China’s whistling tea-kettle

November 9, 2012 | Bubbles, Capital control, China, Economics, Global news, Investment, Real estate, Speculation

By:David A. Smith


A whistling kettle not only keeps the pot from exploding, it tells you the water’s boiling; it’s both a release valve and a signal.  And in China’s economy, as shown in this Wall Street Journal (October 15, 2012) article, the economic tea kettle is whistling loudly:


Capital pressure’s on the boil!


In Reversal, Cash Leaks Out of China


‘Leaks’ is a curiously inapt word, suggesting slow gravity, whereas capital is escaping China at speed and under pressure:


China, once a catch basin for the world’s money, is now watching cash stream out.


General principle of societies: whatever seemingly normal economic behavior the rulers prohibit is not only a powerful clue to underlying forces within the country, but also likely to grow.


For every blockage … Berlin Wall, 1962


There is pressure to escape … Tunnel under the Berlin Wall, 1964


“We all noticed what we suspected, which is that there was significant capital flight,” says Michael Pettis, a finance professor at Peking University who witnessed capital flight up close in his previous career trading Latin American distressed debt. “It’s not a good sign when local businessmen begin to think it’s better to take money offshore, especially when the world economy is in such bad shape.”


Pettis knows what’s not a good sign


In this case, China has put itself in the odd position of attracting massive capital inflows (via exports) and then not importing anything to send that money back into the world economy; as a result, capital starving for yield has been pushing up Chinese property prices, building empty cities and isolated suburbs, and running an overheated patronage money machine.


With all that economic engineering, if you were a Chinese plutocrat watching up close as your leaders pulled the levers of power, you’d very much want to move money into other economies, both for simple diversification and to buy a global luxury lifestyle:


Pay no attention to those bureaucrats behind the curtain!


Wealthy Chinese citizens are buying beachfront condos in Cyprus, paying big U.S. tuition bills for their children and stocking up on luxury goods in Singapore –


That much economic pressure creates large underground rivers of capital.


– frequently moving cash secretly through a flourishing network of money-transfer agents.


Where there is a market need, there will be market providers – currency coyotes.


Smuggling money is easier than smuggling people


A sprawling industry has developed to help Chinese get money out. Services range from the money-transfer agents to private jets that ferry money by customs officials unmolested, according to lawyers and brokers who help Chinese investors find investments abroad. Sometimes bank transfers by companies hide personal money being moved out, these people say. Another method is to piggyback personal cash atop legitimate export and import transactions, at times by using fake invoices, they say. People even carry bags of cash across the border.


Naturally, when the scale is larger, the business professionalizes.  As the Economist reported:


Firms can also spirit funds out of China by understating their exports and overreporting their imports. They may, for example, sell $1,000-worth of goods abroad, show an invoice for $800, and keep the remainder overseas.


Global Financial Integrity (GFI), an American research group that campaigns against illicit financial flows, believes this mis-invoicing is rampant.


Fiddling and diddling


In fact, GFI claims that the total outflows have been $3.79 trillion.  That’s plenty in any economy!


Chinese companies, for their part, are making big-ticket foreign acquisitions, buying up natural resources –


That’s just Economic Colonialism 101.


Back then, colonialism involved occupying nations


– and letting foreign profits accumulate overseas.


Once capital escapes, it can be as a flock of wild geese, endlessly circling.


See any targets?


China hasn’t reported on capital inflows and outflows since last year –


Not that the figures would necessarily be believable


 but it is possible to gauge more recent flows using trade data, foreign-exchange reserves numbers released Saturday and other economic statistics. A Wall Street Journal analysis of that data suggests that in the 12 months through September, about $225 billion flowed out of China, equivalent to about 3% of the nation’s economic output last year.


Inferential arithmetic, convincing logic


Though three percent isn’t a huge sum relative to China’s overall economy, $225 billion is a lot of money, not the sort of capital movement done by a handful of speculators – it’s real pressure.


$225 billion ain’t merely vapor


China officially maintains a closed capital account, meaning it restricts the ability of individuals and businesses to move money across its borders. Chinese individuals aren’t allowed to move more than $50,000 per year out of the country. Chinese companies can exchange yuan for foreign currencies only for approved business purposes, such as paying for imports or approved foreign investments.


Remember, in China, when doctrine conflicts with reality, report the doctrine.


In reality, the closed system has become more porous and the rules are routinely ignored. “The wealthy in China have always had an open capital account,” says Eswar Prasad, a Cornell University economist and former International Monetary Fund official.


You pick up your money here … and you deposit it over there


Zheng Nan recently spent €300,000 ($390,000) on a beachfront condo in Cyprus. At 50 years old, he says he is retired from selling telecommunications gear in China for foreign manufacturers. “My plan is to spend winter there because of the pollution in Beijing,” he says. “And we will be back for summer.”


Of all the world’s places, why Cyprus?


The Greek half, that is


The answer is revealing:


Cyprus has become a popular investment destination for wealthy Chinese. The island nation in the Eastern Mediterranean gives permanent European Union residency to anyone who spends €300,000 on a property.


In other words, you can buy political risk insurance – a place to flee with your world if things get dodgy in the Middle Kingdom.


“People in China are rich,” says Arthur Cheung, a Hong Kong-based immigration consultant who matches Chinese buyers with foreign property sellers, including from Cyprus. “They just buy a passport or permanent residency like a Louis Vuitton bag.”


Yes, but do you get permanent residency with this?


Paschali Developers in Cyprus has sold more than 90 condos to Chinese buyers in recent months. Company spokesman Paschalis Paschali says buyers want to get residency. He declined to discuss how the company’s Chinese customers get their money out.


Why would he?  He’s aiding and abetting the capital flight.  Fortunately, there are as many ways to export capital as there are holes in a sieve.


China’s $50,000-a-year limit on moving capital out presented a problem for Mr. Zhang. He says he got around the restriction by recruiting friends to move chunks of his money under their own names.


We just reform on the other side


Real-estate agents in China say that is a common practice that is largely tolerated by authorities.


Tolerated, or winked at, connived in, and kicked back for?


I call it a ‘flexible payment system.’


For years, China’s economy benefited from large flows of cash into the country from exports and from foreign investors. Incoming dollars were exchanged for yuan at China’s central bank, putting more yuan into the economy. That made it easier for banks to lend and companies to grow, but it also stoked inflation and contributed to real-estate and stock-market bubbles.


We’ve known this for seven years.


Shanghai, 2005


When money leaves, that system swings into reverse, and there is less money available to fund growth. The outflow of money began to pick up in mid-2011, when concern about slowing economic growth, stalled yuan appreciation and falling stock and real-estate prices made holding cash in China less appealing. Money has left China before, most recently during the financial crisis, when outflows peaked at about $110 billion in the 12 months ended March 2009, the Journal’s calculations indicate.


The outflow helps explain why China’s banks have been slow to increase lending this year. Accelerated outflows might force China’s central bank to push the yuan to appreciate more strongly against foreign currencies, to encourage Chinese investors to keep their money in the country.


Pushing the economy is like pushing a suitcase in front of you; it tends to wobble.


Darn it, go that way!


The State Administration of Foreign Exchange, part of China’s central bank, said in a statement that China experienced “a certain degree of capital outflows” in the first half of this year. It attributed the outflows largely to more investment overseas by Chinese companies and individuals. It said it wasn’t concerned that the outflows could destabilize the economy.


Would you announce you were concerned?



In 1998, during the Asian financial crisis, Indonesia saw the equivalent of 23% of its annual economic output leave the country—far higher than the 3% estimated to have exited China over the recent 12-month period.


Unless GFI’s new report is right, in which case the outflows are much bigger.


China’s economy is protected from such catastrophic outflows by its restrictions on capital movement and by its substantial foreign-currency reserves, currently $3.29 trillion.


That’s certainly tremendous leverage.


One factor contributing to the reduced reserves is that Chinese exporters are keeping more of the money they make abroad in dollars, rather than converting it to yuan, economists say.


A good example of market-responsive behavior.


Because the $225 billion figure is derived from broad economic statistics, it is impossible to say how much of the outflow is legitimate personal and corporate transactions and how much was moved illegally or was the product of illegal activities.


May I guess?


Who says you’re not legitimate?


Charlie Zhang, an agent in Shenzhen who matches wealthy mainlanders with real-estate investments abroad, says getting money out isn’t a problem.


“We suggest them to other people, some special channel, that can exchange money outside the banks, outside supervision,” Mr. Zhang says. “It’s not hard for people to solve this problem.”


The ultimate whistling tea-kettle is Hong Kong, conveniently located right offshore:


A recent decision by Hong Kong’s highest court highlighted the territory’s role as a facilitator for mainland money to escape.  [A defendant accused of fraud claimed she thought the money was part of a routine capital-escape money transfer and couldn’t be expected to know it had come from a mortgage fraud.]  Hong Kong’s Court of Final Appeal agreed [and cleared her record].


The court said it was “not surprising” that she would “find it necessary” to use a money-transfer agent since she had to evade the mainland’s currency regulations in order to invest in Hong Kong’s stock market.


We don’t care how you get the money out of the country, just get it to America!