China Experiencing Capital Flight

China’s capital flight attributable to investment opportunities abroad or preparation for what’s to come?

August 22, 2016

By: Bobby Casey, Managing Director GWP

We’ve taken a keen and growing interest in China over the past few years, and with good reason! They are one of the most dynamic economies in the world. That isn’t to say they’ve not seen hardship or made mistakes. Indeed they have. What makes them dynamic is their response to what’s happening in the world.

I mentioned before how the Chinese were buying up US properties, especially in premium areas like the San Francisco bay area. I can’t be entirely sure if this is attributable to the prospect of a Brexit, but it was reported in May (just weeks before the Leave vote claimed victory in Britain) that China is expected to divert more of its foreign investments to Australia as well:

“China took out the title of biggest foreign investor in real estate in 2015, spending $24.3 billion in Aussie property, which was more than a quarter of inbound foreign investment going in all sectors.”

They are on course to be the source for top foreign investment around the world, in fact. Billions of dollars in exponential growth in foreign investment, and their focus is shifting from commodity rich nations to customer rich nations like the US, Australia, and Europe.

“Chinese companies are expected to invest $20 billion to $30 billion in the U.S. in 2016, mainly through mergers and acquisitions, compared with a record $15 billion last year and $11.9 billion in 2014, according to a report published Tuesday by research firm Rhodium Group and the National Committee on U.S.-China Relations, which promotes cooperation between Beijing and Washington.” (Source: WSJ)

Legislators in the US are leery of Chinese foreign investments, in part due to their subscription to the idea of “trade deficits”. The US imports more from China than China imports from the US. The Chinese can buy more US assets (such as real estate and corporations), than Americans can buy from the Chinese. This is largely due to Chinese regulations and state ownership of Chinese property.

But before we talk about “trade deficits”, let’s keep in mind that China is the second largest holder of US debt in the world at just under $1.2 trillion. Albeit, they have been slowly selling it off, they are still only a close second to Japan in US debt holdings.

With that said, the idea of trade deficits is an illusion. It sounds like legitimate economics jargon, but really it doesn’t exist. Here’s a working definition:

“The amount by which the cost of a country’s imports exceeds the value of its exports.”

By this definition, I have a trade deficit with my favorite restaurant and the grocery store I frequent. They never buy anything from me… I’m always buying from them, however. Seems unfair that I would keep paying for their goods and services, but they never buy any of my goods and services. That’s essentially what trade deficits boil down to: a customer who buys from a proprietor but the proprietor likes to deal in cash rather than barter.

Whether it is framed as countries, businesses, or individuals, in capitalism, there is no trade deficit except when there is a line of credit or debt involved. China says, “I made these things. I’m selling them at this price.” The US says, “Cool. I’ll take 10,000 of them.” And China says, “That’ll be X yuan, or Y dollars.” Outside of the scale and volume, this is the exact same conversation I have with my clients… and the exact same conversation I have with my grocer. And there’s never been a mention of “trade deficit”.

So now that we’ve put that to rest, the real question is: WHY? Why is China so eager to buy abroad? Is it because they are the beneficiaries of this “trade deficit” and are now just throwing their wealth in the faces of the West? The Donald Trumps of the world would have to believe that, but no. That’s not it at all. In fact, it’s quite the opposite.

“The challenge for China is that investment outflow may no longer signal growing prosperity, but a belief by Chinese companies that opportunities are now better overseas.” (Source: AEI)

A conservative assessment of that statement is: investment diversification is a solid and good practice and that is exactly what the Chinese are doing.

A more complete assessment of that statement is: capital flight.

“China’s currency devaluation, economic slowdown and stock-market rout are spurring some of the country’s business leaders and entrepreneurs to invest abroad instead of at home.” (Source: WSJ)

“The People’s Bank of China effectively declared war on them in early January, directing state banks to buy large sums of the currency in Hong Kong to support its value and burn the short sellers. With the yuan suddenly scarce in Hong Kong, the annualized cost of borrowing it overnight there hit 66.82 percent on Jan. 12—more than 10 times the usual interest rate. (It receded to 8 percent the next day.)” (Source: Bloomberg)

Not that long ago, I wrote a piece about the United States being the biggest tax haven in the world. It is… for everyone EXCEPT Americans. That’s why Americans send their money to jurisdictions that are great tax havens for Americans.

Diversification is good. And to some extent I believe that’s what these investors are doing. But the extent to which they are doing so has them at the third largest foreign investment country in the world, and on pace to be the first in a matter of a few years. So this goes beyond just “diversification”. The scales are about to tip:

“China was the world’s largest recipient of FDI last year, drawing a record of $120 billion, while ODI surged 14.1% to a new high of $102.9 billion.”

If you take into account their debt holdings, and the amount of foreign investment in the United States from corporate acquisitions to real estate purchases, even the “trade deficit” argument loses momentum.

Capital flight, however, is something Americans know a thing or two about. We saw it in Detroit when Coleman Young became mayor. It was called “white flight”, back then. Even today, Americans are desperately trying to find safe havens for their wealth.

What can onlookers like you and I take from this? The desire to keep earned wealth and profits is rather universal. And while the US might be a safe haven for everyone else, it makes sense to “diversify” offshore as a hedge against impending economic issues at home. And finally, China’s protectionist policies are not sustainable, so the Trump economic plan is not going to go over any better.

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