I wanted to add a few follow up thoughts to the Bloomberg Views piece on the balancing of Chinese capital flows. As usual start there and then come here.
- China over the past few months has essentially balanced currency flows into and out of China. The differences in an economy the size of China for the size of total flows we are talking about are essentially rounding errors.
- Do not call this a win, stabilization, or confidence in Beijing’s policies or the Chinese economy. A better comparison is the holes from the icebergs have been patched so the boat isn’t taking on more water.
- A primary reason I urge you not to think of this as any type of stabilization is how we frame the problem. True, Beijing has now balanced currency flows but to get there it had to impose near draconian capital controls just to get back to zero. In other words, imagine how large the net outflows would be absent the significantly stepped up controls. It is not a stretch to say it would be quite sizeable.
- The only real strategy China has by doing this is to hope that its economy will strengthen enough that people, both domestic savers and international investors, will want to move their money into China. In other words, they hope that things will get better so they can relax controls and money won’t want to leave China.
- I think this is an unlikely scenario for two reasons. First, Chinese citizens and firms have reached a stage of development and asset prices in China are so crazy, that they see better opportunities to move capital abroad. At the very least, they want to diversify their risk. This implies that either Chinese asset prices come down significantly or global asset prices inflate significantly. I think based upon the weight of evidence, it is much more likely that Chinese asset prices will come down to global norms than vice versa over the long run. If China maintains is economic growth trajectory, right now all credit driven, this implies money will want to find a way out to arbitrage those asset price differences further implying China will need to maintain strict controls. If Chinese asset prices come down significantly, it is possible that there is less pressure for Chinese outflows depending on a variety of scenarios. However, China trying to reduce capital outflow pressures by lowering asset prices is not a winning strategy domestically.
- Second, foreign investors are taking notice of not just the capital control restrictions but also the entire domestic anti-foreigner protectionist environment. If you are trying to balance capital flows you still need significant inflows of foreign currency either by trade surplus or investment. Direct investment is and has been falling into China and the trade surplus for a variety of reasons may or may not exist, definitely not remotely close to the levels that are needed for foreigners to effectively fund Chinese investment and round trip the capital back as Chinese investment. If you plan or pushing foreigners out of China and want to balance your flows, that means that outflows have to fall in line with foreigners interest in China.
- There is one final issue that is flow asymmetry. By that I mean, foreign inflows into China even if it really eases have probably reached a type of equilibrium. Foreign firms that wanted to int in China are already here and will grow largely with a trend. I don’t think there is any major underlying pent up demand for Chinese assets. Clearly right now it is in a cyclical downturn for numerous reasons, but that is different from long term demand. However, I think that there is a major pent up suppressed demand for foreign assets by Chinese firms. Let me give you a simple way to think about the imbalance of demand here: assume Beijing announces tomorrow that a) Chinese firms and citizens can do whatever they want with their money taking it wherever they want AND b) all foreign firms and citizens are free to buy any Chinese assets and Beijing will do its absolute best to provide the best business environment for foreign investors. Now, do you think there will be a bigger and longer lasting flow into China or out of China? I don’t think anyone would say there would be a bigger and longer term flood of capital into China. Part of this is the paradox of large numbers. Chinese firms would be at least as acquisitive as foreign firms and there is no way there are more households and individuals looking to buy Chinese real estate than Chinese looking to buy abroad.
- China may have balanced flows but look at how it got there, the long term prognosis is, and what structural issues remain.