The China Capital Control Chronicles

China’s economy is in trouble and has been the running theme in a number of our blog posts over the previous year. For those coming out of their election-bunkers, let us recap these issues and provide evidence for a forthcoming tipping point:

  • China’s debt is the largest it has ever been at nearly $5.5 trillion, which has rapidly risen the government and household debt to GDP. A large part of this credit was misallocated, and the bill is coming due.
  • After the 2015 stock market collapse, Beijing has pushed desperate savers back into property. The property market contributes a large percentage of economic growth. Prices have become unaffordable for all but the very rich. Bejing’s attempts to prick the bubble might cause a financial crisis.
  • In an effort to increase the Party’s power, Xi Jinping embarked on an anti-corruption drive. Many business people and government officials now fear for the safety of their loot and their hides.
  • If credit growth stalls, the party is over. As a result, the PBOC is forcing state owned banks to lend to state owned companies.
  • A stronger CNY decreases China’s competitiveness on exports. In recent years, China’s export growth has dropped from 31% to a dismal 8% while Vietnam, Cambodia, Laos and Myanmar have been picking up the slack, increasing the growth in their exports by over 20% annually. With a stronger greenback on the cards, further depreciation is needed to remain in the export game.
  • If enough capital flees China before the CNY can be meaningfully devalued, China’s capital account will bear the losses instead of domestic savers.

Cognizant of these facts, comrades are devising more and more cunning ways to export capital outside of the Middle Kingdom. The current annual $50,000 limit is insufficient for the amount of CNY that wants to leave.

Last month, China’s foreign exchange reserves dropped by the fastest amount seen since January by $45.7 billion to $3.12 trillion. [Bloomberg] However, some economists point to this figure as being milder than expected given the depreciation against the greenback. Regardless, FX reserves are down from $4 trillion in June of last year.

How are locals actually getting their cash out? There are legal and obviously illegal methods. Illegal (and unusual) methods involve the following:

  • Underground Banking: “Underground banks” take CNY onshore, and deposit HKD into the client’s offshore bank account.
  • Money Mules: Some pay “trustworthy” individuals to strap loads of notes onto themselves ducking and dodging through customs.

However with recent crackdowns resulting in busts up to $148 billion [Bloomberg], these methods have become increasingly risky. Given this, we were not surprised when we heard (although unconfirmed) reports of underground FX dealers charging rates 14% over spot (effectively a USDCNY exchange rate of 7.8).

Other traditional methods include:

  • Overseas Real Estate: Chinese people bought over $100 billion worth of US real estate between 2010-2015. [FT]
  • Alternative Assets: Buying gold, rare coins, or even internet domain names to be resold to an overseas owned company has become popular. [ZH]
  • Fake Trade Invoices: Companies overstate the value of imports into China or understate the value of exports. The invoice is submitted to the bank, and then the company is allowed to conduce a foreign exchange transaction. Over the past two years, the Hong Kong Monetary Authority (HKMA) has cracked down on this practice.

Here are two of the more creative schemes we have heard of:

  1. A Chinese company reportedly approached a law firm to represent it in a fake arbitrationcase against a US domiciled company they actually owned. If the Chinese company lost, the damages would have to be sent from China to the US. The amount in question was over $3.5 million. [China Law Blog]
  2. In a March blog post, “200 swipes: A New Way Chinese Avoid Capital Controls”, we mentioned how it became popular for local Chinese to buy insurance products in Hong Kong. The government attempted to stop this practice by limiting each transaction on UnionPay cards to $5,000. However, that didn’t stop some users from swiping their UnionPay card more than 200 times, bringing a new meaning to “jimmy hands”.

Furthermore, even when comrades try to do the right thing, they encounter obstacles.

There have been reports that locals are having trouble legally converting their CNY to USD. The common theme heard by many is that the bank would avoid paying dollars. Banks are offering various excuses. Some say they don’t have dollars, some reverse previously approved transfers, and others flat out refuse if the foreign entity receiving dollars has a Chinese owner [Above The Law].

The American EB-5 investor program is a popular route to spirit your capital and family out of a hostile China. For a minimum investment of $500,000, a green card can be granted. Companies have sprung up to consult eager Chinese expatriates. Some are now reporting their qualified clients are having trouble moving the necessary capital out of China.

In fact, some of these companies are seriously considering Bitcoin as a means of moving their client’s money into the US for investment. We’ve been told these customers are willing to pay up to 3%. I suspect with further depreciation and the uncertainty surrounding President-elect Trump’s immigration policies [Forbes], they would be willing to pay much higher costs to get through the door before January 20, 2017.

Bitcoin, up to a certain CNY premium, remains a viable option to liberate modest amounts of capital in China. Given that all major Chinese exchanges conduct thorough KYC, those moving large or illicit sums will not choose the Bitcoin route. This is probably why the PBOC hasn’t stomped on Chinese exchanges.

With a surging dollar and whiffs of American trade protectionism, Beijing cannot forestall the hard economic choices any longer. If Beijing cannot politically force the credit misallocation costs onto large industrial companies and the rich, then a disorderly devaluation looms large in the near future.