By MoneyMorning.com.au
Reuters reported last year that Bert Hoffman, World Bank chief economist for East Asia and Pacific is confident business and bank and economic managers in China have it all under control.
He’s so convinced China’s central planners can bring about a soft landing he said…
‘On balance, we believe that while there are issues (in China), they are being managed and the magnitude of those issues does not add up to something that would lead necessarily to a major slowdown as some have talked about.’
It may look like the People’s Bank of China is able to control the economy. But its China’s wealthy that control the central bank.
Here’s how.
China has a country of 1.3 billion people. Out of those, 590,000 make up the richest people in China. A tiny 0.5% of the population. Together these ultra-wealthy own $2.7 trillion of assets, or roughly $4.57 billion per person.
In fact, China officials care most about these super rich. Looked at another way, combined they possess the buying power to potentially pay off one-sixth of the US national debt.
And this group of rich Chinese could be driving the latest bank policy.
In February, the People’s Bank of China (PBOC) lowered the reserve requirement ratio (RRR) by 0.5% to 20.5%. At face value it looks like the PBOC is doing it simply to keep the Chinese credit binge going.
Or, it could be because actual cash is leaving the banking system in record numbers. This is known as ‘capital flight‘, when vast amounts of cash leave the banks. This is important because capital flight sucks the liquidity out of the financial system. How? By taking out deposits that ‘balance’ the loans on a bank’s books.
The Wall Street Journal wrote earlier this year:
‘Estimates of capital flight are sketchy, but it appears there was $34 billion of it in the third quarter of last year and $100 billion in the fourth.’
Okay, so $100 billion is barely 0.005% of the combined wealth of China’s richest citizens. But China has extremely strict controls on how much money ‘leaves’ China.
Firstly, no ordinary person can take more than RMB20,000 in cash out of the country… unless of course you’re heading to Macau – China’s government-controlled version of Las Vegas.
If the report from the Financial Times is right, some Chinese have worked out how to get around the limit.
Gambling in the casinos is up 35% in January. While it’s easy to blame it on Chinese New Year celebrations… there’s a little more to the story. After the New Year’s celebrations had ended, the FT wrote:
‘[it’s]… widely believed to be another way to get money out of China, evading the legal limit on cash taken out of the country by gambling on credit and then receiving any proceeds on (foreign currency) cash outside China.’
Again, it’s still only small amount of yuan leaving China. But it could be an indicator of what’s to come.
Victor Shih, a political economics from Northwestern University in the US, estimates the Chinese banking system could handle half a trillion dollars due to capital flight.
But should it continue, Shih anticipates up to a trillion dollars could leave China’s grasp and see the government lower the RRR to 5% or 6% to combat the lack of cash left at the banks.
This means for now, China has a ‘cushion’ of roughly a trillion US dollars. That’s a lot of money. It’s the equivalent to 15% of China’s yearly gross domestic product.
However he predicts the real problem, is those who follow the ‘smart money’, China’s wealthiest 1%:
‘Sizeable outflows from the smart money would see the remaining 9% of top 10% of households follow the smart money.’
Meaning, if the rich see the super-rich moving their assets out of the country, they’ll quickly follow suit.
This exodus of cash could potentially cripple the Chinese banking system. Simply because the loans in Chinese banks don’t really have an end date. They’re either paid or not. So banks constantly ‘roll over’ bad debts. According to Shih:
‘A lot of loans in China are in reality non performing, they just get rolled over, time and time again, so they don’t ever get paid back. So you have a deposit base shrinking and on the asset side the loans are still there which means after a while you have illiquid banks.’
And should this happen, Shih reckons China’s authorities won’t be able to save China’s banks and recapitalise them. ‘China can’t liquidate its entire $3 trillion foreign exchange portfolio… some of it is already invested in Chinese banks and Chinese institutions.’
‘Chinese bank share prices would completely collapse if the Foreign exchange itself began to sell Chinese bank shares…’
But Shih is quick to point out that a capital flight of this level is more a black swan type of event. He says, ‘It’s a tail risk, but one investors should be aware of.’
In that case, what would cause the super-rich to move their cash out of China?
To protect their investments.
When there’s no longer a return on investment, the rich folks would start to move their cash out of China.
And that could have a huge effect on the Chinese economy.
One trillion dollars leaving the banking system may seem farfetched… but if it happens, a capital flight of this size could be the trigger for an economic crisis in China.
Shae Smith
Editor, Money Weekend
The Most Important Story This Week…
Economics teaches us that prices are a signal. It stands to reason then, that the price of oil – the most important commodity in the world – is the most crucial signal to watch. A rising price spells trouble because so much economic activity is dependent on cheap oil. Everyone will feel a rising oil price painfully. It means expensive petrol. Higher food bills. Less air travel. Less discretionary income to spend.
The only way to benefit from a higher oil price is to have an investment correlated to that same price. Trading oil futures is for the hedge funds and investment banks. But oil stocks are within reach of even the most modest retail investor. And right now, these stocks are trading at depressed prices. Many people are risk averse due to the state of the world economy. But energy is a sure bet in one sense. There is no economy without energy: that means guaranteed demand. Low stock prices? A rising oil price? This makes NOW the best time to move into energy, according to our resource specialist Dr. Alex Cowie in Higher Oil Prices – Government Guaranteed.
Other Highlights This Week…
Dan Denning on When Banks and Bonds Go Pop: “The financial system is surviving on massive air/money pumping by central banks to prevent debt deflation and outright collapse. Central banks – at the very centre of the world system they have created – have taken extraordinary measures without precedent to prevent that world from crashing in around them.”
Matthew Partridge on How Expensive Oil Could Hit the Global Economy: “You can also look at oil companies, and shale gas in particular. While it may not be a miracle cure, that doesn’t mean the companies involved can’t profit from the hunt for alternative sources of oil.”
Kris Sayce on Why You’ll Want to Watch This ‘Bad’ Retail Stock Very Closely: “But a time comes when a market is saturated. In the case of retail businesses, it usually means it has opened as many stores as is economically possible, without it having a negative impact on the business. That’s when management has a choice. Do they stop the business growing or do they look at other opportunities?”
Greg Canavan on Gold’s Down… But Still Our Favourite Asset in Today’s Market: “Gold is insurance against the stupidity and vanity of central bankers and politicians. End of story. Even after gold took a beating last night, it’s still the investment that will offer you protection in this bear market.”
Chinese Banks: Will Missing Yuan Trigger a Capital Flight of China’s Black Swan?
