Concern as money moves out of China
By Keith Bradsher
Monday, February 2, 2009

HONG KONG: In Beijing, an online real estate brokerage has organized a 40-person buying tour to real estate foreclosure auctions in the United States this month, and it had so many applicants that it had to turn away nearly 400 people.

In Shanghai, cash-rich Chinese companies are buying high-yield bonds of American companies in distress, and bringing home fewer of the dollars they earn abroad from exports.

And in Hong Kong, wealthy Chinese from the mainland are turning up in growing numbers at jewelry stores here seeking one thing: diamonds, big ones.

"They're looking for five-carat diamond rings and six-carat diamond earrings - three carats for each ear," said Yollanda Lam, the marketing manager for the King Fook chain. "Because of the stock market and all, definitely people are more willing to buy fine jewelry."

Chinese citizens are starting to send more money out of the country and overseas investors are pulling money out of China while slowing their pace of new investments. The result has been a shift in what has been one of the biggest trends in international finance over the past five years: China's central role in bankrolling trade and budget deficits elsewhere, most notably the United States.

To prevent China's currency, the yuan, from rising in value, the Chinese government has been buying up the dollars pouring into the country from trade surpluses and foreign investment, accumulating more foreign exchange reserves than Japan, Saudi Arabia and Russia put together. It has paid for the dollars by printing more yuan and invested at least two-thirds of the dollars in American securities, particularly Treasury bonds.

China still has torrents of cash pouring in from trade surpluses, as imports shrank faster than exports in the final months of last year. But that inflow has been nearly balanced in recent months by an unexpected outflow of private cash from the mainland and a slowing of investment into the mainland.

The quarterly pace of accumulation in China's foreign exchange reserves plunged 74 percent over the course of last year. In the fourth quarter of last year, it reached $40.45 billion, the lowest point since the spring of 2004, when China's reserves were still much smaller than Japan's.

"There is a recognition for sure that China is slowing down, so why keep your money there?" said Henry Lee, a Hong Kong fund manager.

Prime Minister Wen Jiabao of China made an enigmatic statement about China's purchases of Treasuries during the weekend that seemed to acknowledge that China's need to buy them may have eroded somewhat.

"Whether China will continue to buy, and how much to buy, should be in accordance with China's needs, and depend on the safety and protection of value of foreign exchange," he said during a visit to Bank of China offices in London, according to the semiofficial China News Service.

The tough part for economists is to figure out why money is leaving China - and how long the trend will last.

The most troubling sign for China would be if the money represented capital flight - people taking their money out because they worried about the stability of a country that announced on Monday that 20 million migrant workers had lost their jobs and returned home to their villages. While discerning the motives for any individual's decision to invest elsewhere is extremely difficult, most economists say that actual capital flight seems the exception rather than the rule, and anecdotal evidence seems to bear that out.

Jewelry stores in Hong Kong are one barometer of trends on the mainland, because they do not charge the steep luxury consumption taxes imposed on the mainland and have a reputation for not selling counterfeits.

Daniel Chun, manager of Gaily Jewelry here, said he had seen an influx of mainlanders since December, mainly buying round-cut diamonds either set in jewelry or as loose stones. Sales to mainlanders were 50 percent higher at Chinese New Year this year compared to a year ago, he said, adding that the store had a policy of not selling gold bars.

But Chun also said that it was impossible to determine how much of the increase in demand represented worries about China's future, because customers seldom discuss their motives. The Hong Kong government said on Monday that retail sales of jewelry, clocks and watches fell 9.8 percent in December, but that may have reflected plunging demand from local residents as Hong Kong's economy slowed suddenly.

Hong Kong residents have been snapping up gold bars at a brisk pace in case of greater economic or political turmoil in the months ahead, but few mainlanders have been willing to take the risk of flouting the mainland's stringent gold import regulations by buying gold bars, said Lin Tat Yin, a manager at Chow Tai Fook, a jewelry store chain.

Another motive for money coming out of China may be simply a perception among individuals and companies alike that better bargains are available elsewhere because of financial distress in the West.

Soufun.com, an online real estate brokerage in China, has organized a 10-day tour for at least 40 people to San Francisco, Los Angeles, Las Vegas and New York City, starting on Feb. 24, and found that demand outstripped the spaces available. "The people in the group are obviously interested in diversifying their investments, and the United States certainly is a very attractive location since real estate prices there have dropped drastically," said Zhao Xingyu, a manager organizing the tour.

Chinese real estate industry executives say that there was considerable speculation in recent years by overseas investors, especially overseas Chinese buying properties in Beijing, Shanghai and the Pearl River Delta region near Hong Kong. Those purchases contributed to a real estate bubble in China that peaked last spring and has gradually deflated since then.

"Certainly a lot of the Hong Kong money seems to be coming back," said Brad Setser, a fellow of geoeconomics at the Council on Foreign Relations in New York.

Since the Hong Kong dollar is pegged to the dollar, and the Hong Kong Monetary Authority typically buys more U.S. Treasury notes to offset strong inflows of money, slower accumulations of the notes by the Beijing authorities may be partially offset by more purchases by Hong Kong, he said.

The Chinese government's decision to halt the rise of the yuan against the dollar last July, and even allow a short-lived decline against the dollar in late November, has also removed the incentive for investors to put money into China in pursuit of currency gains.

Stephen Green, an economist in the Shanghai offices of Standard Chartered, wrote in a research note that yet another important contributor to slowing flows of money into China this winter may be that hard-up retailers in the West have been waiting longer before paying for goods from China.

Two agencies have primary responsibility for regulating the movement of money in and out of China: the People's Bank of China, which is the central bank, and the State Administration of Foreign Exchange, which is part of the central bank but enjoys considerable independence. Officials from both agencies have said conspicuously little about capital flight in recent weeks.

The State Administration of Foreign Exchange did subtly change its policy goals at the end of last year, replacing a goal of halting unauthorized flows of money into China with a new target of seeking to control and balance the inflows and outflows.

Some experts see a different motive in the reluctance of officials from these agencies to talk about capital flows in and out of China. The central bank and the foreign exchange administration were supposed to limit unauthorized investment into China, often described as "hot money," but had limited success in doing so over the past five years, said Victor Shih, a specialist in Chinese finance at Northwestern University in Illinois.

With a portion of that money now leaving China, "some parts of the government don't want to admit it is happening," Shih said.