CHINAMacroReporter

Clearing up a few misconceptions on China's capital flight

Last year, I debunked a popular measure of trade misinvoicing as the culprit for China’s capital outflows. Today, let’s scrutinize two other misconceptions bouncing around the China commentator echo chamber.
by

Brandon Emmerich | Granite Peak Advisory

|

CHINADebate

April 26, 2017
Clearing up a few misconceptions on China's capital flight

“It ain’t what you don’t know that gets you in trouble, it’s what you know for sure that just ain’t so.”

– Mark Twain

Last year, I debunked a popular measure of trade misinvoicing as the culprit for China’s capital outflows. Today, let’s scrutinize two other misconceptions bouncing around the China commentator echo chamber.

But first, a summary of the argument from last year: ‘Trade misinvoicing’ is when trading companies undercharge for exports or overpay for imports so that intermediaries can stash the difference in an offshore bank account. The consensus narrative claims that we can observe this directly via discrepancies in bilateral trade data. So, I showed how to generalize those discrepancies to a time series indicator; and, that this indicator offers zero explanatory power for China’s drawdown of FX reserves.

Today, let’s audit another proposed mechanism of capital flight involving artefacts of China’s trade data. I first saw this proposal in a blog post by Christopher Balding, economics professor at Peking University and owner of a delightful twitter handle. Since, many others have reproduced and repacked a similar analysis. Here is the basic idea:

The differences in key data surrounding trade data is illustrative… Whereas Chinese Customs reports $1.68 trillion and SAFE report $1.57 in goods imports into China, banks report paying $2.55 trillion for imports.  In other words, funds paid for imported goods and services was $870-980 billion or 52-62% higher than official Customs and SAFE trade data.  This level of discrepancy is extreme in both absolute and relative terms and cannot simply be called a rounding error but is nothing less than systemic fraud.

In other words, the difference between imports and bank payments data directly exposes the mechanism by which Chinese nationals ferret money out of the country.

Dr. Balding’s analysis is seductive for two reasons: One, we get to cry that China is imploding. Finally! Two, we’re supplied with further evidence implicating the statistical agencies in China Watchers v. Chinese Economic Data. Both get clicks.

However, a rigorous look at the data rejects this hypothesis. We can construct an indicator of this “systemic fraud” by subtracting the value of imports reported by Customs from the value of bank payments for imports (which is reported by SAFE). Let’s call it, “Bank Overpay.” Then, we compare bank overpay to changes in PBOC FX reserves. A final note, while Dr. Balding appears to be citing annual data from 2015, I use monthly data.

China began hemorrhaging foreign exchange reserves in late 2014. However, banks began ‘overpaying’ for imports nearly three years earlier. The eye-test alone debunks this mechanism as a direct monitor for capital flight. Furthermore, a battery of statistical tests show that a model of China’s FX reserves gains zero explanatory power by including ‘bank overpay’ as a predictor variable.

I can’t explain the discrepancy between Customs and SAFE import data, that could be topic for future digging – perhaps even a trip down to the docks. But, this particular statistical artefact and China’s capital flight are unrelated.

So, what does explain China’s recent bout of capital outflows? I still find this BIS report most persuasive. Robert McCauley and Chang Shu offer two drivers: corporates paying down FX debt and foreigners reducing their stock of RMB deposits. A simple model taking those two as independent variables explains around 70% of the variance in the PBOC’s FX reserves.

Now, let’s move on to China’s capital controls. The echo chamber commentators are tripping over each other to tell us that recent capital controls have staunched FX reserve depletion, and we should put worries of China’s capital flight behind us (read here ,here, and here).

What does the data say?

We can use the concept of covered interest parity to quantitatively observe the efficacy of capital controls. CIP assumes that in the absence of country risk, obscene transaction costs, or (most importantly, here) capital controls, an investor should not be able to capture a riskless profit by arbitraging the interest rate differential between two countries.

The methodology: we calculate an ‘FX implied rate’ for SHIBOR, which is what an investor should earn in China based on both USD funding costs and the expectation of future exchange rates. A divergence between the implied and real rates confirms the presence of capital controls limiting the free movement of capital. On the other hand, convergence would show a relative freedom of capital mobility.

A pile of studies (see here, and here) used this methodology to observe the effect of Japan’s capital controls last century finding that strong capital controls contributed to significant deviations from covered interest parity. Applying the same methodology in reverse, we see that China’s capital controls have recently actually become quite leaky.

The left-hand side plots the one year SHIBOR and FX implied rates, the right-hand side the difference between the two. The convergence of the two rates implies that China’s capital account has become more porous over the last 2 and half years, not less. And, recent capital controls certainly haven’t pinched complete capital mobility.

So what does this all mean?

Although PBOC FX reserves have stabilized for the moment, and the government has simultaneously implemented strict capital controls, I don’t believe the latter to be the cause of the former. Not only that, we still don’t have an accurate quantitative measure to observe in real time by which channel money is leaving the country.

Given China’s massive money supply, the RMB still faces tremendous downside risk should China get hit with another economic shock. Regarding capital flight, I believe that China is not yet out of the woods.

More

CHINAMacroReporter

February 11, 2021
'The Biden Team Wants to Transform the Economy. Really.'
‘Biden and his more activist advisers hope to modernize key industries and counter an economic threat from China, swiftly emerging as the world’s other superpower. “The package that they put together is the closest thing we’ve had to a broad industrial policy for generations, really,” says Scott Paul, the president of the Alliance for American Manufacturing.’
keep reading
February 10, 2021
‘What the ‘Hong Kong Narrative’ gets wrong'
‘For a significant cohort of the [“pro-democracy”] protesters, the more accurate label would be “anti-China activists.” The one thing that seems to unite them is not a love of democracy, but a hatred of China.'
keep reading
December 30, 2021
Q&A 4 | Is China Exporting Inflation?
'‘China has its own issues. If you look at the CPI inflation, it looks more moderate. ‘If you look at the producer price inflation, it looks more severe.’
keep reading
December 30, 2021
Q&A 2 | Will the Gender Imbalance Keep Housing Prices Firm in the Medium Term?
‘The part of housing prices caused by gender-ratio imbalance is not going to go away in the medium term. But the government has ways to create volatility in the housing market.’
keep reading
December 30, 2021
Q&A 3 | Property 2022: Stabilization or Growth?
‘The goal is to stabilize housing prices while having housing sector grow.’
keep reading
December 30, 2021
Shang-jin Wei Presentation-3 | Analyzing the Gender Imbalance Data
‘Compare these with graph showing the impact of the same factors on rental prices...'
keep reading
December 30, 2021
Shang-jin Wei Presentation-2 | Gender Imbalance as a Driver of Housing Prices
‘Why does gender imbalance have such an outsize impact on China’s housing prices?'
keep reading
December 30, 2021
Q&A 5 | Will Xi Continue to Favor the State Over the Private Sector?
‘He wants to see a bigger role for the state in the economy. But in the last two years, he has done some course correction. For example, after talking up the role of state-owned firms and building stronger, bigger state-owned firms, he is talking about the equal importance for the private sector.’
keep reading
December 30, 2021
Q&A 7 | Why Did Beijing Ban Online Tutoring?
‘Each policy in isolation – whether its banning online tutoring or protecting data or enforcing anti-monopoly regulations or any other - has its rationale.’
keep reading
December 30, 2021
What Are Your Top of Mind Concerns?
I asked the participants what are their top of mind concerns about China.
keep reading
December 7, 2021
Getting (Xi Jingping's) Priorities Straight
How do you make investment or business decisions in the face of the uncertainties created by Xi Jinping's reshaping China's economy? In this issue, I'll give you a few different ideas on how you might deal with that uncertainty.
keep reading
December 7, 2021
Look Through the Rights Lenses
Getting down more to the nitty-gritty, if you’re evaluating a sector or a company, get your lenses right to get the details right.. Stonehorn’s Sam Le Cornu gives a good example of this in a Bloomberg interview.
keep reading
December 7, 2021
Sometimes You Just Have to Roll the Dice
Telling someone to align him or herself with Beijing's priorities still is generally good advice.And, when I tell you what those priorities are, I know I am right - until I'm not.
keep reading
December 7, 2021
Watch What Beijing Says - and Does
Besides listening to Xi Jinping, you can discern Beijing’s priorities and its likely actions through its big policies - and this is my point here.
keep reading
November 23, 2021
'Biden Has a Summit With Xi, but No Strategy for China'
‘Neither Taiwan nor strategic arms are a hot campaign topic, and China is not yet at the forefront of public consciousness. To ensure America’s eventual strategy is workable, political leaders need to debate the challenges so citizens can appreciate the implications of the choices they will have to make.’
keep reading
November 23, 2021
Xi Jinping's Leadership: 'The Inevitable Outcome of History'
Mr. Xi is the hero of a Resolution on the history of the Chinese Communist Party that painted his leadership as the inevitable outcome of history and all but gave him his third term. Tony Saich of the Harvard Kennedy School did a terrific analysis on this - you'll find it below, after my take.
keep reading
November 23, 2021
'Xi Jinping has made sure history is now officially on his side'
‘While there are murmurs of opposition, the historic plenary session would suggest that the future is in Xi’s hands. However, when politics is so deeply personalised and centralised, there is only one person to blame if things go wrong. Unless, of course, we get a new resolution on history that tells us who led the party astray, despite Xi’s earnest attempts to keep policy on the straight and narrow.’
keep reading
November 9, 2021
'America's China Plan: A Proposal' by Clyde Prestowitz
Outcompeting China and avoiding global extension of its authoritarian and coercive policies and practices is not really about China. It’s about America.
keep reading
October 27, 2021
Why China Won't Invade Taiwan - Yet
Forget Evergrande and the energy crunch. After the recent flurry of alarming headlines, here’s the question I get most often these days from CEO’s and institutional investors: Will China invade Taiwan in the next few years?
keep reading
October 17, 2021
An Energy Crunch. China's Latest Crisis. They Just Keep Piling Up.
‍‘Over the next six months or more, the energy crunch in China will be an even bigger challenge than Evergrande. Will make the Evergrande problem look tiny and has huge global implications. The lights go out in China!’ one experienced and very well-respected reader of long residence in China wrote to me in response the last issue on Evergrande.
keep reading
October 7, 2021
Just How Contagious is Evergrande?
Just as a personal crisis can lead you to dig deeper into yourself, so the rapid-fire events in China - with trillions of dollars of business and investment on the line - have led us to (finally) go deeper into how China works – and to come to grips with uncertainties caused by Xi Jinping’s recent moves to reshape the Chinese economy and the Party’s social contract with the Chinese people.
keep reading
September 27, 2021
'This Time Feels Different'
Just when we thought we were getting used to Xi Jinping’s tech reforms and social-engineering regulations, the Evergrande crisis heats up.
keep reading
September 19, 2021
AUKUS: A New World Order?
‍In case you passed over the news of AUKUS, the new strategic alliance among the U.S, the U.K., and Australia, here a few headlines to encourage a deeper look.
keep reading
September 7, 2021
Xi Jinping: Today, video games. Tomorrow, well ... just be good.
Today's issue is a heads up on what may be Xi Jinping's efforts to reshape Chinese society.
keep reading
August 28, 2021
The Taliban: 'China's Perfect Partner'?
Breaking through the blow-by-blow reporting that started when the Taliban began its sweep to victory are the geopolitical analyses of who gains and who loses in Afghanistan.
keep reading
August 15, 2021
'Xi’s Dictatorship Threatens the Chinese State'
‘Mr. Xi is determined to bring the creators of wealth under the control of the one-party state.’
keep reading
August 15, 2021
'Are you tired of losing yet, America?'
As I write this, Taliban forces have entered Kabul and are reportedly occupying the Presidential Palace.
keep reading
August 15, 2021
China Economy: Industrial Production Down, Demand Resilient
China’s industrial production down 10%. Demand resilient.
keep reading
August 15, 2021
'China Signals More Regulation for Businesses in Coming Years'
‘The State Council’s statement provides a guiding context to interpret current regulatory thrusts. The blueprint as an attempt by Chinese authorities to help investors understand the motives behind the regulatory push.’
keep reading
August 5, 2021
‘Global investors shocked to have discovered that China is run by Communists.’
‘Global investors are shocked to have discovered that China is run by Communists.’
keep reading
August 5, 2021
'Shocked Investors Scour Xi’s Old Speeches to Find Next Target'
‘While China’s policy moves can feel ad hoc particularly to foreign investors, the changes are quite targeted on certain sectors.’
keep reading
August 5, 2021
Don't Say Xi Jinping Didn't Warn You
‘Global investors are shocked to have discovered that China is run by Communists.’
keep reading
August 5, 2021
'China Wants Manufacturing—Not the Internet—to Lead the Economy'
‘Social media, e-commerce and other consumer internet companies are nice to have. But in his view national greatness doesn’t depend on having the world’s finest group chats or ride-sharing.’
keep reading
August 1, 2021
'Stock Market: China Doesn’t Care How Much Money Investors Lose'
‘Does Beijing not care how much money foreign investors have lost? Does the government really want to close China Inc.’s access to the deep pool of global capital? The short answer is, no, the government doesn’t care.
keep reading
August 1, 2021
'Xi's Four Pillars of Regulation'
‘Broadly, Beijing is concerned about four pillars of stability: banking, anti-trust regulation, data security and social equality. All of Beijing’s major interventions reflect these concerns.’
keep reading
August 1, 2021
China's Tech Crackdown: 'Nobody Saw It Coming.' — Huh?
‘Carnage in China's financial markets signals the beginning of a new era as the government puts socialism before shareholders, and regulatory changes rip apart the old playbook,’ writes Reuters’ Tom Westbrook.
keep reading

Heading

Lorem ipsum dolor sit amet, consectetur adipiscing elit. Suspendisse varius enim in eros elementum tristique. Duis cursus, mi quis viverra ornare, eros dolor interdum nulla, ut commodo diam libero vitae erat. Aenean faucibus nibh et justo cursus id rutrum lorem imperdiet. Nunc ut sem vitae risus tristique posuere.