The milk of innovation keeps flow of hot money alive

PUBLISHED : Saturday, 19 February, 2011, 12:00am
UPDATED : Saturday, 19 February, 2011, 12:00am

When it comes to innovation and creativity, it is hard to match our neighbours on the mainland. Just imagine making baby milk from an old leather sofa!

The price of milk on the mainland is determined by its protein content. The higher the protein content, the higher the price.

To some heartless mainland ranchers, the challenge is how to raise the protein content of the milk without giving expensive feed to the cows.

Melamine is handy and cheap but too dangerous, given tight government monitoring after the 2008 poison milk scandal. So unscrupulous producers have turned to an 'organic' source instead - leather.

Leather is animal skin and, therefore, full of protein. Treat the leather in water and one gets some hydrolysed protein. Just a bit of that and a bucket of 'high-protein' milk is ready for sale. It is cheap, too, because there are plenty of old leather sofas and shoes around.

How widespread is this practice? It is hard to determine, but at least one Zhejiang milk producer has been caught using the leather 'additive'. That was in March 2009 - only months after the melamine scandal, according to mainland media.

That same kind of innovation, creativity and guts is at play in the so-called 'hot money' flow.

It's no surprise that the State Administration of Foreign Exchange (SAFE) has found locals to be the masterminds behind the US$35.5 billion in hot money illegally brought into the country. The figure accounts for 7.6 per cent of the increase in foreign exchange reserves since 2009.

No 'jinrong dae [financial crocodile]' like George Soros is involved. Rather, it's mainland individuals, corporates and overseas Chinese who move the money in bits and pieces like 'ants moving their home', said SAFE in its first hot money report released on Thursday.

The mainland allows no massive repatriation of foreign currency or conversion into yuan without government approval.

But it is being done and it does not involve jet boats or suitcases of cash but a more civilised transfer.

The report provides little detail but a chat with three mainland businessmen reveals the craft. (The following details don't speak to the resourcefulness of the businessmen but to the openness of this operation.)

'These are the ancient tricks. I can list at least a dozen,' said one businessman.

First, the overpaid workers. It's probably the oldest trick. Since China opened its doors in 1978, there has existed the processing trade in which a foreign entrepreneur imports raw materials and components into the country for assembly or processing.

The foreign partner is allowed to send foreign currency across the border, convert the currency into yuan to pay for labour and overheads.

So, one simply shows customs that you are paying the workers 3 million yuan (HK$3.55 million) a year, when in fact they take home only 2 million yuan, and you sneak 1 million yuan into the country.

Then you can buy some flats, bet on the A-share market, speculate on garlic or simply act as a loan shark and enjoy monthly interest of 15 per cent. There are many ways to profit from the spare yuan.

As long as you have supportive local partners and government officials, it is hard to prove anything illegal.

Second, the prolonged payment. Imagine you are a Guangdong manufacturer of teddy bears for export.

Each month, you are allowed to send US$10 million from Hong Kong to your mainland subsidiary to pay for the rolling eyes, the stuffed bodies and ribbons that you source from a neighbouring supplier.

By convincing your suppliers to accept payment every 60 days instead of 30 days, you have double the amount to play with. Yes, you have to pay that out in two months, but by then another payment has arrived.

Third is the imaginary business. The real business sets up a shell company in Shanghai. It writes a contract for the Shanghai firm to do market research and consultancy for a Venezuelan food company, which of course does not exist. Then US$5 million is sent to Shanghai to pay for the service.

As for taxes, there are many ways to make the Shanghai company a loss-maker.

Fourth is excess equity. Put in an application to set up a textile factory. It has to be a sizeable one (at least on paper) to justify a significant equity injection, say 200 million yuan.

Once the money is in, confirmed by the authorities and the business licence arrives, you can pull the money out of the bank and have fun.

There are supposed to be tight controls on the movement of money from the capital account into other accounts. But this is no real hurdle as long as you have the right friends. And money is a lubricant.

What about the promise you made to build the factory? Well, you can spend months changing the design and then months on the equipment selection.

After years of delay, you would build a factory but it would be on a much smaller scale. Or you can simply claim the newly set-up company made a grave mistake in buying some obsolete machines, write off the investment and build no factory.

You can see that the hot money business is too difficult a craft for international speculators to copy. It requires not only a good knowledge of the system but, more importantly, the right connections and a complete disrespect for the law.

As SAFE said, the legal risk is too high for international speculators to get money into China illegally.

In the meantime, SAFE pledged to plug the holes. How successful will it be? I wonder. After all, it's hard to outwit citizens who can make milk from shoes and sofas.