[MUSIC]
Hitting the latest news
about China's ebb and flow and
global economic power,
feels like riding a roller coaster.
When things are going well for
China, the headlines scream about
how it's going to overtake the US
in the next 5 years.
When things are going badly for
China, you'll read about how it's
done for, it will never catch up.
Our research at the Global Capital
Allocation Project takes a step
back to examine the larger
pattern in China's ups and downs.
One thing we've been watching is
how China's trying to become
a global reserve currency.
Our reserve currency is a currency
that other countries hold as any
other account, because it's going
to hold up its value when investors
needed the most in a crisis.
For the last 100 years or so,
the US dollar has been the world's
dominant reserve currency.
When a crisis hits you and
you need money, if you have bonds
in dollars, you can sell them
without losing much value.
And because it's their own
country's currency,
the federal government and
American corporations have
the privilege of borrowing in
dollars at very low interest rates.
The United States has the home
court advantage, so to speak.
China now wants to be a player in
this reserve currency space,
both to build its own financial
power and to isolate itself from
the financial richer the US.
One way to do that is to
internationalize its cabinets, and
our basic requirements that is
getting foreign investors to
participate in its bond market.
That's a big deal.
China's bond market is the third
largest in the world, but
until recently, it was essentially
restricted to Chinese residents.
Foreigners couldn't really
invest there.
Over the last 10 years,
that has started to change, and
foreigners have progressively
entered this new vast market.
As China gradually opened up its
bond market to foreigners,
our research found that it
was strategic,
targeting different types
of investors at different times.
At first,
China was only looking for
large official creditors,
like foreign central banks or
foreign sovereign wealth funds.
Investors looking for
long term stable returns,
that helped get the world familiar
with this new market and started to
build up China's reputation as
potentially a safe place to invest.
A few years ago, China opened up to
a typical short-term investors like
mutual funds and hedge funds.
Surprisingly, we found that
the investors holding Chinese
debt are an unusual mix.
Some normally specialize in
emerging markets and others usually
invest in developed countries.
So investors see China as somewhere
in the middle.
Now China is still at the beginning
of this internationalization
process, and
it has a very tightrope to walk.
Our research provides a framework
to think about China's strategy.
China needs to build a reputation
for being a place where you
can park your money,
where it's liquid and safe, meaning
if you want to take it out you can.
Unfortunately, but that means
that if the rest of the world gets
scared about China and
wants to get their money out,
that sudden withdrawal of capital
will be expensive for the country.
Now that it has allowed more and
more short term investors,
this type of capital flight is
bound to happen.
In fact, through in 2022,
we saw some foreign investors pull
their money out of China.
And historically,
it has been hard for
countries to resist the temptation
to prevent investors from fleeing.
That's why it's really difficult to
become a reserve currency.
During China's next political and
financial crisis,
the government might decide to shut
down the market, locked the gates
on foreign investors and get stuck
with a terrible reputation.
Or they might find the strength to
go through the short term pain and
build for the long run.
Ultimately, why do we
care about this?
Well, this is a pattern that
is going to change the way money is
invested around the world if it
continues.
For example, it's going to change
how Americans and
Europeans invest abroad.
A big chunk of what your pension
funds or mutual funds hold could be
in China, and this could push up
interest rates in other countries,
like the US.
On the geopolitical side,
if China's currencies become
a viable alternative to the dollar,
it will limit the United States'
ability to freeze bad actors out of
the world financial system.
For example, recent efforts to
economically punish Russia for
its invasion of Ukraine wouldn't be
as much of a threat to Russia if
it had another available option
beside the dollar.
Of course,
the United States doesn't want to
be eclipsed as the epicenter of
the world financial system.
So while China tries to build up
its investor base, the US can try
to keep its good reputation by
issuing a lot of safe assets and
making it clear it's a safe and
open market.
It honors its promises and
it pays debts.
The US wants to signal to investors
that there is no need to go to
China or anywhere else.
[MUSIC]