China is going broke. This statement comes as a shock to those who have heard over-and-over that China is a rising economic superstar and will soon be the greatest economy on earth, surpassing the U.S. in the #1 role. How can China go broke? The math is simple. In round numbers, China started 2015 with about $4 trillion in hard currency reserves. About $1 trillion fled the country in 2015 and 2016 based on fears of yuan devaluation. That’s classic capital flight. Another $1 trillion is relatively illiquid, including direct investments in mines and natural resources through sovereign wealth funds such as China Investment Corporation. That’s wealth, but it’s not money if needed in a liquidity crisis (in fact, valuations would crash in a crisis). Finally, $1 trillion has to be held as a precautionary reserve to bail-out China’s insolvent banks, and Ponzi-style “wealth management products.” Failure to bail-out the banks and WMPs could lead to social unrest that would topple Communist rule, so that won’t be allowed. That leaves only $1 trillion of the original $4 trillion in liquid form. The problem is that capital flight is continuing at a rate of $1 trillion per year, so China will be devoid of usuable liquid assets by late 2017. Under standard “impossible trinity” analysis, China’s only policy choices to keep from going broke are devaluation, capital controls, or interest rate hikes. Higher interest rates would trigger a credit crisis, so they’re off the table. Yuan devaluation is happening in baby steps, but that may soon turn into a one-time “maxi-devaluation” of 30% or more to stop the bleeding. In the meantime, the article below explains how China is using weak capital controls to slow down the outflows. History shows that weak capital controls may be worse that no controls because they send a message of “no confidence” while not really stopping the outflows. The mother of all liquidity crises is coming to China sooner than most realize. – Rickards
China Gets Strict on Forex Transactions to Stop Money Exiting Abroad
Bloomberg NewsAt risk of capital flight, China marked the new year with extra requirements for citizens converting yuan into foreign currencies.
The State Administration of Foreign Exchange, the currency regulator, said in a statement Dec. 31 that it wanted to close loopholes exploited for purposes such as money laundering and illegally channeling money into overseas property.
While the regulator left unchanged quotas of $50,000 of foreign currency per person a year, citizens faced extra disclosure requirements from Jan. 1.
The annual limits for individuals’ currency conversions reset at the start of each year, potentially aggravating outflow pressures that intensified in 2016 as the yuan suffered its steepest annual slump in more than two decades. An estimated $762 billion flowed out of the country in the first 11 months of last year, according to a Bloomberg Intelligence gauge, pumping up residential property markets from Vancouver to Sydney. Some money also spilled across the border into Hong Kong insurance products.Key elements of the new requirements:
- Customers must pledge money won’t be used for overseas purchases of property, securities, life insurance or investment-type insurance. While such rules aren’t new, citizens previously didn’t have to sign such a pledge
- Customers must give a more detailed account of the planned use of funds, such as business travel, overseas study, family visits, medical treatment, merchandise trade or purchases of non-investment insurance policies, including the timing, by year and month
- Violators of foreign-exchange rules will be be added to the currency regulator’s watch list, denied foreign-exchange quota for three years and subjected to anti-money-laundering investigations
- Customers must confirm compliance with restrictions on money laundering, tax evasion and underground bank dealings
- Customers must now confirm they aren’t lending or borrowing quotas to or from other citizens
The measures may curb enthusiasm for purchases of dollars and ease pressure for capital outflows, according to Zhao Yang, chief China economist at Nomura Holdings Inc. in Hong Kong.
The yuan fell 0.1 percent to 6.9554 per dollar on Tuesday, approaching an 8 1/2 year low.
SAFE also warned of the potential risks from investing in foreign assets, adding that yuan deposit rates are “significantly” higher than overseas equivalents.
Investors face “significant uncertainty and risks” on the returns from foreign-currency holdings, SAFE said. Banks should make spot checks on individuals’ foreign-exchange reports, penalizing those who provide false information or illegally move money abroad, it said.