Simon Cox and others, I apologize as I don’t know the commenters only via email address, have raised some issues about my previous post about my posts on trade balance, payment flows, and growth. Scroll through the comments sections here and here. To briefly summarize, the basic objection is that the payment discrepancy does not change the “actual/true” trade surplus that China generates and as Simon points out this would still generate Chinese savings by holding assets abroad. I am trying to faithfully represent their views as they are reasoned and logical so my apologies if that doesn’t accurately capture their views in one sentence. I disagree with part of this and agree with part of this though with caveats.
When a country runs a nominal trade surplus, especially one as large as China’s in 2015, there are certain things that happen. For instance, the surplus financial inflow creates additional liquidity, demand, wages are pushed up, the currency appreciates, and other spillover effects. To be very kind absolutely none of these things are happening in China. In fact, the exact opposite is happening. If China was running a trade surplus, then the PBOC would have to be pushing the RMB down not keep it from dropping. This brings us back to the difference between actual/true, real, and nominal growth. China may have actual/true official growth of 6.9% if we consider the trade surplus actual/true. However, based upon the financial flows that accompany a trade surplus and the spillover effects, we absolutely cannot say that China has a nominal/cash trade surplus and this has significant implications for what we see in the economy. One way to think about this is an accounting trick companies frequently use to boost their profits. A common trick of companies the world over if they need a quarterly profit boost is write up the value of some of the assets on their books. There has been no real change to the company other than an accounting trick. That is essentially what is happening here. The domestic cash flow, both for firms and surplus cash flow into China, simply is not present to associate with a trade surplus equal to 5.5% of GDP and the accompanying GDP growth. What is happening is essentially an accounting trick. You can’t say growth exists but that none of the positive things that go with it do not.
Simon raises the very real issue about the capital flight being savings, which whether it is kept in China or the around the world, boosts national wealth and income. From a national accounting perspective, he is totally correct. If it is a simple matter of portfolio diversification, then the savings relationship in national income accounting still holds and growth goes up. However, for many reasons I think the story is more complicated and not as positive. The primary reason is that money leaving China is not a simple story of portfolio diversification. Foreign assets owned by China from September 2014 to September 2015 are essentially unchanged. In a year when nearly $1 trillion left China via fraudulent payments, official assets are unchanged. This matters because the money leaving China is designed to stay off the grid, underground, out of sight, unknown to Chinese authorities. Why does this matter? If it was a simple matter of portfolio diversification, like companies want to expand abroad, we would expect it to show up in official statistics even in China. However, it is not a simple matter of portfolio diversification. The intent behind this money, I strongly suspect and related data supports the idea, is permanent expatriation of capital out of China. By that I mean, this money is leaving China and never coming back. Wealth managers survey of clients for a number of years have found that wealthy clients are actively looking to leave China. The number one sending country of immigrants into the United States is now China and it would not be surprising if other countries like Australia, New Zealand, Canada, and the UK (just to name a few) were not experiencing similar influxes. The Chinese immigrants into these countries however are not the poor, hungry immigrants that arrived in Ellis Island but families buying businesses to obtain visas or attend graduate schools that lead to permanent residency. They bring with them large amounts of capital that is coming from China. According to some data, 90% of Chinese students that go to the United States for either college or graduate school, stay there never to come back except for vacation or to visit their parents. Stories of cities seeing real estate prices sky rocket and Chinese become a primary language are common from Sydney to Vancouver and London but more importantly, the visas and residence permits that come with them. Anecdotally, everyone in China above a certain income threshold has either plans to ultimately leave or contingency/fall back plans in case they need to leave. Getting back to the point about how to interpret this financial flow, if it was pure portfolio diversification, there would be a case to incorporate some percentage of this outflow into national accounting based upon GDP. However, based upon the illicit method of its departure, the accompanying asset purchases, and simultaneous emigration I do not think you can say this is standard portfolio diversification. A major portion of the money leaving China that we are discussing here, the nearly $1 trillion in fraudulent payments, is not for domestic business expansion but rather permanent or quasi-permanent capital flight. Real portfolio diversification has no reason to use this channel so at the least this needs to be called a hedging strategy and much of it permanent capital flight. The other thing is that despite people just waking up to this capital flight, this started in 2012 and has been growing every year. It did not reach a critical mass until about 18 months ago, but this is not a new phenomenon.
Capital outflows are a long term phenomenon. The one game winning streak put together in February is little more than a reprieve. What reason does capital have to stay in China or flood in from abroad? To everyone who hangs on what a 0.1% means in China, learn the concept of long term trend and statistical randomness around a trend. The long term trend is clear and hasn’t changed.
It is amazing how the conversation about China has changed. There almost is no such thing as a China bull anymore, there is only bulls trying say “it isn’t that bad”. Their biggest argument now is that it isn’t as bad as Kyle Bass makes it sound, like that is a ringing endorsement. The big key going forward is I simply don’t see what the signs for optimism are. Fiscal stimulus? Great, more debt and things people aren’t going to use. Monetary easing? Great, stoke capital outflows, break the RMB peg, and deplete FX reserves. VC funds to drive entrepreneurship? Great, cause throwing vast sums of money with little oversight never created problems and definitely not like stimulus projects in China. There are sectors growing in China and doing well but for the economy as a whole? No. Rebalancing in China is a scam much like the rule of law or human rights.
Everyone who essentially hangs their hopes for an improved Chinese economy on the policy making brilliance of Beijing: please up your meds. The problem is simple. It was easy to seem brilliant when you had an undervalued asset (fixed currency) and people bought into your story. Now that people have wised up and are asking difficult questions, Beijing has no clue what to do or handle the questions. Now that they actually have to make decisions and trade offs, the reality has come out. Like they always say about managers, it is easy to seem brilliant during the good times, but you prove your worth in the bad times. We are getting an answer about Beijing’s ability and they are not doing well.