Enter the Dragon

By Bill Powell / Shanghai

The issue is straightforward enough, even if few countries have ever had to deal with it on this scale before: thanks primarily to its thriving export industries, China has $1.4 trillion (and counting) in its pocket and has to put it somewhere. For years, the investment of choice has been the riskless solidity of U.S. Treasury bonds. But as the dollar drops and higher returns can be gained elsewhere, China has begun to eye more alluring places to stash some of its cash.

On July 23, Beijing made its boldest investment play yet. The China Development Bank (CDB), a huge, state-owned institution that until recently has focused on making large, subsidized loans for infrastructure projects, typically in the country's poorest regions, is plunging into the middle of a takeover fight for one of Europe's biggest and most venerable banks. Teaming up with Singapore's state-owned investment vehicle, Temasek--which will put up an initial $1.9 billion--CDB will fork over $3 billion for a stake in Barclays, the British bank locked in a struggle with a consortium led by Royal Bank of Scotland (RBS) to acquire Amsterdam-based ABN Amro. If Barclays increases its $94 billion cash-and-stock bid--unlikely unless Barclays' stock price rises--to beat RBS's $98 billion offer, CDB will boost its stake in Barclays to $13.5 billion, making it by far the biggest Chinese offshore investment ever.

The point is that there is more, much more, where that came from. To date, China's economic engagement with the outside world has come largely via exports (it exported $969 billion worth of goods last year) and by attracting huge amounts of foreign direct investment, mostly from manufacturers taking advantage of its low labor costs. That is changing rapidly. A month ago, Beijing's recently formed State Investment Co. bought a $3 billion stake in the Blackstone Group just before the U.S. private-equity giant went public (an investment that so far is more than $300 million under water). This and the CDB stake in Barclays are the most high-profile foreign investments China has made since the oil firm CNOOC tried and failed to buy U.S. oil company Unocal in 2005. Says Jing Ulrich, JPMorgan's Hong Kong--based head of China equities: "China has a wall of money--a tsunami, really--that is about to hit the rest of the world. In terms of global capital markets, there is just nothing happening that's bigger than this right now." Indeed, JPMorgan figures that if China boosts its national savings 10% a year--a "conservative" estimate, it says--and only 5% of the total leaves China each year, by 2020 China's outbound investment from individuals and corporations alone (not including money from the State Investment Co.) would amount to $822 billion. Total Chinese foreign investment last year was a mere $16 billion.

For Beijing, having $1.4 trillion to invest is a nice problem but a complicated one nonetheless. "It's the classic elephant-in-the-room syndrome," says a Western banker who advises the State Investment Co. "Where does he sit? Anywhere he wants, sure. But he's got to be very careful that he doesn't squash anything when he does." The mere whiff of a rumor that, say, Beijing may shift part of its foreign-exchange holdings from dollars into euros has rattled world currency markets several times in the past year.

To date, most of the direct investments Chinese companies have made abroad have been relatively small, aimed principally at gaining access to key supplies of oil, gas and minerals in Africa and elsewhere. Much of this has gone largely unnoticed. Chinese companies, for example, quietly invested $4.2 billion in Russian companies last year. But some, of course, has been decidedly noticed. The country's investments in Sudan, which increased in early July when China National Petroleum Corp. said it would spend an additional $25 million developing an offshore field there, have become a global flash point given the carnage the Khartoum government has allowed to continue in Darfur.

Nor has that been the only political problem tied to foreign investment for China. Beijing has not forgotten the protectionist uproar that was triggered in the U.S. when CNOOC tried to buy the Los Angeles-- based Unocal. The lessons, say people involved in the deal, have been seared into the brains of the Chinese and have been evident in the plays in Barclays and Blackstone. Rather than trying to swallow big, high-profile Western firms in one bite, the Chinese are taking smaller, strategic stakes and working, in the case of the Barclays deal, with another prominent partner, Temasek.

This measured approach may help Chinese firms avoid the disaster that befell many Japanese companies when they went on their foreign-spending spree in the late 1980s. The Japanese not only met xenophobic public opposition in the U.S. but also in several instances vastly overpaid for glamorous properties, like Rockefeller Center. "I don't expect China to go in for trophy properties," says JPMorgan's Ulrich. "They know the lesson of the Japanese debacle." That said, she concedes, the odds are that Chinese companies will make mistakes of their own, given the sheer volume of deals to come. "This," she says, "has only just begun."

With reporting by Adam Smith / London