I’ve tried to have more dignified labels for recurrent phenomena, but I keep defaulting to “scary bad” when I get updates on China.
The latest is that Michael Pettis does his usual workmanlike job of trying to make sense of China’s generally incomplete reporting on its funds flows. While one suspects the gaps are in part by design, to keep foreigners guessing, it worrisomely is also a function of China having a less-than-mature financial system. The mechanisms for good data capture simply don’t exist.
The shortcomings are evident in the area Pettis probes today, namely, that speculative money has all sorts of ways of getting into China. As an article in Caijing that summarizes a survey by Deutsche Bank’s Jun Ma found:
For those with ‘business’ connections/enterprises: 52% opted to bring money in as ‘FDI’, and 11% as under-invoicing. For those who bring money the old fashioned ways: 85% use either US$50,000 per person per year, using multiple relatives and friends, or the RMB80000 per day TT limit. 57% of respondents forecast RMB to rise to 5.50-6.00.
The survey also suggests that the “unexplained” portion of reserve accumulation – after backing out the trade surplus, FDI, interest income and revaluation gains – is biased downwards, since there may be substantial amount of hot money in the trade and FDI numbers. Take this out and add it to the “unexplained” part and the most stable sources of reserve growth – FDI, the trade surplus, and so on – are becoming an increasingly small fraction of total net inflows. …Chinese monetary policy is largely a function of massive and very volatile speculative inflows driven by RMB appreciation.
China, in other words, is in a nasty fix. Speculative capital is coming in through so many channels that even if the authorities were to impose capital controls, the impact would be limited at best. And the magnitude of the funds flows is eyepopping (note Pettis does go into some detail before reaching his conclusion):
Headline reserve growth for the first four months of this year was a breathtaking $228 billion…..A plausible guess, then, is that hot money inflows are greater than the headline reserve growth, or at least not a whole lot less.
So the net effect is that China has lost control of its monetary policy. It cannot sterilize this volume of inbound funds flows, so it stokes inflation, and inflation is already running at a level that is politically problematic:
Since the PBoC must monetize these inflows – either by issuing currency or by issuing central bank bills – these inflows end up adding to the country’s money base. With the largest part of the inflows probably consisting of speculative money, that is what I mean by saying that Chinese monetary policy is now driven primarily by RMB speculation.
Unfortunately I don’t think we are likely to see much improvement in the next few months, and remember anyway that even if there is a reduction in speculative inflows, it would have to be a massive reduction to mean anything. As money continues to pour into the country, the problems of inflation and overinvestment are going to persist and get worse. As they do, it will become all the more obvious that China is facing serious appreciation pressure, and the talk of a maxi-revaluation will simply increase. Needless to say, this can only increase speculative inflows.
And what happens to China’s exports if the RMB is revalued sharply upwards? Even though the economy also has investment as a driver of growth, to have a large minority of the population that depended on export industries suddenly foundering is also potentially destabilizing.
Pettis’ article also indicates that there has been a rapid increase in mortgage loans. That on the surface may not be as bad as it seems, since mortgages are not all that common in China. But if the amount of homes bought with mortgages were to spike up and then fall back, you’d presumably see a price impact in both directions.