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A Tale of Two Post-Bubble Capital Flows

Ichiro Suzuki China’s renminbi is under pressure recently. Beijing is reportedly making great efforts to stem the currency’s decline as its economic woe deepens. State-owned banks are buying the RMB in the offshore market. Foreign investors are selling Chinese stocks and pulling money out of the country. Wealthy Chinese people have been making every effort to get their money out of the country, getting around tight foreign exchange controls, thus exerting downward pressure on the currency. This is a standard behavior of a currency of a country that is in trouble. In contrast to China today, Japan in the first half of the 1990s ‘suffered’ from the yen’s sharp appreciation. (Right. Revaluation of a currency was taken as a hardship.) Having parked profits earned by overseas subsidiaries, Corporate Japan brought back such profits to the headquarters at home amid deepening economic problems. By the middle of the decade, such repatriation drove the yen to the levels that were never experienced, generating deflationary pressure that would persist until the second decade of the 21st century. Fears of a rising currency greatly affected the psychology of the Japanese public, who opted to hold onto yen assets at a time when long-term government bonds’ yield were rapidly approaching zero. Unlike Chinese people who are risk-takers, vast Japanese household sector assets stayed home. This was an act of ultra risk aversion rather than patriotism. Japan doesn’t have a strong tradition of its people moving to unknown overseas land in search of greater opportunities. But for a handful of exceptions, wealthy people didn’t make a choice of going some place else where not only the grass looked greener but also tax rates were significantly lower than in Japan. Thus, households’ capital stayed home while corporate capital returned, a perfect recipe for currency appreciation. Fears of the yen’s rise has dominated Japanese psychology for nearly half a century, with intense focus on its negative aspects such as job losses in the export sector, downward pressure on prices, or foreign exchange losses on overseas assets. In the face of deflationary pressure, the Bank of Japan was reasonably creative and aggressive on interest rates. BOJ governor Toshihiko Fukui pioneered a zero interest rate policy (ZIRP) in response to the Japanese economy’s struggle. Later, in the aftermath of the 2007-09 global financial crisis, Fed chairman Ben Bernanke made the BOJ look timid with his quantitative easing. At the time of its introduction, the ZIRP was a novel experiment of an idea that existed only in theory. Governor Fukui’s fault perhaps was terminating the ZIRP too early, on the eve of what turned out to be the severest baking crisis in 70 years. (Such strong home bias among Japanese people probably made policy makers complacent. They didn’t have to make any efforts to make Japan an attractive place for their money to stay.) The People’s Bank of China, on the other hand, doesn’t have the luxury of responding to marked economic slowdown with super aggressive interest rate cuts for fear of the RMB’s fall. The currency officially belongs in the jurisdiction of the Treasury and not the central bank. Nonetheless, the PBOC still acts intensely in concert with the government. The Communist Party strongly dislikes a weak currency, more than a strong RMB perhaps. A weak currency not only makes China look bad, but also drives wealthy Chinese people to let their money leave the country. Rich people make every effort to do it, however aggressively the authority tries to prevent it. On top of that, Corporate China, unlike Japanese counterpart, has little profits overseas to bring back home. While China’s private sector capital wants to leave the country, foreign capital is seeing China less attractive than it once did. While foreign capital, especially American venture capital funds, have made immense contributions to development of China’s tech sector, they can no longer be counted much going forward. In addition to them, multi-national corporations in the developed world are having second thoughts on their direct investments in China in the face not only of economic slowdown but also of geopolitical tensions. Their investments would not evaporate for sure, but foreign direct investments in August is the lowest since records began 25 years ago. Foreign capital’s inflows are going to be found far less robust than they once were. The problem China is facing today is beginning to look like a classic developing country malaise: fighting against capital flight and potential capital shortage. Japan has had its own serious problem but it appears that China is getting into a deeper one. It remains to be seen how it goes over a long period of time.

About the author: Mr. Suzuki is a retired banking executive based in Tokyo, Japan.

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