AEI (American Enterprise Institute)
Less American Money in China, for Now
December 18, 2023
There are technologies Chinese entities can’t legally acquire in the US. Similar technologies can’t legally be sold to Chinese entities through exports. Yet American funds can be used to develop any of these technologies in China. Some limits on US investment in the People’s Republic of China (PRC) are long overdue. The good news, confirmed last week, is the amount of American money in China fell in 2022.
Per dollar, the more valuable kind of investment is direct—creating a new asset or taking a sizable stake in a foreign company. US direct investment in the PRC is fairly stable. The stock was $167 billion in 2016, $216 billion in 2022, and the biggest annual change was $18 billion. Computers and electronic products (no technology category exists) saw investment stock $12 billion higher in 2022 than in 2016.
Portfolio investment is the acquisition of securities. It’s less valuable per dollar but vital for US-China relations because changes are huge. To see this, don’t use the Department of the Treasury’s monthly data on portfolio flows. These data show the leading recipient as the Cayman Islands, at over $2.5 trillion total. The true number is near zero. The Caymans doesn’t have securities markets, it’s a holding area for funds headed elsewhere.
Once a year, the Federal Reserve determines where investment in offshore financial conduits such as the Caymans and Ireland actually goes. Last week the Fed published a paper including data on the true national destinations of portfolio capital. At the end of 2022, the largest final destination is actually the US—money just comes back.
In receiving capital through offshore conduits, China is a distant second to the US but well ahead of all others. The true stock of American portfolio investment in China and Hong Kong in 2022 was $910 billion, falling $260 billion from 2021. In 2016, the stock was $516 billion. It soared to a 2020 peak of $1.4 trillion, before fading. America’s portfolio investment in the PRC dwarfs direct.
The portfolio shifts are due chiefly to holdings of common stock. Yet, other than a plunge in 2018, the PRC’s benchmark Shanghai index hasn’t moved more than 15 percent in any year. Changes in value may matter less than new money flow. Some swings for US investors do stem from Alibaba, whose stock peaked in 2020, then lost $650 billion capitalization after a clash with Chinese regulators.
American regulators have done nothing. Constant claims that the Biden administration restricts investment in China are false. After more than two years of chatter, rules have only been proposed, no action taken. The proposal itself is absurdly weak. The implementing authority is the Treasury Department, where Secretary Yellen frequently calls for cooperation with Xi Jinping. Draw your own conclusions.
Yet the Biden administration’s record is better than the Trump administration’s. In 2016, referring to the trade deficit, candidate Trump criticized the loss of American money to the PRC. Money does leave the US in China trade, with goods and services coming back. When funds leave the US as investment in the PRC, what comes back (or not) is profits for investors. Which is a bigger loss for America?
Combining the trade deficit and (gross) US portfolio spending, the top year for money leaving the US in this sense is 2017. The second-biggest is 2019 or 2020, all under Trump. Consider 2020: while COVID spread from China to kill hundreds of thousands of Americans, US capital either saw huge profits from PRC investments or poured hundreds of billions of new dollars into the PRC or mixed the two.
Since then, the value of existing investment has dropped, and/or money has been withdrawn. But 2017–2020 makes clear Wall Street will rush to partner with China, and 2017–2023 makes clear the Department of the Treasury will help. It’s up to Congress to stop treating Xi Jinping as a partner, especially in technology. While Congress has not acted to date, the 2024 door is open.
The first step is transparency. The US has never even attempted to monitor what American money supports in China. Shoes or surveillance? Good policy requires this knowledge, and those opposing transparency are undermining markets. Senator Rubio and others last week introduced a major step forward in getting the information policymakers need.
The second step is preventing American funds from helping the PRC in a few key areas. This can’t be done by targeting individual firms, Beijing will just swap in other firms. The model is existing US restrictions on exports to China and Chinese acquisitions here. Certain technologies already covered should be off-limits to American investors, too. Start with the most urgent, then build up knowledge and capabilities to get the policy right.
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