Not a Run on China, But a Brisk Walk; Wealthy Chinese are voting with their feet to move wealth abroad. That ought to send a message to investors

TUESDAY, FEBRUARY 11, 2014

Not a Run on China, But a Brisk Walk

By RANDALL W. FORSYTH | MORE ARTICLES BY AUTHOR

Wealthy Chinese are voting with their feet to move wealth abroad. That ought to send a message to investors.

The popular perception is that money is gushing into China, between its burgeoning trade surpluses and the rush to invest in the world’s second-largest economy. That perception is sorely out of date.

Like most things in China, movement of capital is tightly controlled, and Beijing has sought to offset the influx of money that would naturally push up the value of its currency, the renminbi or yuan, by purchasing foreign currencies. The widely held presumption is that China is manipulating the RMB to depress it in order to spur exports.

But away from this Western view, Chinese nationals have been trying to get around the capital controls and diversify away from supposedly undervalued RMB assets. This is visible in a variety of ways, from the recent frenzy for bitcoins, to massive buying of gold, to wealthy Chinese leaving the country altogether.

In other words, while the West thinks the RMB is too low, rich Chinese think it’s too high — and are taking steps to protect their wealth.

Financial reforms that would loosen restrictions on capital flows are presumed to result in further currency appreciation, which Beijing might welcome to grow its domestic bond market and enhance the RMB’s status to that of a global reserve currency to rival the U.S. dollar, according to new report by Lombard Street Research’s China watcher, Diana Choyleva.

“But be careful what you wish for,” she writes. Further RMB appreciation would force the “decimated” corporate sector to cut jobs and wages in a deflationary “race to the bottom” resulting from slowing export demand. That is, she adds, unless policy makers “opt to throw money at unproductive capital spending yet again.”

More likely, free movement of capital is more likely to result in an exodus, pushing down the RMB and pushing up domestic interest rates. That actually would smooth “the difficult transition from state-driven capital spending towards genuine consumer demand,” Choyleva writes. At the same time, Chinese banks would have write off theirbad loans while the central bank, the People’s Bank of China, would need to support domestic liquidity.

There is a narrow window of opportunity to purge these problems. “The choice is between painful but still manageable financial distress now and a major crisis in a few years’ time,” she writes.

Another Western presumption is that China’s accumulated cache of foreign assets can take care of any problems. Choyleva contends, foreign-exchange reserves equal to 40% of gross domestic product would preclude “external pressures” — in other words, acurrency crisis. “But internal financial deadlock, as in Japan in 1997-2002, could thwart growth.”

If Beijing allows market forces to determine exchange rates and interest rates — which she contends is “the only viable route to rebalancing growth” — the RMB would decline. And if the government reverts to pumping up state-directed investment and exacerbates the past excesses, capital flight would be encouraged further — also tending to lower the RMB.

This theory has yet to be tested, but several symptoms are suggestive of the problems she describes. First is the decline in Chinese stock prices in the midst of a global bull market and a putatively booming economy featuring 7%-plus real economic growth.

Against the backdrop of this supposed economic miracle, China has overtaken India as the largest importer of gold. If China’s economy and currency were on the ascent, why would domestic investors and savers covet a lump of metal that can’t grow or produce income?

In any case, the South China Morning Post reports Tuesday that mainland China’s imports of gold from Hong Kong last year were equivalent to 40% of mine output. Of course, the newspaper points out, most of that metal came not out of the ground but from paper gold — in the form of liquidation of exchange-traded funds.

China’s demand for gold suggests a desire for a reliable store of value, not just as a hedge against a decline in the RMB, but also because of internal credit problems.

What’s come to the surface is the near-default in one of the so-called trusts that comprise a large part of China’s shadow banking system. As my colleague Shuli Ren reports in herEmerging Markets column

this week, the secrecy surrounding the RMB 10 trillion ($1.6 trillion) trust sector and the circumstances of the bailout of this $500 million trust don’t inspire confidence.

Gold is an ancient hedge against the recurrent losses of wealth from credit excesses that are recurring in a fiat currency system. But wealthy Chinese are taking a more radical step — pulling up stakes to emigrate, to Australia, Canada and the good, old U.S. of A.

Craig Stephens of MarketWatch reports on the exodus of rich Chinese looking to emigrate either Down Under to the Great White North (actually, more verdant British Columbia.)

“It could be simply cleaner air, given the pollution gripping many cities across China. Or perhaps some could be feeling twitchy as President Xi Jinping continues his year-long anti-corruption campaign,” he writes.

But it’s also possible the moves arefinancially motivated. Stephens relates that, at a Chinese new year lunch last week, one diner allowed said his Shanghai colleagues would shift their savings to greenbacks if they were free to do so.

To be sure, such anecdotal evidence is far from conclusive. But in the New York area, the interest in establishing a residence here by Chinese is apparent, and perhaps more pervasive than the widely reported influx of other worldly wealthy to buy real estate in these environs.

Property here is viewed both as a desirable place to live as well as a reliable store of value in an economically and politically unstable world. And it’s revealing that high-end realtors in the area advertise their Asian links in attempts to secure seven- and eight-figure listings. Employing experts in feng shui to enhance the appeal of a home for sale also is a popular tack in these parts.

None of this is conclusive, to be sure. But wealthy Chinese appear to be voting with their wallets and their feet to get their assets and families out of China. It’s axiomatic that insiders have a better clue to what’s really happening than outsiders. And the rich in any country didn’t get that way by being complacent or oblivious.