What is American investors’ exposure to Chinese securities? Official data suggest a figure around $150 billion—but that's more than $500 billion too low, according to Chicago Booth’s Brent Neiman. Together with Harvard’s Antonio Coppola, Stanford’s Matteo Maggiori, and Columbia’s Jesse Schreger, Neiman has used micro data to construct a new picture of country-level investment portfolios. The data allow the researchers to, among other things, follow investor preferences in global currencies and disentangle the complex web of international investments created by some companies’ use of offshore affiliates for stock and bond issuance.
Note: Neiman’s summary is based on several papers that are coauthored with Coppola, Maggiori, and Schreger and can be found at www.globalcapitalallocation.com/research.
We started from the desire to understand what country investment portfolios looked like. So for example, for the United States, you know, what countries are we holding the stocks and the bonds of?
You might think this is something that’s pretty basic that we would have really good information on, but in fact, it’s one of the few areas in economics where there’s a pretty limited amount of micro—very detailed—data. Instead, you have to go to websites and data sources like the IMF or the US Treasury, which give a much more aggregated picture than what one would want.
And why do we want to understand what bonds and stocks a country holds? Well, there’s all sorts of reasons, but let’s say that when Americans are investing, they hold a whole bunch of securities issued by Brazil. Well, now the wealth of all American citizens on average is going to be tied to the economic performance of Brazil. Or let’s say, when Americans buy foreign bonds, they’re almost always buying foreign-currency-denominated bonds. Well, now it means that if the US dollar changes in value—let’s say it depreciates, which is a weakening of the value—well, then those investments will do better and the wealth of the United States associated with those investments will go up, and vice versa.
So these are just two examples. There’s a number of reasons why one would want to understand how countries are linked around the world. It’s pretty intuitive to understand that they’re linked around the world due to trade flows, but they’re also linked around the world due to capital flows, which is a way to say some countries invest in the economic activity of other countries. And we wanted to try to better understand what those data and what those patterns of investment look like.
One thing that we’re able to do then is because for each CUSIP, if it’s a bond, we know whether that bond is denominated in US dollars or in other currencies. You know, one thing that we’re able to do, for example, is see: Are international investors tilting their portfolios toward certain currencies or away from other currencies? And using that type of analysis we were able to, for example, spot that since the 2008 global financial crisis, the share of the US dollar in bonds that are held by investors in countries that are different from where they’re issued—in other words, international investment fixed income flows—the currency use shifted quite starkly from euros to dollars.
Another example, which is really the subject of the most recent paper I have with Coppola, Maggiori, and Schreger, is to try to associate the borrowers—in other words, the companies that are issuing the bonds or the stocks—with their ultimate parents. And this can be a little confusing. Let me zoom out a little bit and explain the problem more broadly.
If you looked in the Treasury data on US investments abroad, you would note that a very large share of US investment is in tax havens, like, for instance, the Cayman Islands. You know, more than 10 percent of all of US foreign stock and bond investments are of firms that are resident in the Cayman Islands, but the Cayman Islands is tiny. You know, its GDP is something like $2 billion. So how can this possibly be the case?
It’s been well known that what’s been going on is foreign companies set up affiliates in tax havens, like the Cayman Islands, and those affiliates then issue stocks and bonds that Americans, let’s say, but investors around the world, buy. And so in aggregated data, of course it’s going to look like the US is buying a ton of securities issued by the Cayman Islands, by firms in the Cayman Islands. But what our micro data allows us to do is we can associate the borrower in the Cayman Islands with their ultimate parent firm, the foreign affiliate or the parent. And therefore, instead of associating those investments with the Cayman Islands, which for most practical purposes, most economic analysis is not so interesting, we can instead associate it with the actual foreign parent company.
So let me give you an example. When Americans buy the stock Alibaba, ticker symbol BABA—this is one of the largest companies that if you asked, you know, peers, if you read the newspaper, and you say what country’s activity is associated with Alibaba’s economic performance, we would all say China. It’s one of the most prominent Chinese companies. But it turns out that the share that you’re actually buying is a share in an Alibaba affiliate that’s a resident in the Cayman Islands. And actually the same is true for Tencent, for JD.com, for Baidu, for some of the most prominent Chinese companies. Those would all be listed in most official aggregate statistics as if they’re Cayman Islands companies borrowing from Americans.
But what we can do with our micro data is we can say well, look, I can see the particular firm that the Americans are buying in the Cayman Islands, and I can associate it with the country of the ultimate parent, in this case China. And therefore, I can restate these accounts that otherwise would show the strong link between the US and the Cayman Islands, and instead it paints a picture of a strong link between the US and China.
And for example, if you simply looked at the aggregate statistics and naively asked, what’s the economic exposure through stock and bond ownership of Americans to China? You’d get a number like $150 billion. And we actually find that that’s more than half a trillion dollars too low. When we actually reallocate these links between American investors and firms in tax havens like the Cayman Islands with instead their parents in China, we find that the link is more like $700 billion, a really big difference.
And it changes, you know, important economic questions like, what is the nature of this bilateral relationship between the US and China? There’s oftentimes a caricature of this relationship described as, you know, the US sells a whole bunch of Treasury bonds to China and US investors buy very little Chinese securities in return. In fact, if you take into account these securities that technically, by residency, are Cayman Islands securities, but in an economic sense are perhaps best thought of as Chinese securities, it reduces a lot of that asymmetry and it changes the way that you might want to view that relationship.
Similarly, it’s not just China. Companies in countries like Russia and countries like Brazil also commonly do this. For example, Brazilian oil or energy giant Petrobras doesn’t borrow directly from Americans or Europeans or developed countries’ investors, we find. Instead, we find that they borrow via affiliates in the Cayman Islands, in Netherlands, or elsewhere around the world, not directly in Brazil. And so when you account for that linkage, when you essentially restate the accounts to highlight the direct linkage between the rich country investors and the borrower in Brazil, it makes it look like the exposures to Brazil are much, much larger than naive statistics would suggest.
We’re finding that, you know, over the last 10, 20 years, the extent to which international investment is routed through a tax haven has increased quite a lot. This might be important for public finance for tax reasons. At the very least, we know it’s important for trying to understand you know, what’s going on, how this stuff works. The current statistics that don’t take into account money raised through offshore affiliates are increasingly removed, are increasingly off from what I think most economists would argue is the more important fundamental economic relationships connecting the world.
Recently, the administration has proposed a number of things with regards to US investment in Chinese firms. For example, one thing that’s been proposed is that US markets would delist Chinese firms that issue through these tax-haven affiliates, at least absent some improvement in transparency and some greater ability to understand the corporate structure that they use. Now, you know, greater transparency and regulation of that kind may very well be a good thing, but to the extent this sort of policy is politicized and it invites a response, it’s quite important to know what’s at stake. And for example, our research suggests that more than half a trillion dollars of US investment wealth, more than what you would get from what the raw aggregate official statistics suggests, is at stake.