Why China is Luring Western Investment Into their Financial System

Boom in asia

China is incredibly strong.

They’ve got a massive population, which is growing wealthier by the year. They’re one of the most important importers for most nations. And the government is planning to steer the country into a future of prosperity and power.

China is definitely not short of problems, which I’ll touch on in a moment. But investing in China can be extremely lucrative.

The Hang Seng Index is up more than 33% this year. And house prices continue to climb to new heights.

The Hang Seng index

Source: Google Finance

Many believe various Chinese assets are in bubble territory. Yet, that doesn’t stop the herd when there is growth to capture.

Of course, no one expects asset prices to continue their climb in perpetuity. Sooner or later, prices will stagnate or pop.

China’s Huge Debt

The number one cause for the latter could be China’s huge debt burden. As a percentage of gross domestic product (GDP), China has a total debt to GDP of close to 260%.

China debt

Source: Bloomberg

For financial institutions like banks, it’s an extremely risky time. High asset prices are causing more people to borrow, hoping they can sell their assets at even higher prices to pay off their debt.

We could see a similar crash to the one we saw in 2008.

China’s Inviting Foreign Capital

Of course this is the last thing China wants. That’s why they’re inviting foreign capital into their financial industry. The hope is, according to Bloomberg columnist Noah Smith, that Western capital will flood into highly leverage financial institutions. Thus reducing the blow of a crash if one does eventuate.

The opportunity might seem tempting. But developed-world buyers should beware — it’s possible that it’s a trap.

On Nov. 10, Vice Finance Minister Zhu Guangyao announced changes in the rules limiting foreign ownership of Chinese financial companies. Foreign investors will now be allowed to take controlling interests in Chinese securities firms, insurance companies, asset managers and futures traders. Banks may soon follow.

That sounds like a move toward greater openness for the world’s biggest economy. If so, it would run exactly counter to the recent trend of increased Chinese protectionism and economic nationalism. Why would China open its financial system to foreign investment even while it slowly closes off its consumer markets? I suspect that this move toward openness and globalization might not be all that it appears.

I don’t totally agree with Smith, but I can see his point. A foreign cushion of cash could create a way to protect against falling asset prices.

However, I suspect China is inviting foreign cash into their borders as a way to increase the purchasing power of their middle income class.

With more money in the system, Chinese lenders can give out more capital to consumers and small businesses. It could encourage more spending, growing earnings for many over-leveraged businesses, who can use their growing cash flows to pay off debt.

We probably won’t see the effects of this in the next few months, or even years. But a decade from now, all investors will want exposure to Chinese businesses and real estate.

Cheers,

Härje Ronngard,

Junior Analyst, Markets & Money

PS: Chinese real estate may be the place to be in a decade. But right now, Aussie property prices continue to defy gravity. Those who have tried to predict the top have been wrong thus far. And that’s because property prices still have a long runway of growth ahead.

If you want to read more about long-term booming property, check out our Markets & Money report, ‘Why Australian Property Is on the Verge of a Decade Long Boom’.

Härje Ronngard

Härje Ronngard

Harje Ronngard is a Junior Analyst at Markets and Money.

With an academic background in finance and investments, Harje knows how simple, yet difficult investing can be. He has worked with a range of assets classes, from futures to equities. But he’s found his niche in equity valuation.  

Härje Ronngard

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