Hysteria over China has become ridiculous
China is recovering but the world is not yet out of the woods. Capital outflows are dangerous wild card in China's currency drama
By Ambrose Evans-Pritchard
Forecaster Nouriel Roubini said in Davos that markets have swung from fawning adulation of the Chinese policy elites to near revulsion within a space of 12 months, and they have done so based on scant knowledge and a string of misunderstandings.
In fact, Mr Soros issued no such "declaration of war", and nor is he so foolish as to take on a foreign exchange superpower and net global creditor with $3.3 trillion in foreign reserves.
As it happens, I was at the dinner at the Hotel Seehof in Davos - drinking white Rioja - where Mr Soros supposedly revealed his plot. What he did let slip is that he had been shorting some Asian currencies - the Malaysian Ringitt or the Thai Baht, perhaps, out of nostalgia for the 1998 crisis.
Mr Soros made general comments, claiming that credit in China has reached 350pc of GDP and that the hard landing is already happening. "I’m not expecting it, I’m observing it,” he said. The observations were boilerplate, what are called "tourist" insights in hedge fund parlance. He is not a player in China.
So let us return to reality. The economic facts are in plain view. China is not slowing. It is picking itself up slowly after a "recession" in early 2015.
Car sales give us a steer. They collapsed early last year and touched bottom at 1.27m in July.
Sales have been rising every month since, surging to a record 2.44m in December thanks to lower taxes.
New registrations were up by 37pc for GM and 36pc for Ford and Mercedes.
House prices have been climbing for three months. The nationwide index was up 1.6pc in December. Shanghai rose 15.5pc and Shenzhen 47pc. Even the "Tier 3 and 4" cities are coming back from an epic glut.
The economy did indeed hit a brick wall early last year due to a fiscal shock and ferocious monetary tightening (passive) in late 2014. That was the time to lambast the Chinese authorities for errors of judgment, and some of us did so.
Capital Economics estimates that growth slowed to 4pc based on its proxy indicator, and others broadly concur. These indicators are not derived from the now useless "Li Keqiang index" of rail freight, electricity use and credit growth, which overstate the slowdown.
Growth of total freight traffic has risen to 5.4pc from 3.5pc in June. That is a plausible gauge of what is really happening.
A short-term economic rebound is already baked into the pie. Fiscal spending jumped 30pc in October and November. New bank loans and local government bond issuance - together, the proper measure of credit - reached a 12-month high of 14.4pc in December.
It is stimulus as usual. The Politburo is back to its bad old ways. "Despite talk of deleveraging, credit growth continues to expand far more rapidly than GDP growth because, quite simply, they are not willing to tolerate any slowdown," said Prof Christopher Balding from Peking University.
"Right now, I think it highly unlikely that Beijing would let any financial institution of any real significance collapse. They won’t let any firms collapse, much less the stock market. Their entire strategy appears to be 'paper things over and deal with it later'," he said.
"The current leadership is acutely aware of its place in history and the comparisons to the USSR. They are absolutely determined to not suffer the same fate."
Yet there are limits to what the Communist Party can achieve by flicking its fingers at this late stage of China's $26 trillion debt debacle. The Achilles Heel is capital flight.
The authorities botched their switch from a dollar peg to a trade-weighted currency basket in August, and botched it again in December when they fleshed out the details. The result was an exodus of money in two big bursts. Both Chinese and foreign investors concluded that this was camouflage for devaluation.
Fang Xinghai, a top adviser to president Xi Jinping, admitted in Davos that communications had gone horribly wrong. "We're learning," he said.
He vowed that the Party is absolutely committed to the defence of its new basket. "It is the decided policy of China," he said.
The facts bear him out. JP Morgan estimates that the authorities spent a record $160bn defending the yuan in December, a colossal mobilisation of resources.
Mr Fang said a country with a current account surplus of $300bn and a tight labour market does not need a devaluation. It would go against the central thrust of policy, undermining the planned switch to consumption-led growth.
He insisted that China funds itself from internal savings, unlike the usual suspects in emerging markets. "If China was relying largely on foreign capital, any major financial risk could derail our growth. But China is different," he said.
What he omitted, however, is the painful fact that running down reserves at the current pace entails monetary tightening, compounding the internal credit crunch.
This is the Impossible Trinity. A country cannot manage its exchange rate and keep control of monetary policy at the same time in a regime of free capital flows.
Haruhiko Kuroda, governor of the Bank of Japan, said one must give. He suggested that tougher capital controls "could be useful", the lesser of evils.
The Impossible Trinity is the nub of the issue. It is this that threatens to overwhelm the PBOC and ultimately force China to devalue - against its wishes - setting off a pan-Asian currency crisis to dwarf 1998, and transmitting a wave of deflation through the world economy.
So the vital question is the scale and make-up of the capital outflows. Fresh data from the Bank for International Settlements show that the foreign liabilities of Chinese companies and investors dropped to $877bn in September from a $1.1 trillion peak in September 2014.
Short-term debts have dropped from $858bn to $626bn, and have undoubtedly fallen much further over the past three months. In other words, the Chinese are paying off dollar debts and unwinding the dollar "carry trade" as fast as possible in advance of further rate rises by the US Federal Reserve.
Bhanu Baweja from UBS said the repayment of foreign debts accounted for almost all the capital flight in the third quarter. It is therefore arguably harmless, potentially a one-off effect that will play itself out.
Yet views differ. The Institute of International Finance in Washington estimates that $676bn left China last year, and that only half of this was used to pay off debts or balance books. It says outflows reached $187bn in the fourth quarter. There has been a surge in “errors and omissions”, a cover for capital flight through false trade invoices and other tricks.
The IIF said China is not in meltdown and Chinese companies are now far less exposed to foreign currency debt. There is a fair chance that "tactical" outflows will slow down of their own accord, taking the pressure off the central bank. Nevertheless, the risk of a broader rush for the exit has "materially increased".
There is a world of difference between precautionary moves to cut dollar debt, and a mass exodus by Chinese and foreigner investors because they think Beijing has lost control. Exactly which of these two themes dominates will shape world events this year.
Any hint of relative optimism on China in the currently wildly-polarized mood can easily be misunderstood. My view has long been - and continues to be - that China has left it too late to wean the economy off debt-driven growth and over-investment in industry, and will therefore drift into the middle-income trap.
Since China's banking system is an arm of the state, bad debts will be rolled over in perpetuity. There will be a slow loss of dynamism rather than a "Minsky" moment. It will be a denouement "a la japonaise", a landscape of soporose companies.
The Communist Party may have bought another year to 18 months. If so, the reckoning has been delayed again. Optimism means nothing more than that.