Privatising Beijing’s reserves
China-watchers have for some time been telling everyone about the country’s accelerating capital flight. The nervousness has now gone mainstream, with Japan’s central bank governor publicly advising Beijing to tighten controls on capital outflows. The FT’s editorial column agrees.
There are two very good contrarian points one might make against this by-now-conventional narrative. One is: doesn’t China already have capital controls? The second is: doesn’t it still run a current account surplus — in other words, trading and earning enough to continue to rack up financial claims on the rest of the world? In other words, what is there to worry about?
On the capital controls, it is true that China’s capital account is far from open. But it is open enough that nearly $700bn worth of cash was moved out of renminbi since the summer, financed by one-sixth of Beijing’s pile of foreign exchange reserves.
Some of this leakage goes out through loopholes that can be plugged, such as over-invoiced imports. But even legally, Chinese citizens can exchange $50,000 of currency a year. With a population as large as China’s, it would only take a few per cent of Chinese individuals to use up their quota before official reserves would run out.
And more importantly, both China and the International Monetary Fund have staked a lot of prestige on nursing the renminbi towards greater convertibility, with its inclusion in the basket making up Special Drawing Rights, the fund’s quasi-currency. That’s the right direction of travel (though the road will be bumpy): in the long term capital controls are an invitation to trickery and misallocated investments. A full-fledged run on Beijing’s reserves seems entirely possible — Chinese officialdom’s gratuitous protestations that “Soros’s war on the renminbi [cannot] succeed” is the surest sign that it’s worried. Its better option is not tighter capital controls but to move with greater deliberation (and better communication!) towards a floating exchange rate. Accepting fluctuations would allow both greater convertibility and protect government reserves.
On the second contrarian point, it is true that the term “capital flight” may be misleading. Given the continuing current account surplus, the Chinese economy as a whole is racking up more, not less capital. What is really happening is that the public sector is financing a redenomination of private claims from renminbi into dollars and other hard currency.
As the chart below shows, the fall in reserves is largely accounted for by the excess of private portfolio outflows over the trade surplus (net income payments to the rest of the world offsets the trade surplus somewhat as well). Net foreign direct investment has shrunk to zero.
The content of the private outflow is also evolving, as FTAlphaville recently reported. From corporates repaying their dollar debts as renminbi devaluation became a worry, the capital account problems now also include the worsening direct investment balance and individual citizens selling renminbi-denominated assets to buy foreign-denominated ones.
The upshot is that China’s mountain of foreign currency investments is gradually migrating from public Chinese hands to private Chinese hands. Is that a problem? It can be, for three reasons. First, it would leave the government with a smaller arsenal should it need to deal with a big crisis such as large-scale defaults in its overindebted economy. (And from an authoritarian government’s perspective, even without a crisis it may be unnerving to have a lot of citizens enjoying the independence afforded by a foreign bank balance. We should count that as a positive for freedom, though.) Second, it could easily cause a domestic monetary contraction, which is the last thing China or the rest of the world needs. Third, it means Beijing will sooner or later be forced to float the renminbi in any case. It could save itself and everyone else a lot of trouble by moving ahead of its own accord.
Southern way of life?
Last year we covered the extraordinary finding by Anne Case and Angus Deaton that mortality has been on the rise in America’s middle-aged white working class since about 2000. We also reported how researchers digging into the Case-Deaton data found that — in contrast with the reaction that this was a function of underemployment by white working-class men — the rise in mortality was confined to women. Andrew Gelman now documents a further strange detail: the rise in mortality only happened among white working-class middle-aged women in the US south (and to some extent the midwest). Men in the same regions saw a weak increase but that reversed before the financial crisis.
- An alert Free Lunch reader, noting the piece on Sweden’s move to intervene in foreign exchange markets earlier in the month, corrects the suggestion that Sweden is unique in explicitly targeting a value range for its flexible exchange rate to beat deflation: the Czech central bank has been doing this for the last two years.
- Open Europe, the London-based think-tank, ran two sessions of “war games” about Britain’s referendum on EU membership on Monday. Former high officials from the most important EU countries and the commission role-played, first, the negotiations on David Cameron’s four demands, and second, negotiations on a new settlement after a British referendum vote to leave the EU. Both sessions are available on video here.