First, though, to recap:
i) Current global monetary conditions don’t suggest the world economy is likely to plunge into recession, and globally domestic demand data remains relatively robust. In particular, labour markets remain strong in the US and UK, are clearly improving in the Eurozone, and also in Northeast Asia (outside China).
ii) Within the private sector, there has been no noticeable credit cycle, and no bubble-like investment cycle, which invites or requires re-winding.
iii). Although oil prices are falling, this reflects a supply-glut caused by attempts to resist a historic unwinding of the OPEC monopoly, rather than a shortfall in demand. (In fact, OPEC’s global demand figures suggest world demand rose by 1.9% in 2015, up from 1.5% in 2014 and 1% in 2013, although they expect a moderation to 1.3% in 2016.)
Rather, the key to the current volatility, and also to China’s ‘capital flight’ lies somewhere else: specifically, it has its roots in the dollar going on a tear between the middle of 2014 and early 2015. Between July 2014 and March 2015, the currency rallied 12.2% against the IMF’s basket currency, the SDR. Money suddenly got more expensive.
The widest-angle view of the dollar helps explain why its movements matter so much: the dollar is the world’s currency, and when you see it strengthen, it means the value of money has just gone up. But now narrow it down to the company level. Imagine your company has borrowed in dollars to fund a new machine, and the dollar has just risen against the currency of a major competitor. Tomorrow you find your competitor has dropped his dollar selling price, so you face the choice of cutting your price or losing market share. Either choice cuts into your profits and cashflow, and that makes it tougher to make your interest payments.
What’s worse, your banker knows this, and feels just a little less friendly to you than he was last week. Don’t be too hard on him though, because the chances are that the bank’s own dollar-funding opportunities are also shrinking. After all, his own earnings have also just fallen in dollar-terms. This is what happens when the value of money rises.
A rising dollar provided the background to Asia’s financial crises in 1997 and 1998, with the yen falling 33% yen against the dollar between June 1995 and April 1997 (from 84.5 to .125.5 to the dollar). At the time Japan accounted for just over half of all NE Asia’s exports, so as Japan dropped its prices, everyone else did too. It was also the background to the 2000/2001 US recession was a strengthening of the dollar, which rose 16.2% against the SDR between October 1998 and mid-2001.
Today’s worries have once again been crystallized by the strength of the dollar. This time the stress is less to do with export prices, and more to do with a loss of funding opportunities. Yes, globally manufacturers felt the chill of deflation; but Asia’s export economies are cushioned not only by the margins relief of falling commodity prices, but by the huge foreign exchange reserves, which are the prize won by the private sector running persistent sector savings surpluses. When the dollar started rising in July 2014, China had US$3.966tr in foreign reserves, and Asia ex-China had a further US$2.983tr.
China responsibly, but also rashly, decided the Rmb would remain effectively pegged to the dollar even as it rose. This caused, and is causing, some pain. But in truth, the pressure on export was not decisive - as sustained trade surpluses and the global resilience of domestic demand attests.
The tougher impact came from the impact on capital flows. The rise in the dollar reminded the world’s banks of ‘what happened last time’ and they set about cutting credits to those perceived vulnerable (including each other).The Bank for International Settlements (BIS) in Basel tracks cross-border lending, and although its quarterly reports are slow to appear, they tell a very clear tale.
Between September 2014 and September 2015, foreign lending into the US fell by $321bn, into the UK fell $544bn, and by $83bn into both France and Germany. In all, that’s a fall of just over $1tr in cross border lending into the major financial capitals of the work during the 12m to September 2015. Asia’s international finance centres were hit too: cross-border lending into Singapore dropped by $67.4bn (or 11.1%) and lending to Hong Kong fell $19bn (or by 3.1%),
But the worst hit of any country was China, where cross border lending fell by 20.9% yoy, or by $231bn in the 12m to September 2015. During the same period, China’s foreign exchange reserves fell by $374bn. So it is this net repayment of cross-border debt which accounts for the majority of China’s alleged ‘capital flight’.
When it comes to lending into China, Hong Kong plays a special role - and the HKMA produces its data (slightly) faster than the BIS. HKMA’s data tells us that Hong Kong’s net lending to China fell from US$333bn in September 2014 to just US$100bn by October 2015. On those trends, net lending into China by Hong Kong will have fallen to around US$50bn by end-January, and will have been all squared away by April. Most likely, however, the pace at which lines have been pulled will have quickened over the last few months.
This pulling of banking lines to China does seem to be the fundamental force skinning China of its foreign reserves. But if so, it has two important consequences. First, when all the credit lines are pulled, the pressure on China is likely to ease: as far as Hong Kong’s position is concerned, we’re probably nearly there already. And second, it means we must re-think those tales of China’s ‘capital flight’.
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