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 That is, of course, if China carries on allowing capital to flee,
far from a certainty.
China logged its biggest-ever fall in foreign exchange reserves in
August, down $93.9 billion last month to $3.557 trillion as it
battled a slide in the yuan prompted by capital flight, People’s
Bank of China data showed on Monday.
How, for how long and under what rules of engagement China fights
this battle will matter a great deal for it and the global economy.
Where the money leaving China goes, what it buys and what those who
sell to Chinese capital owners do with the cash will also have a big
impact; potentially changing the global price of money and with it
the price of financial assets.
Money leaving China does so for a complex set of reasons. Some
individuals fear further devaluation of the yuan and falls in
Chinese asset prices and go abroad seeking better investments. Some,
especially those with fears over corruption prosecution and the rule
of law, seek safety, often by buying property in places like London,
New York, Hawaii or Canada, or even art. Property can act as an
escape hatch as well as a store of value, while art is easy to store
and easy to own anonymously.
To understand the impact these flows might have on markets it is
important to remember how and why China built up the largest foreign
exchange reserves in history, and what it bought on the way up.
The foreign exchange pile was largely built up in an effort to hold
down the value of the yuan and support exports. To do so China
needed to hold on to many of the dollars it earned in exchange for
exports. The PBoC did this not like a pension fund, seeking to
maximize risk-adjusted return, but simply with the economic and
exchange rate management as a goal. The result was that China became
the biggest creditor to the United States, owning at least $1.5
trillion of U.S. debt.
So when money flows out of China, as it is now, the PBoC must either
allow the yuan to fall in value or stabilize it by selling reserves,
mostly Treasuries, and handing over the cash to owners who are
expatriating it. The vast majority of this is done against
regulations, but happens none the less.
DIFFERENT PREFERENCES
While the amount of dollars doesn’t change, the preferences of these
dollar’s new owners is likely to be hugely different. Some Chinese
will park some of their money in Treasuries, but many will instead
buy real estate, art or other assets.
“If China is forced to significantly run down FX reserves to defend
its economy from disorderly capital outflows (which we believe would
be dominated by domestics looking abroad as opposed to foreigners
repatriating) and undesired currency depreciation, then this could
have a notable impact on the U.S. term premia,” economists at
Societe Generale led by Michala Marcussen wrote in a note to
clients.
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“However, that would depend also on which assets capital outflows
seek out; if the Chinese private sector buys U.S. Treasuries as the
official sector sells then it is merely a swap of Chinese external
assets from the public sector to the private sector. In the real
world, such perfect matching is unlikely.”
This is where the preferences of the sellers of Picassos and luxury
apartments come in. They too are unlikely to want to turn their new
cash piles into exclusively liquid Treasuries. The upshot is a drop
in overall supply of Treasuries offered, combined with a drop in
demand, forcing interest rates up or increasing longer-term rates
particularly.
Remember too that the 10-year Treasury price is sometimes called the
most important price in the world for a reason. Treasuries have a
special power of influencing the value of other assets in financial
markets. The higher the price of Treasuries, the cheaper other,
riskier assets look in comparison. Reverse the first part of that
and you reverse the second.
The trend of capital flows does not appear over.
“The evidence indicates not that the market is settling back down
but rather that the market is betting more and more against the RMB
stabilizing. Capital appears to be flowing out at a faster rate,”
writes Christopher Balding, an associate professor at Peking
University HSBC Business School. http://www.baldingsworld.com/
The open question is how China might try to stem flows, though many
of those efforts may only make money more eager to leave.
From Maui to Wall Street, the impact will be large.
(At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. Hemay be an
owner indirectly as an investor in a fund. You can email him at
jamessaft@jamessaft.com and find more columns at http://blogs.reuters.com/james-saft)
((jamessaft@jamessaft.com))
(Editing by Dan Grebler)
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