China’s currency is back in the news. Large volumes of money have left China since Russia’s
invasion of Ukraine began, pressuring the yuan downward. This is worth watching,
but China has seen large capital outflows since 2014. The issue is less
short-term yuan weakness and more long-term broad financial weakness.

China’s General Administration of Customs (GAC) reported a
goods trade surplus of $677 billion in 2021. This is the most frequently
cited trade figure, showing how much more economic activity China drew in than
it supported elsewhere. But it’s not very informative.

The State Administration of Foreign Exchange (SAFE) is one
of China’s more professional, if secretive, government bodies and its balance
of payments accounting effectively dissects the goods trade surplus. SAFE
reports a 2021 current account goods surplus of $563 billion. Current
account goods balances usually differ from simple goods trade, but $114 billion
vanishing says pay more attention to the smaller number.

Another $100 billion was offset for a conventional reason: a
2021 services trade deficit. You’d think this might leave a current account
surplus still above $450 billion, but no. There’s also a $164 billion deficit
in current account investment income, money leaving in salaries, dividends, and
interest. It can be seen in part as a price to relocate economic activity —
China pays foreigners to help do so.

Or the $164 billion may be wrong. It’s easily the largest
result ever in that category, 37 percent more than 2020. It leaves a full
current account surplus of $317 billion in 2021, where the latter is often used
to see if external finances are unbalanced. The current account coming in below
half the goods trade surplus raises suspicions SAFE is manipulating numbers to
hide, among other things, yuan undervaluation.

Another possibility is investment income hid capital flight.
Flight is definitely present in the current account’s opposite number, the
financial account. In 2021, the latter shows $150 billion leaving the country.
The balance of payments version of direct investment shows $200 billion more
entering than leaving. Here SAFE clashes with the Ministry of Commerce (MOFCOM)
which claims, not credibly, inbound and outbound investment are nearly
equal.

Portfolio investment added $50 billion more in surplus. All
but erasing direct and portfolio investment is the dreaded “other investment”
category, with a net deficit of $230 billion. Most is said to be Chinese
lending overseas, but there was $90 billion net departure of cash and deposits.

Beyond clashing with GAC and MOFCOM, SAFE may clash with
itself. Its balance of payments shows a $147 billion rise in foreign exchange.
Its statement of reserves shows a $35 billion increase. This
may be due to exchange rate movements, but SAFE’s monthly reserves statements
are amazingly stable, suggesting they are also manipulated.

Another cloud is the final category of “errors and
omissions.” Since 2015, the pesky errors show $1.25 trillion exiting for
unclear reasons, $167 billion last year alone. The short story of why recent
outflows are unimportant is there are always large outflows. The 2021 trade
surplus was offset by $560 billion net outflow under primary income, other
investment, and errors and omissions. All gross outflows exceeded $1.4
trillion.

The start of 2022 is more of the same. The goods trade
surplus was $116 billion in the first two months, yet foreign
currency reserves fell
$30 billion, another instance of China reporting the world’s largest trade
surplus dissipating in balance of payments leaks. The important questions are
where and why.

Some of China’s apparently missing money goes to its own
banks. In 2021, banks were said to add $256
billion. That number has been rising — Beijing is capping reserves by
shunting money into other state-controlled institutions. Contrasted to a yuan
under pressure, this is an attempt to hide that China’s external surpluses are
excessive and the yuan presently overvalued.

Given reporting flaws, the amount diverted to state banks
may not be accurate, either. If it is, it would leave potentially $300 billion
in capital flight in 2021. The amount of true flight would be lower and, in any
case, China can absorb the loss, last year and this year, as long as exports bring
in so much foreign money.

The issue is not capital outflow, therefore, it’s how much longer huge trade surpluses can be maintained in the face of foreign hostility, worries about global supply chains, and China’s rapid aging. With “merely” a $300 billion trade surplus, no money goes to banks and capital flight threatens both the yuan and China’s external finances as a whole. The present outflow will be handled, again, but a long-term overhaul is unavoidable.

The post Money leaving China, again appeared first on American Enterprise Institute – AEI.