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The China challenge: How will global markets react?

Among economists, how China invests its massive new wealth has become a topic of fascination and worry. Each month China puts an estimated $17 billion into dollar-denominated assets like U.S. Treasury securities, helping offset the effect of the growing U.S. trade deficit and keeping interest rates near their historically low levels.

So the capital markets were rattled back in January when a Chinese official said China was considering diversifying its foreign-exchange reserves away from U.S. debt instruments. No reason was given for the contemplated shift, but some economists speculated that China might invest some of the money in infrastructure at home or in creating strategic commodity reserves. Others believe China may be interested in higher returns than are possible with Treasuries.

To date, no big change has been evident, but the announcement has kept the topic on the front burner. Among the interested parties are U.S. real estate developers, who have benefited from the availability of inexpensive capital in recent years. A marked reduction in U.S. Treasury purchases by China could bring the dollar under pressure and drive interest rates higher, thereby reducing developers’ ability to fund new projects.

But the relationship between capital flows and the economic policies of an emerging power like China are not simple. For example, U.S. interest rates remained low in recent years even as an increasing amount of capital flowed into overseas projects in recent years, noted Charles Grossman, a managing director at ING Clarion Partners and the 2005-2006 chairman of ICSC.

“Investors more and more have a global perspective, and they will go places where risk-adjusted returns are the highest. And that may not be here,” he said. “It’s not that capital wouldn’t come here, but that you’d find more of it being diverted.” With such growth in other parts of the world and such a high level of new construction, how else can you build all the shopping centers that China is going to need, or India?

Will China somehow provoke a global capital shortage by its actions? Some economists think that’s unlikely, noting that the unique role of the dollar in the world economy will continue to attract foreign investors. Besides, some say, it is in China’s interest to keep subsidizing the U.S. trade deficit, which helps Americans keep buying Chinese goods.

Too much equity

The ongoing flood of private equity into retail chains has benefited shopping centers, but landlords should be wary of the rising number of leveraged buyouts of their tenants, executives said at ICSC’s Western Division Conference, in Palm Springs, Calif. “A lot of deals are being done at high multiples,” said Blythe Jack, managing director at San Francisco-based Rosewood Capital, which has invested in Anna’s Linens. “We’re seeing some big debt packages on low-growth retailers.” The situation gets ugly when retailers become overleveraged, as they did in the 1980s, said Richard Kuhle, president of Vestar Development. “Once consumers stop spending,” Kuhle said, “retailers can’t make their debt payments and end up giving up on rent.”