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This Is How China Hides Its Capital Outflows

November 3, 2015

Here is the latest articles penned by our friend Valentin Schmid over at the Epoch Times. Valentin will also be joining us on this week’s weekend show so tune in for that interview.

Click here to visit the Epoch Times website.

For China, things have been going according to plan in recent weeks. Despite the slowing economy and more stimulus, bad news about capital outflows have abated.

Instead, the regime successfully leaked its plans to fully float the yuan by 2020. This is probably an effort to convince the International Monetary Fund to include it in its global reserve currency this month.

However, some cynics might say the float will come sooner rather than later and not by choice. As much as $850 billion in capital had left China by the end of September of 2015, putting huge pressure on the currency.

The country may be hiding even more capital outflow through derivative contracts.

Judging by the example of Brazil, this practice probably won’t end well. “They are using forwards like Brazil does. This masks the capital outflow because they are getting banks to short the dollar on paper. That is what Brazil did and it was a disaster,” says Jeffrey Snider of Alhambra Investment Partners.

In layman’s terms, this means the regime is forcing state-controlled banks to enter into derivative transactions—a bet purely on paper—to push up the value of the yuan, rather than outright sell foreign exchange reserves.

This practice can mask the reserve drain until the forward positions are unwound, because derivative contracts by private banks aren’t often reported publicly.

“If you can intervene without actually diminishing your reserves, it’s somehow viewed as better,” Steven Englander, global head of Group-of-10 foreign-exchange strategy in New York at Citigroup Inc. told Bloomberg.

According to the latest data from August, the People’s Bank of China (PBOC) and onshore banks increased their holdings of yuan forwards (a derivative contract based on the currency) by $67.9 billion.

Goldman Sachs suspects the PBOC might help banks to hedge their risk exposure: “The large gap between [September’s outflow data] and the other PBOC data for September suggests that banks might have used their own spot foreign exchange positions to help meet some of the outflow demand. Banks’ overall foreign exchange positions might still have been squared with the PBOC via forward agreements,” Goldman writes in a note to clients.

This is exactly what Brazil did in 2013 and didn’t work out in the long-term, explains Snider:

“They manipulated the onshore rate so the local Brazilian banks had an incentive to increase their short-dollar positions via derivatives. The dollar problem goes away for a while. Then a lot of those swaps and forwards are coming due. They are inefficient and expensive from the central bank perspective, so they stopped rolling them over. Without the artificial incentive, the real just tanked.”

Indeed. In the chart below, the Brazilian real briefly rallied in the summer of 2013 and held stable for most of 2014 before crashing 40 percent in the last 12 months. The underlying economic problems—ironically closely tied to a slowdown in the Chinese economy—just hadn’t been fixed.

Brazilian Real in U.S. Dollars (Google Finance)

November is going to be an interesting month for China as the IMF is due to make its decision about the country’s inclusion in the elite of global finance. We are also waiting for new data on foreign exchange reserves to come out.

In the meantime, the global currency used to funnel money out of countries with capital controls (Venezuela, Cyprus) has doubled since the Chinese economy started to unwind in the middle of July 2015. No, it’s not the U.S. dollar—it’s the digital currency Bitcoin.

The price of Bitcoin in U.S. Dollars in 2015 (Google FInance)

Discussion
14 Comments
    Nov 03, 2015 03:34 PM

    There are now very few Caucasian people living in the inner core of Toronto everywhere you go it is predominantly Asian. It is shocking to see this transformation that has taken place in the last ten years but accelerated in the last three years. DT

      Nov 03, 2015 03:40 PM

      They are Canadians DT. What is so shocking about that? Which country did your parents come from? I am assuming you are not Native American and have roots in Europe or some other foreign land. Sorry, but I am all in favour of Multiculturalism. It’s what makes Canada one of the greatest countries on earth.

        Nov 04, 2015 04:59 AM

        That’s not the issue here but I’m not surprised that you got it wrong! DT

          Nov 04, 2015 04:23 AM

          OK, I am open minded. Explain what you really meant that I did not understand when you used the word “shocking” in your post. Webster’s defines shocking this way:

          “Very surprising and upsetting. Causing a sudden feeling of horror or disgust”

          Are you disgusted about all the Chinese in Toronto?

            Nov 04, 2015 04:26 AM

            Bird, stop trying to twist what I said out of context, maybe you should look up the meaning of the word “twist” in your Funk and Wagnalls. DT

            Nov 04, 2015 04:07 AM

            Still waiting for your answer. What exactly is the issue here? Don’t keep diverting with pointless posts. Just make your point man! What is it you are trying to tell us?

            Nov 04, 2015 04:25 AM

            Bird, you don’t want an answer you just want an argument. DT

            Nov 04, 2015 04:00 AM

            Just admit to racism and gets this over with.

            Nov 04, 2015 04:06 AM

            Bird, Al should remove your last post as it is totally uncalled for, demeaning and slanderous. DT

            Nov 04, 2015 04:44 AM

            DT, that’s all the guy knows. Hopefully most here are smart enough to see that.

            Nov 04, 2015 04:07 AM

            Actually it is YOUR first post on this thread that should be removed.

    Nov 04, 2015 04:33 AM

    I’m in the “core” of Toronto, and it looks pretty white to me DT. Sure there are “Asian-looking folk” but like the Bird, I’m not so afraid of immigration and the multiculturalism; especially as it is part of our nations story.

      Nov 04, 2015 04:45 AM

      Confused, I am not afraid of immigration or multiculturalism either, I was only pointing out that there are signs of change, which is altering the temper and ways of Canadian life. DT

    Nov 04, 2015 04:24 AM

    Canadians are so screwed. I wonder when the will learn like Germany did. Muslims are the next to be imported. So as to gain control of the elections. and then we shall see how high and mighty the “multicultural” pawns are. lol