Why China Does Not Have a Trade Surplus

Life has few certainties except for death, taxes, and large Chinese trade surpluses.  The expected large Chinese trade surpluses are always referred to as both proof of the strength of the Chinese economy and its financial foundation as money continues to flow in.  In nominal RMB terms, the trade surplus amounted to 5.5% of GDP or 79% of total GDP growth.  In other words, in 2015 China is almost entirely dependent on maintaining a large trade balance to drive GDP growth.

However, what if the assumed trade balance did not actually exist?  In fact, how would it change our understanding of the Chinese economy and financial markets if the assumed trade surplus was actually a trade deficit?  Unfortunately, this is not a counterfactual but the reality.  China is running a small trade deficit.

The widely cited international trade data is provided by Chinese customs records.  The value of goods leaving and entering and China is recorded by the Customs Bureau.  According to Customs data, China imported $1.69 trillion (10.45 trillion RMB) and exported $2.27 trillion (14.14 trillion RMB) for a resulting trade balance of $593 billion (3.7 trillion RMB).  These often repeated numbers form the basis for why China is running a large trade surplus.

Before explaining why China has no trade surplus, it is important lay some related groundwork.  By now China watchers knows about the practice of trade misinvoicing.  This is the practice where, as originally executed, capital was either moved into or out of the country based upon fraudulently invoicing an import or export.  For instance, by over invoicing an export, capital can flow into China as the foreign counter party is over paying for the good and vice versa for imports.

To take one example, of trade between Mainland China and Hong Kong, there are significant discrepancies between the value reported to Chinese customs and Hong Kong customs.  Hong Kong reported imports from China worth $255 million USD but China reported exports to Hong Kong of $335 million USD.  The 31% difference in customs prices, or $79 million, is too large to be unintentional and acts as a capital inflow into China.  Conversely, China reports $12.8 billion USD of imports from Hong Kong but Hong Kong only reports $2.6 billion USD of exports to China.  The 385% difference is far in excess of the low mid to single digit invoicing discrepancies that are standard in global trade.  Consequently, the $10.1 billion USD in over invoiced Chinese “imports” acts as a capital outflow from China.

Misinvoicing contributes a not entirely insignificant share to unrecorded capital inflows and outflows.  However, Chinese authorities have become much more aware and concerned about these issues and  gone through various waves of cracking down over this issue.  Furthermore, the aggregate sums here are not enough to move the RMB and cause the currency pressures we are currently seeing.  In fact, misinvoicing is merely the beginning of the financial flow problems in trade with Chinese innovation taking it a step further.

China, as a country with strict currency controls, maintains records on international financial transactions sorted by a variety of categories.  For instance, there is data on payment or receipt of funds by current or capital account, goods or service trade, and direct or portfolio investment.  For our purposes, this allows us to compare in a relatively straightforward manner, how international payments are flowing compared to the customs reported flow of goods.

The differences in key data surrounding trade data is illustrative.  Chinese Customs data reports goods exports valued at $2.27 trillion, with SAFE reporting goods exports of $2.14 trillion but Chinese banks report receipts of $2.37 trillion.  In other words, funds received for exports of goods and services or about $100 billion higher than reported.  At 4-11% higher than the Customs and SAFE reported values this is slightly elevated, but given expected discrepancies in the mid-single digits, this number is slightly elevated but not extreme.

The differences between import and international payment data, however, is astounding. Whereas Chinese Customs reports $1.68 trillion and SAFE report $1.57 in goods imports into China, banks report paying $2.55 trillion for imports.  In other words, funds paid for imported goods and services was $870-980 billion or 52-62% higher than official Customs and SAFE trade data.  This level of discrepancy is extreme in both absolute and relative terms and cannot simply be called a rounding error but is nothing less than systemic fraud.

If we adjust the official trade in goods and services balance to reflect cash flows rather than official headline trade data as reported by both Customs and SAFE, the differences are even worse.    According to official Customs and SAFE data, China ran a goods trade surplus of $593 or $576 billion but according to bank payment and receipt data, China ran a goods trade surplus of only $128 billion.  If we include service trade, the picture worsens considerably.  China via SAFE trade data reports a $207 billion trade deficit in services trade.  Payment data reported via SAFE actually reports about $42 billion smaller deficit of $165 billion.  In other words, the supposed trade surplus of $600 billion has become a trade in goods and services deficit of $36 billion.  Expand to the current, through a significant primary income deficit, and the total current account deficit is now $124 billion.

There are two very important things to emphasize about these discrepancies.  First, the imports customs and payment discrepancy is responsible for essentially all of the discrepancy between payments and customs.  Neither goods exports or differences between service imports at customs and payments explain the difference.  In fact, service is underpaid according to payment and customs data.  Second, if there was a more benign explanation, we would expect to see symmetry between various categories.  Rather, we see most categories reconciling close enough and one channel, conveniently enough one that funnels capital out of China, enormously mis-stated.

This discrepancy between official reported trade data and bank payments is a relatively new phenomenon but has been growing rapidly and reveals important details about flows into and out of China.  For instance, since 2010 China has an aggregate trade in goods and services surplus based upon payments of 1.9 trillion RMB; however, since 2012 an aggregate deficit of 120 billion RMB. 2010 and 2011 were the only years where China ran a trade in goods and services surplus using payments data rather than customs data.  Expanding to consider the current account significantly worsens the outlook.  From 2010 to 2015, China has run a current account surplus of 462 billion RMB but from 2012 to 2015 ran a deficit of 1.44 trillion RMB.  The reason for the shift is simple.  In 2012, China freed international currency transactions made through the current account creating an enormous asymmetry.

There are a number of important conclusions and implications of the data presented here.  First, if we adjust the Chinese traded good surplus on a cash flow basis and include the trade deficit resulting in a net export deficit, Chinese GDP growth in 2015 grew only 0.3%.  If a positive trade balance in economic accounting directly adds to GDP growth then a deficit directly reduces it.  Consequently, swinging from a goods trade surplus of 5.5% of GDP to a goods and services trade deficit of negative 0.3% of GDP has an enormous impact on GDP growth rates.  There is a key distinction here that is important to note and that is on a cash flow basis.  Economic accounting holds that GDP grows because when running a trade surplus, additional cash flow is received than is expended.  This leads to higher investment through savings. In 2015, financial flows indicate this did not happen and there was not trade surplus on a cash flow basis due to the discrepancy between Customs and SAFE reported trade in goods and services values and what banks paid.

Second, the impact on real GDP and output is currently unknown.  There are numerous reasons to question the veracity of numerous aspects of the data which would change our understanding of the data.  For instance, there are examples of goods round tripping into and out of China designed solely to facilitate implicit capital transactions.  Given the enormity of the discrepancy we see in payments for imports, we cannot rule out that a not insignificant amount of trade was either round tripping or phantom trade.  As physical output of many products from industrial to consumer only increased in the low single digits, this would match closer the implied Chinese growth rate of 0.3%.

Third, this sheds new light on the state of Chinese finances and RMB outflows.  For instance, the differential between Customs and bank data reveals rising outflow discrepancies since 2012.  While many have begun to worry recently about rising pressure on the RMB, it is clear that outflows from China are long lasting, large, and completely domestically driven.  In 2015 the capital account maintained healthy levels with the outward direct investment balance in a small deficit of 28.3 billion RMB while the securities investment balance was in an even tinier deficit of 2.9 billion RMB.  Consequently, calls for “temporary capital controls” or attributing it to a recent increase in outward direct investment reveal a profound misunderstanding of what the problem is. There is nothing temporary, foreign, or speculative about RMB outflows.  In fact, quite the opposite.  It is domestically driven long term capital flight which should change the framework of what solutions are called for in managing RMB policy.

Fourth, the change in the current account deficit is a major driver in changes to PBOC foreign exchange reserves.  While these are disguised capital outflows, for accounting purposes it is showing up in the current account statements.  Consequently, while China shows only small capital account deficit of $75 billion and a cash flow current account deficit of $121 billion, this shift largely explains the currency pressures on the RMB.  If you look simply at the Customs reported trade surplus, it would understandably be puzzling why the RMB is under so much pressure when China continues to run a $593 billion trade surplus.  However, in reality official flows are negative to the tune of about $200 billion in 2015.  Add in official net errors and omissions outflows in 2015 of $132 billion and it becomes quite clear why the Chinese RMB is under pressure.

Fifth, regardless the impact on GDP, it is quite clear that cash flows within the Chinese economy are very tight.  The boost from surplus payments that is typically seen from a trade surplus is not present and firms are struggling to pay bills.  Payables and receivables continue to rise rapidly as liquidity deteriorates.  Again we cannot say for sure whether this is actual production being purchased or simply phantom production, though it is likely some blend of the two. What is important to note is that liquidity is much tighter within the Chinese economy than understood.

Sixth, the nature of capital flight from China cuts directly to the heart of why capital controls would be a poor remedy.  Capital is not leaving through the capital account.  Rather with a restricted capital account and a relatively free international transaction via the current account, enterprising Chinese are moving capital via the current account.  To arrest the flood of capital leaving this way, it would require China to bring goods and services trade in the world’s second largest economy to a complete standstill.  Every transaction would have to be verified for units, market price, agreement between importer and exporter, and accurate payment matching the invoice.  It is simply not feasible to impose currency controls that would arrest disguised capital outflows via international goods and services payment without bring international trade in China to a halt.

It is likely the PBOC is aware of the discrepancy between Customs and SAFE reported trade data and what the banks are paying via the current account.  In his interview with Caixin, PBOC Governor Zhou Xiaochuan was very careful to say that China ran a “surplus in the trade of goods” rather than current account, trade surplus, or payments and receipts for international trade.  Many foreign and Chinese agencies and analysts confuse these multiple categories referring to them as one category but they are not.  His mention indicates he likely understands how capital is leaving the country and why capital controls would be a poor remedy which is also indicated.

It is quite clear that the expected $600 billion trade surplus is not hitting the Chinese economy for reasons and some implications that are still unclear.  What we can say, is that this is negatively impacting GDP growth and liquidity.

What’s Really Happening in the Global Economy?

For the past month, I’ve been bouncing around Europe talking to a variety of people about primarily the Chinese economy but really about all about the global economy.  In all the conversations I have had, there is one theme that comes through both implicitly and explicitly: people are scared because they do not understand what is going on throughout the global economy and everywhere they look are pockets of real risk.  I had one very smart person works for a major asset manager look across the table and say to me: the problem is nobody knows what the _____ is going on right now.  Many other people have expressed similar sentiments even if not quite so bluntly.

A lot of the markets are pricing in major adjustments even if there is little evidence that major dislocations are occurring.  I want to differentiate here between a correction and a major dislocation or crisis.  While it is undeniable that the global economy is in USD nominal terms contractionary, the sense of impending doom seems overblown.  There are two important points here.  First, major real economies are not strong by any means, but nor are they collapsing in free fall.  Second, fear is a major driver of economic and financial events and the unknown is a major variable here that cannot be ignored.

Going off my usual topics, I want to ask in a very broad sense: what is happening to the global economy and by that I mean it in the broadest process oriented sense.  I think there are factors and processes that we just do not understand at play here.  Let me throw out some ideas but emphasize that these are just ideas that I have heard or seem to have some credence about a variety of factors.  I’m not about to say they are all true or should be believed or are in any specific order but just to discuss ideas.

  1. I am increasingly convinced there is an issue with the measurement of economic output, specifically with regards to economic output. This manifests itself in a couple of ways.  First, quality (which is very hard to measure) and quantity (which is very easy to measure) are, I suspect, not being properly measured with regards to GDP.  Let me give you a simple example.  Assume there is a farmer who grows a vegetable, let us assume 100 units of lettuce or potatoes.  I use agriculture because let’s also assume static output.  Now let’s assume that the farmer plants a new variety of lettuce or potatoes that are maybe healthier for the consumer or don’t require any pesticide.  For simplicity sake, let’s assume the farmer again produces 100 units and at the same price as before.  Now the consumer is better off by consuming healthier food or requiring fewer inputs not to mention lower economic impact.  Quantity, output is identical but quality has increased significantly.  Though a distinction like this is typically cited for high tech products, I increasingly believe this to be true across a much wider variety of products.  Second, historically, deflation has been the result of reduced money supply.  Thinking simplistically, deflation has been thought of as driven by lower money supply or lower credit by tightening demand.  Lower demand, lowers prices.  However, I have become increasingly intrigued by the idea of supply side deflation, which central bankers are largely powerless to stop.  While people frequently cite the Fed low interest rates as pushing down oil prices, this process strikes me as overly simplistic.  With oil prices north of $100/barrel, it seems bankers would have signed on for most projects until interest rates were truly exorbitant.  Interest rates even at 3% would likely have had little to no impact on the number of oil projects globally given their historical highs.  This leads us to the supply focus on deflation.  If we return to the example of the farmer, it seems in many cases that qualitative output productivity is going up more rapidly than we expect pushing down prices across a range of products and services.  I was talking to a movie producer recently who was lamenting that in just a couple of years, animation work went from Los Angeles, to DMs looking to build animation industries, to emerging markets that can do high quality work.  What used to take a team of animators now takes a couple people in India.  Whether it is movie animation or rapid increases in organic non-GMO output, the growth in quality output is impacting prices.  The reason that this matters is that we are using old tools to fight new problems and we likely aren’t even measuring the problems correctly.
  2. One of the many assumptions made with increased prosperity is that as people grow increasingly prosperous, there will be an increasing diversity of products and services. What if this isn’t true though?  The basic idea is that the more food people have, the greater variety of other products and services they will produce and consume.  The more diversity of products and services, the more people will be employed in these new industries. However, what if there is some type of implicit limit on the heterogenous nature of products/services to absorb the decline in other employment?  If you take a simple example of what I’m referring to, let’s assume there are two companies GM and Facebook.  The decline in employment at GM is not made up for by the growth of Facebook and there is resulting mismatch in employment skills resulting in labor market pressure and wages.  The only way this happens if there are numerous Facebooks to absorb the slack from lower employment at GM.  What is the relationship between the implied growth of heterogeneity in products and services and employment with regards to the evolution away from more necessity products.
  3. How many economic events are a result of increasingly perfect competition (and I don’t mean that as a bad thing)? It seems that everyday, we move closer to the economists idea of perfect competition.  Trade has generally speaking never been freer, information for financial markets is nearly instantaneously distributed, capital markets are global, while large barriers to employment remain there is rapidly increasing internationalization even here, and various forms of trade reduce physical relocation.  In short, global competition continues to increase, though yes this is not universal and there are areas where this is not true but the trend is clear.  We can see this through significantly lower international income equality but higher internal income inequality.  Virtually any consumer/producer/employee/capital is exposed to global price pressures.  This has brought enormous benefits, but maybe that is also driving many of the processes that we do not understand with regards to prices.  In essence, we may be in the middle of the great convergence of prices.  I was recently in Thailand and after a local guide found out what I did for a living, he frustratedly noted that his business was down significantly and that Russians wouldn’t return until oil hit $80/barrel to strengthen the rouble increasing tourism.  He gave another example of how the higher pound brought more Brits who could easily compare prices online with a higher pound.  Perfect competition is impacting Thai tourism and movie production just to name a few.  It is worth noting that the most rapidly rising incomes seem to accrue to those with some type of “monopoly” whether in industry, employment, or capital allocation.  Increasingly perfect competition across borders impacting everything.
  4. How much of current events are a redistribution of existing resources or remaking of existing resources? By that I mean, oil production used to be the Middle East was the dominant producer of oil.  Now, while still significant, enough has been distributed throughout the world that they are effectively politically irrelevant.  OPEC can’t even agree to a meeting.  Between energy efficiency gains (real energy efficiency gains) in China and increased solar adaption at economical rates, it cannot be ruled out that China won’t need to build a coal generation plant or increase coal consumption ever again which has likely entered a long term decline.  These are just a couple of examples where it seems very likely that we are in the middle of incredibly disruptive periods of economic production redistribution between what types of products are made and where they are made.  We do not need or want the same basket of products and the products is being made by different people in different ways than before.
  5. How much do structural factors impact the global economy and economies? Demographics not just within a country but across the world are enormously important but I think poorly understood. How much of a shock China had on the global economy for instance in areas like commodity consumption is well understood but what about other areas where it seems less well understood.  I don’t think we understand the increased influence of China well on what is driving global economic events, and the same is true increasingly of India.  These structural factors and shocks have been enormous and I would say generally, I think poorly understood even by myself.  As one example, you have every major economy, let’s even include BRIC type economies, either in deflation or with extremely low inflation.  Can anyone say we really understand what is driving this across such a diverse range of economies?

I am not claiming to have answers here but rather things I have heard from people or ideas that have struck me.  One thing I can say, I think many very smart people are left grasping for answers, not really understanding what is going on the global economy right now.

Why A Lower RMB Isn’t the Worst Thing in the World

I want to delve deeper into the technical points made in my BloombergViews piece. It is taken as gospel by that a lower RMB will wreak havoc, is unnecessary, or bad policy.  However, as I will always come back to, pay attention to the details.  We need to look closer to say that a lower RMB will harm China, the world, and bring out Godzilla to wreak havoc.  There will be some, but let’s try and proceed somewhat carefully.

First, let’s discard with say one-third of Chinese trade.  The reason is simple, this is roughly the amount that is related to processing trade.  Processing trade is when China imports components, assembles them, and re-exports them in a different grouping.  The best example of this is the iPhone.  One study found that of the roughly $300 export value of the iPhone only about 3-5% of that was Chinese, even though the iPhone is stamped made in China.  To make the iPhone, China will import components from all over the world, assemble them in China and re-export them.  Consequently, processing trade is essentially immune to changes in currency prices.  The only part China itself is selling is the labor required to assemble the iPhone.  A lower RMB may mean higher component prices but then they make more money selling the final product, so there is essentially no change to profitability.  In other words, about 1/3 of Chinese trade is pretty much immune from any change to the RMB.

Second, China imports lots of commodity products think iron and gas among others.  The key issue here is how price sensitive are Chinese importers if the RMB goes down and imported prices go up?  The likely answer is…not very price sensitive.  There are numbers of reasons to believe this.  For instance, Chinese certainly weren’t price sensitive when prices were at the peak for a number of years.  If high prices didn’t slow import growth of these products, what makes us think that lower prices are going to kick start them?  Furthermore, in a surplus capacity environment, there is little reason to think that import commodity prices are going to play a major role in investment.  As has been widely noted, the high levels of investment that will eventually need to return to more normal levels will play a much larger role.  Given also that many commodities here like oil, to continue to grow in volume on trend, there is little reason to believe that a lower RMB will have any significant impact on imports.

Third, almost 60% of Chinese exports are electronics and textiles/garments which are unlikely to be impacted much by RMB movements.  Not only are large amounts of electronics processing trade, something we have already covered, but given that China produces the large majority of consumer electronics globally, it is going to grow with global demand not lower RMB.  TV’s and computers for instance, China makes most of the global products in this area.  Consequently, this will essentially track global demand not a single currency price.  Same thing for garments and textiles where China has a more than 40% global export market share.  It has such a large share of the market in these areas, it will track global demand for these products more than a currency devaluation will be able to help.

Despite all the press releases about China is moving up the value chain, it simply isn’t at least in international trade markets.  How do we know this?  Let’s look at a simple comparison of what China trades and the prices it gets for those products.  For our example here, we are going to use steel products. China is both an importer and an exporter of steel products.  In December 2015 China imported 1.2 million tons of steel and exported 10.7 million tons of steel. Wait though, there’s more to this story.  China paid $1.2 billion for the imported steel and received $4.9 billion for the exported steel.  Why does that matter?  China was importing steel at $1,023/ton and exporting $459/ton.  In other words, China was paying twice as much for its imported steel products as what it exported.  Now the price difference is almost certainly due to qualitative differences in the products.  This implies that China is importing high quality steel products and exporting low quality steel products, which could mean galvanizing or fabricating in some way.

The reason this matters is that developed countries have the least to fear from a falling RMB.  China simply does not make the higher quality value added products that compete with the highest quality products globally.  The countries that should be fearful are other emerging markets.  Who is producing garments and other basic manufactured products?  It is other south east Asian and increasingly, though not enough to impact global markets sub-Saharan African countries.  Those countries may feel pain for sure, but there is little reason to believe it will have global consequences.

What is most amazing here is that the countries/firms that are likely to be most impacted by a changing China are already feeling it independent of any change in the RMB.  Chinese imports of machinery are down (read German) as are some commodity products.  However, most importantly I am referring to a change in commodity prices.  In all fairness this is due as much to surplus capacity as it is to weak demand.  I haven’t seen a good estimate of how much blame should be assigned to both sides, but there is undoubtedly some blame to go around.

Finally, it is worth noting that the financial flows between China and the rest of the world are limited.  Consequently, it is unlikely that we would see large spillover effects.  China still owes about $1 trillion in foreign debt, a large percentage of which matures this year.  This is undoubtedly a not insignificant amount of money but should not trigger a financial crisis.

Leaving aside the potential impact of a lower RMB, I return to a couple of simple questions that are more strategic.  First, what do you hope to accomplish by propping up the RMB, drawing down reserves, and/or tightening hard capital controls?  I would love a good clear answer.  Time? Time for what? Reform? Economic rebound? If it is problems you are trying to avoid, what problems?  Looking at China or the rest of the world, there would clearly be some adjustment costs, but doom mongers about a lower RMB don’t seem to be making a case about a lower RMB.  My first problem is that it is enormously unclear what the purpose of preventing a lower RMB is.  If the argument for using FX reserves or imposing capital controls depends in anyway on “reform” or improved policy making from Beijing, I don’t want to hear it.

Second, it would seem to be worthy of preventing a fall in the RMB if there is a good probability of longer term success.  Again, the argument to me seems utterly deficient.  Let’s assume capital controls are imposed or reserves are used to prevent a slide in the RMB.  What are the longer term chances of success?  I’d have to say pretty low.  I see little near to middle term (within 2016) probability that capital outflows will reverse.  So let’s assume you burn through reserves trying to make everything seem fine and then decide in 2017 to float.  What have you gained other than spending $1 trillion to delay the inevitable?  Even there is a clear and decisive reason for maintaining the RMB at an artificially high value, I do not see the purpose of entering into a battle with certain defeat.  This does not mean victory has to be assured, but it would seem foolish to prop up the RMB if the expectation is that policy will be reserved or removed within a year.

Right now, I am struggling to see why a lower would be the worst of possible outcomes before us.

Follow Up to the Question of Chinese Foreign Exchange Reserves

As usual, I want to do my follow up to the BloombergView piece about whether the $3.3 trillion in FX reserves is adequate.  I normally reserve what I do here on my blog as a more technical exposition on the ideas presented in the BV piece, so as always, start there.

  1. Many people make the assumption that the only thing FX reserves are used to do is defend the currency. That simply is not true.  FX reserves serve numerous other purposes acting like a bank account for the country.  Paying bills that come due in other currencies is the primary issue.  When you have a fixed currency and capital controls, the central bank has to provide the liquidity unlike in a floating regime where participants can just go to the market and buy whatever currency they need.
  2. Many people make the erroneous assumption that FX reserves can be taken down to 0. Again, not remotely close.  Because FX reserves serve multiple functions and are used in different ways, they cannot be taken to zero even if the government wanted to.
  3. China cannot take its FX reserves all the way down to zero. Doing so would essentially bring a halt to any international trade.  One item is international trade.  A comfortable amount is FX reserves equal to about 3-6 months of imports.  China currently imports almost $200 billion USD a month so let’s assume for round number sake, they need $800b-$1 trillion in FX reserves just to grease the wheels of international trade.
  4. Then lets add in the official numbers of what China classifies as “external debt” which they list as $1.5 trillion of which they classify $1 trillion as short term. It is worth noting that the BIS and IMF IIP data list China as having about $1.1 trillion with similar split in maturity.  If we assume that approximately $750b-$1t is coming due in 2016, that gives us another number to add to our list of what the FX reserves need to accomplish.
  5. For 2016, we are already up to say $1.5-2 trillion is needed in 2016 for foreign currency needs. Between just paying bills and having liquidity to engage in international trade, China needs about $1.5-2 trillion in FX reserves.  We could move it a little lower by taking on some more risk, but you can’t move it a lot lower without increasing your risk very very fast.
  6. Now let’s add into the equation that the PBOC has illiquid assets of about $1 trillion USD. These are tied to a variety of different commitments, but the PBOC has about $1 trillion linked to investments and holdings that they cannot easily access to defend the RMB.
  7. We are now at $2.5-3 trillion USD in reserves that are semi-in-use or committed elsewhere.
  8. When people say the PBOC has $3.3 trillion and years of defense left, that simply is inaccurate. They have to have liquidity to engage in international trade and pay the 35% of global EM debt they owe.  They cannot take $3.3 trillion to zero without creating a truly enormous crisis.  There are commitments before then that come with numbers.
  9. Add in, there is a lot more money leaving China than entering right now, and it becomes quickly apparent how serious the situation is.
  10. The PBOC spent a little more than $100b in December and began slow walking FX requests.  While there has been month to month fluctuations, the long term trend of capital outflows is clear and accelerating over time.  There is no obvious trigger that would cause the outflows to stop or reverse.
  11. If we take the numbers presented here that the PBOC has commitments of say $2.5 trillion, that means at current rates, the RMB peg/basket as we know it has less than one year of shelf life left. In other words, the PBOC will have to either impose hard capital controls (70%) or float (30%).
  12. One very important factor here is that the capital outflows out of China are clearly domestically driven. There is not one shred of empirical evidence that this is driven by international investors.  In fact, international investment via FDI and portfolio flows continues to hold up even in a rocky 2015.  The inflows were not as large as in previous years but they do continue to grow.  Pressure on the RMB is completely, entirely, 100% driven by domestic investor capital flight from China.
  13. The reason the composition of funds leaving matters is that this is not a temporary issue. This is been going on for more than a year and picking up speed as it goes.  This is not hot money these are not international investors looking for quick buck these are Chinese citizens and firms moving their money out of China at least semi-permanently.   Definitely more than a simple short term vacation.  That means this is a structural issue that will not be fixed with temporary solution but is structural and long lasting in nature.  Which means….
  14. Get used to this new normal. It isn’t changing anytime soon. Capital will not come flooding back. (Would you send your money back to China?) Deal with the situation and don’t pretend it isn’t happening.