So just a little more follow up to my most recent piece for Bloomberg Views on disguised capital flows from China. As usual start there and finish here if you haven’t already.
- Here are some slides I prepared for the Foreign Correspondents Club in Beijing this week. You can clear see visually when the outflows really began and the direction they continue to go. Hint: they are not reversing.
- You should not believe any of the official data on inflows or outflows. According to China, they had a pre-net errors and omissions balance of payment surplus of nearly $200 billion. The NEO figure just brought the BOP into balance. What country has large BOP surplus is bailing water from the bowels of the Titanic to keep the RMB from dropping 25%? This happens because BOP data is built on other faulty data like official trade surplus data. So whenever someone cites the large trade surplus, they have proven to you that they do not know what they are talking about.
- All of the economic issues that people cite as attracting capital from China like the Fed and interest rates are simply compounding factors rather than driving factors. If China were actually enjoying large cash inflows from a $600 billion trade surplus, then the level of foreign debt repayment we are seeing would be completely and entirely irrelevant. In fact, the PBOC would be forced to push down the RMB rather than prop it up. However, that is not happening and that is why foreign debt repayment matters at all. These are compounding factors but definitely not the driving factor.
- The Bank for International Settlements report a few months back was a classic piece of weak analysis without proper perspective. They cited foreign debt repayment as a primary factor for outflow but even by their own words, this analysis was extremely limited. First, it only focused on the third quarter when the original devaluation took place. This omitted any look at a long time horizon. Why does that matter? Between February 2014 and February 2016, foreign debt declined (drum roll please…..) by a grand total of $7 billion. Second, by their own words, it only accounted for about a quarter of capital flows. How does that count as the driving factor? Given the magnitude of what we know about the gray market flow, foreign debt repayment is nothing more than a compounding factor and not remotely close to what should be considered a driving factor.
- I think there are three things that started this whole outflow process. First, China liberalized current account payments in 2012. Consequently, if you wanted to buy a house in Sydney in 2012, you could either try and legally move it through the capital account, though with lots of difficulty. You could also just import something from Sydney and enormously overpay so that money ended up in Australia so you could buy the house. Guess what people did? Second, economic activity peaked somewhere between late 2011 and early 2013 and has been on a downward trend ever since. Given the vast over capacity and declining investment opportunities, this was likely Chinese seeing the declining opportunities taking some of their money off the table for better destinations. Third, there was a political handover beginning in early 2013 that radically changed the atmosphere and likely well connected were hedging their bets well before it officially happened. This is absolutely also a contributing factor.
- When I say that Chinese are moving their money abroad for additional security, I am using security in a very holistic sense. People are concerned about the cost of real estate, complete lack of the rule of law, the environment, getting caught up even tangentially in a corruption case, or so many other things. No one in China views China as a secure destination, especially if you have any money. Whether it is thoughts about where they want to send their children to school or comparing junk local Chinese government bond yields to high credit quality US corporate debt yields, for many reasons that bring greater security.
- This is not a short term process. Expect the capital outflows to continue. This is not going to turn around even if the economy does turn around for real.