The Chinese yuan and the misconceptions: Central bank governor is correct to play down FX fears

As this week draws to an end, global concern over the dwindling level of China’s FX reserves has reached a very unusual place indeed – the Chinese government.

As far as economy, policy and governance is concerned, China is such a vast industrial and financial powerhouse that is closed from the rest of the world, employing its own very clever form of communism, which has afforded it the unique position of being completely autonomous in terms of society, industry, and indeed its tremendous financial strength.

China very rarely engages in any direct dialog with participants in free market economies, and has a very different (yet highly effective) means of conducting business overseas than any other nation.

Long the darling of the FX industry, China’s burgeoning middle class with its organized business ethic, disposable income and enthusiasm to create wealth has been a combination which has led many FX companies to attract vast amounts of business from China.

The government official in question here is Zhou Xiaochuan, Governor of the People’s Bank of China – a very senior government official indeed.

Mr. Zhou has publicly played down concerns over the decreasing levels of FX reserves within China, saying that “speculative forces” were responsible for the value of the yuan having decreased against the US dollar.

“International speculative forces have recently focused on shorting China” said Mr. Zhou in an interview with China’s Caixin financial magazine.

Among that speculation has been the notion that China may strengthen capital controls in order to attempt to prevent the yuan from a sharp fall against the US dollar. Mr. Zhou said:

“It is normal for foreign reserves to rise and fall as long as the fundamentals face no problems. At the moment the level of cross-border capital flows is within the normal region. We need to differentiate between capital outflow and capital flight” – Zhou Xiaochuan, Governor of the People’s Bank of China.

FinanceFeeds has conducted extensive research within mainland China with regard to how wealth is not only distributed, but invested, and into what specific assets.

From this research, very important and often unreported factors are critical to bear in mind. When assessing the fiscal system and how cross-border investments (especially in FX) are made in China, there is no method of finding out the real figures other than to spend time with fund managers, wealth management companies and large FX introducing brokers in second tier development towns across China.

Due to the lack of press freedom, researching the underlying ecosystem is near impossible unless experienced first hand, at which point an entirely different, and far more healthy picture is painted.

Officially, things are somewhat different

In 2014, professional services consultancy Capgemini stated that the population of high net worth individuals in China rose by 18%. This metric consisted of people with over $1 million in net assets.

In 2013, the nation had 157 billionaires according to statistics.

Did it really?

Statistics available outside China have very little value whatsoever, because the majority of wealth in China is not for official publication, and is considered ‘off the books’, which in turn means, due to the over-reaching administration of the Chinese government ensuring that the entire nation’s infrastructure is aligned and controlled centrally, that there is no possible way of telling exactly who has what from the outside.

The Chinese government’s milimetric precision and extremely sophisticated internet system which connects goverment department to state owned banks, businesses, and all other aspects of life in China means that the Chinese government knows exactly who is doing what, right the way down to the last transaction, but the overseas media, management consultants and researchers will never be able to find out.

After an investigation across cities including Shenzhen, Zhengzhou, Guangdong, Guangzhou, Shijiazhuang, Beijing, Nanjing and Shanghai by FinanceFeeds, it is clear that there are over 200 million people in China with over $15 million in net assets.

This figure has been validated by a number of large FX portfolio management companies in China, many of which conduct over 80,000 lots per month and have assets under management of over $50 million per portfolio management company.

The majority of this wealth is contained within tier two development towns, such as many of the ones mentioned here, and has been generated over the last eight to ten years as a result of entrepreneurs who invest in large scale property development – usually in the form of a tower with over fifty floors containing apartments, offices and shopping malls, which has been funded with no loans.

Once constructed and inhabited by the various residents and businesses, the investors then look to leverage the immediate profit the solid, long term asset that they have built by investing in liquid assets for a quick profit such as leveraged FX.

All of this order flow goes abroad, and is sent by IBs to Western brokerages. The investors concerned are shrewd in that they maintain their property assets and then invest monthly returns in FX, as well as other ventures such as agricultural technology which is a massive industry in China’s second tier towns.

Almost all of this money is completely off the books and is internal, hence the lack of impact on or reliance on FX reserves.

Western consultancies often produce figures on FX returns, an example of which is Lombard Street’s report that China paid out $99.5bn (£68.6bn) dollars in January, with its FX reserves falling to $3.23 trillion which is the lowest since 2011. The consultancy explained that not all of the reserves are instantly accessible and that around a third are tied up in illiquid assets. This report is now publicly available but it is very unlikely that any government agency in China would provide all of the information that it has, including off-the-books capital (domestic or foreign) to a large consultancy from a free market nation.

It is of merit to consider that China’s government makes its revenues from profit on business because the country owns a minimum 50% stake in every business in China, and instead of using management consultants, lawyers and corporate governance executives, there is a government department for every aspect of the running of every single business and therefore Chinese companies gain the services that would be chargeable in western countries for free, and in return, the government has an interest in every firm in the country.

From this perspective, mergers and acquisitions are dealt with in a completely different manner to in the West.

In China, if a company wishes to buy a stake in a firm abroad, government officials from the entity which has a stake in the Chinese company will go to the overseas firm and do the deal. This leads on to the next matter to consider which is the stock market in China, and its supposedly falling prices.

It is not accurate to consider that poor performance of Chinese stocks is the reason for falling stock prices, because China’s stock market venues are owned entirely by the government, and the listed companies have a minimum 50% stake held by the government, therefore should China wish to go on a buying spree, and get a very good deal in doing so, it can affect its own stock prices at government level in companies with partnerships with publicly listed companies on Western venues, collapse their shares, then buy controlling stakes for cheap.

This is why Chinese investors prefer FX – they actually want to influence their own investments. Equally, Chinese investors are likely to want to buy shares in FX firms that have recently gone public because they want to be able to influence the value of the stock by trading its assets to profit to strengthen the firm’s position.

When looking at matters from within China, it is to be viewed with trepidation as to whether the Chinese government is concerned in any way whatsoever about dwindling FX reserves, and indeed to expect that the country knows exactly what it is doing especially at a time when it is being led by very business-savvy president Xi Jinping who leads the world in identifying business potential in overseas firms and investing dollars which have been converted from yuan in the billions in national business development.

Photograph: Hengsheng Road, Shanghai. Copyright FinanceFeeds.