterprises, with a large piles of fresh-off-the-US-presses US dollars, seek to enter the US economy, they have found repeatedly that while they are most welcome to lavish money on America in the form of debt, their attempts to purchase American companies are often met with hostility.

On February 7, the Chinese lunar New Year’s Day, the US-China Economic and Security Review Commission held a hearing in Washington, suggesting that Congress should pay special attention to any investment from Chinese enterprises that may have implications on national security or key industries. Two weeks later, Bain Capital Partners, a US private equity firm, and China’s telecommunications equipment maker Huawei Technologies shelved a deal to acquire 3Com due to the opposition of the Committee on Foreign Investments in the United States (CFIUS). Liu Jianchao, spokesman of the Chinese Ministry of Foreign Affairs, protested and hoped that competent US authorities would "deal with relevant problems according to law and create a fair and reasonable environment for the investment of Chinese companies in the US". 

China’s investment in the US is comprised mostly of investment in financial securities with some industrial investment. China is a main holder of $400 billion of American debt and some of that has aided the US in its anti-terrorism campaigns as the wars against terrorism have boosted the Bush administration’s huge budget deficits.

So China’s investments in American bonds and stocks have been encouraged, and Secretary of the US Treasury Henry Paulson has urged China to loosen capital controls and allow even more Chinese capital to flow out. According to the memorandum of understanding between the US Securities and Exchange Commission and the China Banking Regulatory Commission, Chinese banks are allowed to launch open funds investing in the US stock market. However, the late stock slump in the US market has caused large losses to QDII products and Chinese interest in investing in American stocks has waned for the nonce. And due to the low and lowering rate of return on American debt, China’s foreign exchange fund is gradually cutting the proportion of Treasury paper it holds and increasing its stash of municipals and corporate bonds.

But Americans, at least many outside the financial industry, are not welcoming China’s investment in Wall Street. They see the Chinese funds moving into American financial enterprises as tainted by the Chinese government’s touch, and Chinese investors?participation as serving the global investment strategy of Chinese state-owned enterprises. And who knows, but that might negatively influence both American and global financial markets. In the US, Congress passed a law in 1991 disapproving any attempt by foreign banks to acquire, merge with or hold any American bank.

That foreign investors, including Chinese, might be willing to support Wall Street and Americans?consumption levels in order to avoid a recession of the US economy to maintain and thus ensure the stability of their own economies that are dependent on exports to the US seems, for many Americans, hard to understand.  The Foreign Investment Study Act of 1974 requires all companies with a 10% or higher percentage of its shares directly or indirectly controlled by foreign investors and their subsidiaries to declare such to competent authorities. Investment under 10% is regarded as a passive stake and needn’t to be approved by the CFIUS. To avoid unnecessary political conflict, the China Investment Corporation (CIC), China’s sovereign wealth fund, limited its recently acquired stake in Morgan Stanley, much welcomed by that company, to 9.9%. CIC said the investment was completely passive and it would not demand board representation nor would it try to influence the daily operation of the company. But in hearings of the US-China Economic and Security Review Commission, several senators appealed to the Bush administration to examine every investment in US enterprises by funds established by foreign governments, "no matter how small it is". 

The US restrains foreign capital from investing in areas related to national defense, natural resources, land and mine exploitation, telecommunications, domestic and coastal shipping, domestic air transportation and energy exploitation. In 2005, the US government banned the China National Offshore Oil Corporation from acquiring Unocal Corp, an American oil company. 3Com, which Huawei Techonologies wished to acquire, is a telecommunications company and provides services for the Pentagon. So the deal was opposed by the US government, which deemed it non-market oriented behavior. Observers regard these as tip-offs that similar deals between Chinese and US companies will be blocked. "It was a bad deal for American security, but also a harbinger of challenges facing the government, as China, awash in capital, continues to look to the U.S. for acquisition opportunities," Said Duncan Hunter, a Republican member of the US House of Representatives from California. "China has lots of cash, American companies are in need of cash," Rep. Hunter said. "There's going to be a continuing conflict, between American security interest, and the desire for ready cash."

According to US regulations, overseas investment is allowed in industries such as chemicals, building equipment, electronic products, medicine, TV making, and wineries, among others. The direct investment of China’s manufacturers in their US counterparts seems welcome. By establishing factories in the US, Chinese enterprises can enter the market directly and avoid tariffs and non-tariff barriers. In 2004 Lenovo, a Chinese PC maker, successfully acquired the personal computer business of IBM for $1.75 billion, Earlier, in 1999, Haier, a Chinese home appliance maker, invested $30 million to set up a production base in South Carolina. Just as Japanese companies investing in America’s automobile industry, Haier has completely fitted its factory into its new home. Its over 300 employees, both management and labor, are all from the local area. The state government loves it and has even named a road after Haier. Unlike its investment in financial areas, investment by Chinese in traditional manufacturing is seldom examined by the CFIUS. In the summer of 2005, Haier’s plan to acquire 100% of Maytag, a US white goods manufacturer, did not require CFIUS approval. However, due to the high labor costs in the US, most Chinese companies show little interest in setting up production in America or purchasing American manufacturing enterprises. 

The investment relationship between China and the US is bound to remain tetchy.  The US government will favor Chinese FDI that creates job opportunities but US trade unions will not welcome mergers that may suck those jobs back to China. M&A in resource areas and strategic investment in financial areas are blocked. Currently, direct inflows from China are mainly portfolio investments with low percentage stakes. Actually the US prefers money borrowed from the Chinese rather than M&A, which might put a Chinese in the driver’s seat.  For the foreseeable future, Chinese investors buying 1% in 10 companies will be easier for the US to swallow than buying 10%,or more, of a single company.






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