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China: What Flows in, Must Flow out

After years of money flowing in, in the past year the trend has been reversing: cash is beginning to flow out of China. The Wall Street Journal estimates that $225 billion left  China in the 12 months leading up to September. These estimates are based on analysis of trade data, recent foreign-exchange reserves numbers and other economic statistics. WSJ:

“We all noticed what we suspected, which is that there was significant capital flight,” says Michael Pettis, a finance professor at Peking University who witnessed capital flight up close in his previous career trading Latin American distressed debt. “It’s not a good sign when local businessmen begin to think it’s better to take money offshore, especially when the world economy is in such bad shape.”

China officially maintains a closed capital account, meaning it restricts the ability of individuals and businesses to move money across its borders. Chinese individuals aren’t allowed to move more than $50,000 per year out of the country. Chinese companies can exchange yuan for foreign currencies only for approved business purposes, such as paying for imports or approved foreign investments.

What was once a manageable trickle of cash leaving the country has become an untamable river. More and more wealthy Chinese are circumventing the law to pay for foreign goods such as college tuition, real estate, and other luxury goods. Meanwhile, many others have found legal ways around these requirements. Many Chinese exporters now keep foreign earnings as dollars, rather than converting them back to yuan. Other companies have gone public in Hong Kong and then sold shares there, generating cash outside of the restrictive laws of mainlaind China.

In many ways, China is becoming a victim of its own success. The manufacturing boom of the past twenty years has made China more powerful and made its citizens wealthier than ever before. But China is quickly finding out that a wealthier population is often more demanding. The past few years have seen a spike in domestic unrest, as millions of Chinese demand higher pay, better living conditions, and an end to government corruption. Now wealthier Chinese are skirting the rules too, finding ways to avoid the restrictions the Communist Party counts on to keep the country under control. It’s becoming increasingly difficult for Beijing to keep the lid on the tensions around the country.

This is a serious change for China and it’s not yet clear how the ruling party plans to deal with this transition. How Beijing handles this is one of the biggest questions of the 21st century. Watch closely.

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