Spooked by Yuan Drop: China’s Top 1%

So you think the USA is finished? Think again. Many predicted the fall of the US dollar as the reserve currency and the rise of Euro or the Chinese RMB; that does not look to be the case now. As we highlighted a number of years ago, there is just too much trust at the moment in the Chinese system. Over time this will change; just the sheer number of people in China and the size of its economy as it continues to grow will overshadow the US economy. Aivars Lode

Fears the megarich will take flight puts a floor under the currency’s slide against dollar

By Andrew Browne 

SHANGHAI—China’s superrich are nervously watching as the Chinese currency weakens against the dollar.

Because of the extreme concentration of money at the apex of Chinese society, national stability rests to an extraordinary extent in the hands of just two million or so families. They are the top 1% of urban households, and already, their confidence in China’s future under President Xi Jinping is shaky.

Many are fleeing with their cash--not all of it, but enough to bid up prices of luxury real estate from Mayfair to Manhattan to Mission Bay, a waterfront neighborhood of Auckland, New Zealand. 

Financial authorities are trying to ensure that the remainder doesn’t disappear across the borders. A potential trigger for a disorderly exodus of capital, one that could threaten the entire fragile financial system, would be a precipitous decline in the value of the Chinese currency.

That’s one reason—an important one—why a sharp yuan drop is unlikely, even though a slowing economy is increasing domestic pressure on the government to let the yuan fall in a bid to boost exports.

Indeed, in recent weeks there’s evidence that financial authorities are reversing years of intervention in foreign-exchange markets aimed at stopping the yuan from rising too rapidly against the dollar: Now the government appears to be surreptitiously propping it up—or at least to try to prevent a too-sharp decline.

One sign of reassurance that the yuan won’t be allowed to plunge came last week from a senior State Administration of Foreign Exchange official, who was quoted by the official Xinhua News Agency quoted as saying the yuan would remain “basically stable” in 2015.

That doesn’t mean the yuan will halt its gentle downward trajectory. It lost about 2.5% against the dollar last year and has edged down almost 1% so far this year. However, against the currencies of China’s other major trading partners, including Japan and those in Europe, it’s still riding high, partly a result of its loose peg to the dollar. 

Beijing’s apparent efforts to defend a still-strong yuan in the face of the weakest growth in China in almost a quarter-century reflect a variety of national concerns.

Not least, under Mr. Xi a powerful yuan has become a symbol of China’s global resurgence. The thrust of Chinese currency policy has been to erode the influence of the mighty dollar in international trade and investment and to persuade foreign governments to include the yuan in their baskets of foreign-exchange reserves. A volatile yuan would work against all those goals.

There’s little doubt that the growing anxieties of China’s superrich also weigh on currency decision-making.

Mr. Xi has shaken up the status quo with the fiercest campaign against corruption in modern times. That’s creating political tensions at the heart of the Communist Party. The Gilded Age is over: We’re in a new era of austerity. All this uncertainty has unsettled the owners of China’s great fortunes who are now focused on protecting their capital.

Those on the lower rungs of China’s monied classes don’t have many options. They’re suffering, too, as the economy slows and the property market teeters. But it’s hard for them to get around the rule that prevents individuals from taking out of China more than $50,000 each year. 

The superrich have clever ways of circumventing such restrictions—one of the reasons many of them got rich in the first place. The government knows this. It also understands that although its $4 trillion in foreign-exchange reserves would be a formidable defense in any crisis, they are not invulnerable.

In 2011, a study by Victor Shih, then a professor at Northwestern University, showed that the richest 2.1 million Chinese households controlled a staggering $2 trillion to $5 trillion in financial assets, such as stocks and bonds, and real estate. If they liquidated 30% of their wealth and moved the proceeds out of China, Mr. Shih calculated, they’d drain $1 trillion or more from the reserves.

Since that report came out, the concentration of wealth in China has likely become even more extreme. Capital flight is well under way. And the reserves are already starting to dwindle as hot money pulls out of China in anticipation that the U.S. Federal Reserve will increase interest rates, making investments outside China more attractive. 

Making matters worse, the megarich and the companies they control have been using their Chinese assets as collateral for loans outside China. Those borrowings—more than $1 trillion, according to the Bank for International Settlements--are now so large they’ve caught the attention of banking regulators elsewhere, particularly those in Hong Kong. A devaluation of the yuan would add to the burden of repaying that foreign debt. 

Moreover, if foreign banks turn wary about the value of that collateral, and call in their loans, the rich might have to sell off their Chinese assets and send the cash offshore, further depleting the foreign-exchange reserves.

Preventing panic is now a priority for the Chinese government. That doesn’t rule out more weakening of the yuan. But it does dramatically reduce the chances of a sudden devaluation as authorities put a floor under its slide.