A man checks Chinese yuan bills in Beijing on July 28, 2015. The yuan is declining against the dollar and bitcoin as Chinese move money out of the country. (FRED DUFOUR/AFP/Getty Images)A man checks Chinese yuan bills in Beijing on July 28, 2015. The yuan is declining against the dollar and bitcoin as Chinese move money out of the country. (FRED DUFOUR/AFP/Getty Images)

The Chinese currency, the yuan, is a strange animal. Linked to the dollar, it hardly moves—but when it does, financial markets get jittery, especially when it’s going down.

The yuan lost 1.1 percent against the dollar in October, which doesn’t seem like a lot. It’s what’s behind the one percent move that has markets on edge.

According to investment bank Goldman Sachs, as much as $500 billion in capital has left China this year through September. Chinese companies and citizens, as well as foreigners, convert their yuan holdings into dollars and other foreign currencies, moving the price of the yuan down. Outflows picked up especially in September, reaching $78 billion.   

gsyuanoutflow

If there is no additional demand for the yuan from trade, for example, the price of the currency has to move down to adjust for the imbalance in the demand for foreign currency. Fundamentally, this is a vote of no confidence in the Chinese economy. If risks and returns of Chinese assets were favorable—as they were for most of the past decade—capital would be flowing into China and not out.

Regime Meddling

However, the Chinese leadership wants to limit the visibility of this vote of no confidence and give the impression of financial stability, so it is applying two levers to obscure the move.  

First, it is selling off its once mighty stash of official foreign currency reserves, down from $3.33 trillion in January to $3.17 trillion at the end of September. In August of 2014, it was close to $4 trillion.

It is simply a transfer of public Chinese foreign exchange assets to private hands intermediated through global financial markets. If the amount of foreign currency bought by the private sector and sold by the official sector matches, the impact on the price of the currency is limited.

For example, Chinese official holdings of U.S. Treasury bonds are down from $1.25 trillion at the beginning of the year to $1.19 trillion at the end of August. However, Chinese corporates have either completed or announced $218.8 billion in mergers and acquisitions of foreign companies this year, according to Bloomberg data.  

(Bloomberg)

(Bloomberg)

The rest of the record corporate buying spree was financed by Chinese state banks and other foreign exchange reserves held at the People’s Bank of China (PBOC).

Chinese companies have previously invested in steel mills and coal mines like there is no tomorrow. However, because mining and manufacturing have massive overcapacity and debt issues, Chinese companies are looking overseas for better investments.

But it’s not only Chinese corporates that are suddenly discovering the value of foreign assets. Chinese citizens have also been active buyers of foreign real estate and stocks. Purchases of equities traded on the Hong Kong stock exchange by mainland citizens, for example, hit a record high of $12 billion worth of buy orders in September, up 64 percent from August.

Capital Controls

So the Chinese regime is pulling the second lever to limit outflows: capital controls. Transfers of capital for citizens are already capped at $50,000 per year, so people found nifty ways around this limit. Like buying millions worth of life insurance products, a form of capital investment, in Hong Kong for example with their Union Pay debit card. But not anymore.

As of October 29, they can only use their UnionPay cards to buy insurance related to travel, according to UnionPay Co. Mainland visitors bought $3.9 billion worth of insurance products in Hong Kong in the first half of the year, according to the city’s insurance industry regulator, an increase of 116 percent over the same period of 2015.

The regime also continues to crack down on underground banks which facilitate capital outflows. According to reports by mainland paper Financial News, the State Administration of Foreign Exchange (SAFE) seized $8.4 billion in foreign exchange funds during an investigation in late October.

So unlike the mostly state-owned companies which are snapping up foreign assets with the blessing of the regime, Chinese citizens have to find other ways to reduce their exposure to the Chinese economy. They are fed up with the low-interest rates on bank deposits and are increasingly afraid of the risks of the unregulated wealth management products.

(HSBC)

(HSBC)

One channel that still seems to work is the flow of yuan from the mainland to offshore centers like Hong Kong and Singapore. Goldman estimates $45 billion out of the $78 billion in September outflows was transferred from the mainland banking market to the offshore yuan market, where it was likely converted into foreign currency.

The offshore yuan (CNH) has lost 4.8 percent against the Hong Kong Dollar since May where its domestic counterpart (CNY) only lost 4 percent, indicating more selling pressure on the offshore yuan.   

Another vehicle, mostly used when all else fails, is the electronic currency Bitcoin. After moving sideways for most of the summer, the price skyrocketed since late September, coinciding with the latest measures to restrict capital outflows and the drop in the yuan. Alas, it is a bit more volatile than its official counterpart. It’s up 23 percent to $705 since Sept. 25, without regime meddling and for everyone to see.

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Silver coins with the Bitcoin logo on them are displayed at a Bitcoin conference on at the Javits Center April 7, 2014 in New York City. (Andrew Burton/Getty Images)Silver coins with the Bitcoin logo on them are displayed at a Bitcoin conference on at the Javits Center April 7, 2014 in New York City. (Andrew Burton/Getty Images)

Chinese speculators have the reputation of buying anything and everything that is going up.  

Real estate, the stock market, copper, bitcoin, and now silver. Futures in Shanghai reached their upside limit when prices hit $21.13 per ounce, up 6.9 percent on the day.  Chinese are behind the bulk of the buying as volumes on the Shanghai futures exchange exploded to 95 billion yuan ($14.2 billion) last Friday.

The price has since retreated to a tad below 20, but the overall performance over the second quarter is best in class, up 17 percent.

(Provident Metals)

(Provident Metals)

At least considering traditional asset classes. Bitcoin, the preferred Chinese capital outflow vehicle is up 66 percent in Chinese yuan over the same time period. After peaking on June 16, it has leveled off a bit, a good chance for Chinese traders to focus on silver again. Like Bitcoin, silver is not part of the Chinese banking system and provides insurance for a possible debt restructuring. 

Throughout history, the Chinese have been alternating between currency systems based on silver and currency systems based on paper money. Genghis Khan was the first emperor to force his citizens to use paper money,  Chiang Kai-shek’s Nationalist Party was the last one to switch silver for paper in 1935. 

The fact that the traded volume goes up while the open interest goes down is a clear indication that day traders have taken over for now.

— Ole Hansen, Saxo Bank

The current Chinese communist regime has been remarkably lenient in letting the Chinese people buy gold and silver, maybe because they know they can confiscate it at any given time.

“They know that in crisis situations, the central government can confiscate gold and hand out paper money in return. Especially in a centrally controlled country like China,” gold expert Willem Middelkoop told Epoch Times in an earlier interview.

Until then, the Chinese probably don’t care so much about the philosophy of different currency systems, but rather like to speculate and make a profit, according to Ole Hansen, Saxo Bank’s  head of commodity strategy. 

“The emergence of commodity trading venues in China has, however, changed the balance in the market. Back in April, a sudden rise in demand for steel rebar and iron ore futures from Chinese day traders triggered a major surge in daily volumes,” he writes in a blog post.  “The fact that the traded volume goes up while the open interest goes down is a clear indication that day traders have taken over for now.”

Chinese traders had invested in steel and iron ore earlier in the year, only to see their prices go down by a third. Will the same happen to silver? Not according to Hansen.

“No is probably the shortest answer. Silver is a much more globally traded commodity than some of the other futures currently available for trading in China.”

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Chinese traders love speculating in anything that’s not bolted down. So they effectively took over the virtual currency Bitcoin, representing 90 percent of global trading volumes. And if trading the volatile Bitcoin cryptocurrency wasn’t enough, BitMEX offers them the opportunity to use leverage as well.
“Our goal is to let anyone bet on anything at any time,” BitMEX founder Arthur Hayes told Bloomberg. The 30-year old ex-Citigroup trader founded BitMEX in Hong Kong two years ago, modeling it after the Chicago Mercantile Exchange (CME). The CME allows traders to buy or sell vast quantities of commodities or financial instruments putting little money down.
This process is called speculating on margin, a process BitMEX has taken to the cryptocurrency world. Traders have to deposit Bitcoin (or other cryptocurrencies) instead of dollars or euros or yuan to fund their accounts.
They can then use one Bitcoin to buy a contract worth 100 Bitcoin—100 times is the exchange’s maximum leverage—and BitMEX charges a fee of 0.005 percent for each transaction.
Similar to the real futures exchange in Chicago and elsewhere, all the traders are doing is entering a legal contract, which is settled in cash (or cryptocash in this case) after it expires or the trader is stopped out. Real bitcoins, altcoins, ether, or daos—all cryptocurrencies—don’t change hand.
In the example above, a trader could buy a contract worth 100 bitcoin for only one bitcoin. If the price goes up 5 percent the trader makes 5 bitcoin or a 500 percent return on his original 1 bitcoin investment. However, if the price falls 1 percent, he loses 100 percent or all of his initial investment. There is no chance to buy and hold, or wait until the price recovers.
This is similar to regular spread-betting exchanges like Alpari or the bucket shops of the roaring 20s. 
A preview of the BitMEX trading dashboard (BitMEX)
The exchange’s algorithms and computer programs make sure winners and losers always net out to zero, again similar to the real futures exchange. However, unlike the role-model, winners may be asked to subsidize losers at times. 
“BitMEX contracts have high leverage. In very rare cases, profits may be reduced during certain time periods if there is not enough money on the exchange to cover user profits,” it states on the company’s website.
The company wants to expand its offering beyond cryptocurrencies so Chinese speculators can bet on Western financial indices and stocks and Westerners interested in Chinese stocks can bet on mainland financial markets.
While China has regulated inbound and outbound money transfers and investments, bitcoin can flow freely, making it possible for mainlanders and Westerners to found their account and start betting.
Because they aren’t really buying or selling anything and merely entering into contracts, BitMEX doesn’t need to worry about moving around the underlying financial products.
So far, the company is far away from its goal to have “anyone bet on anything,” however. Chinese can only bet on U.S. dollar interest rates (one contract) and Westerners can only bet on the FTSE China A50 share index (one contract.)

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Last time around, the love affair with China and the virtual currency Bitcoin didn’t end well. In December of 2013, the Chinese central bank barred financial companies from having anything to do with Bitcoin and the price crashed from $1095 to $105.
However, this love has been rekindled as the virtual currency quietly rose from $200 in August 2015 to $525 now.
“It went down for many reasons in 2014, the most important one was that it was too high. These days Chinese activity is driving the ascent in the price of Bitcoin. There is not a lot of other factors going on right now,” says Gil Luria head of technology research at Wedbush Securities.
If you are willing to get capital out of China badly, then you are willing to take the risk. — Gil Luria, Wedbush Securities

Coincidently, Bitcoin reached its bottom just after the surprise devaluation of the Chinese yuan against the dollar and about the time ordinary Chinese started to move money out of the country in earnest. Some of it leaves China via Bitcoin.
“In countries … that struggle with high inflation and capital controls you see a move toward bitcoin,” Tuur Demeester, editor in chief at Adamant Research, said in an interview with RealVisionTV.
Safe Haven?
The Chinese economy is struggling and the banking system is loaded with bad debt.
Demeester likens the recent rise in Bitcoin to what happened in Cyprus in 2013 when Bitcoin first became mainstream news. As the banks in Cyprus closed down, the virtual currency rose from $15 to over $230 in the span of a couple of months.
Price of Bitcoin against the U.S. Dollar (Coindesk)
“The price was going nowhere for the last two years, but in the past year, we have seen these trends. Back in 2013, Cyprus was the reason why Bitcoin spiked in April 2013. Bitcoin survived but the money that was in the bank didn’t,” Demeester says.
Bitcoin during the Cyprus banking crisis (Coindesk)
That may be the reason why Chinese are willing to pay hefty premiums to buy Bitcoin to get rid of the risk of holding bank deposits in yuan.
For example: The price of one bitcoin in yuan on June 1 was 3608. This is equivalent to $548. But the dollar price of Bitcoin was only $525, a 4.4 percent premium.
In addition, even if the objective is to get rid of yuan, there are violent price moves even in U.S. dollars, like during the 2014 crash. So an ordinary Chinese citizen is paying up and taking a lot of price risk just to get rid of the Chinese currency.
The amount of money that can be transacted via Bitcoin is unlimited.

“If you are willing to get capital out of China badly, then you are willing to take the risk,” says Luria.
Since there are no transaction costs for shifting from yuan into Bitcoin and from Bitcoin into dollar, it means traders think the Chinese currency is at least 4.4 percent overvalued compared to the U.S. dollar. 
“Even though 60 percent of the new supply of bitcoin comes out of China, despite that you have these positive spreads on Chinese exchanges,” says Demeester.
The amount of money that can be transacted via Bitcoin is unlimited—at least in theory—as Bitcoin is not part of the limitation on overseas money transfers and investment opportunities.  
“You can take Bitcoin out to anywhere in the world and that’s a way to get capital out of China,” says Luria.
Chinese can open overseas bank accounts while traveling and then exchange their bitcoins for foreign currency in their new bank accounts. Direct transfers to overseas bank accounts are limited, but this roundabout way is not.
While the price moves and discrepancies are exciting, but the total amount of Bitcoin in circulation ($8.3 billion) is tiny compared to the Chinese banking system ($35 trillion) and even compared to the total amount of capital that left China in 2015 ($676 billion).
We cannot ignore the revolutionary changes it brought to the financial sector. , Cyberspace Administration of China

However, China is the world leader in Bitcoin mining (the mathematical process through which new bitcoins are created) as well as Bitcoin trading. Chinese Bitcoin exchanges account for as much as 92 percent of global volumes (around $22.5 billion during the last 30 days).
Bitcoin Ban
So didn’t China ban Bitcoin at the end of 2013? And why did the price crash so much?
In short, the answer is no, China did not ban Bitcoin. China barred financial companies (including the big, non-bank payment providers like Alibaba’s Alipay) to deal with Bitcoin. It did not ban Bitcoin exchanges like Huobi or the transfer of bank deposits in exchange for bitcoins.
“The Chinese government [was] highly worried that, if the banks and Alipay connect directly to the Bitcoin infrastructure, the banks or Alipay will do something really stupid and the government will have to bail them out,” Joseph Wang of Bitquant wrote in a blogpost.
So there was a good reason for the steep price decline after the Chinese added this regulation. By prohibiting big payment companies like Alipay to use the virtual currency, China ensured that Bitcoin would not become the currency of choice for sales of goods and services, especially in its booming online market.  
“Merchant fees in China are lower than in the West and platforms such as Alipay and WeChat or Tenpay dominate the mobile and non-bank payment market,” writes Coindesk’s Aiga Gosh.
Using Bitcoin for real live transactions is an important driver of demand for the virtual currency. If this factor of demand is removed, the price must fall, although the Cyberspace Administration of China has recently used softer tones when talking about the currency in October of 2015:
“Although some people think that Bitcoin and its underlying technology, the Blockchain, is not stable, we cannot ignore the revolutionary changes it brought to the financial sector. The new technology has led to the expansion of a distributed payment and settlement mechanism, which will innovate financial transactions.”
(Wall Street Journal)
 
Pure Speculation
So using Bitcoin as a payment for goods and services in China has been removed from the equation,

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In the fall of 2015, we know that all is not well with the Chinese economy. People are trying to get their money out as fast as they can. 
Some of these methods, like using underground banks or hiring people to carry physical cash out of the country are hard to do for ordinary Chinese savers.
Instead, they may be using the digital currency bitcoin to funnel money out of the country. 
“Some Chinese traders are expressing a view on the yuan exchange rate after the last devaluation and you have interest by mainland speculators to move to other assets after the stock market fallout,”  Jack C. Liu, the Head of International at OKCoin told Bitcoin Magazine. 
As a result, Bitcoin has roughly doubled since the Chinese stock market started to unwind in the middle of July 2015 and hit the overdrive after the currency devaluation of August 2015. 
Price of Bitcoin in U.S. Dollars over the past three months. (Google FInance)
Bitcoin can be made completely untraceable so the authorities won’t catch the person who transferred money out of the country.
This is how it works:
A Chinese saver who is scared to lose his life savings invested in real estate, the stock market, or bank deposits takes cash to an underground money exchange. 
The underground exchange then provides the saver with an anonymous bitcoin wallet. IP addresses, the only thing linking the bitcoins to the owner, can be hidden using Virtual Private Networks or the TOR network. 
The saver can then exchange Bitcoin for dollars at any of the global Bitcoin exchanges without anyone every knowing his identity.
The only tricky part is to get the dollars out of the Bitcoin wallet outside China. That would require a connection to a bank account overseas but at
least the Chinese authorities cannot meddle with that process. 
The underground exchanges have more traditional ways to get money out of the country, using different channels to get foreign currency.
Ultimately, they will have to use that foreign currency to buy bitcoin to pass on to their local Chinese customers. This is why the price has gone ballistic recently in all major currencies. 
The underground exchange can also procure bitcoin directly from so-called bitcoin miners, many of which operate in China and need to pay utilities in yuan.

However, Chinese don’t have to use this secret process. BTCC, China’s leading bitcoin exchange announced on Nov. 4 it will now let accept direct deposits from Chinese citizens, which can then be exchanged for Bitcoin.
The digital currency is up more than 20 percent on the news on Nov. 4, trading at $487. 
To gauge how much it could rise in total, it is interesting to look at the Cyprus of 2013. Deposits on the small Mediterranean island were frozen in the wake of a sovereign debt crisis. So Russian oligarchs used bitcoin to get their money out. 
In 2013, Bitcoin rallied from $13 dollars to $121 just after the crisis and before a speculative mania pushed it as high as $1127. In Cyprus we were talking about billions of dollars of deposits. In China we are talking about trillions.
How much can the $5 billion pool of bitcoins absorb? The answer is all of it, it just depends on the price.  
 
 

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