For many retirees, China may hold key to success

SHANGHAI, China — It may come as a surprise to many Americans, but their retirement security may depend in large measure on China's development of capital markets and the willingness of Chinese savers to buy the stocks and bonds that baby boomers will unload in coming years.

Next year the first U.S. boomers, born from 1946 to 1964, begin qualifying for early retirement under Social Security. They'll enjoy full retirement benefits beginning in 2011.

From that point forward, for about 15 years, there'll be fewer and fewer active workers to support the boomers' retirement, and fewer working Americans putting money into the stock market through their 401(k) retirement plans and Individual Retirement Accounts.

Experts such as Jeremy Siegel, a business professor who wrote the seminal book "Stocks for the Long Run," think that the value of U.S. retiree holdings in stocks and bonds — valued by the Federal Reserve at more than $6.5 trillion — could drop by as much as 40 percent if boomers must rely solely on domestic buyers when they sell their assets.

Enter China.

The world's fastest-growing large economy has virtually no retirement safety net for hundreds of millions of Chinese workers. It's in the early stages of trying to create a pension system, one patterned after the defined-contribution model in the United States, in which a tax-deferred portion of a worker's salary is diverted into the stock market for withdrawal after reaching retirement age.

"The savings and buying power of the developing countries is absolutely critical to our own welfare in the future. When all the baby boomers try to sell their assets ... there are not going to be enough workers in the developed world alone to absorb them," Siegel said in an interview. "The demand that would be coming from Asia and other developing countries will be critical to support the prices of these financial assets."

Rich nations in Europe and Japan have populations graying even more quickly than the United States.

Therefore China, with a population exceeding 1.3 billion, holds the greatest potential for U.S. boomers who are looking to transfer their assets. It's why the U.S. Labor Department recently announced that it would help China create an American-style 401(k)-type retirement program.

That could result in a win for both economies.

"I think it is a complement, in the sense that they're going to be acquiring assets for pension funds and all these things, planning for a time when their boomers start retiring," said Robert Hormats, the vice chairman of Goldman Sachs International, a division of the giant investment bank.

China, he suggests, has a big incentive to create an effective retirement system. Almost 30 percent of its population will be older than 60 in 2040, according to a report by the Center for Strategic and International Studies, a center-right U.S. research center.

Today, however, China's capital markets are in their infancy. China now allows only some foreign mutual funds and investment companies to buy Chinese stocks and bonds. More than two dozen foreign companies are designated as Qualified Foreign Institutional Investors. To qualify they must manage more than $10 billion in securities abroad and must invest in China through Chinese banks.

But for U.S. boomers, preserving the value of their financial assets may depend on the speed with which China builds up its Qualified Domestic Institutional Investor program. The QDII program works like U.S. mutual funds, in which a fund manager makes investment decisions for pools of income.

Currently, the QDII program relaxes foreign-exchange restrictions by allowing some Chinese banks and insurance companies to convert the yuan into foreign currencies, then buy either fixed-income assets such as bonds, or foreign stocks. But the program remains limited.

China has expanded its QDII program at a glacial pace, in part because this opening is linked to how fast it allows its currency to be valued by the open market.

China's reluctance to move from a fixed exchange rate to one set by markets remains among its thorniest disputes with the United States.

"Ten years from now, I can see a scenario where Chinese investors get to put some of their nest eggs overseas," said Fu Teh-Hsiu, the chief executive officer of Everbright Pramerica Fund Management Co., a joint venture between China's Everbright Securities and the U.S. retirement-fund giant Prudential Financial.

It seems likely that Chinese citizens will be allowed over time to invest abroad in the United States. There's clearly investor interest now.

"If there was a way, [Chinese] people would invest in blue chips in the U.S. market," said Larry Zhang, the chief financial officer for a large Chinese company. He asked that his company name not be used for fear that it could be seen as contradicting Chinese policy.

Although the Chinese stock market has seen share prices rise almost 200 percent over the past two years, most Chinese economists think this isn't sustainable. Chinese view the U.S. stock market as a safe haven.

"The U.S. market is the most trusted," Zhang said.

Will that be the case 20 years from now, with the labor force shrinking?

The question of what effect demographic changes might have on U.S. finances has the Congressional Budget Office worried.

It'll soon study the question of what the transfer of boomers' assets might mean for retirement incomes.