For some time, the Chinese government has been promoting the Yuan as a medium of international trade, and reducing the influence of the U.S. dollar. A pilot program was launched in 2009, and there have been high profile deals and negotiations since — for example, with Russia, where there is also a keen interest in dethroning the U.S. Dollar from its top spot in global exchange. China has expressed plans to bring Shanghai to the level of an international financial center by 2020, unveiling rules in February to make it easier for multinationals located in the new Shanghai free-trade zone to transfer Yuan into and out of China.
In spite of this, we believe that a Yuan challenge to Dollar dominance is far off, if indeed it ever happens. The deep-rooted economic and cultural realities that make the Chinese financial system closed and opaque will take a long time to address, although there will be incremental gains — particularly if the U.S. persists in its own fiscal and monetary follies.
New Evidence of Experimental Liberalization
Nevertheless, we got a new piece of evidence last week that was something of a revelation about how the Chinese government is experimenting with currency trade liberalization.
It answered some questions about how Chinese buyers have been able to get their money out of the country and purchase real estate abroad. Chinese buyers of U.S. real estate spent about billion in the twelve months ending in March 2014, up 72 percent from the same twelve month period last year. This includes buyers from Hong Kong and Taiwan, but money from the mainland is a major component.
Growth of Chinese money flowing into real estate in Australia has been similarly dramatic, and in Canada, Vancouver has anecdotally seen home price pressures rise dramatically as a result of Chinese demand. We read a report last year about a new 153-unit condo development in Vancouver that sold out in two and a half hours after the developer advertised it in Chinese media — and 40 percent of the buyers were Chinese. Data from Integrity International show a total of .7 trillion in unexplained funds moved overseas between 2002 and 2012.
How is the money getting out, has been everyone’s question.
Hush-Hush Programs
China Central Television (CCTV), which is state-operated, broke a story last week about a service provided by the Bank of China. (Although the Bank of China is one of the large state-owned banks, it is a different entity than China’s central bank, the People’s Bank of China, or PBoC.) That service, called youhuitong, or “preferential transfer channel,” allegedly permits Chinese nationals to work around the restrictions on foreign-currency conversions — and the bank has responded that the program was legal and known to regulators. It also asserts that many other Chinese banks offer similar services, although no other banks have commented.
Under the broad regulations, Chinese citizens can convert up to ,000 worth of Yuan each year. Obviously that is not enough for a wealthy Chinese businessman or bureaucrat to buy a multimillion dollar home in Los Angeles, Sydney, or Vancouver. The youhuitong gets around the limit by transferring Yuan out of the country and converting them in an unregulated foreign venue, rather than doing the conversion in China. It’s designed specifically for would-be emigrant investors and property buyers; in the case of real estate purchases, the converted funds go directly to the lender.
Experimental Liberalization, and a Deal for Insiders
Xi Jinping’s anti-corruption drive has been no secret, and his anti-corruption chief, Wang Qishan, has been pushing a crackdown on capital flight overseas. High-profile cases, such as those against former Chongqing party boss Bo Xilai and former railway minister Zhang Shuguang, have included potential seizures of overseas mansions in France and California.
However, interestingly, the response of the central bank to the current revelations has been neutral — no investigation has been announced, and the PBoC has merely “noted” the news reports. The youhuitong has been suspended — although nothing has been said about the other banks’ offerings.
We believe that a great deal of the money leaving China to find a home in overseas assets is derived from corruption. So the Chinese authorities are — as is often the case — fighting on two fronts. First, they want to rein in corruption — not out of purely ethical considerations, but because they see that corruption ultimately poses grave risks to the stability of the Chinese state and the ability of the Chinese economy to keep its citizens happy with continued growth.
But second, they also want to liberalize the Chinese financial system to the extent necessary for China to take a greater share of global financial markets.
The first goal means cracking down on capital flight. The second goal means putting more holes in the bucket that keeps capital locked in China. Are anti-corruption officials and financial regulators at loggerheads? Perhaps the PBoC’s tepid response to the Bank of China’s youhuitong comes from a basic conflict of interest within the Chinese leadership.
Investment implications: Potential regulatory action could affect Australian, Singaporean, Canadian and U.S. real estate markets where Chinese demand has lifted prices. The Chinese domestic economy could be affected by stresses as China moves towards a more open financial system.
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