• Tracing China’s Hot Money (Two) —China’s Fake Foreign Businesses

    by  • August 11, 2013 • 程晓农文集 • 0 Comments

    By Cheng Xiaonong on August 9, 2013

     

    In my article published in the website “China in perspective” on August 5 I analyzed the movements of China’s hot money and pointed out that in the past two and a half years, up to hundreds of billions of yuan of hot money got in and out of China frequently. In a timespan of just a few months, this hot money entered China as quickly as it left.

    In this essay, I prepared to discuss the origins, and the possible owners of this hot money.

    China’s media often mentioned the huge influx of hot money into China, but it came to the owners of this hot money, these media outlets were either evasive on the issue or pointing that to U.S. investment funds and their maneuver in Hong Kong’s stock market. And so, they linked the movements of hot money to the monetary policy of the U.S. Federal Reserve Board.

    In today’s China, it has almost become a popular trend to relate hot money in China to the monetary policy of the U.S. Of course, this kind of propositions is closely in line with the preference of the authorities as these implied a notable increase in China’s international status.

    The problem is, is it true to say that China’s hot money is predominantly owned by U.S. investment banks? That in fact is not the case.

    Wang Wei, head of BOC International’s bonds research department stated recently that the value of A-share market stocks held by foreign institutional investors was less than 2% of the total market capitalization; and it was not easy for them to withdraw their funds. Moreover, of the money deposited with the banking system of China, the proportion of that comprising hot money was very small.

    The truth is, China’s hot money originated in another source, that is, corrupt officials of China.

     

    1: Where Does China’s Hot Money Come From?

     

    Of the foreign capital introduced to China from 1997 through to 2008, those that originated in industrialized countries stood steadily at around 21 to 25 billion U.S. dollars; by contrast, foreign funds from Hong Kong, Macao and nine small island nations (British Virgin Islands, Cayman Islands, Samoa, Mauritius, Barbados, Bermuda, the Bahamas, Brunei and the Marshall Islands) grew rapidly every year, shooting up from 20.2 billion U.S. dollars in 2002 to 67.3 billion U.S. dollars in 2008. Once accounting for 38% of the overseas funds introduced into China, hot money came to make up 73% of foreign capital.

    As for foreign funds from Hong Kong, in 1997 the figure was $ 21.6 billion; by 2008 it increased to $ 41 billion, making up for 44% of foreign capital introduced into China.

    It should be noted that local Hong Kong old enterprises large-scale industrial investment in mainland China began back in the late 1980s, and came more or less to an end in the mid-1990s.

    After entering the 21st century, Hong Kong’s investment in mainland China came more often from “enterprises” set up and registered by mainland Chinese in Hong Kong. Instead of industry, these “corporations” mostly engaged in trade, real estate and so on.

    Since the Turnover, it has become very easy for mainland Chinese to get to Hong Kong, and it is very convenient to transfer funds between Hong Kong and mainland China. The trend of false exports that took place during the first quarter of this year illustrated fully that Hong Kong had long become the best place for money laundering for mainland Chinese.

    Specifically, foreign capital from the nine island nations was only $ 2.6 billion in 1997. It grew gradually in the years that followed and actually reached $ 26.2 billion in 2008, ten times the size a decade ago, accounting for 28% of the total of foreign funds introduced. These small islands are basically without decent modern industries, some of them even coming last in the ranking of developing countries. According to recent World Bank data, the total GDP of these nine island nations combined was only $ 50 billion. With poor economic powers like these, is it possible that the nationals of these island nations took out half of their GDP each year to invest in China, and in a consistent fashion, remaining as keen and unremitting as they were ten years ago?

    The people of these nine island nations are mostly poorer than urban residents in China, and some are even making a living with pre-modern way of fishing, hunting and gathering, how would they have the money to “help develop China’s economy”?

    It would make more sense if the Chinese government is being generous and offers these island nations some financial assistance.

    Clearly, the “foreign funds” from these island nations are basically not the spare money of local nationals.

    It can be said that in the past decade or so, the foreign funds originating in Hong Kong, Macao, and the nine aforementioned island nations are basically not industrial investment; rather, these are funds with no industrial development plans, no technological background and quite probably aiming to speculate, that is, hot money.

     

    2: Domestic “Foreign Capitals” that China Introduced

     

    The nine aforementioned island nations, scattered in the Caribbean, Central Pacific, South Pacific and the Indian Ocean, seemingly unrelated to one another, share one thing in common: these nations, with loose financial management, have been chosen by foreigners as money laundering centers. Foreigners can incorporate companies there, transferring funds in and out of those islands freely. Thus, these places carry an elegant title in the financial sector: offshore financial centers.

    Ever since China’s rich people began contemplating asset transfer and migration, the term offshore financial center became a familiar word among the wealthy in China. Many intermediary companies have been set up in China to provide service to the rich who need to incorporate companies, to set up bank accounts in offshore financial centers and transfer their funds there.

    Those Chinese people who can afford these can complete all the procedures to incorporate companies, set up bank accounts in and transfer funds to these nations even if they themselves have never set foot on those islands before and become “foreign business people” running companies in offshore financial centers. With that, their funds leveled up to the category of “foreign funds”.

    The trick, of course, is that these “foreign business people”, born and bred in China, have to get themselves a nationality of another country, any country, even the Emirate of Samoa would do. They would also need to change their names and stop using the one on their Chinese ID cards. Otherwise, how would they be able to pose as foreign business people?

    At around 2004, some scholars inside China conducted researches on this type of “foreign funds”. They called it “round tripping capital” in that these funds were actually from China, and they went back there as “foreign funds” after undergoing a round of laundering in offshore financial centers, Hong Kong or Macao. Unfortunately, studies like these have been few and far between, as if the issue has been deliberately sidestepped or concealed inside China; and in other countries few would be willing to delve into it.

    As a result, even though “round tripping capital” is hugely popular in China, government departments and the media never touched the topic.

    As a matter of fact, “foreign funds” originating in Hong Kong, Macao, and the nine aforementioned island nations, making up more than half the amount of that introduced into China are basically “round tripping capital”. In other words, more than half of those foreign funds introduced into China are money of the Chinese people that pose as foreign capital. And that means those are nothing more than fake foreign funds.

     

    3: Hidden Agents of Foreign Funds Introduction—Fake Foreign Businesses

     

    It is definitely not easy to operate “round tripping capital”. Owners of small private enterprises who feel content with little wealth are not well read and may lack the relevant knowledge to do so. While those in the white-collar occupations with small savings may understand how money laundering works and may have some spare money, they do not have the positions and access to channels that make money laundering easy for them. Those who really are capable of operating “round tripping capital” with ease are mostly officials and people who held managerial positions (including those managers who privatized state-owned enterprises into their own). And it is no doubt that with their salaries and savings alone, these people couldn’t possibly become “foreign business people”. Only the corrupt officials have what it takes for this. Thus, it could be said that the owners of “round tripping capital” would most probably be corrupt officials.

    In today’s China, corrupt officials, with the help of intermediaries, can easily complete a series of operations to move their funds out of the country, to launder money overseas, to set up companies abroad and then move their funds back into China without the need to resign and stay put in the new country where they would emigrate to.

    More importantly, it is necessary to complete the procedures of moving hot money out of China and back through a host of institutions such as foreign trade firms, banks, Customs, the Industry and Commerce Bureau, real estate companies and so on, and it involves a series of complicated “non-legal” processes. For persons on the street, these processes require “clearance channels” beyond their access, let alone the unaffordable “processing fees” and “commissions” such procedures entail. For “leaders” who have in their hands some solid power, though, it would be an entirely different story, they may not need to pay any “commissions” at all.

    It is likely that those fake foreign business people are sitting inside their government offices across the country, “guiding” the local “work” while at the same time they manipulate with ease and flair their hot money in the capacity of national of another country.

    One thing is certain: they have to do these with stealth. After all, aliens “being elected” as “representatives” in different levels of government in China, making decisions “on behalf of” the Chinese people is not something that can be exposed in any case. As a result, the true origin of this hot money became a closely guarded secret.

     

    4. Investment Directions of Fake Foreign Funds

     

    What do fake foreign business people do with their hot money? Of course they wouldn’t bother to engage in hard work like industrial investment. Besides, once they inject their funds into industry and commerce, those funds would cease being hot money because capitals invested in industry and commerce could not be readily withdrawn at any moment.

    It is precisely because fake foreign funds made up the bulk of the foreign capitals introduced into China that the way these funds operated in China differed significantly with those in other countries.

    From 1996 through to 2005, about 70% or so of foreign direct investment in the world have been used in merger with and acquisition of local enterprises, the most convenient shortcuts for industrial investment. Yet in China—with the exception of 2004 through to 2008, when U.S. banks were invited to become stake holders of major state-owned banks of China, thereby increasing slightly the numbers of mergers and acquisition

    —only about 5% of the foreign funds introduced were used in mergers and acquisition, a ratio that was pitifully low.

    Those fake foreign business people would certainly not be so foolish to put their funds idly in China’s banks to gain meager interest. The field of investment they are most interested in is real estate.

    With these sizable “foreign funds” as support, there’s no question that China’s real estate would be thriving indefinitely. In China the issue of foreign hot money speculating the country’s real estate is often discussed. And yet chances are, the owners of overseas hot money are mostly people with power and privileged positions who were born and grew up in China like all other Chinese do.

    They are the only group with this level of understanding of the way China’s real estate market works; they are the only group that is able to navigate around the government, banks, and real estate companies. Regardless of how the Central government regulates the real estate market, these people are able to buy and sell easily and make a hefty profit out the trade on all occasions.

    And they are the only group that understands so thoroughly the political climate and economic situation of China, so sensitive to signs that they always manage to pick the best time to enter and leave the market and never suffer no losses.

    In my next article I would discuss whether such a large group of fake foreign business people driving the “development” of the Chinese economy is a blessing or a curse for China.

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