In the recent decade ( 2003-2013) , world has witnessed,China’s tremendous Economic growth powered by its diversified export oriented economy ,with sizeable import of raw materials like Coal,Iron ore,Petroleum products etc. to meet its domestic energy needs.In 2013,china had a total trade surplus of $259.24 billion by exporting goods worth $2.63 trillion & has $3.5 trillion in its Forex reserve. With this amazing monetary figures one may think that China has strong economic credentials & a disciplined financial system & is definitely marching ahead,with its contemporaries especially in the BRICS community still struggling to keep their economic condition afloat,while rest of the global economic powers gradually recovering from 2008 economic shock. More often ,china’s newly earned economic might is compared with US and an intense debate ensues that who owns whose key to economic interdependence & how it affects America’s Asia-Pacific policy & China’s gameplan in South China sea,Indian Ocean Region,Persian gulf, Middle East ,Aghanistan & in African continent.So,this further triggered my curiosity to delve into the chinese economic system,which is one of the important factor contributing to its huge military modernisation programme & her aggressive behaviour in the South China & East China sea ,with its growing clout in African countries.
In free market economies like India,Indonesia,Japan,European Union,US,UK and other western countries their currency value fluctuate depending upon Domestic & International Market conditions,Sovereign Debt ,Trade Imbalance (Import & Export), Monetary Policy ( as decided by their Central Banks like RBI,US Federal bank) , Political Stability etc.,whereas China, fixes the exchange rate of its own currency (YUAN) against Dollar ($) & other leading currencies every morning before the transactions begin in its stock markets i.e around 0915hrs (UMT+8). So basically it has a very tight economic system with two key players acting as the main controller of its financial structure : The Chinese Government ( ran by Communist party of China) & People’s Bank of China (PBoC)- china’s central bank).
So the moot question is how China despite wavy world economy manipulating its Currency & keeping its value intact ….. ?
Unlike emerging economies (India,Brazil,South Africa etc.) China doesn’t need foreign currencies to finance its trade & investments abroad ,rather she borrows loans to finance her banks and then banks lend each other to keep ailing domestic companies afloat.So you can say that this borrowed money provided china’s financial system with easy liquidity(cash).But the interesting part of this cheap money lies in the way it is raised.Here PBoC (People’s Bank of China) plays a crucial role to push or pull the value of Yuan.So as to secure loan from foreign banks, it issues Letter of Credit (LC- they are meant to assure seller of any product that it will get paid on behalf of the buyer once the product is delivered to the buyer) to real as well as shell companies ( frontline companies created to carry out transactions with no real manufacturing activity) ,when they provide PBoC with trade order (trade order contains information regarding selling/buying of any products),the bank in turn use the Trade Order as its collateral and get the Loan amount from the foreign bank,then it converts the money received in Dollars into Yuan & provide the amount to the respective Companies ,who then invest the money in its Stock markets ,Housing properties,manufacturing activity etc.The bank in turn pocket the Commission arising out of the difference in the value of currencies dollar & yuan ,when the loan is repaid by the bank at the end of the loan period to the foreign bank. The PBoC prints yuan, hands it to Chinese banks, which print up LCs for Chinese companies (or help facilitate the trade credit directly with a foreign bank). Foreign banks then issue dollar loans with the LC (or an asset) as collateral,and those dollars are swapped for yuan, given back to the Chinese company, which then invests it in China = Instant finance,no hassel.
Chinese government doesn’t track the issue of LCs & Chinese Banking Regulator doesn’t hold LC’s as loan ,else they would have caught this new from of instant money making business of their banks .Currently,Chinese banks have issued outstanding LCs of 3 trillion Yuan ($482 Billion ) which itself has surpassed its total trade growth in 2011 & 2013.So this doesn’t mean the Chinese Goverment is completely oblivious of this business,instead as i said before in this article ,they deliberately stalled the opening of the country’s Capital Account ( the account keeps track of Capital expenditure [in FDI,Shares & Stocks] & Incomes by the way of funds flowing in & out of the Economy) to facilitate such easy money making business of their banks & to fund their defaulting Companies without touching its $ 3.5 trillion foreign reserve.Unlike free market economies China doesn’t have Capital Account to keep track of its investments and Income.Due to this china also encourages its companies to keep stock of dollars with them to bail themselves out of bankruptcy in case of emergency.
Now, you may have the doubt ,why do foreign banks lend money to chinese corporations despite knowing its bad practices ? The answer lies in its huge Foreign Currency Reserve & the confidence on its rising export & credit ratings being accorded by the Rating agencies like Fitch,Moody,Standards & Poors etc.
Another way of raising money in Chinese system is FAKE TRADING or FAKE INVOICING.Chinese companies see this as a suitable media to earn profit & make some easy money. They borrow dollar loans by faking their trade taransactions or by swelling their order books,convert them into yuan and invest them in the real estate properties,wealth management products & risky investment products through Non Banking financial Companies engaged in Banking buisness that give rise to Shadow Banking.As long as the Yuan is strong against Dollar ,they are assured of the profit arising from the difference between the two currencies ,otherwise they become sick companies if yuan becomes weak. So here PBoC comes into picture to regulate Yuan.In 2013 around $500 billion of “hot money,” flowed into China, largely via the fake-trade channels.
So, as to control appreciation of yuan in domestic & international market Chinese government blocks the Speculative trading by its domestic Companies of its currency,else that will affect its export competitiveness.Chinese government subsidizes its exporters with enough finance to purchase dollars & hence they use it for further acquisitions abroad.
Again,China also has a feat of being World’s biggest Natural Resource hungry country owing to its huge manufacturing & export oriented economy.It imports huge amount of Coal,Copper,Iron Ore and many other metals needed by its industries,but what lesser known in the public domain is how it uses them.Since its well known of China’s housing Bubble,Ghost towns ( towns with no inhabitants/Apartments not being purchased by the people & are lying vacant) etc. One should doubt how the companies involved in raising those ghost cities , Ailing Manufacturing units come out of shock without affecting the Country’s financial System.Now the crux lies in the way they pay their collaterals.Chinese metal traders have long imported copper & iron ore as collateral for onshore loans (loans taken from Banks or Financial institutions within the country), profiting both from the Strong Yuan and from high onshore interest rates & sometimes they also profit from using the same pile of metal to borrow multiple loans.Around 60-80% of China’s imported copper is used as collateral for loans & since most of that was bought priced in dollars & will be sold back onto the global market in dollars,the weakening of yuan makes those dodgy traders lose money & in panic they sell back these accumulated metals to cut back their loans & also to bail out their firms..
It seems China follows the teachings of Suntzu in Financial Systems as well to Inflate & deflate its Currency , to Sack or Sail Companies to keep its systems away from breakdown ..So Is China heading for a Financial Breakdown in Days to Come , time will say that …….
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