China’s consumption ratio is no longer falling. Its reserves are no longer rising

The Economist

January 21, 2012

DATA points sometimes change faster than debating points. It is conventional wisdom that China’s export-led growth squeezes consumers at home and competitors abroad, even as it adds inexorably to the country’s huge foreign-exchange reserves. But figures released this month complicate these arguments.

China still runs a sizeable trade surplus. But its net exports fell in 2011 (in absolute terms) for only the third time since 2000, subtracting 0.5 percentage points from its growth. Thanks to home-grown spending, China’s economy still managed to expand by 9.2% in 2011, remaining surprisingly strong even in the fourth quarter. This growth owed an unusual amount to consumption (both public and private), which contributed over half for the first time since 2001. As a consequence, the share of consumption in China’s GDP edged up in 2011 after falling for ten years in a row.

The mainstay of China’s growth remains investment, on which its economy remains worryingly dependent. Indeed, when China’s critics are not bashing it for overexporting, they bash it for overinvestment in property. Its housing boom is, however, slowing markedly. China this week reported that the price of new homes fell in 52 out of 70 cities across the country in December, compared with the month before. Households are struggling to obtain mortgages; developers are finding it almost impossible to obtain a loan. The drying up of foreign funds is particularly dramatic, points out North Square Blue Oak, a research firm based in London and Beijing. Foreign capital fell by 65% in December, compared with a year earlier.

The flight of foreigners from property partly explains another unusual twist in the China story. Its foreign-exchange reserves fell in the fourth quarter for the first time since the height of the Asian financial crisis in 1998. The drop was small, from $3.2 trillion to $3.18 trillion, but also a little mysterious. China still exports more than it imports, and attracts more foreign direct investment than it undertakes. These two sources of foreign exchange must, then, have been offset by an unidentified drain.

The worry is that China’s capital controls have sprung a leak. “Hot money”, attracted by the country’s growth, may be flowing out as the property market falters. Some even speculate that China’s rich may begin to smuggle their new-found wealth out of the country en masse.

These fears are overblown, for now. Some of the drop probably reflects a change in the value of China’s euro holdings. Some does represent the departure of short-term money, but an ebb and flow of hot money is not unusual. Moreover, some kinds of hot money are more scalding than others, says Stephen Green of Standard Chartered. At one end of the thermometer, an exporter might delay the conversion of his legitimate foreign-exchange earnings. In other, warmer cases, an importer might illegally overstate the size of his purchases, so as to remit more money out of the country. Capitalists eager to take their money out also have other cards to play. Mr Green estimates that last year about $185 billion might have passed from mainland China through the VIP rooms of Macau’s casinos.

Victor Shih of Northwestern University reckons that China’s richest 1% hold $2 trillion-5 trillion in liquid wealth and property. If they were ever to smuggle that money out, the outflow would dent even China’s reserves. That would be a disaster for China’s economic management, putting heavy downward pressure on the yuan. At least China’s critics could no longer trot out another familiar accusation—that it undervalues the exchange rate.

Source: thanks to Tony Padua