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Tickers in this Article: GE, GS, GOOG, BX
When China announced that it was taking a $3 billion stake in U.S. private equity firm Blackstone Group LP (NYSE:BX) last May it signaled to the markets that a large "C" change had occurred in its foreign investment philosophy.

Up until that point, the country had acted in accordance with the standard sovereign investment model: play it safe and buy lots of foreign government bonds. Now that it's portfolio of U.S. Treasury bonds stands in excess of $404 billion, or about one-third of its total foreign exchange reserves of $1.2 trillion, playing it safe now demands that China start adding a bit of equity into the portfolio mix, if for no other reason than for the sake of some common sense diversification.

That's why the Chinese recently took steps to create, an as yet unnamed, state investment corporation (SIC), and provide it with initial funding of roughly $200 billion. With the Chinese economy generating a monthly forex surplus of about $45 billion, some economists have calculated that about $10 billion of this could be earmarked for the coffers of the SIC each month. At this rate, the SIC could be managing a $1-trillion investment portfolio in less than a decade.

So where's all this money going to go?

Less Demand For Bonds
One place that won't be attracting this cash, at least not at the same rate as before, is the U.S. Treasury bond market. This has significant implications for the direction of U.S. interest rates and the U.S. dollar.

Over the last few years, the recycling of the huge China trade surplus back into the U.S. bond market kept rates lower than they otherwise would have been. Its also helped keep up the value of the U.S. dollar. Now that demand for T bonds is likely to taper off in the coming years, rates should move higher in future. We've already seen long-bond yields rise by 50 basis points since May, suggesting the market may have already digested the Blackstone investment news and its implications.

Fuel for the Private Equity Bonfire
Now that it appears to have the inside track to this potential wall of cash, the buyout gurus at Blackstone are no doubt sharpening their pencils drafting a whole slew of investment proposals for presentation to the SIC. While Blackstone will probably get its fair share of the funds flow out of the SIC, its not the only player in the private equity space, and the need for prudent management by the Chinese dictates that the money gets spread around. However, the likely net effect will be that the global, private-equity M&A mania run a bit longer than would otherwise have been the case.

Strategic Objectives Also Guide the SIC Mandate
In addition to making a decent return on its investments, the SIC's mandate will probably be guided by strategic national objectives. Despite two decades of breathtaking economic progress, China still lacks the key skills in areas such as technology, investment banking and advanced business management. Gaining access to these strategic competencies could involve taking stakes in global multinationals such as General Electric (NYSE:GE), Goldman Sachs Group (NYSE:GS) and perhaps Google (Nasdaq:GOOG).

Protectionist Sentiment Could Shut Out China
These investments represent a new direction for China, which has, to date, steered its foreign investment funds into resource investments around the world, from stakes in Canada's oil sands to copper mines in Zambia. However, while it's had a free hand in investing in Africa, it could still face protectionist resistance from U.S. lawmakers concerned about undue Chinese influence in the U.S. economy.

Anti-Chinese sentiment that thwarted its acquisition of Unocal in 2005, is still very much alive in the halls of Congress. There is increasing support for high tariffs on Chinese goods entering the United States, in an effort to get Beijing to raise the value of its currency. (For more, see What Is International Trade?.)


Global Equities Should Benefit
No matter how things play out, the key point here is that a major new flow of funds has now emerged - a flow that represents a significant long-term support to global equities. This could be enough to keep the global bull market rolling ahead longer than would be the case under a normal business cycle.

Figuring out exactly where the money will go is going to be virtually impossible. As is the case with other sovereign investment entities such as the United Arab Emirates' Abu Dhabi Investment Authority or Singapore's GIC, expect the SIC to play its cards close to the vest, disclosing very little about its investment plans or portfolio. However, I suspect there are more than a few hedge fund managers out here who are already placing their bets to guess where all that cash will go.

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