The Threat from China's Capital Flight
Perhaps as much as $500 billion a year is likely leaving the country in ways that are not showing up in the official financial accounts. That is putting downward pressure on the currency.
Officially, Chinese residents have spent $209 billion less than they earned in 2023Q1-Q3. That modest current account surplus would be equivalent to less than 2% of China’s national income, which may help explain why the International Monetary Fund (IMF) made no mention of China’s trade surplus or external imbalances during the most recent Article IV visit. In fact, the only mention of the Chinese economy’s connection to the rest of the world was a brief reference to “subdued external demand”.
Yet this is likely a mistake. There are enough oddities within China’s official balance of payments statistics to suggest that the country’s actual current account surplus may be nearly three times the official figure. If so, that would make China’s current account surplus not just the largest that it has ever been in absolute terms, but about as large as it has ever been relative to the rest of the world’s economy.
Perhaps surprisingly, the emergence of this massive surplus has coincided with downward pressure on the Chinese yuan, with the People’s Bank of China (PBOC) selling $43 billion in foreign exchange reserves in 2023Q3.1 The likeliest explanation is that Chinese are now pulling about $500 billion/year out of the country in ways that would normally be categorized as “net errors and omissions”.
In other words, capital flight pressures have intensified over the past few years, perhaps in response to the Chinese government’s increasingly arbitrary exercises of power against its subjects. Whatever the reasons, the impact on the rest of the world is going to be substantial—unless the Chinese government offsets the surreptitious outflows of the private sector by selling some of its ample official and quasi-official reserves to prevent the yuan from depreciating further.
The good news is that this seems to be what is happening, at least so far—and in spite of the IMF’s advice. The danger is that Chinese officials may decide to change course if they come to believe that they need to tap external demand to compensate for sustained weakness in domestic consumption and the property market. In that scenario, producers in the rest of the world would be overwhelmed with a flood of underpriced goods at the same time as producers outside China would find it even harder to sell their goods and services to what should be one of the world's largest markets.