Jake's View

Free-trade Shanghai will trigger brief tsunami of cash flowing out, that's all

PUBLISHED : Sunday, 22 September, 2013, 12:00am
UPDATED : Sunday, 22 September, 2013, 2:47am

Beijing's landmark plan to create a Hong Kong-like free trade zone in Shanghai - the mainland's biggest economic experiment since the creation of Shenzen, its pioneering special economic zone - has sparked a debate over whether it would lead to the twilight of Hong Kong.

South China Morning Post
September 19

I don't know that I would choose the imagery of twilight for this threat - it implies a slow, steady darkening, a calm and inevitable decline.

What I have in mind is more sudden shock and horror on the faces of people everywhere in this town as they feel a deep rumble under their feet and turn north to see a mountainous tsunami of cash rolling down from the border and bowling them over.

Let's say Premier Li Keqiang really does open a free yuan zone in Shanghai, a district where every financial concern registered as having an official presence can exchange yuan for foreign currencies in any amount it chooses and at any exchange rate it chooses.

The yuan will crash on foreign exchange markets and the economy will go into a tail dive

Of course it may be less than this. We may have only three or four mainland banks setting up shop in this district and under orders not to transact more than a token amount each day on pain of Beijing's great displeasure. This would not be a yuan free zone, more an early opening of Shanghai Disney.

We shall assume, however, that Premier Li really means it, that, odd as it may seem, he really has no comprehension of what will happen to him when he tries it, and that he will permit a meaningful number of financial institutions to do with the yuan as they will.

What will happen almost instantly as the starting gun goes off is that corporations and individuals of significant wealth right across China will make their way to this free zone with fistfuls of cash, screaming to be let in through the doors so as to take the money out.

I am speaking here, of course, of entities that have not yet discovered electronic payment systems and other better ways of moving money than suitcases and bags marked "Loot". There are many more who have made this discovery and they will have laid their plans in advance.

It will do no good then for Mr Li to protest, "I only meant Shanghai. I didn't mean everyone should do this". Unless he builds a new Great Wall around Shanghai, as high this time as an airplane can fly, he will be out of luck. The money will flood in from across the country. It will be like a breach of the Three Gorges Dam at the height of the rainy season.

First stop will be Hong Kong. That's the tsunami we will see rolling in. As it passes over us it will seek out our property market and flick aside the restraints we thought we had imposed on this form of speculation through punitive stamp duties. It will probably blow the peg to the US dollar right out of the water.

But it will roll on, next stop London and New York, property first and then anything on offer at any price. You may think that the big financial news of the day is US Chief Monetary Wastrel Ben Bernanke deciding not to "taper" his "quantitative easing". It will mean nothing if the tsunami from China hits him.

And that tsunami will only grow bigger as the effects within China are felt. The yuan will crash on foreign exchange markets and the economy will go into a tail-dive recession with a financial crisis that will expose gross misallocation of capital everywhere across the country.

Premier Li will try to stop it, of course. I expect that within 48 hours at most of opening the yuan free zone he will try to close it again. The problem is that trying to close it may be like trying to repair a breach of the Three Gorges Dam, not until the full flood is gone.

Don't be so pessimistic, you say. They must know what they're doing in Beijing. They won't let things get out of hand.

Okay, okay, let's see.