Setser: Hot Money Fleeing China

Even though China’s trade surpluses continue at record and near record levels (imports are falling faster than exports), China’s foreign exchange reserves are not even close to keeping pace.

Readers may recall that a massive amount of money flowed into China, a good bit of it disguised (FDI was one of the suspect categories) because RMB appreciation looked to be a one-way trade. Given China’s currency controls, there were limited options for playing that point of view from overseas, hence the funds influx.

But now that China has quietly gone back to a hard peg to the dollar, the dreams of a quick profit have been dashed, and the hot money is making an exit. Per Brad Setser (part of a longer and useful post, hat tip reader Michael). The reserve requirement mention comes about because the PBoC requires banks to hold some of their reserves in dollars, which means that the true FX reserves are greater than the official reserves:

There is only one way to square a record trade surplus with the sharp fall in reserve growth:

Hot money is now flowing out of China. Here is one way of thinking of it:

The trade surplus should have produced a $115 billion increase in China’s foreign assets. FDI inflows and interest income should combine to produce another $30-40 billion. The fall in the reserve requirement should have added another $50-55 billion (if not more) to China’s reserves. Sum it up and China’s reserves would have increased by about $200 billion in the absence of hot money flows. Instead they went up by about $50 billion. That implies that money is now flowing out of China as fast as it flowed in during the first part of 2008.

And in December, the outflows were absolutely bruta….$70 billion plus in monthly hot only outflows … That’s huge. Annualized, it is well in excess of 10% of China’s GDP. Probably above 15% …

No wonder the PBoC is worried about unusual swings in capital flows.

China can absorb such a swing in capital flows better than most….

In one sense this is good – it makes it harder for China to engineer a controlled depreciation against the dollar. And that may mute internal calls for China to prop up its exports with a depreciation. China presumably doesn’t want to create perception that the renminbi is a one way bet down after it was long considered a one-way bet up….

Over time, if hot money outflows subside, China’s reserve growth should converge to its current account surplus (plus net FDI inflows). That implies ongoing Treasury purchases – though not at the current pace – barring a shift back into “risk” assets. And if hot money outflows continue, watch for Hong Kong and Taiwan to buy more Treasuries. The money flowing out of China doesn’t just disappear … it has to go somewhere.

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  1. Anonymous

    What will drive the hot money outflow is if internal stability and security deteriorates.

    Many cadres and their relatives and friends have to worry about socking money out of reach of the government, just in case 1949 comes again.

    They know too well what their fathers did or went through (depending on what side of the fence they were on).

    That is one of the reasons that Chinese currency is inherently not a strong, international reserve capable currency. There is not enough confidence in the Yuan inside China — a requisite to it being a credible storehouse of value outside of China.


  2. Anonymous


    Do you know what percentage central banks of foreign countries need to keep in US dollars as backstops to their own currency? Assuming that this is substantial, would not all these countries be destined to inflate their currencies to keep the inflationed dollar value at (backstop) par for their currency?

    Faced with rampant inflation of the US dollar, wouldn’t the rest of the world want to abandon the dollar in mass? I think if this is not happening yet, it will soon.

  3. Anonymous

    And in December, the outflows were absolutely bruta….$70 billion plus in monthly hot only outflows … That’s huge. Annualized, it is well in excess of 10% of China’s GDP. Probably above 15% “

    annualized? come on… then we gonna talk about some $700B … Is there that much money in the planet ? not to mention the amount of inflation induced if $70B a month cash flowing into one country.

    but incidentally, china get what they want. dollar out of china (reduced value of yuan) I suspect it will be hard peg or down slightly. (they did reduced value of yuan few eeks ago.)

    So this is the “competitive devaluation phase” of their move. albeit with “hard peg”. But forcing dollar out and flooding US with cash has similar effect.

    Anybody watching Russia? I told you so.

    (here is a strange thing Everybody is talking about china and russian implosion. But how about UK, Italy, Spain?… seriously. their number is beyond “imploding” but nobody is talking about crashing UK economy (or insolvency, or how easy of a target UK is for currency attack.)

    why is that? are we still doing cold war jingle as if that is how the world operate?

    No wonder Russia nd China have no sympathy over our problem whatsoever.

  4. wintermute

    I have suddenly become fond of Denningers “market ticker”

    Most of the world has benefited from, or participated in, a debt-financed orgy of consumerism (or quaffed profits from consumer-driven exports).

    It is the biggest ponzi-bubble of all-time. The silver-lining is that it will shock a generation of people into learning about Austrian economics in order that the same stupidity is not repeated.

    (But I am not holding my breath..)

  5. Anonymous

    An off subject thought…Rapid communication has sped up this financial collapse much faster than the ’30s Depression. many areas of the country were not aware of the magnitude of the crisis, thinking “we have not seen a slow down here yet”, or ” things were great last year, this year will be even better”. With lightning fast communications (internet, tv, etc..etc) EVERONE IN THE ENTIRE NATION knows we are in deep s***. This will compress what took years into weeks or at most months. On the positive side, as parts of the country pull out of this, news will spread just as fast. Just an off subject thought..

  6. Anonymous

    Russia relies on energy demand, China relies on product demand.

    If both demands fall, they are directly affected.

    Nothing would really stop the countries that have been outsourcing massively from turning around and producing at home. It is much easier for this to be done among Western nations, especially for the US.

    When you’ve hit the bottom, you can only bounce up. Plenty of Americans would line up to make cheap shoes or pickup veggies or whatever.

    It is much easier for a country like the US to adapt. For China, the disparity of living standards is too great, and there are too many people, which makes any change of direction very risky and unpredictable. The US could seek to greatly reduce every American’s energy spending so as to increase their purchasing power for other necessities (hence raising demand where it needs to rise), while creating jobs by financing the development the sector that will be in charge of this energy consumption reduction.

    The US can seize an opportunity, but it doesn’t have much time and it might just not seize it.

    Or China can always cancel the US debt;)

  7. Edwardo

    Capital flight, eh?

    I’ll keep this short and simple. None of the fiat currencies around the globe will be able to displace the crumbling dollar and shore up the tattered Bretton Woods II regime until governments respond to gold along the lines described by Antal Fekete.

    Until that happens, we will collectively continue down the path of financial chaos and economic collapse. And all the folks who scoff and dismiss gold as, well, a barbarous relic, simply don’t understand how important gold is and have not been paying attention to developments that clearly indicate that gold is slowly but surely returning as money.

    Remember Gresham’s law, which is bad money drives out good, and that is why gold is becoming more and more difficult to acquire. When the wholesalers get cornered, and they will, it will be game over. Gold will not be available at anything but astronomical prices. Given the way nation’s are debasing their own currencies, why would anyone exchange gold for a pile of greenbacks or pounds or Yuan except for the fact that gold coins can not (yet) be exchanged directly for soap, toilet paper, or a cut of steak?

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