The business news is full of reports and speculation about capital flight out of China. Foreign investment was essential to China’s rapid growth over the last decades. Foreign investors are pulling money out and wealthy Chinese are moving their money offshore. Will capital flight kill the Chinese economic miracle? If so, how does that effect the rest of us? Bloomberg Business writes about the weak spot in China’s $3.3 trillion foreign reserve stockpile.
By almost all measures, China’s $3.3 trillion foreign reserves, the world’s largest, look formidable. Except one. Compared with the amount of yuan sloshing around in the economy, a proxy for potential capital outflows, China’s firepower seems limited. The dollar reserves account for 15.5 percent of M2, a broad measure of money in circulation. That’s the lowest since 2004 and is less than levels in most Asian economies including Thailand, Singapore, Taiwan, Philippines and Malaysia, according to data compiled by Bloomberg.
The low coverage on the money supply does highlight the risk that the buffer can run down quickly if capital outflows, which approached $1 trillion over the last year through November, accelerate. That is perhaps why China has tightened capital controls and stepped up its defense of the currency to damp expectations of further depreciation, which may lead to more money leaving the country.
Rich Chinese who made fortunes as China’s economy grew, are not interested in seeing their wealth depreciate along with the yuan. So, many are moving money offshore from China. This flight of capital drives down the value of the yuan versus the US dollar making it more urgent for other wealthy Chinese to convert their wealth into dollars, yen, euros or British pounds. $3.3 trillion foreign reserve stockpile is huge unless you consider that half a trillion was spent last year supporting the value of the yuan and several hundreds of billion more were spent propping up their stock market. Capital flight is a symptom of China’s problems and a contributor to more trouble. But, why should we care?
Capital Flight from Developing Nations
Capital flight is not just limited to China. According to the South African Rand Daily Mail there is a trillion dollar exodus from emerging markets.
More than a trillion dollars of investment flows has fled emerging markets over the past 18 months but the exodus may not even be halfway done, as once-booming economies appear trapped in a slow-bleeding cycle of weak growth and investment.
While developing economies are no stranger to financial crises, with several currency and debt cataclysms infecting all emerging markets in waves over recent decades, leaders gathering for this year’s World Economic Forum in Davos in the Swiss Alps are fearful that this episode is much harder to shake off.
Seeded by fears of tighter U.S. credit and a rising U.S. dollar, and coming alongside a secular slowdown of China’s economy and an implosion of the related commodity ‘supercycle’, there’s growing anxiety that there will be no sharp rebound at the end of this downturn to reward investors who braved out the worst moments.
Many emerging economies such as Brazil have suffered greatly as China’s economic miracle has slowed down. Brazil is in a recession as bad as the Great Depression. The issue for North America, Europe and Japan is that when business slows across the globe no one has any money to invest or import foreign products. As capital flight kills the economic miracle in China and elsewhere advanced economies suffer as well.