Jake's View

Yuan outflow is a misnomer as no currency came in or left the mainland

What it really means is that Chinese people are more keen to invest abroad rather than at home

PUBLISHED : Wednesday, 16 November, 2016, 4:30pm
UPDATED : Wednesday, 16 November, 2016, 10:49pm

Beijing can’t stem yuan outflow

SCMP headline, November 16

Question: How does one explain the balance of payments in 700 words?

Answer: One can’t.

Question: How does one explain the balance of payments in 7 words?

Answer: Easy – There is no yuan outflow to stem.

This has to be obvious if you think about it. There is only one place in the world where people accept yuan in payment for goods and services and that place is the mainland. If you take yuan out of the mainland all you can really do with it is stuff it in a mattress until you decide to take it back again.

Yes, you can exchange it for a foreign currency when you take it out but all this does is give someone else the problem of what to do with the yuan. The person changes. The problem remains the same.

Chinese yuan falls faster, touching lowest level in eight years

And, yes, you may be able abroad to pay for imports from the mainland in yuan. But why bother when the entire transaction is much more simply done in US dollars? The only reason it is ever done in yuan is to speculate on yuan strength. Bad time to do it just now.

What we actually mean by yuan outflow, or at least what economists mean, is that people in the mainland would on balance prefer to invest abroad rather than at home.

They must therefore find the foreign currency to do this and they have two ways of getting it.

The first is to export more than they import in goods, services and a few miscellaneous categories of trade. This is called a current account balance and the mainland at present has a current account surplus running at about US$270 billion a year. Keep it abroad rather than bringing it back and there is your money for foreign investment.

The other way is to induce your government to draw down its public foreign reserves and give this foreign currency to you in exchange for yuan so that you can set up your private foreign reserve, your foreign investment.

In both cases it is called yuan outflow and in both cases, as you can see, there was none. It was just foreign currency that was kept abroad or changed hands. There was no change at all in the stock of yuan in the mainland. Yuan outflow is a misnomer, a misleading figure of speech.

Yuan weakness is making a virtue of necessity

All that you really have is pressure on the yuan’s exchange rate. If people shun the yuan in favour of foreign currency then the yuan will come under downward pressure until the cost of buying foreign currency becomes just too great and people decide that another time would be better to invest abroad.

So here is the firm law in these matters – the balance of payments must always balance. The sum of the trade balance plus changes in foreign reserves must always be the opposite of foreign investment. Add them up and you always get zero.

(Note to technical nitpickers. Yes, I have treated errors and omissions as non-reserve financial account movements. Why? Cuz that’s what they are).

Now turn to the chart and you can see it in colour. In the blue line you have the mainland’s current account balance plus foreign reserve movements while in the red line you have the private capital account flows. Add them up at any point you choose and you get zero. No yuan came in or left the mainland.

But look at that red line again. It says that people want out to the tune of almost US$700 billion a year at the moment and it is not getting any better.

Did I already say that just now does not seem a good time to bet on yuan strength?

Best say it again.