The Capital Note

The Capital Note: Following the Money in Beijing

Workers help to dock a COSCO container ship at a port in Qingdao, China, in 2018. (Stringer/Reuters)

Welcome to the Capital Note, a newsletter about business, finance and economics. On the menu today: Parsing China’s economic data, oil industry consolidation, and a new paper sheds light on the vulnerability of the Chinese real-estate market.

Beijing: Follow the Money

The Chinese government reported 4.9 percent growth for the third quarter, driven in large part by growth in exports of personal protective equipment and medical devices. The official narrative is that China has more or less contained COVID-19 and has therefore maintained industrial production despite global lockdowns.

At the same time, though, the Chinese government seems desperate to move money offshore. So much so that it snapped up a record $21 billion of Japanese government bonds (JGBs) between June and August, moving away from U.S. Treasuries even as it pushes greater bilateral financial integration (or at least tries to appear to). More likely Chinese authorities just need to get yen out of the country. In any event, these purchases represent a small portion of a much larger flow of funds out of the country.

The Council of Foreign Relations’s Brad Setser explains:

The scale of the state banks net foreign asset accumulation is significant. The banks did not borrow abroad to lend abroad; they moved a portion of China’s savings to global markets and thus they are responsible for a large share of the net buildup of Chinese assets abroad necessarily associated with a current account surplus.

There was no corresponding surge in domestic foreign currency deposits in the second quarter, so the sources of funding for this increase in the banks external portfolio aren’t entirely clear.

Even in this bizarre state of affairs — amid a pandemic, interest rates at zero everywhere, and massive fiscal intervention across the world — the China story remains the same: The world’s fastest-growing economy is investing in the world’s slow-growing developed nations. Not just the government and the central bank, but also, as Setser notes: China’s state investors, who “bought $10 billion of foreign equity and private Chinese investors moved another $75 billion out of China through ways that the government cannot fully explain.”

Those outflows are taking place despite strict capital controls, which show no signs of abating. In effect, Chinese authorities are taking foreign reserves earned on exports — exports which are supposedly growing at nearly 10 percent annually — and parking them in zero-coupon developed-market bonds. Meanwhile, state fund managers are buying up foreign equities despite fears that the U.S. and Western Europe will continue to falter amid the pandemic. All while foreign investors’ appetite for Chinese bonds grows and the renminbi sees a modest rally against the dollar.

Meanwhile, Beijing’s debt levels remain on par with those in the developed world, and the recent near-bankruptcy of Evergrande, China’s second-largest property developer, raises broader concerns of deep and hidden financial imbalances in the country.

The headlines say China is leading the world — the flows of funds say otherwise. Buyer beware.

Around the Web

As I mentioned back when oil prices went negative, the drop in oil prices catalyzed by the Covid recession meant that small energy producers would have to sell or die. Today, the New York Times reports a surge in oil M&A.

Most companies have cut back drilling, laid off workers and written off assets. Now some are seeking out merger and acquisition targets to reduce costs. ConocoPhillips announced on Monday that it was acquiring Concho Resources for $9.7 billion, the biggest deal in the industry since oil prices collapsed in March.

The acquisition, days after the completion of Chevron’s takeover of Noble Energy, would create one of the country’s biggest shale drillers and signals an accelerating industry consolidation as oil prices languish around $40 a barrel, just above the levels many businesses need to break even. Just last month Devon Energy said it would buy WPX Energy for $2.6 billion.

Apropos of China’s economic headlines, AEI’s Derek Scissors gives an incisive analysis of the flow of funds in and out of the country:

Oddly, despite the simply amazing rebound, money may be leaving the country, as it has for more than six years. Shouldn’t the only large, growing economy draw capital? To be fair, there are more possibilities here than in official GDP accounting. Funds may be leaving on a net basis, but be exaggerated by false invoicing. The People’s Bank may be selling dollars to strengthen the yuan. Still, finance seems to be rejecting Xi Jinping’s regime.

Bad day for stocks. As to why, your guess is as good as mine. The pundits say it’s stimulus talks, but when were the prospects for a pre-election stimulus ever good?

Random Walk

When evaluating China’s economic imbalances, real estate is among the first places to look. Massive fiscal stimulus has for decades fueled property bubbles and even created “ghost cities” — with plenty of housing but no residents. In a recent NBER Working Paper, Kenneth Rogoff and Yuanchen Yang find major vulnerabilities in the Chinese property market:

China’s real estate has been a key engine of its sustained economic expansion. This paper argues, however, that even before the Covid-19 shock, a decades-long housing boom had given rise to severe price misalignments and regional supply-demand mismatches, making an adjustment both necessary and inevitable. We make use of newly available and updated data sources to analyze supply-demand conditions in the fast-moving Chinese economy. The imbalances are then compared to benchmarks from other economies. We conclude that the sector is quite vulnerable to a sustained aggregate growth shock, such as Covid-19 might pose. In our baseline calibration, using input-output tables and taking account of the very large footprint of housing construction and real-estate related sectors, the adjustment to a decline in housing activity can easily trim a cumulative 5-10 percent from the level of output (over a period of years).

— D.T.

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