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China could use pile of cash to invest in USA

August 9, 2007

At the end of an easy-money era that buoyed and then battered both Wall Street and Main Street, one global market player stands out as noticeably flush: China.

Though still nominally communist, its institutions are sitting on a mountain of capitalist cash. Beijing now could spend some of its hoard on cross-border investments, taking advantage of market turmoil ignited by the mortgage industry meltdown.

“There is no doubt in my mind they would love to further buy into the U.S. financial sector, especially at bargain prices like these,” says Donald Straszheim, vice chairman of Los Angeles-based Roth Capital Partners.

Even after markets steadied Wednesday, some industries China is known to covet are attractively priced. The Standard & Poor’s investment bank and brokerage index, for example, is down 15% since hitting a 52-week high on June 13.

But any Chinese shopping spree is likely to trigger political controversy. In June, after China bought a $3 billion non-voting stake in the Blackstone private-equity group (BX), Sen. Jim Webb, D-Va., complained to Treasury Secretary Henry Paulson about China’s “undue influence” over national security contracts held by a Blackstone subsidiary. Likewise, a Chinese oil company dropped its bid for Unocal in 2005 after drawing fierce congressional opposition.

Since then, China’s cash stockpile — fueled by imbalanced Sino-U.S. trade — has only grown. Earlier this year, the Chinese government announced plans to use some of its $1.33 trillion in financial reserves to create a $200 billion state investment company. The country’s state-owned banks are well-heeled, and foreign investment by its leading corporations hit $16.1 billion last year, up 31% from the year before, according to Jing Ulrich, managing director of JPMorgan in Hong Kong.

Shares of one of the Wall Street names hardest hit by recent mortgage-related losses, Bear Stearns, are trading more than 29% below their 52-week high, meaning the firm “could be a potential takeover target” for one of China’s state-owned banks, said Fraser Howie, author of Privatizing China. In July, another Chinese financial institution, China Development Bank, bought a 3.1% stake in Barclays Bank of the U.K.

“I presume some part of China’s government will soon buy an equity stake in a major hedge fund or investment bank as well. … Anyone looking for financing to do a really big deal will, I would guess, soon make a pilgrimage to Beijing,” economist Brad Setser wrote recently on his RGE Monitor blog.

Renewed talk of China’s investment ambitions grew out of market upheaval that began with subprime mortgages, loans extended to borrowers with poor credit histories.

The market’s woes would be remedied if “China-based capital starts buying mortgage companies that it views as bargains,” CNBC’s Jim Cramer mused on-air Monday.

That possibility is regarded as far-fetched by China-watchers, including Straszheim, who says the residential-loan business holds no strategic value for Beijing. Likewise, government bureaucracy and lack of experience in cross-border deals mean China is likely to move slowly, says Rand’s William Overholt. It also means that the Chinese, like Japanese investors in the 1980s, may make some rookie mistakes. “Americans are going to make a lot of money out of these transactions,” he says.