The Last Stampede: Capital Now Exiting China Aug 4th 2013, 18:07
According to calculations by Dow Jones, the People's and Chinese banks sold a net 41.2 billion yuan ($ 6.7 billion) of foreign currency in June. Others believe the amount of net sales that month was closer to 48 billion yuan. In any event, June's net sale of foreign currency was not large. The statistic, however, is significant because it suggests that the liquidity crisis that month reversed strong capital inflows. In short, money is now leaving China. Prior to June, money was flooding into the country. Net purchases of foreign currency averaged 377.5 billion yuan a month from January through April of this year. In May, the pace declined as banks purchased only 66.9 billion yuan. Zhao Qingming believes the decrease in foreign exchange purchases "isn't a big deal." The professor at Beijing's University of International Business and Economics points out that China went through a seven-month decline in such purchases in 2011 and 2012. That may be true, but confidence in the Chinese economy was especially high then. The noticeable fall in net purchases in May, however, coincided with the origin of the country's liquidity crisis, which can be traced back to events in the second week of that month. And June—when net purchases became a net sale—witnessed extraordinary events. There were two failed government bills auctions, two spikes in short-term interest rates, two waves of bank defaults, and two emergency injections of liquidity. Moreover, the People's Bank of China that month secretly rescued financial institutions with cash injections. Among the bailout recipients was the Industrial and Commercial Bank of China, the country's largest bank. , as the behemoth is known, was obviously in distress: it even had to shut down its ATMs to conserve cash. Bank of China, the country's third-largest commercial bank, was also on the edge of default. Professor Zhao is certainly right to put June's net sale of foreign currency in perspective, but there are other troubling indications of capital flight. First, Chinese banks with overseas branches are now making, at those foreign branches, foreign-currency loans secured by renminbi assets at home, an indirect method of extracting funds from a country. The phenomenon is undoubtedly the reason for the surge in U.S. dollar loans in Hong Kong beginning in May and continuing in June. In fact, the Hong Kong Monetary Authority, essentially the city's central bank, was so worried by the new greenback lending that it issued warnings and begun inspections of the new credits. Second, there is an increased acceptability of U.S. dollars in China. In June, dollar deposits there increased by about $ 600 million, and when July statistics are released we will probably see such deposits jumped by an even larger amount. Moreover, wealth management products in China are now being denominated in greenbacks even though the yields on the greenback WMPs are far less than those of renminbi products. The move to hard currency, a precursor to capital flight, is pronounced. Third, on-the-ground observers in Hong Kong, like longtime resident and China watcher Eric Kalkhurst, are noticing a large increase in Mainlanders transiting his city. Kalkhurst thinks the increased traffic, evident since June, may be a hint of accelerated capital flight from China. Fourth, Macau gaming revenue, considered a rough measure for Chinese flight capital, is on the upswing. Such revenue, in year-on-year terms, was up 13.5% in May, 21.1% in June, and 20.0% in July. In general, Macau's prosperity today is the result of capital exiting China. Of course, there has always been money leaving the People's Republic since 1978, what the world calls the reform era. In recent times, the pace has obviously quickened. The U.S. Treasury, for instance, noticed a surge in outflows beginning the summer of 2010, and there was another surge starting in mid-2011, when economic problems became apparent in the coastal cities. There was another noticeable pickup in capital flight in the third and fourth quarters of 2012 when, in the words of the Economist, outgoing flows "seemed unusually heavy." Nonetheless, the overall amount of capital leaving China, which has been masked by speculative inflows, has remained modest. High estimates put the amount of capital flight last year at about $ 300 billion. Now, after a brief period of inflows, money is starting to leave China again. Even though the State Administration of Foreign Exchange sees nothing to worry about—"Currently, we do not have signs of active and sudden flight of foreign capital"— state media is talking about "capital outflows." China Daily, for instance, notes that Nomura's Zhang Zhiwei foresees money leaving China "in the second half of this year and the first half of 2014 as growth slows and investors worry about a potential hard landing in China." China is already landing hard—GDP growth is perhaps a third of the claimed 7.5% rate of the second quarter—and most preconditions for a crash exist. The principal reason the economy doesn't fall apart is a belief—hope, actually—that Beijing can get through this especially difficult period. Now, the key indicator of confidence is the value of the renminbi. "Expectations of appreciation of the yuan have eased," SAFE noted in its July 22 statement. "Yuan forwards even imply broader depreciation against the dollar." Sentiment has turned against China's currency because, among other things, the central bank has gone on a money-printing binge. Binges first lead to rapid currency depreciation and then capital flight. Many analysts say there can be no run on the renminbi because the People's Bank of China tightly controls the currency's value and enforces the country's strict currency controls. Yet those currency controls are notoriously porous, and the fixing of a currency can, in certain conditions, contribute to panic. There was panic in China in June, but the central bank was able to restore order. Yet it did so by acting in secret. Since then, the situation has changed so that secret actions probably will not work again. Why? Everyone is watching closely after analysts have openly speculated that China will, to use Paul Krugman's imagery, "hit its Great Wall." Today, the subject of a catastrophic failure, although not widely accepted, is nonetheless widely discussed. The change in narrative is already having consequences. As Stratfor's George Friedman correctly noted late last month, "The admission that a crisis exists is a critical moment, because this is when most others start to change their behavior in reaction to the crisis." When perceptions change, even government reassurances can cause panic as they are then seen as tacit admissions of dire circumstances. China is not quite there yet—Premier Li Keqiang's words can still soothe markets—but the general erosion of confidence over the last two months is evident. As a result, money is again leaving China. In view of the seemingly intractable problems now afflicting the economy, it's not clear what will stop the outbound flow of cash this time. Follow me on Twitter @GordonGChang
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