Sunday, June 17, 2012

Chinese Capital Flight and FX Reserves

A recent paper is making the rounds which seeks to illustrate the risk of mass capital flight in China.  The Recapitulator has warned readers regarding similar flight risks for years.

The important point regarding the level of reserves is their composition and ownership rights.  The problem with Foreign Direct Investment (“FDI”) is that it gets listed as “foreign exchange reserves” under national accounting standards, but those standards to not account for the transitory nature of FDI, or who ultimately owns the stock or flow of cash resulting from such investment. 

Much ballyhoo has been made over the massive notional amount of Chinese FX reserves.  The total figure appears to be in the  1 Trillion range, but again, who owns those reserves, how portable and fungible are they, and what is the physical location (be it in cash or accounts in respective countries) of these reserves?  Bear in mind China is under no obligation to disclose any of the above, and the fact it has not done so given the total amounts involved should induce disquiet in China bulls.

It is somewhat similar to capital reserve rules under Basel II with respect to what assets are considered respectable collateral.  FDI is by definition capital that can quickly move in to or out of a country.  It serves no master and has been the bane of many nations who sought to open previously constrained and controlled markets.

I have maintained that global properties being purchased by Chinese nationals could very well serve as colonial ensconcements once domestic policy disfavors wealthy Chinese in favor of more “traditional” communist ethos.  The problem is, once Freedom is experienced, it cannot be un-experienced.  The slope is slippery and the U.S.S.R. serves as an example of utilizing half-measures in front of the Tsunami of public opinion.

The world has yet to discount the possibility that foreign "hard" asset purchases by Chinese nationals may serve as "factories" (to use the English East India Company term for "semi-sovereign trading posts owned by resident aliens") for wealthy Chinese looking to park assets in safe jurisdictions.

My instinct informs me the tethers of control in the middle kingdom are dissolving quickly.

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