• Tracing China’s Hot Money (Part Three) —Hidden Agents who Shake the Chinese Economy

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

    By Cheng Xiaonong on August 12, 2013

    In my two previous articles published in the website China in Perspective on August 5 and 9 respectively I analyzed the movements of China’s hot money and their owners—fake foreign business people in China. This article is the last of the series; here I would analyze the reasons why these fake foreign business people are powerful enough to shake the Chinese economy.


    1. Dynamics of Hot Money


    These fake foreign business people do not always play the role of the positive force supporting the Chinese economic miracle. Looking for signs of changes all the time, they move their funds in and out of China, thereby determining the trends of the Chinese economy.

    China’s media outlets tend to blame the movements of hot money on changes in the U.S. Federal Reserve monetary policy. Comments like this are of course politically safe and can make China appear to be important, yet they also conceal the true colors of “fake foreign funds” that make up almost 70% of foreign funds introduced into China and at the same time misguide the formulation of economic policies.

    Moving huge amounts of illicit hot money into China at one time, and swiftly move it out at another, and u-turn back to China again, are these hidden owners of hot money too bored with nothing to do? That is of course not the case. That corrupt officials are moving their money in and out of China has actually nothing much to do with policies of the U.S. Federal Reserve; rather, these actions are probably closely related to the political and economic situation inside China.

    When monetary easing is implemented in China, hot money would enter China in bulk; when anti-corruption efforts are stepped up, or when the determination to curb the real estate bubble increased, this hot money would leave China, thereby inducing a shortage of money, causing a decline in forex funds and a loss in bank deposit.

    The people who are able to suddenly move hundreds of billions of yuan in a month or two are not simply several hundreds or thousands of corrupt officials.

    To describe it in modern economic terminology, those are collective actions of hundreds of thousands of “invisible hands”. Between them there probably is no “organized” cooperation; instead, these people are just acting instinctively based on their acute senses of whether odds are in their favor or not.


    2. Macroeconomic Management in China: Fake Foreign Business People Regulating the Central bank


    It is an indisputable fact that China’s hot money poses serious impact on China’s economic stability. Recently, the Chinese government is preparing a financial reform, hoping to reinforce effective macroeconomic management through market-oriented reforms. One of the main objectives of this is to not shake the confidence of the international community in the Chinese economy.

    And Western financial institutions always seek to understand the impacts “foreign” hot money has on China using normal market economics logic. The questions are, can these fake foreign business people be seen as purely a market force and nothing more? Are they “foreign investors” or “insiders” in China? A further question is, whether or not these people are passive recipients of policies or are they participants in policy-making? If it is the latter, then, where does the initiative of macroeconomic management lie? Is it with the central bank? Or is it with the thousands of hundreds of fake foreign business people who are inside the system?

    Given that thousands of fake foreign business people can mobilize hundreds of billions of yuan of hot money with ease, moving those funds in and out of China as though there is no hindrance, they can turn the monetary policy of the central bank upside down at any moment. For example, when the Central bank intends to loosen money supply, if the fake foreign business people judge that the political climate has turned against them, or that the economic situation is bad, they would decide to move their funds out of China, and so mass exodus of hot money would occur, causing foreign funds to decline and effectively tightens money supply instead.

    On the contrary, if the Central bank wants to tighten money supply when all those fake foreign business people move their funds into China simultaneously, the Central Bank’s efforts would become wasted.

    Only in one case would the central bank and fake foreign business people take concerted actions. And that is when the policy of the Central bank suits the interest of fake foreign business people. Where does the interest of fake foreign business people lie? They would naturally hope that the dangerously big bubble of the Chinese real estate becomes even bigger because that’s the only way they could earn some profit.

    If both they and the Central bank consider the economic bubble to be too big, then the direction of movement of the two parties could be similar, they both need to withdraw money. However, those fake foreign business people would definitely not wait until the Central bank completed its monetary tightening policy to suffer huge losses. They would learn in advance what would come and pull their money out of China before the Central bank takes any action. As a result, fake foreign business people would make the standing of the already contracting Chinese economy turn even worse. For instance, the Central Bank initially intended only squeeze the bubble a little. Yet as the whole flock of fake foreign business people pulling their money out of China, they would make the rip of the bubble bigger, or they may simply unwittingly burst the economic bubble.

    If the policies of the Central Bank and the NDRC aim to stabilize the economy and at the same time maintain the confidence of the international community in the Chinese economy, then chances are the fake foreign business people would begin to act before these policies are rolled out.

    Therefore, before everything else, the Central Bank and the NDRC would need to stabilize the confidence of fake foreign business people, so as to prevent them from wreaking havoc.

    It is, however, easier said than done to have a clear understanding of how the fake foreign business people would act.

    During the formulation process of China’s monetary policy, the Central Bank would be forced to guess what the tens of thousands of fake foreign business people have in mind.

    In such circumstances, which side would have the upper hand anyway? Let’s not forget that among the fake foreign business people, many are working in the economic department of all levels of government and have some degree of influence on the formulation of policies. Or, even though they are directly involved in the policy-making process, they have channels and capability to indirectly influence the way policies are shaped.

    Otherwise, how would it be possible for them to exercise control over huge amount of hot money?

    When “international investors” and “insiders” are actually the same group of people, who exactly are shaking the confidence of the international community in the Chinese economy? The answer would probably be quite obvious. Those tens of thousands of fake foreign business people who are also “insiders” gain profit from the Chinese economy and yet at the same time, they would deliver blows to the Chinese economy at any moment.

    In this case then, rather than saying that the Central Bank is able to regulate the movement of hot money of fake foreign business people, it would be more accurate to say the fake foreign business people gain great power to influence the policies of the Central Bank.


    3. Enormous Power of Hidden Agents that Shakes the Chinese Economy


    The sources of fake foreign funds are illicit income of corrupt officials. Turning these funds into foreign capital is a form precautionary measure they adopt. Even though this involves some inconveniences, the benefits of doing so are evident all the same because, neither the Central Discipline Inspection Commission nor Ministry of Supervision can directly dispatch work teams abroad to investigate the sources of funds of foreign companies and their business records. And so long as China sticks to Opening Up, it cannot block foreign investment; to conduct thorough checks on foreign funds and to identify the fake from the real ones would be an extremely difficult task. Even if checking foreign funds in China, Hong Kong or Macao would be feasible, those offshore financial centers, at the very least, would highly unlikely be cooperative: those small nations have long come to be dependent on hot money, and the people’s livelihood there now relies on the Chinese who set up companies there.

    After all, greenbacks from China are in their eyes genuine foreign funds which do not necessarily violate local laws.

    In China, as long as owners of fake foreign funds continue their corrupt activities, they could earn illicit income incessantly. And moreover, the number of people joining their ranks would grow rapidly. There is no doubt that over time, the scale of hot money flowing in China would be become bigger and bigger, and thus those fake foreign business people would be able to shake the Chinese economy with a power that grows by the day, a formidable force indeed.

    Given that fake foreign business people use their funds as hot money, they pay close attention to any signs of trouble inside China. It might not be an overstatement to liken these people as burnt children who dread the fire. They would readily move their money out of China whenever there are bad signs; once those bad signs are over, they would, in a swarm, move their funds into China again.

    Around the time when the 18th National Congress of the Communist Party of China was held, such an incident appeared to have happened.

    So far, the scale of hot money flowing in and out of China each single month has been hundreds of billions of yuan. It would only be a matter of time for the scale of hot money to exceed trillion.

    Hot money so massive in scale could induce shortage of money. It could also inundate an economy, as was the case in Taiwan in the early 1990s.

    Whenever the Chinese economy experiences an impact, the Central Bank could only clean up the mess left behind by the fake foreign business people.

    When hot money flees China, the Central Bank has to immediately issue more money to make up for the void, as has happened in late June 2013; when hot money flood in, causing real estate price to surge, the Central Bank has to tighten monetary supply, and the NDRC has to adjust policies on real estate purchase. And it is possible that as soon as the policy documents are announced, the bulk of hot money flees China again.

    For the Chinese financial regulatory authorities, there is a pressing problem that they need to study on as soon as possible. That problem is the law of the inflow and outflow of hot money. In other words, they need to understand the motives behind each massive inflow and outflow of hot money so as to be prepared for what would happen.

    But it is difficult to understand this because the truth is hard to grasp. The commonly used method of interview questionnaire by researchers would definitely not work. Just as a researcher cannot expect officials to answer questions like “how do you take part in corrupt activities?” Surveys that seek to work out the movements of hot money can in no way expect owners of hot money to say that they arranged their funds to flee China because they are worried about a particular political development or a certain economic policy”.

    Besides, no one would take the initiative to admit that they are owners of hot money. Both the regular research methods, interview with questionnaires and on-site observation would be of little use. The only way to find out the answers then, is to secretly monitor the targets. But in so doing, wouldn’t it result in putting the targets on alert?


    4. Economy with a Chinese Characteristic: Hot Money Dependency


    Corruption has been in China for thousands of years, and movements of hot money are seen regularly in countries around the world. However, in contemporary China, the movement of hot money carries some uniquely Chinese characteristics.

    First of all, in other countries, hot money is a kind of temporary foreign funds. The withdrawal of which, even if that happens, would not shake the foundation of the local economy. Yet in China, hot money is a major component of the wealth created by Chinese economy. The grossly unequal income distribution has determined that the bulk of wealth in China is in the hands of the elite group. Under the circumstances that the “insufficient domestic demand” of the general public is unchangeable, the funds in the hands of the elite have become the largest potential demand to drive economic growth. However, the real estate purchase restriction policies, the coming measure to make real estate information system transparent, and the anti-corruption pressure all entail troubles and risks for the elite if they purchase directly a large number of real estate. Therefore, sending the money outside China to “bleach” it and then move it back to “invest” in the country as foreign capital are not only the best option for the elite group, but also the driving force to sustain the continuous growth of the Chinese economy.

    Otherwise, if the elite move their money out of China for good, the Chinese economy would lose its growth momentum.

    Hence, the reason that hot money is crucial to China is it actually helps restore a sort of temporary “balance” to the already imbalance of Chinese economy. This is a secret of China’s economic growth that is also itself an odd case unique in world economic history.

    Second, the majority of owners of hot money are both “foreign investors” and “insiders” who could sway policy-making within the system. That’s why hot money moves in and out of China in ways dissimilar to those of other countries. In other countries, foreign owners of hot money could in no way influence the central bank’s monetary policy of the host country, all they could do is to compete openly with the central bank of the host country through pure market operation. Yet in China, owners of hot money possess internal information of the policy-making process and the ability to sway the central bank’s decisions. As a result, it is likely that the owners of hot money would act before the Chinese central bank does anything.

    Moreover, hot money flowing to other countries would generally be active in financial market and could trigger a financial crisis, but its influx does not directly induce shocks in the manufacturing sector of the host country. In China, however, the involvement of fake foreign funds in the domestic economy through real estate speculation is so deep that it probably is unprecedented in the world.

    That these owners of hot money could cast a huge impact on the pillar of the Chinese economy, the real estate per se and its upstream industries is precisely because they are “insiders” who have the conditions to find a spot—predominantly in real estate at this moment—to earn big and fast and are certain that they could make safe retreat at any time.

    Hot money can bring such industries as iron and steel, nonferrous metals, building materials, furniture, transportation and many others into boom and prosperity; it can also push them into the abyss all of a sudden.

    Downstream industries of real estate (such as advertising, media) would immediately plunge into a depression without hot money to shore them up. That’s how the Chinese economy developed a “hot money dependency syndrome”.

    Furthermore, local governments around the country are pushing for urbanization and building infrastructure with the aim to sell land and generate revenue to support local fiscal budgets. If a crackdown on hot money shakes the cornerstone of real estate, then wouldn’t it be tantamount to cutting off the lifeline of local governments?

    When it comes to rampant hot money, people might want to ask a question: Since hot money would cause such a serious problem, what isn’t it outlawed so it can’t flow across countries? Sadly, for the Chinese government, this simply is not a possible option.

    To begin with, those fake foreign business people are masters of funds transfer techniques and have access to various channels to make their hot money appear to be legitimate. To identify owners of hot money and to discover the true intentions of the flow of capitals are difficult enough. And the fact that Chinese economy is dependent on hot money makes a massive crackdown on hot money a measure hard to implement.

    Given that the Chinese government considers economic stability the most important matter, and that economic stability relies on hot money, to crack down on hot money would means dealing a blow to the Chinese economy.

    In this light, fake foreign business people don’t just influence the central bank, but they also hijack government of all levels.

    Ironically for China, the massive economic-shaking power of fake foreign business people comes not only from their huge financial resources that grow by the day alone, but also lies in just their identity as “insiders” that enables them to do anything they want. It is also that, any attempt to peel away their guise of hidden agents would result in flight of hot money even more massive in scale. Therefore, any political figures who seek to crackdown on hidden agents would have to bear the political responsibility of destroying the prospects of the Chinese economy.

    Past comments about such phenomena as corruption, hot money, real estate bubbles tended to focus individually on each of them. By linking all these together a new conclusion can be found: the severe inequality of income distribution, and the insufficient domestic demand from the populace would have meant doing continuous damages to the Chinese economy. However, since corrupt officials found a short cut to bring home their hot money and speculate on the real estate, the wealth of corrupt officials headed back to China and was injected into real estate speculation, thereby making the Chinese economy dependent on hot money and real estate development.

    On a track like this, the boom and bust of the Chinese economy are determined by the flow of hot money. In other words, owners of hot money became a key influence that dictates the destiny of China’s future.

    Knowing this, one could see why anti-corruption in China could only be superficial: if owners of hot money are startled, they would shake the whole of China’s economy to its core. Likewise, the reason the middle class always find their social and economic status insecure is that their destiny is in fact in the hands of owners of hot money.

    When and if those owners flee with their hot money, the middle class would find their status turned from bourgeois to proletariat, or worse, they would find themselves in a state of negative equity.

    At this point, the so-called market-oriented reform has become “aspirin” for the Chinese economy. Taking it won’t be killed, and the disease won’t be cured either.

    Unless, in the name of patriotism, those owners of hot money are willing to stick with the Chinese economy, for better or worse, it is possible that they would readily pull out their funds and leave, dragging the Chinese economy down into a quagmire whenever bad signs emerge.

    Can the China count its future on the patriotism of these owners of hot money? Do bear in mind that many of them are already nationals of other countries (including Samoa and Tonga). When it comes to wealth preservation, who could tell which country would they love?

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