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Posts Tagged ‘inflation hedge in China’

13
Jan

THE RETURN OF CAPITAL FLIGHT?

   Posted by: Mr. Gold    in Uncategorized

Hot on the heels of yet another missed lending quota, the first quarter of 2011 begins like any other in China – by a huge liquidity binge. The archaic banking system pushes as many loans as possible early in the year to earn the near-full interest within the calendar year, which in China corresponds to fiscal year. These developments were of marginal interest to the world when China was merely an ambitious ‘emerging market’. It is more vital to the global economy, and indeed to gold prices, now that the country’s M2 is nearing $11 trillion, or a stunning 26% higher than the US whose economy is still three times China’s size.

As the QE2 detractors know well in the US, money creation is a good friend of the gold prices, or indeed of many other commodities as well. This year is unlikely to avert further inflationary pressures in China, where food prices are running at 20% pa – four times faster than the usually underreported corresponding figure in the United States. Exhortation against “food price speculation” and price controls are unlikely to resolve the problem of China’s excessive liquidity. All this leaves 300 million Chinese consumers and investors in a bind. Inflation expectations are now entrenched and self-fulfilling. Yet a Chinese citizen can do precious little to protect him/herself against the flood of money. After placing overseas the maximum of $50’000 per year through the narrow crack of QDII (“Qualified Domestic Institutional Investor”) scheme, a Chinese saver has only domestic assets to choose to fend off inflationary embrace – stocks, property and precious metals.

Shanghai stock market has been in a sorry state for three and half years. The relentless ride up to 2007, which hiked the emerging market indices globally, now looks like an isolated Matterhorn peak, ever more distant on the chart. Property investments, on the other hand, have paid off handsomely for those who could enter early. Nationwide, prices march on with double-digit annual gains, but in 2009 the city of Wenzhou registered an average annual gain of 845% year on year. Such appreciation means that despite the commitment of savings of three generations, a young Chinese man is finding it increasingly difficult to pay western rates per sq ft and thus fully satisfy his future bride’s parents.

And so, the saver is left with one last inflationary hedge: gold. Gold jewelry demand may have been lackluster, but the trading volumes at Shanghai Gold Exchange have jumped up considerably in the recent weeks. Meanwhile, Lion Fund Management has raised domestically nearly $0.5bn to manage money via overseas gold ETF exposure (I have not seen the prospectus, but if the QDII quotas are observed, Lion must have gathered an army of 1 million retail investors). In Hong Kong, China-destined HK now claim a hefty retail premium at around $3/oz. No doubt, the GFMS/WGC’s “China investment” figures are bound to look good.

But here comes the caveat. If gold constitutes this one last avenue towards savings security, any change to capital account regulations, and QDII in particular, could damage this fast growing market. Most emerging markets are now struggling with excessive liquidity, “speculative” capital inflows and renminbi competition. Stronger EM currencies have led to current account deficits in India, Brazil and Turkey. Increasingly, a panacea is sought in encouraged capital outflows, in addition to limiting inflows. Thailand has now eliminated limits on overseas investment and lending to foreign entities. Who would have thought back in 1997?

China experimented with such schemes before, only to backpedal after witnessing instant damage to Shanghai stock market. It seems that any crevice in the capital account fortress leads to capital flight. Opening this floodgate could actually solve the problem of foreign reserve accumulation.

Except that China’s mercantilist leaders and their military brethren are not seeing “accumulation” of foreign reserves as evil any more than hoarding of “strategic reserves” of various commodities, even though such war chests are inherently inflationary (as is war itself). It is therefore fascinating to observe the new pilot project for relaxed QDII quotas emanating out of… Wenzhou. The great city of Wenzhou, whose denizens are known to have enjoyed an unprecedented appreciation in real estate values. And who also gave Italy its largest sweatshops.

The move is destined to cool the real estate bonanza a bit. But should this pilot project become more successful than the previous ones, the recent growth rate in gold investment on the mainland may soon fade into the oft-rewritten “5000 years” of history.

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