Beijing growing desperate on balance of payments dilemma
Beijing tightens controls on hot money
SCMP headline, November 10
It's a headline that will soon rival 'President seeks new Mideast peace accord' as the most overworked one of history. Let's put it into its larger context. We are talking of China's balance of payments crisis. Yes, 'crisis' is fast becoming the right word.
In September, the country's foreign reserves rose by more than US$100 billion, a record. I stress 'rose by', not 'rose to'. Malaysia has foreign reserves of US$100 billion, the United States slightly more, Britain slightly less. China has foreign reserves of US$2.65 trillion.
Put it into further context. In September, China's foreign reserves rose by the equivalent of HK$300,000 per second. That's right. In the time that it takes you to read out this sentence, China's foreign reserves rose by HK$2.4 million. And this went on for a whole month.
These figures are so big they are beyond real comprehension.
It happened, of course, because people have been putting money in yuan through every channel they can find, many illegal, on what seems a sure bet that the yuan will have to rise much further against the US dollar. They are right. It is indeed as close to a sure bet as any investment proposition can be.
This has put enormous strain on China's financial system. If dollar-bearing speculators can slip through the controls meant to keep them out, Beijing must find the yuan to give them in exchange for their US dollars. The dollars go into foreign reserves. The yuan comes from the banking system and the banks have increasingly less to spare.
There are two alternatives. The first is to refuse to make the exchange, in which case the credit of China's export industries is destroyed and the economy comes to a screeching halt. The second is to open the capital account and let the yuan float free on foreign exchange markets, in which case Beijing loses most of its central authority.
It would happen because people would then be able to snub their noses at anyone who tells them where to put their money. With an open capital account they can always take that money abroad. Both of these alternatives are repugnant to the authorities and they have therefore resorted to blaming US government monetary policy for their troubles.
But it's a false bogeyman. Beijing's balance of payments troubles are of its own making. It deliberately undervalued its currency to help create a sophisticated modern economy but it also wanted to keep full control of that economy.
This is a classic case of having your cake and eating it too. And now the talk is of a 'strategy' to deal with the problem by making the yuan an international currency without opening the capital account. This is like trying to eat a tin of beans without opening the tin, but Beijing is growing desperate.
The idea, highlighted in our Insight Page on Monday by a Chatham House research director, Paola Subacchi - 'Trailblazing yuan', is twofold. The first is that China should settle an increasing part of its trade bills with yuan rather than US dollars, starting in Asia. The second is to boost Hong Kong as an offshore yuan market. Settle your deals with yuan and you won't have dollar holders bothering you any longer.
Great idea but it solves nothing. Yes, China can settle trade bills in Thailand with yuan but only to the extent that Thailand has trade bills in China to settle. If China exports more to Thailand than it imports from Thailand, the Thais will soon have no more yuan to pay for their Chinese-made goods. The only solution when this happens, and inevitably it will, is for China to lend Thai importers the money to pay these trade bills. This balances the balance of payments.
Money that flows out of Thailand for imports on the current account flows back in as loans on the capital account. But does Beijing really want to finance the operating capital of private Thai importers? Could it ever convince the Thai government to guarantee such debts?
The answer on both counts is obviously no, except perhaps for a tiny face-saving show that the politicians on both sides might agree to stage. Thus this trade scheme will work wonderfully right up to the point for which China wants it and then it won't work at all.
Likewise, the offshore yuan market in Hong Kong. It's an illusion. The yuan in the yuan deposit accounts you take up never really leaves China. If you don't believe it, offer some yuan banknotes at the supermarket checkout next time you buy groceries. We don't buy and sell things in yuan here.
Your only option, Mr Hu [Jintao], is a much stronger yuan against the US dollar. The faster you get there the less overall pain you will suffer.