March 9, 2017    3 minute read

The Great Currency Wall of China

What Money Can Buy    March 9, 2017    3 minute read

The Great Currency Wall of China

China’s recent efforts to prevent funds from leaving the country seem to be working, and this can have significant implications on the rest of the world.

An Outflow of Yuan

Over the past few years, China’s problem has been that a large number of Chinese nationals and businesses have sold yuans, thereby moving money out of the country. Consequently, in order to stop the yuan from falling off a cliff, Beijing has been actively buying the currency using dollars. The yuan weakened by a record 6.5% against the dollar last year. However, if the yuan does fall, China would prefer it to be a gradual decline and not a sharp one.

Thus, it must spend its foreign reserves on buying its own currency in the open market in order to support the yuan’s price. However, China has only a limited amount of foreign reserves, or dollars, in the bank and, therefore, cannot keep buying dollars to support the yuan indefinitely. The selling of dollars from its reserves led to its foreign exchange reserves falling below $3trn for the first time in five years this January.

The Chinese Government Takes Action

To help assuage the issue of depleting reserves, the Chinese government introduced more stringent measures aimed at reducing the amount of money that individuals and businesses can move out of the country. For instance, Chinese banks now have to report all foreign transactions made by individuals that amount to more than $10,000.

Furthermore, China also stated that the value of the yuan, which is set each day by the government, will be less correlated to the dollar and more directly tied to a basket of other currencies. Hence, if the dollar continues its climb against a basket of other major currencies, as measured by the dollar index, the yuan will continue to weaken against the dollar. Therefore, if money moves out of China, it is essentially worth less in dollar terms.

The restrictions instituted by the Chinese government seem to be working as its foreign exchange reserves rose by $6.9bn to reach $3.01trn at the end of February. According to a Reuters poll, Analysts had predicted a decline of $25bn.

Impact on Property Prices

The aforementioned restrictions already seem to be impacting property prices in many cities. In the past decade, and more so in the last few years, a large outflow of funds from China has moved into properties abroad, particularly in countries such as Australia, Canada and the United Kingdom. Thus, difficulties in moving funds out of China means that investments in properties abroad will fall thereby leading to a fall in property prices in those regions.

Impact on the Markets

Last year was a record one for Chinese firms purchasing companies abroad. However, it appears that the above restrictions are limiting Chinese companies making foreign acquisitions, thereby having a negative impact on stock prices, in particular, those of companies that could be targeted for takeovers by Chinese companies.

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