A teller counts yuan banknotes in a bank in Lianyungang, east China's Jiangsu province on August 11, 2015. (STR/AFP/Getty Image)A teller counts yuan banknotes in a bank in Lianyungang, east China's Jiangsu province on August 11, 2015. (STR/AFP/Getty Image)

Everything seems to be well in China, maybe except for the rising defaults. The currency is up almost a percent against the dollar for the last month and foreign exchange reserves only decreased by $4.1 billion, to $3.2 trillion. Long gone are the months of triple digit reserve drain during the turn of the year.

But underneath the surface the picture may not be as rosy.

“Our preliminary estimate of People’s Bank of China (PBoC) reserve operations suggests that net capital outflows amounted to some $39 billion in July, marking the largest net outflows in six months,” write the International Institute of Finance (IIF) in a report. 

There’s a difference between having enough reserves to meet normal balance-of-payments needs and adequate reserves to defend resident-driven capital flight in a panic.

— Worth Wray, STA Wealth Management

So all the money that China made exporting goods, and then some, just stayed abroad. “We would not want to read much into a one-month pick up in capital outflows but we continue to caution that investor concerns about the policy environment and
pace of economic growth will continue to influence the rhythm of capital flows to China,” the IIF states.



Worth Wray, the chief economist of STA Wealth Management, thinks there is a high risk that outflows could pick up again very soon. His premise is that while Chinese currency reserves are still high in absolute terms, and should be sufficient to finance trade, they will not last long if Chinese citizens lose confidence in the economy and move money abroad wholesale. 

“There’s a difference between having enough reserves to meet normal balance-of-payments needs and adequate reserves to defend resident-driven capital flight in a panic. My point is that the buffers continue to fall and Beijing can’t keep following this policy course forever,” he told Bloomberg. 

He compares the exchange reserves against deposits available in the banking system, made up of the savings of companies and citizens, also called the M2 money supply.

The ratio is now at its lowest level since 2003, according to Wray’s figures. 

“We’ve seen an alarming fall in the ratio over the last few years. It was as high as 27 percent as recently as 2014—when FX reserves totaled more than $4 trillion—but is now closer to 14 percent. That’s well below the [International Monetary Fund]’s advisable 20 percent threshold,” he said.

(Source: Bloomberg)

(Source: Bloomberg)

In other words, while M2 is increasing—deposits in yuan can’t really leave China, it’s the owner who changes hands—because of new loan issuance, foreign exchange reserves are decreasing because citizens exchange the money for U.S. dollars and other foreign companies.

The domestic stock market crash was a watershed moment for Mr Wu’s asset allocation strategy, he said.

—  FT Confidential Research

According to investment bank Goldman Sachs, Chinese residents buying foreign assets made up 70 percent of capital outflows during the last 9 months.

This estimate is consistent with survey data from FT Confidential Research. More than 60 percent said they are moving money overseas because of risk diversification and more than half expect the Chinese economy to slow further. A total of 56.8 percent of respondents said they will increase their investment overseas in the next two years.

(Source: FT Confidential)

(Source: FT Confidential Research)

The survey also confirmed the Chinese tendency to overpay for assets, as almost a third of respondents said they are looking for attractive returns overseas. It seems in their case, it is the return of their money, not the return on their money that counts:

Aaron Wu, a 31-year-old financial worker in Beijing, invested more than A$1m ($770,000) last year in a Sydney apartment and another A$240,000 in Australian shares after losing more than Rmb1.5m on the Shanghai stock market. The domestic stock market crash was a watershed moment for Mr Wu’s asset allocation strategy, he said.

China has tried to counteract this trend by making moving money abroad more difficult and 67.6 percent of the respondents say it has become harder to circumvent the $50,000 limit. 

According to Assia Nikkei review, the PBOC has told banks in a private meeting last month to clamp down in international transactions but didn’t make new regulations official. 

And it’s not just the citizens moving money abroad. Companies, whose deposits are included in the above M2 analysis, are also buying foreign assets to the full extent of the law.

Chinese companies bought a total of 493 foreign firms for $134.3 billion during the first half of the year, according to a report by PriceWaterHouseCoopers (PwC) cited by ChinaDaily. This is an increase of almost 350 percent compared to the same period last year.

Contrary to its citizens, the regime is encouraging companies to take over foreign firms, following the Chinese premier’s Li Keqiang’s “going out” policy.

“The outbound M&A is an irreversible trend in the long term,” Liu Yanlai of PwC states in the report. 

Read the full article here

China’s currency and foreign exchange reserves have been front page news since the start of 2016 because they impact Western stock markets and economies.
After bleeding almost $100 billion in January to defend the value of its currency against the U.S. dollar, speculating the yuan would fall became a one-way bet.
“Extreme credit growth usually leads to a credit bust,” Mark Hart of Corriente Capital said in an interview with RealVisionTV. He thinks the Chinese currency will drop 50 percent in value this year. To his credit, he got into the trade before everybody else in 2014, but his 50 percent drop scenario hasn’t materialized yet.
Instead, foreign exchange reserves decreased only $29 billion in February (to $3.2 trillion) and investment bank Société Générale thinks they may even increase in March. Likewise, the yuan even went up a little bit against the dollar in 2016.
“The accommodative global  sentiment notably  reduced  depreciation  pressure  on  the  Chinese currency,  and,  as  a  result,  the  renminbi  (RMB) weakened  against  a  basket  of other  currencies  in March  without  weakening  against  the  dollar  at  all,” analysts Wei Yao and Jason Daw write in a note.
However, this may just be a lull in the storm, according to the lasts report of the Institute of International Finance (IIF):
“China is likely to continue to face substantial net capital outflows, and there remain concerns that the RMB may at some point be devalued more meaningfully in the face of persistent declining reserves.” The IIF believes outflows could total $530 billion in 2016.
In April China released a breakdown of capital flows called the Balance of Payments, which shows who exactly is moving money out, thereby putting pressure on the exchange rate, or moving money into China.
“First, external debt deleveraging is likely nearing the end and should be welcomed in any case. Second, the authorities seemed to have some control, even overshadow outflow channels,” according to Société Générale.
This means that China’s corporations are paying back dollars they borrowed before when they expected a rising renminbi. And while Société Générale thinks the repayment of debt may soon be over, China still has about $1.4 trillion in foreign liabilities.  
“The unwinding process has already gone quite a long way but could potentially continue to feed significant outflows,” the IIF report states.
In addition, Chinese companies are not only paying down debt but also snapping up foreign companies like there is no tomorrow or are at least trying, like theChinese insurance company Anbang, which bid $14 billion for Starwood Hotels but later abandoned the offer.
However, companies are not the most important actors in the China currency game: It’s the Chinese people. They are allowed to transfer $50,000 overseas every year and can also invest in foreign stocks, bonds, and real estate through other channels or withdraw up to $15,000 with the UnionPay while traveling in foreign countries.
If only 5 percent of the Chinese population chose to use this limit, the whole $3.2 trillion would be wiped out. This is why investor Kyle Bass of Hayman Capital says China’s reserves are inadequate when measured against all the deposits which could be transferred. He said the currency will soon devalue.
Nick Lardy, a senior fellow at the Peterson Institute for International Economics thinks this is not the case and believes the outflows will stop as soon as companies have paid back their dollar debt.
“The view that the decline in China’s foreign exchange reserves is because panicked mainlanders are desperately seeking ways to get money out of the country is misinformed. Rather, the decline largely reflects the unwinding of the renminbi carry trade and Chinese companies paying off dollar debt, both of which are self-limiting. Thus, the market is unlikely to force a large currency depreciation,” he said in a presentation at the Peterson Institute.
However, both Société Générale and the IIF have compelling reasons to think the opposite is true, according to the Balance of Payments data. 
“Resident portfolio outflows remained modest but rose notably to $9.5 billion for equity and  $6.4 billion for bonds, highlighting Chinese (retail) investors’ increasing appetite for overseas securities,” the Société Générale report states.
“This process of international portfolio diversification has only just begun. At present, the home bias of Chinese investors is much higher than in mature economies, and this should gradually decline as income levels continue to rise and China continues to liberalize its financial account,” states the IIF.
Because the Chinese regime takes these flows seriously, it has done the opposite and stopped the liberalization of outbound investment but relaxed the criteria for foreign investment in Chinese bonds and stocks.
The IIF also recognizes that given this movement, reserves may be inadequate. “Reserves look less impressive by other measures, for example as a ratio to [bank deposits], (a measure of vulnerability to capital flight by domestic residents).”
So the traders betting against the Chinese currency may still get their rapid devaluation scenario, despite the recent recovery.
And Société Générale says now is a good entry point for the trade. “Determining an appropriate entry point is tough (especially after a painful position unwind), but risk-reward is the most compelling it has been in a while.”

Read the full article here

An introduction to lawyer, portfolio manager, government adviser, lecturer, and author James Rickards could easily be five pages long. Sifting through his CV, it’s easier to pick the things he doesn’t do rather than listing all the different jobs and responsibilities he holds and has held over the past decades. This is what is keeping him busy at this moment:
He is the chief global strategist at West Shore Funds, is a registered investment advisor, and he edits the financial newsletter Strategic intelligence. He advises the department of defense and also lectures at Johns Hopkins University among others. What he is best known for, however, are his two best-selling books about the global financial system, “Currency Wars” (2011, Portfolio Penguin) and “The Death of Money” (2014, Portfolio Penguin).
Both books have defined and predicted important trends in financial markets that the mainstream media and other commentators frequently overlook or pick up on years later.
Epoch Times spoke to Mr. Rickards about his new book “The New Case for Gold” (Portfolio Penguin, 2016), the coming reform of the financial system and China’s role as a source of global market volatility.
Read about why the Fed didn’t hike rates at its last meeting and why gold is the real money in part I of this exclusive interview with James Rickards. Skip to 14:16 in the video to directly delve into financial system reform and China.  
The powers will come together, they will reform the international monetary system.

Epoch Times: In your new book you quote the book of Revelations in the Bible, a quote about the new Jerusalem where the streets are paved with gold. But before we get to the new Jerusalem, there is some volatility according to the Book of Revelations. Where do you draw the parallels with our financial system at this moment?
James Rickards: I’ll leave the biblical interpretation to the scholars, I’m more of a financial analyst and a gold analyst. Clearly central banks have pulled out all the stops, they printed trillions of dollars, they’ve swapped trillions of dollars. They guaranteed the money market funds in 2008 and the guaranteed all the bank deposits. They did everything possible.
We might have avoided something worse that might have happened, like the Great Depression, but none of that policy has been reversed. The Fed’s balance sheet is still bloated. A lot of the swap-lines are still in place. They haven’t been able to normalize policy since 2008.
So what’s going to happen in the next crisis? And these crises come every seven to eight years. We go back to 1987, the stock market fell 22 percent in one day. Not a year, not a month but one day, 22 percent. By today’s Dow Jones Index that would be the equivalent of 4000 Dow points.
Now if the stock market fell 400 points I guarantee it would be on every evening business show, front page news, every website. Imagine if it fell 4000 points. That’s the equivalent of what happened in October of 1987. In 1994 we had the Mexican Peso crisis. Then we had a surprise interest rate hike, Orange county went bankrupt. In 1997/1998 we had the Asian financial crisis, the Long Term Capital Management (LTCM) crisis.
James Rickards with his book “The New Case for Gold” (James Rickards)
I was the general counsel for LTCM, and I negotiated that bail-out. I had a front row seat on that one. I know exactly how close global markets came to a complete collapse. We were within hours from shutting every exchange in the world. People forget about that but that’s exactly what happened.
In 2000 we had the dot.com crash, 2007 the mortgage crash, 2008 the Lehman and AIG panic. These things happen like clockwork. Every six, seven, eight, nine years. It’s been seven years almost eight years since the last one. How long do you think before another one comes? And yet they haven’t normalized policy, so what’s the Fed going to do the next time.
Are they going to print another $4 trillion? Legally they could, but they are at the outer limit of what they can do without destroying confidence. And confidence is the key to the whole thing.
Epoch Times: You talk about the concept of world money in your book, sponsored by the International Monetary Fund (IMF).
Mr. Rickards: So what you are going to see is world money. You are going to see the IMF print Special Drawing Rights (SDR). It’s a geeky name but it’s a kind of world money printed by the IMF. They’ll flood the world with trillions of SDRs. It might work because people don’t really understand what SDRs are. It might just blow by everybody.
At best it will be highly inflationary. At worst it won’t work because people will say, we’ve lost confidence in these other kinds of paper money and fiat money, why should we have any more confidence in that.  
And then you’ll see a gold buying panic and the dollar price of gold would skyrocket. It would be better if the leading financial and trading powers in the world sat down today in relatively calm times and did something like Bretton Woods and reform the international monetary system.
I think if they did, gold would play a role. I am not saying it would be a strict gold standard but I am saying gold would have some role. I don’t think that is going to happen. I think we are going to see a crisis first. Going back to your version of the Book of Revelations you have to have some rough times before you get to the good times.
The Chinese citizens love buying gold.

The powers will come together. They will reform the international monetary system, but they’ll do it in a state of collapse and panic rather than in a calm, orderly state.
In that world, people are going to go on their own gold standard. They’re not going to wait for the financial powers to create a gold standard, they’re going to have a gold standard of their own.

Read the full article here

The world has somewhat gotten used to the gradual meltdown of China’s foreign exchange reserves, down another $29 billion in February to an even $3.2 trillion, much lower than the $4 trillion peak in 2014.
What the market hasn’t figured out is how long this drain will continue and who is actually responsible for the capital outflows behind the foreign exchange drain.
Some commentators like Peking University professor Michael Pettis says China has more than plenty liquid reserves available to defend the currency, given its large trade surplus.
But he also warns, however, that losing $150 billion of reserves per month for a little bit longer will soon trigger a crisis of confidence.
A new report by investment bank Societe Generale sheds light on the origins of the outflows and concludes that a devaluation of the Chinese currency to at least 7.5 yuan per dollar is very likely in 2016.
(Societe Generale)
The reason: Most of the outflows come from ordinary Chinese who want to diversify from Chinese bank deposits, real estate, or the stock market.
“In the past six quarters (Q2 14 – Q3 15), a cumulative $657 billion of net capital has left China, mostly related to domestic resident outflows,” states the report. A large part of the $353 billion coming from the residents is the allowed quota of exchanging up to $50,000 per year.
The problem: “If only 5 percent of the population (65 million) choose to do this, the annual outflows would already equal to the entire stock of official reserves,” states the report, citing this type of outflow as the biggest risk to the stable currency regime.  
This is why even a trade surplus in the region of $500 billion per year will not be enough to offset 1.3 billion potential sellers of the Chinese currency.
As a consequence, China is mulling tighter capital controls again, a move which goes completely against the regime’s reform agenda.
Societe Generale’s China economist Wei Yao thinks this is coming, “including interbank, [outbound investment] and underground banking. Tightening capital controls on local residents, particularly the $50,000 conversion quota, will provide more bang for the buck,’ she writes.
So what would trigger a devaluation to 7.5 yuan per dollar in 2016? “If the pace of reserve selling remains fast for two to three quarters, the People’s Bank of China (PBOC) would come under mounting pressure to consider faster adjustments of the exchange rate.” Adjustment downward, of course.

Read the full article here

By and large, the market is used to China fiddling with its economic numbers, or making them up completely, like GDP figures.
The market, however, mostly believed the figures on foreign exchange reserves as well as capital flows released by the People’s Bank of China (PBOC) and the State Administration of Foreign Exchange (SAFE). At least until now.
According to the South China Morning Post, the PBOC removed a key number about foreign exchange transactions in the banking system for January 2016. The report in question is titled “Sources and Uses of Credit Funds of Financial Institutions.”
The January report only includes foreign exchange transactions by the central bank and excludes the remainder of the banking system. It also merged another item related to foreign exchange transactions of banks and the central bank into an “other” category, making it harder to distinguish economic actors.

Not the First Time
This change in methodology comes at a crucial time for China, which is bleeding foreign exchange reserves and foreigners as well as citizens are pulling out capital in record numbers.
Foreign exchange reserves at the central bank level decreased by $99 billion and the Institute of International Finance (IIF)estimates as much as $113 billion in capital left the country in January.
We have this on our radar as a significant risk to watch for. We are not the only ones who are worried about this.— Emre Tiftik, Institute of International Finance

Emre Tiftik, who tracks the data for the IIF, says he started to notice strange moves in the data regarding capital flows after the surprise devaluation of the renminbi last August.
“Starting from the third quarter, there are so many outliers in tiny places which created the impression officials are trying to reduce the outflows,” he says.
An example is the category of “other assets,” in the capital account which represents “other” inflows into China. According to Tiftik, it wasn’t much higher than $50 million per quarter and then suddenly increased to $100 billion in the third quarter, reducing the net number of outflows.
Outward direct investment, the money Chinese are investing abroad also turned sharply negative, which means Chinese are selling foreign assets and repatriate the money. Another reduction in the total outflow figure.
“They completely changed the outward direct investment figures, they were -$30 billion now they are -$45 billion,” said Tiftik.
MORE:Steve Keen: China’s Stock Market Is an ‘Unbelievable Bubble’
Robin Koepke, chief economist at the IIF notes another instance of data manipulation occurred in the middle of 2015: “This is a massive problem. We had the same issue when they started reporting more data on equity portfolio flows in early 2014 and then stopped in the summer of 2015, right when the markets became volatile,” he says. The last number of June 2015 shows an outflow of $11 billion.
Without adjusting for all these erratic moves, the IIF estimates $637 billion left China in 2015.

But the people at the IIF and the South China Morning Post aren’t the only ones missing data on China’s foreign exchange holdings or transactions.
Last October, Harvard professor Carmen Reinhart noted the Federal Reserve had stopped separating official and non-official foreign holders of Treasury securities in the Flow of Funds report.
China is becoming the capital provider to the rest of the world.— Emre Tiftik, Institute of International Finance

“They always reported ‘Rest of the World,’ and then within ‘Rest of the World’ they segregated ‘Official Institutions’ from ‘Non-Official.’ In the last couple of reports, they stopped separating into ‘official’ and ‘other.’ ‘Official’ were foreign central banks. Within foreign central banks, China was in a league of its own. I don’t know really what prompted that change,” she said.
What Happens Next
When officials stop releasing certain data, it usually doesn’t bode well for the future. In 2006, the Federal Reserve stopped releasing data on M3, a measure of the money supply, which included so-called repurchase agreements or repos.
In 2008, Lehman Brothers went bankrupt after financial markets found out it funded itself almost exclusively with short-term repos, had borrowed too much to begin with, and most likely wasn’t able to repay its lenders.
MORE:Market Forces Could Push China to the Brink
As for China, Tiftik thinks Chinese people are going to move money out of the country wholesale and foreigners won’t move a lot of money in.
“We believe that non-residential inflows [investment by foreigners] are going to be weak in 2016. Residential outflows [investment abroad by Chinese] are going to increase in 2016. China is becoming the capital provider to the rest of the world. This is unavoidable, this will happen,” he said.
This is only possible, however, if China sticks to its agenda to liberalize the current account and does not impose more capital controls because of outflows.
With a closed capital account and stable exchange rate “the Chinese [regime] invested foreign exchange on behalf of private parties. They collected reserves and invested them in Treasurys. Now the residents and the corporates are starting to provide capital to the rest of the world with the capital account liberalization,” says Tiftik.
Will this move lead to a rapid devaluation of the yuan versus the U.S. dollar?
“We have this on our radar as a significant risk to watch for. We are not the only ones who are worried about this.”

Read the full article here

Until now, most of the action has been taking place overseas, far away from American shores. But in an interconnected global economy and financial system, the China crisis is already impacting the United States and will soon impact you too—both positively and negatively.
Financial markets reacted first. China’s stock market is down 22 percent this year. Japan is down 14, Germany 16 percent, all of them extending their slump from 2015.
Relatively speaking, the United States is doing well—the S&P 500 is only down 9.3 percent. But even America won’t be able to save itself from the contagion of a Chinese economy on the edge of the abyss.
Growth in China has slowed to a number much lower than the official 6.9 percent. Capital is leaving the country by the hundreds of billions of dollars every month, the stock market is crashing, and the currency depreciating.
The Ghost of 1997
“There are worries about a rerun of [the 1997 Asian financial crisis] of a series of competitive devaluations,” says Sherle Schwenninger, director of the World Economic Roundtable at the think tank New America Foundation.
Whether competitive or not, almost all emerging market currencies from the South African Rand to the Turkish Lira and the Chinese renminbi are falling against the dollar, exacerbating a problem which started in China in late 2014.
Schwenninger says if emerging market currencies fall in value, dollar debt increases in value, which makes it harder for companies and countries to pay it back. And it’s not just China that has lots of it, $870 billion according to the Bank of International Settlements.   
Those two factors together, China and commodities, are both stimulative for the world economy and a central part of the adjustment to get away from the post crisis distortion.— Charles Dumas, Lombard Street Research

“The larger amount of corporate dollar debt is held by Asian economies and the Western exposure ripples through London Hong Kong and European banks. … The Hong Kong banks are heavily exposed to China’s state owned enterprises,” says Schwenninger.
“Deutsche Bank is a perfect example. They are knee deep in all that stuff,” says Jeffrey Snider, chief investment officer of Alhambra Investment Partners. Deutsche Bank shares are down 39 percent this year, a little more than the shares of Swiss bank Credit Suisse (-35 percent), which Snider says invested too much in its Fixed Income, Currencies and Commodities (FICC) division, or everything that is suffering right now. As a comparison, U.S. bellwether JPMorgan Chase & Co. is only down 13 percent.   
But the banks aren’t just exposed to corporate debt from Asia. The China slowdown has wreaked havoc among energy and commodity traders and producers alike.
Commodity Carnage
“There are systemic linkages to the international financial system. Major commodity firms may end up defaulting in 2016. This is coming to play out in the coming months as more and more cracks are appearing in the commodity complex,” says John Butler, head of wealth services at Gold Money.

Energy and commodity producers world-wide were counting on China to keep on growing 7 percent every year indefinitely and invested hundreds of billions to expand supply.
Once demand for commodities started slowing in China, prices for copper (down from $4.5 to $2.12 per pound since Jan. 2011) and iron ore (down from $180 per ton to $38 per ton since 2011) crashed. China is not alone responsible for the decline in the oil prices (West Texas Intermediate is down to $31 from a little over $100 in 2011) but this trend is also hurting producers and the banks who underwrote the loans to energy companies.
“People were holding oil and copper and other things not because of good fundamentals but because they thought the returns there would be greater than in Treasurys and German government bonds. A lot of that money has come out of the market. Hedge funds have been delevering and liquidating their positions in the China growth story. You had the rush of money out, which creates a contagion effect,” says Schwenninger.
I think the idea is that you feel so smart and so wealthy because of appreciating asset prices that you are led to consume more. I think the empirical evidence for this wealth effect is very, very slight.— James Grant, Grant’s Interest Rate Observer

“There is a lot of bad collateral out there, there is a lot of junk debt that has been overvalued and it is going have to be written down,” says Butler.
Shares in British commodity trading companies like Glencore PLC is down 62 percent over the last year. The mining company Anglo American PLC is down 68 percent and announced it would fire tens of thousands of its work force.  
Multinational Impact
Even if U.S. banks for once are not exposed to the epicenter of the crisis, the fact that three large sectors of global multinationals (banks, commodities, and energy) are on the defensive means it has an impact on the earnings of U.S. multinationals as well.
“American multinationals who depend on global markets are going to be hurt competitively, and we have seen that show up,” says Schwenninger. Apple Inc. is down 11 percent in 2016, partly due to a bad earnings report, which blamed China for weak iPhone sales.
Apple’s share price year-to-date (Google Finance)
“We are coming off four or five quarters of negative earnings growth,” says Snider, who also believes the market has lost faith in central banks to fight off a global crisis. “It’s the idea of transitory. It’s all short term, don’t worry about it,” he says has been the mantra of global central banks the market has believed in so far, but not anymore. “The fact it has dragged on over a year, the idea of transitory and temporary weakness is no longer plausible.”
So how does this affect you? Unless you own a lot of stocks in general or the weak sectors in particular or you work for a shale gas producer, the whole China slow-down could actually have a positive effect on the consumer.
We are coming off four or five quarters of negative earnings growth.— Jeffrey Snider, Alhambra Investment Partners

It’s the exact opposite of

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The central bank of China probably regrets having released this one last data point before the Chinese New Year on Feb. 8. The celebrations could have been so much nicer without it. 
Some analysts estimated Chinese intervention in the currency markets in January was as high as $185 billion, intervention which burns through China’s foreign currency reserves. 
According to the latest data released by the People’s Bank of China (PBOC) just before the new year, these estimates were a bit too high, but still. China lost $99.5 billion of its foreign exchange stash, which now totals only $3.23 trillion.
There were several hints that China would bleed more reserves in January, which is not exactly the same as intervention in the currency markets, but is a good indicator. For instance, the PBOC pushed  $233 billion into the domestic financial system in January.
China’s foreign exchange reserves as of Jan. 2016 (Bloomberg)
This is the highest number in years and the extra liquidity is supposed to make up for foreign exchange sales, which shrink the central bank’s balance sheet and drain liquidity from the banking system.
When the central bank sells dollars to prop up the exchange rate, it has to buy yuan from whomever wants to buy the dollars. Those yuan then vanish from the financial system in an accounting exercise on the PBOC’s balance sheet. This exercise has a negative effect on liquidity in the financial system and by extension the whole economy.
This is why China has to inject the massive amounts of new yuan into the system and lower interest rates as well, which ironically leads to more pressure on the exchange rate.
As to actual capital flows for January, we won’t know until data on foreign direct investment as well as the trade balance come out later in February. Usually those bring dollars into the country and a very simple estimate of capital flows just adds the drop in foreign exchange on top of those two numbers. Foreign direct investment usually adds $100 billion, whereas the trade balance averages around $50 billion. Unless there are significant changes in these numbers, total outflows could be as high as $250 billion. 
There are other numbers which influence the reserve figure, such as currency moves which influence the total value of China’s portfolio. It also includes assets denominated in other countries, although the exact composition is a secret.
The International Institute of Finance recently used a more elaborate method to estimate that $676 billion of capital left China in 2015, but the country sold only $513 billion of reserves over the same period, which are also subject to valuation effects.
“With such leaky capital controls, China’s war chest of $3 trillion won’t be enough to hold down the fort indefinitely. In fact, the more people worry that the exchange rate is going down, the more they want to get their money out of the country immediately,” writes Harvard professor Kenneth Rogoff on Project Syndicate. 
As to who is moving the capital out of the country, Goldman Sachs has a pretty good idea.
“The estimates, though, do seem to suggest that the incentive for Chinese residents to accumulate foreign assets appears to be the biggest swing factor to the capital flow picture and the trajectory of the yuan,” a report states.
One preferred method to get money out of a country with capital controls is overpaying for services abroad (mostly tourism), which created to a pretty suspicious service sector deficit recently.  In fact, the service sector deficit for 2015 was a record $137 billion, up 14.6 percent over the year.
And it gets even worse. If China didn’t have capital controls, which it has been tightening recently, Goldman thinks its citizens would invest 60 percent of GDP abroad. That’s more than $6 trillion and too much for China’s foreign exchange reserves.

Read the full article here

After some terrible data in January, the Chinese economy is out of the woods for the rest of the year. The Chinese lunar year that is, because until February 7, 2016 there are only two official data releases, none of them terribly important.
But even if we will be spared confusing trade data, bad manufacturing and GDP figures, as well as the constant drain on foreign exchange reserves, it doesn’t mean analysts can’t come up with their own estimates of economic data and spook the markets.
Like the International Institute of Finance (IFF) for example, which said Chinese capital outflows were as high as $676 billion in 2015.
International Institute of Finance
“The 2015 outflows largely reflected efforts by Chinese corporates to reduce dollar exposure after years of heavy dollar borrowing, as expectations of persistent yuan appreciation were replaced by rising concerns about a weakening currency,” the report states.
This behavior refers to the infamous “carry-trade” where investors borrow in a country with a low interest rate (the United States) and invest in a country with a high interest rate (China).
In previous cases of this carry trade phenomenon, it was usually international banks or hedge funds doing it. This time is was Chinese corporations, which in the absence of some real economic opportunities on the ground also used to engage in real-estate speculation while the sector was still hot.
“Chinese money is going into real assets in the West and to some degree repaying foreign currency debt.”— Charles Dumas, Lombard Street Research

This carry trade was a safe bet because the Chinese central bank guaranteed the yuan to be stable vis-a-vis the dollar or even let it appreciate a bit. This convincing value proposition let Chinese gross external debt double since 2009 to $900 billion in 2014.
This safe bet changed when the regime surprisingly devalued the yuan in August and openly stated it would like to have a cheaper currency, even though Charles Dumas of Lombard Street thinks the market gets the causality wrong.
“They are reading the regimes desire to have a weaker currency because the economy is weak. The cause and effect is the other way around. It’s the weakness in the economy which is driving the currency and the market.”
(International Institute of Finance)
Whichever came first, the chicken or the egg, there was pressure on the currency since the end of 2014 as the smart money (i.e. the politically connected) started to move out.  
Once the regime confirmed its new currency policy, the flood gates opened and carry-traders scrambled to close a now losing position, not knowing how much the yuan was going to drop against the dollar.
“Foreign investors in local currency products have faced large losses measured in dollar terms and domestic borrowers in foreign currency have suffered balance sheet losses from currency mismatches,” states the IFF report.
But it’s not only the carry traders and the smart money who are moving their money out. Average Chinese are funneling money out of the country in record numbers as well, despite the capital controls.
“[The] data showed a broadening in the pattern of net outflows, including a significant decrease in foreign direct investment and, to some extent portfolio flows, especially debt, and a jump in unrecorded outflows reflected in errors and omissions.”
The IFF thinks these $216 billion worth of “errors and omissions” are a good proxy for capital flight.
“Chinese money is going into real assets in the West and to some degree repaying foreign currency debt,” says Dumas.
The regime desperately tried to contain the situation by openly intervening in the foreign exchange markets, spending up to $405 billion according to IFF estimates, but the yuan still dropped 5 percent since last January.
As for both the Gregorian and the Chinese 2016, the IFF doesn’t think it will get any better. “China would see further large overall capital outflows as it continues to struggle against macroeconomic headwinds and to intervene heavily to stabilize its currency,” states the IFF report.
According to Dumas the current monthly outflows are as high as $100 billion.

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Even before the work week starts properly on Monday morning on the East coast, the bad news from China are already flowing in Sunday evening because of the time difference.
This time, the Shanghai Composite is down another 5 percent to 3017 on Jan. 11, minus 15 percent for the year. On the upside, the yuan is only down 0.1 percent against the dollar and its little brother, the offshore yuan (mostly traded in Hong Kong) is up 1.2 percent to 6.60 per U.S. dollar.
Of course, it wouldn’t be China if the regime hadn’t intervened heavily in both markets. For the stock market, all it could do was to prevent it from dropping more by buying stocks without caring for the losses.
And the losses for the regime are substantial. Goldman Sachs estimates the regime bought stocks worth 1.8 trillion yuan ($270 billion) from June to November of 2015 to prop up the stock market after the July crash.
(Goldman Sachs)
The so called “national team” spent the money in vain, as prices approach the August bottom of 2927 for the Shanghai Composite.
As for the currency, and especially the offshore yuan (down 2.3 percent for the year already), the Chinese central bank made it go up on Monday, but it also paid a heavy price for it.
Overnight interbank lending rates in Hong Kong went up a ridiculous 9.39 percentage points to 13.4 annualized on Monday, a sign that the interventions on the currency market are draining liquidity from the interbank market. This is the highest rate on record.
The movement in the currency and the interbank lending rates is a perfect example of how putting out one fire stirs up another, a problem the regime finds impossible to manage since the shock devaluation of last August.
The offshore yuan (the ticker is CNH and there are about $230 billion of them) sit around as deposits on the balance sheet of private banks, mostly in Hong Kong.
When the Chinese central bank buys up these deposits and hands out dollars in exchange, these deposits are no longer available for private use not even for private banks. They are now locked up on the central bank’s balance sheet.
So if a bank now needs offshore yuan, there are now fewer of them sloshing around in the market. Because there are so few of them to begin with ($230 billion is really nothing compared to the size of the euro or the Japanese yen foreign exchange markets) the market is very sensitive to changes in liquidity and banks have to pay a high interest rate to get the offshore yuan funding they need.
The same is true for the domestic stock market. When the People’s Bank of China sells dollars and buys yuan in the market, those yuan aren’t available for private use anymore, like for investing in the stock market. As a result of the intervention, the stock market—and everything else for that matter—goes down.
The only solution to the problem of the impossible trinity: Let the currency go free.

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China is probably looking forward to the new year. A fresh start on Feb. 8, putting all the currency chaos behind.
This may well remain wishful thinking, as events are going from bad to worse—and Jan. 6 is no exception.
The Chinese yuan fell 0.6 percent—this is a lot for a big currency—to 6.55, the lowest level since March 2011. Traders dumped the yuan after China’s central bank fixed its value 0.22 percent lower, another official devaluation.
China first devalued the yuan in August of 2015 and then intervened with great force in the market to keep its value relatively stable, spending $255 billion of its foreign currency reserves by the end of November.
China’s foreign exchange reserves as of Nov. 30, 2015. (Bloomberg)
After the International Monetary Fund included China in its basket of reserve currencies in November as well, Beijing reduced the reserve burn and let the currency drift down gradually.
Beijing also gave the market a fair warning, as it said it would index the value of the yuan against a basket of currencies, not just the U.S. dollar.
The yuan’s value in U.S. dollars dropped in 2015, but it rose against the trade-weighted basket. This gives Beijing justification to further devalue against the dollar.
(Capital Economics)
“China is going to have to dramatically devalue its currency,” Kyle Bass, principal at Hayman Capital Management LLC., told Wall Street Week. He thinks the devaluation could be as much as 20 percent.

So investors took heed and are getting out of the yuan as fast as they can. After all, why stick around to lose money in a falling currency. The problem: This herd behavior leads to, you guess it, a falling yuan. 
And while Chinese regulators can stop them from wantonly selling the mainland currency (CNY) because of capital controls, nobody is stopping them from selling the freely traded offshore yuan (CNH), mostly traded in Hong Kong
READ about China’s two different currencies here
The CNH dropped 1.1 percent against the dollar, trading as low as 6.70, the lowest since September 2010. The spread between the mainland and the offshore currency also widened to a record 2.5 percent.
Capital Outflows
Behind the move in the currencies is the tectonic shift in capital flows. Up until 2014, China attracted capital, driving the exchange up. Now capital is moving out, driving the exchange rate down.
“You’ve gone from a period which you had this one-way bet—the currency was going to appreciate, capital inflows—to the reverse. Having a period in which your own residents want to diversify into something else,” says Harvard professor Carmen Reinhart.
She thinks China is facing “a significant internal debt crisis,” which is why domestic citizens and international investors are moving their money out.
READ Carmen Reinhart on China’s Debt Crisis
“You do have a shift in capital flows and in fact, that shift has also accelerated purchases of real estate in London, in Boston, in New York. You see that it’s not just Treasurys. We see that from China and we see that from Russia,” she says.
Bloomberg estimates as much as $367 billion of capital left China in last three months of 2015. Epoch Times previously estimated capital outflows of $850 billion in the first nine months of 2015, so the total could be more than $1.2 trillion, the same as Societe Generale’s worst case estimate. 
China’s big trade surplus is the reason it didn’t have to sell more foreign exchange reserves to keep the currency from collapsing. 
Why Devalue
There is nothing China can do against the capital flows per se, expect for completely reforming its economy.
It can intervene in the markets by selling its foreign currency reserves to stop the exchange rate from collapsing. For the onshore yuan, it can also enforce capital controls more strictly, which it has done, but that goes against the promised reforms. 
However, given only bad choices, managing a gradual devaluation in the offshore and onshore yuan is actually the best of the worst.
Past currency crises, like the British pound devaluation in 1992, the Asian financial crisis in 1997, and the recent Ruble crash, show the value of the currencies will always drop to its equilibrium level—no matter how much a country spends intervening in the market.

So if the currency has to drop, China can at least keep its large stash of foreign currency reserves, although cynics may then ask what good are they for after all. 
“The foreign exchange reserves are just that: they are foreign. They are not renminbi [RMB]; they are not money that can be brought to bear domestically,” says Fraser Howie, author of “Red Capitalism.”
A lower currency on the other hand will support the country’s export sector, which, thanks to rising land and labor costs, is not as competitive as it used to be. Kyle Bass thinks a devaluation will help China “come back to some level of competitiveness with the rest of the world.”
It needs to compete not to generate growth, as many think. Although the Beijing Academy of Sciences just estimated GDP will only grow 6.7 percent in 2016 (below the official target of 7 percent)—it is employment and public sentiment that matters most to the regime.
The export sector still contributes around 10 percent to total employment.
Gordon Chang, author of “The Coming Collapse of China” says: “Where you have people just sick and fed up, especially when the system is no longer delivering prosperity. When you have real serious economic problems, I think people are going to say, ‘I’ve had enough.’”
Until then, the yuan has a lot further to drop.

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To its credit, China actually implemented a couple reforms this year. Does this mean, it will let markets rule? Most likely not. Because when push comes to shove, China will stop reform and subdue market forces.
Case in point: The central bank and regulators now micromanage the foreign exchange market and have suspended at least three foreign banks from foreign exchange trading until March 2016, according to Reuters.
They also asked banks to disclose names of clients with the intent of stopping state owned enterprises from buying foreign currency.
“They are worried about falling foreign exchange reserves. The yuan faces obvious depreciation pressure as the Fed (U.S. Federal Reserve) may continue to raise interest rates, so policymakers are concerned and intend to take effective measures to respond,” a senior economist at a think-tank linked to China’s Cabinet told Reuters.
Massive capital outflows have pushed the onshore and the offshore yuan down to levels not seen since 2011. Some people in China’s regime might welcome this move, as it could boost exports and prevent mass unemployment.
“Capital flows depends on China’s economic fundamentals; we shouldn’t worry too much about short-term capital outflows if we are confident about our economic fundamentals. The direction of capital account reforms will not change,” a government policy advisor told Reuters.
Some others want to micromanage it, fearing outflows may spiral out of control and hurt the country’s economist stability. Because of the economic law of the impossible trinity, China can’t have a stable currency, independent monetary policy, and a free capital account at the same time.
For now, it seems policy makers sacrifice the free capital account—originally on the reform agenda—for a stable exchange rate.
MORE:Was 2015 a Historic Turning Point for the Chinese Economy?
In November, “Red Capitalism” author Fraser Howie said China hasn’t really been tested with regards to letting market forces play out in the foreign exchange market.
“You don’t simply have a free trading currency just because you say so. How is China going to respond in times of crisis?”
Judging from the reaction of Chinese authorities to the continued drop of the yuan, we now have a crisis and we also now know how the authorities respond.    

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China is growing fond of currency baskets. After the International Monetary Fund added the yuan to its reserve currency basket, China decided it wants to use a basket to track the exchange rate of its currency, rather than just the U.S. dollar. 
This opens the door to further yuan depreciation, not to increase growth, but to prevent mass unemployment. 
China has tracked the movement of the dollar until 2005, when the People’s Bank of China started to adopt a softer peg, but still kept the exchange rate under close control. This summer, the PBOC almost abandoned the peg and devalued the yuan, much to the surprise of the market. Since then it has gradually managed the decline against the U.S. dollar and that’s where the new basket comes in.
Like the IMF’s special drawing rights (SDR) basket, the trade weighted index of the PBOC is an empty basket. It just provides a reference to the value of the Chinese yuan compared to the currencies of its most important trading partners.
The U.S. dollar expressed in Chinese yuan. Down means yuan appreciation (Google Finance)
Under normal circumstances this is hardly worth mentioning. The U.S. dollar index or DXY is exactly the same and nobody ever thought it strange.
These baskets help to gauge policy makers whether their currency is over or undervalued against its most important trading partners. In the case of the Chinese currency for example, the yuan isn’t much overvalued compared to the U.S. dollar, but more so against other currencies.
The Chinese yuan compared to several global currencies (SLJ Macro Partners)
The Chinese Foreign Exchange Trade System (CFETS), which is part of the PBOC and calculates the basket, said as much in its original press release: “Therefore, the renminbi is a relatively strong currency among the major international currencies.”
Mark Williams, chief economist of Capital Economics says: “Because of the link to the strengthening dollar, the renminbi has appreciated significantly in trade-weighted terms. Yet any sustained weakness in the renminbi relative to the dollar tends to be interpreted as ‘devaluation’ and trigger market concerns.”
Yes, the mini devaluation in August did not even reach 3 percent and yet financial markets across the world went haywire at the end of the month.
Since the IMF added the renminbi to its SDR basket, the PBOC let the yuan drop for seven consecutive days as of Dec. 15, the biggest devaluation record, again very much under the scrutiny of the media and financial markets.
 The yuan dropped another one percent against the dollar since Nov. 16, the day China was all but certain it would get the approval for the SDR.
If China wants to significantly devalue against all of its major trading partners, it will have to devalue even more against the dollar, which only makes up 26 percent of the basket and has been rising against other big currencies like the euro or the yen, taking the yuan with it on its rise.  
The renminbi expressed valued against the new CFETS indext and a BIS index (Goldman Sachs)
Because “the authorities have increasingly drawn public focus to the renminbi’s performance on a trade-weighted-index basis rather than simply against the U.S. dollar, it reinforces the likelihood of moderate depreciation versus the U.S. dollar, should the broad U.S. dollar continue to strengthen,” Goldman Sachs writes in a note.
In other words, according to Goldman Sachs, it gives Beijing an excuse to say, “Our currency is very overvalued and we need to depreciate, especially against the U.S. dollar.”
Analysts at Macquarie think the yuan could weaken as much as 5 percent against the dollar in 2016. Most analysts, however, believe the yuan is about 15 to 20 percent overvalued on a trade weighted basis. With the new excuse in the form of the basket, this makes are larger devaluation against the dollar more likely.  
Why They Are Doing It
Why is China going to great lengths to justify devaluing its currency not just against the U.S. dollar but also against the currencies of its major trading partners?
Many analysts believe it’s because China wants to boost growth through exports. This, however, is unlikely.
“They were at the peak which was just a few years ago. Their net exports were 8 percent of GDP. Now it’s just a couple of percent of GDP,” says Richard Vague, author of “The Next Economic Disaster.” Net exports contribute almost nothing to GDP growth.
According to World Bank data, the share of total exports of GDP has been declining to 22.6 percent in 2014 from 25.5 percent in 2011. So what is all the fuss about?
China’s and the world’s share of total exports as a percentage of GDP (World Bank)
Trade still significantly contributes to employment in China.
“China is so much about jobs as opposed to profits, it is very important for the government to maintain jobs,” says billionaire investor Wilbur Ross of WL Ross & Co.  
It’s especially important to maintain jobs when the economy is slowing down and labor costs are becoming less competitive. In this respect, 2015 was a complete disaster:
“From January to November 2015, China’s exports of labor-intensive products contracted by 6 percent year on year while exports of hi-tech products were flat. China’s processing exports, which are built on low labor costs, fell 10 percent, while China’s ordinary exports increased by 2 percent,” investment bank Macquarie writes in a note.
According to a report by the Bundesbank, employment from exports was still 80 million people in 2009 (or 10.2 percent of total employment) down from 99 million in 2007 (12.9 percent of total employment).
Although the report was released in 2014, the data from 2009 is a bit dated and also reflects the fall in employment because of the financial crisis.
According to a report by the George Washington University, more than 20 million people lost their jobs in Chinese coastal areas after the financial crisis—the main reason China started its infrastructure and investment program, which provided work but also produced massive overcapacity.
Exports picked up shortly after for a couple of years but have been declining for the last five months in 2015.  
Because investment spending is

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The only thing China had to wait for was the official inclusion into the International Monetary Fund’s (IMF) reserve currency basket.
Now it can devalue its currency as it pleases—and it may not even have a choice.
“A devaluation could be as much as 20 percent against the U.S. dollar because in real effective exchange rate terms the yuan is about 15 percent overvalued at the moment,” says Diana Choyleva, chief economist at Lombard Street Research.
The Chinese currency has gained 15 percent against other major currencies since the middle of last year, according to an analysis by Westpac Strategy Group.
On cue, China set the yuan at 6.414 to the U.S. dollar Wednesday, its weakest level since August 2011 and down 3.4 percent since the mini-devaluation in August.
Choyleva thinks the IMF inclusion may have even prevented a sharper one-off devaluation. “They would not be so keen to be a responsible citizen,” she says and expects further gradual devaluation.
Macquarie analysts also believe Beijing now likely won’t “risk their credibility by devaluing the yuan sharply after that.”
But while there is clarity as to how (gradual) and how much (15-20 percent) China will devalue, there is still confusion as to why they have to do it.
Market observers usually cite exports as the major reason for a cheaper currency. In theory, prices for Chinese goods would become cheaper on international markets so volumes would pick up.
In practice, this rarely works, as imports become more expensive, as China is a big importer too.
In addition, trade just doesn’t contribute that much to the Chinese economy anymore.
“They were at the peak which was just a few years ago. Their net exports were 8 percent of GDP. Now it’s just a couple of percent of GDP,” says Richard Vague, author of “The Next Economic Disaster.”
Exports make up even less of GDP growth, barely visible on the chart below. Consumption and investment make up most of Chinese GDP growth.
To fire up consumption and not let investment drop of a cliff, China has lowered interest rates 6 times this year.
“You have had six interest rate cuts in the past year. And yet the economy is meant to do fine at 7 percent or so. And that doesn’t tally with the reality on ground—the economy is growing much slower,” says Fraser Howie, author of “Red Capitalism.”
It’s the combination of low growth and easy money which puts pressure on the currency. Because the regime created a debt bubble of epic proportions and investors now realize they won’t get the promised returns, capital is flowing out of the country at a record pace.
Until the imbalances are fixed and China takes its losses, and stops the easy money policies, outflows will continue and the regime will face continued pressure to devalue.

So far, the regime has managed the decline by selling foreign exchange reserves. Purely from an economic point of view and disregarding the IMF power politics, it would be better do correct the imbalances with a one off devaluation.
History teaches us that countries spend foreign exchange reserves to defend their currencies and most have to devalue in spite of it. The Russian ruble is a good example from the recent past, the Asia currencies and the British pound are good ones from the 1990s.
So if you can’t have your cake and eat it too, why not just keep it?

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When China reported another month of foreign exchange outflows Dec. 7, analysts were hoping trade numbers on Dec. 8 would be the saving grace. They were not.
Exports fell 3.7 percent in November, the fifth consecutive decline. Imports dropped 5.6 percent, the 13th consecutive decline. The drop in activity brought down the trade surplus to $53.5 billion. All three numbers came in below market expectations.
If China has a trade surplus, it means foreign exchange is flowing into the country to counteract outflows of capital.
If trade slows down further, the pressure on foreign exchange reserves and the currency will only get worse.
“A Lower trade surplus is one of the drivers of the fall in foreign exchange reserves … All else being equal, this combination of trade data tends to put more pressures on the yuan to depreciate,” Goldman Sachs writes in a note. 
So the weak trade data translated into a weaker yuan on Dec. 8. It fell 0.14 percent to 6.4172 a dollar, the weakest close since August 2011.
Many analysts speculate a weaker Chinese currency could bolster exports.
“The yuan is the only major currency that is overvalued and Beijing is the only one that has not engaged in the currency war,” says Diana Choyleva, chief economist at Lombard Street Research.
Investment bank Macqurie, however, doesn’t think it will help much, because most of its competitors have devalued already. “It’s hard for China to use devaluation to grab more market share. It also means that China has to rely mainly on domestic demand to bolster growth,” it states in a note to clients.

However, sometimes bad news is good news, according to research firm Capital Economics. 
“The sharp fall in commodity prices at the end of 2014 along with the weakness in exports at the start of this year will soon provide a much more flattering base for comparison,” it states in a note. In other words bad data from the past will make for good data in the future. 

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After a pretty rough ride in the summer, China is staging a comeback in the fall. 
Just as the International Monetary Fund is about to decide whether to include China in the world’s reserve currency basket, the stock market is rallying, up 15 percent over the past months.
Large swings in China’s stock market are pretty common, but there is another indicator that has turned around: foreign exchange reserves.
They rose by $11.4 billion in October. The market expected outflows in the range of $50 billion, similar to the drain plaguing China for over a year.
The depletion of China’s massive pile of reserves ($4 trillion at the peak in 2014) means capital if leaving the country, and has been for a while. Now the sudden and unexpected change. 
Does this mean the trend of capital flight has reversed for good? Most likely the answer is no for several reasons. 
First of all, nobody really knows what’s included in China’s $3.5 trillion piggy bank. If the market value of the portfolio appreciates by only 1 percent for example, FX reserves rise by $35 billion without anybody moving a finger.
Goldman Sachs says: “Besides currency movements, there could also be significant valuation effects from changes to the market prices of the People’s Bank of China’s investment portfolios, and those effects are hard to estimate given the uncertain asset composition.”
In addition, China is hiding outflows with derivative transactions through state-owned banks, which may only register at a later date. 
For example: Factoring in banks’ derivative positions, China’s foreign exchange reserves dropped by $110 billion in September compared to official figures of $43 billion, according to Goldman.
Nomura found movements in the currency markets support the argument China was still intervening to support the yuan in October.
“Intervention was especially heavy on Oct. 30 when both onshore and offshore yuan gained substantially against the dollar. Daily volume transacted was also larger than normal on Oct. 30.
Price movement of the U.S. dollar compared tot eh Chinese yuan on in October. (Nomura)
Also, foreign exchange reserves are just one element of the total movement of capital. Foreign money is still moving into China through trade (roughly $61.6 billion in October) and other channels, but the largest portion of it flows straight out again.  
MORE:As Much as $850 Billion Left China So Far This Year
So despite the small break in October, Nomura believes outflows will continue in the medium term: “We see some risk of increased capital outflows from locals as well as increased investment outflows especially as China’s capital account liberalization continues.”

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