A reader pinged me the other day about China “dumping” US treasuries.

I responded, “dumping” does not properly describe what’s happening. China did not sell US treasuries because it wants to get rid of them. Rather, China’s reserves plunged because of capital flight. China is doing all it can to stop capital flight and shore up the value of the yuan.

China has tightened capital controls a couple of times, but so far, it hasn’t worked.


China’s Foreign Reserves Drop Most in 10 Months

Bloomberg reports China’s Foreign Reserves Drop Most in 10 Months as Yuan Slumps.

Key Points

  • Reserves decreased $69.1 billion to $3.05 trillion in November, the People’s Bank of China said in a statement Wednesday
  • That compares with the median forecast of $3.06 trillion in a Bloomberg survey of economists
  • Decline was biggest since reserves tumbled $99.5 billion in January

Big Picture

The fifth-straight monthly decline brings the reduction in the stockpile to almost $1 trillion from a record $4 trillion in June 2014. While authorities have begun tightening capital controls, a $50,000 limit that Chinese citizens are allowed to convert from yuan annually will reset at the start of the new year, potentially adding depreciation pressure on the currency.

“A combination of yuan weakness and a peak in the mainland property sector is conspiring to increase capital outflows,” Bloomberg Intelligence economists Tom Orlik and Fielding Chen wrote in a report. “Another month of falling reserves does little to inspire confidence, especially as households await the renewal of their FX quota at the start of 2017. Even so, with the yuan steady so far in December and capital controls in place, there’s reason to hope China’s reserve buffer will end the year on a more stable note.”

“The announcement of additional capital controls will smooth the fall in reserves for some time but won’t solve the problem,” said Alicia Garcia Herrero, chief Asia-Pacific economist at Natixis SA in Hong Kong. “China isn’t out of the woods.”

“I smell more capital controls, which run against any hopes of reform or internationalization of the yuan or a sharp drop in the yuan,” said Michael Every, head of financial markets research at Rabobank NA in Hong Kong. “And all these fun and games come before we have even seen President Trump.”

Capital Controls on Insurance

One of the ways corporations have been getting money out of China has been via insurance schemes.

In response China Clamps Down on Insurance Companies’ Buying Spree

Chinese regulators have intensified their crackdown on insurers’ use of high-risk, high-return products, which are often used to fund corporate deals.

The clampdown comes days after the country’s securities regulator separately denounced companies making highly leveraged takeovers as “barbarians” and “robbers”.

The China Insurance Regulatory Commission on Tuesday said it had barred Foresea Life Insurance from issuing “universal insurance” products.

Regulators have become increasingly wary as Chinese insurers have made a series of highly leveraged acquisitions in recent years. Such concerns were believed to be part of the reason Anbang Insurance withdrew its $14bn bid for Starwood Hotels & Resorts.

“If you use funds from questionable sources to undertake highly leveraged buyouts, and turn from an [industry] stranger to a barbarian, and finally become a robber, this is not acceptable,” said Liu Shiyu, head of the China Securities Regulatory Commission, in a weekend broadside.

Earlier this year, the chair of the CIRC warned against insurers, awash with cash from universal insurance premiums, becoming “automatic teller machines” for takeovers.

Buying Sprees About to Hit Brick Wall

The Financial Times reports on the Buying Spree Behind Beijing’s Investment Curbs.

The days when a Chinese iron ore miner could buy a UK video game developer are drawing to a close as Beijing tightens up on cross-border investment by its companies.

Investment banks in Asia have worked overtime this year on bringing an expansive range of acquisition targets to aggressive Chinese groups, many of which have strayed far beyond the acquirers’ original scope of business.

According to commerce ministry data, overseas purchases by Chinese companies have surged past last year’s record of $121bn for non-financial outbound investments, reaching $146bn over the first 10 months of 2016.

The spree in the past few years has seen an airline buy a financial services business, an insurer move into the global hotel industry and a shopping centre developer purchase a blood bank. Most notably, Shandong Hongda, a lossmaking Chinese iron ore miner agreed to buy UK game developer Jagex earlier this year.

The State Council plans to issue a circular that will tighten regulations on Chinese groups that acquire overseas companies that have little to do with their core business. Such acquisitions worth more than $1bn would not gain regulatory approval, according to two people that have seen a draft of the document.

It has also proposed stricter approval requirements for cross-border deals worth more than $10bn and on state-owned enterprises investing more than $1bn in foreign real estate, according to the two people.

“There have been a lot of deals that don’t make strategic sense. [A crackdown on capital controls] would be a reaction to that,” said a senior M&A banker based in Hong Kong.

One Hong Kong-based lawyer said that Chinese regulators such as the State Administration of Foreign Exchange had recently increased the time it took to process applications, effectively killing some time-sensitive deals. In some cases “they don’t reject the application, they just don’t respond”, the person said.

Deals Refused for Thee Not Me

Despite capital controls, HNA-Ingram Deal Lifts China Offshore Acquisition Fears.

Bankers working for China’s HNA Group have been buoyed by the successful completion of its $6bn deal for US technology group Ingram Micro — indicating that other pending acquisitions of overseas assets will not be blocked by restrictions on moving capital offshore.

HNA’s Ingram deal had been awaiting approval from China’s State Administration of Foreign Exchange. But it was thrown into question by new State Council restrictions on Chinese groups buying overseas companies in areas outside their “core” business.

Any noncore acquisition worth more than $1bn will now be refused regulatory approval, according to people who have seen documents on the new rules.

This clampdown is intended as a stopgap measure, in response to $146bn of outbound investment by Chinese companies in the first 10 months of 2016. Regulators have publicly stated they will crack down on so-called “fake deals”, or transactions designed to move capital offshore.

As a result, bankers had been worried as to whether Ingram’s technology supply chain operation in the US could be deemed as “core” to HNA, which is a Chinese conglomerate built around an airline business.

HNA has remained confident. Earlier this week, the chief investment officer of one of its investment arms was quoted by Reuters as stating that restrictions on cross-border investment would impact some of its Chinese competitors — but not HNA itself, which might even benefit from having fewer rival bidders.

Nuclear Option Nonsense

The idea, widely promoted at times is China holds some sort of nuclear option threat of dumping its treasuries.

It’s a theory stressed by hyperinflationists, and it’s nonsense. I discussed the nuclear notion at length on July 30, 2010 in Should China Dump Dollars for Commodities? What about the “Nuclear Option” of Dumping Treasuries? Can Global Trade Collapse?

Check out this spot-on prediction of Michael Pettis who I quoted at the time.

An awful lot of investors and policymakers are frightened by the thought of China’s so-called nuclear option. Beijing, according to this argument, can seriously disrupt the USG bond market by dumping Treasury bonds, and it may even do so, either in retaliation for US protectionist measures or in fear that US fiscal policies will undermine the value of their Treasury bond holdings. Policymakers and investors, in this view, need to be very prepared for just such an eventuality.

… the idea that Beijing can and might exercise the “nuclear option” is almost total nonsense.

In fact the real threat to the US economy is not the dumping of USG bonds. On the contrary, in the next two years the US markets are likely to be swamped by a tsunami of foreign capital, and this will have deleterious effects on the US trade deficit, debt levels, and employment. Investors and policymakers should be far more worried that China and other capital exporting countries are trying their hardest to maintain and even increase their capital exports, while the capital importing countries are either going to see capital imports collapse, or are trying desperately to bring them down.

So why not worry about Beijing’s “nuclear option”? For a start, unlike you or me the PBoC cannot simply sell Treasury bonds, pocket the cash, and go home. Dollar bills are just as much obligations of the US government as are USG bonds, only that they pay no interest. If the PBoC wants effectively to reduce its holdings of USG bonds it must swap them for something else.

I cannot take credit for that. It was written by Michael Pettis. The link I have is no longer valid so I cannot point to his complete article.

China accumulated a massive amount of US treasuries. I have long stated the money must return and it would via China buying US assets. China went on a US buying spree: properties and corporations.

Now China appears to want to stop that, and the US is increasingly worried about China acquiring technology companies and trade secrets as well.

On November 17, 2016 CNN Money reported U.S. panel wants to ban China from buying American firms.

The U.S. commission, which provides non-binding recommendations to Congress, is accusing Beijing of using its huge state-owned enterprises (SOEs) as tools to advance national security goals.

Sorry Charley, one way or another, those dollars will return, buying US assets. It’s the price we pay for running a trade deficit with China.

US Dollar/Yuan Weekly Chart


As a result of capital flight, the Yuan has weakened against the dollar for nearly two years, exactly the opposite of what hyperinflationists figured would happen.

This poses a problem for Trump, who thinks the yuan is too low. Trump also accuses China of being a currency manipulator.

The irony in this setup is that China is desperate to stop capital flight and the weakening of the Yuan. Trump’s China-bashing rhetoric isn’t helping any.

Mike “Mish” Shedlock