First, details matter. Broad blunt measures like debt to GDP might provide a good headline but do little to advance our understanding of what is really happening. Second, numbers must reconcile relatively closely. There is enough data throughout the Chinese economy that we should be able to match, within some reasonable error or noise level, a wide variety of data. Third, a long and broad memory is important to best utilize points #1 and 2.
Let us start with a rough estimate of how much RMB is leaving China. This is not FX transactions conducted inside China, but rather international transactions that are denominated in RMB. As a final caveat, it is worth noting that about 75% of international RMB transactions are conducted between China-China or China-Hong Kong.
There is a very close relationship between RMB outflows, the net balance of international RMB transactions and RMB denominated balances in Hong Kong the primary offshore center for the RMB. Since we have international RMB transaction data back to 2010, there has been a pretty close relationship between net RMB outflows and RMB balances in Hong Kong.
This is intuitive and straight forward. Hong Kong is the counterparty in never less than 70% of international RMB transactions and remains the dominant source of offshore RMB in the world. As I frequently stress, we are not looking for exact matches or reconciliation between numbers but rather numbers that are so grossly out of place to cause concern. For most of the period we have data for, the relationship between RMB outflows from China and Hong Kong RMB deposits is relatively stable.
There are a number of ways that we can conclude that the relationship between RMB ouflows and Hong Kong RMB balances is pretty stable. I will just give you a few data points. First, in August 2015 the difference between the aggregate outflow of RMB from China since January 2010 to RMB deposits excluding the starting balance as of January 2010 was less than 38 billion RMB. By comparison, total RMB deposits in Hong Kong in August 2015 was 979 billion RMB, so the discrepancy was equal to 3.9%. Given the total size of flows and number of offshore RMB centers, this is a relatively small difference.
Second, if we compare the difference between the September 2015 and November 2013 aggregate outflows and Hong Kong RMB balances, we see how closely related they are. During a time when aggregate outflows went from 940 billion RMB to a peak of 1.72 trillion before falling back to 940 941 billion, Hong Kong RMB deposits witnessed nearly an identical pattern with an important caveat. While Hong Kong RMB deposits did go up during the same time frame, they increased much less than the total amount of outflows. While aggregate outflows during this period peaked at 779 billion, RMB deposits in Hong Kong never rose by more than 176 billion. It was during this time that many other offshore centers were gaining large inflows of RMB. However, by September 2015 RMB had moved back to Hong Kong so that even as aggregate RMB outflows were up only 628 million, RMB bank deposits were up 68 billion. By November this gap between aggregate outflows and RMB deposits had shrunk from a 69 billion to an insignificant 15 billion.
Third, Hong Kong RMB deposits as a percentage of RMB outflows have averaged about 65-85% depending on some various measures. Given that more than 70% of international RMB transactions involve Hong Kong, this number again tells us that as RMB leaves China a pretty stable amount of it ends up in Hong Kong.
However, since August 11, 2015 these numbers have changed dramatically. In November 2015, the Hong Kong RMB deposit to aggregate outflow ratio stood at 70%. This matches the transaction volume and other metrics of where RMB was going and how much was leaving China. However, since November 2015 this ratio has fallen to 19%. In other words, Hong Kong deposits of RMB are equal to only 19% of the aggregate outflow.
What is notable is that both numbers have changed dramatically in the wrong direction. Since October 2015, aggregate RMB outflows, as measured by net receipts from banks, grew from 1.02 trillion RMB to 3.17 trillion RMB. In other words, in one year there were outflows from bank receipts less payments totaling 2.15 trillion RMB.
All this outflow should have shown up in higher RMB denominated bank balances right? Wrong. In that same period, RMB denominated bank balances shrunk from 854 billion RMB to 663 billion RMB or by 192 billion RMB. Put another way, during a one year period when RMB was flooding out of China by more than tripling the aggregate net outflow level, RMB deposits rather than growing roughly in line with a historical trend fell by 22%.
If we take just the fall in Hong Kong RMB deposits, this implies that there is approximately 2.34 trillion RMB or $339 billion USD, using current exchange rates, that we should be able to see somewhere in the offshore market that simply isn’t there. It is worth noting that RMB deposits in other offshore centers have fallen by similar relative levels.
We are now left with a simple conundrum: if RMB denominated outflows from China exploded and RMB bank balances dropped sharply within the past year where did that RMB go? Even in China, this is simply an unexplainable amount of money. From January to October this year, the last month for which we have banking flow statistics, the combined amount of outflows and drop in RMB deposits equaled 1.56 trillion RMB or $228 billion USD. However, FX reserves in China had only dropped $110 billion.
While the PBOC would have been, by its own numbers, unable to soak up all the new RMB in offshore centers, this leaves us with two specific alternatives. First, the PBOC numbers are unreliable. While we cannot rule that out, I think it is pretty unlikely that the PBOC is releasing fraudulent data for many reasons. Second, the more likely explanation is that there are unofficial official actions being taken to drain the RMB liquidity leaving China from settling in offshore centers and pushing the wedge between the CNY/CNH.
I want to stop now because there is so much more to write on this topic, as we piece together how the money is flowing and why these numbers are simply inconsistent. However, we can say now that the amount of RMB that is leaving China on a net basis simply cannot be reconciled with the amount of RMB we see showing up in offshore centers. That leaves us the question for the next time: if the money is leaving China but isn’t showing up in offshore centers and offshore center RMB deposits are falling, where is this enormous amount of RMB going and who is doing it?