Financial arbitrage between the official interest rate and black market rates is fueling the real estate boom, with taken overseas through various channels via cities such as Shenzhen and Shanghai. The money is round tripped, re-entering as foreign investment, which is then recycled into the shadow banking system, filtered through real estate to obtain more financing (Chinese banks are falling over themselves to make "safe" loans, see Residential Mortgages Account for 102pc of Lending Growth and also Real Estate Crisis Possible in 2017) and then pumped back overseas. This cycle is bleeding dollars because a portion of assets are taken overseas and do not return.
If this thesis is correct, then the housing recovery engineered by the government and central bank is not only unstable, but also accelerating capital outflows. The bigger the real estate bubble grows, the higher the demand for black market funding, the higher real estate prices go, and eventually, the greater the outflows. In the end, the renminbi exchange rate pays the bill.
Citizen economist Wu Di explains:
The answer lies in China's actual financial economics: the black market interest rate.Cheap credit is created by the banking system and funneled into the shadow banking system by various players in order to make arbitrage profit between the official interest rate for SOEs and the black market rate for private companies, with rates rising the further you move away from an official source of funds. The insolvent small real estate developer is paying sky-high rates for bridge loans to keep construction going.
In the financial system with Chinese characteristics, Shenzhen play an extremely important role. Shenzhen is the most critical part of China's black market interest rate. Black market interest rates have their origin in China's non-market interest rates, uniform regulation by the central bank, deposit and loan spreads too high; plus the financial resources are monopolized by state-owned companies. The vast majority of bank credit resources g to state-owned central enterprises and privileged private monopolies, the majority of private enterprises cannot obtain loans. Interest on bank credit funds are often less than 10%, according to data of the micro-gold, the Chinese private lending market has an average interest rate of around 30%. To know China industrial enterprises average profit margin of only 5%, so many state-owned central enterprises and private enterprises after the privilege to get cheap money, not to engage in industrial production, but in the capital reselling. Today, the black market rate is the Chinese capital market arbitrage and reselling channels (P2P, Internet banking, financial products, etc., the development of the chain of home illegal P2P, Internet banking and wealth management products to push up prices of scandal does not surprise me, because interest rates the average income arbitrage return to the black market rate is significantly higher than the black market outside the enterprise, but also proved my prediction before: real estate crisis is not a crisis of supply and demand, but the financing leverage crisis), Chinese shadow banking is a large part of the black market interest rate.
Corruption, rent-seeking and interest rate arbitrage creates a steady stream of black-market funds, these funds after the completion of arbitrage need to escape from China. According to the report the international anti-money laundering think tank of the global financial integrity of the organization, (as shown below) a total of about 3.75 trillion US dollars in illicit cash flowed out of China between 2000-2011, of which a considerable part was corruption income. Illegal outflows of cash now exceeds 10% of GDP per year. Each year, more than 1 trillion US dollars in funds flows between China, Hong Kong and the British Virgin Islands. After the corruption and rent-seeking income flows abroad, it returns as foreign hot money, once again flowing into the black market interest rate arbitrage (foreign persons, non-real foreign capital), and so on ad infinitum.
Below to reveal the great significance of the black market in Shenzhen in China's interest: "Hong Kong is the Chinese mainland's black market of illegal cash flow interest rate money-laundering center (every year hundreds of billions of dollars is huge), Shenzhen adjacent to Hong Kong, enjoying the massive flow of underground banking facilities, there will be a lot of money in the form of buildings hoarding, since Shenzhen real estate collateral for financing can be done in certain financial institutions in Hong Kong, you can make black money outflow overseas through Shenzhen. P2P banking, Internet banking, trust, financial products, underground banks, etc. respects forefront of the country, the Shenzhen property market (especially large size) with hot real estate market is inseparable. "Wu Di doesn't see this ending well:
In short, the black market interest rate is trying to rush ahead of the full-blown debt crisis and rapid devaluation of the Chinese renminbi, turning renminbi assets into dollar assets abroad. Since the black market interest rate has trillions of yuan flowing into renminbi assets that need to turn into dollars assets abroad, the Shenzhen property market blowout occurred. In the end how much black market interest rate will need to flow into dollar assets abroad? According to the latest data compiled by Bloomberg in January, in 2015 the total amount of funds out of China reached $ 1 trillion, the highest ever on record. Meanwhile, the Shenzhen property market price growth also reached a record high.How this affects the exchange rate:
Shenzhen is adjacent to mainland China's black market interest rate money-laundering center in Hong Kong (hundreds of billions of dollars moved every year), then what about Shanghai? Shanghai has a free trade area. FTA is also a money-laundering haven. Since before the free trade area, it has played in the Shanghai Free Trade Zone of copper money laundering and financing a vital role, and now with the FTA, Shanghai will be the ability of future money-laundering booming out. Years after the Shanghai housing prices is a sign of a blowout.
At this point the amazing truth of Shenzhen and Shanghai property prices skyrocketing in focus combined with China's actual financial economics exposing the true colors. The important thing to say it twice, Shenzhen, adjacent to China's money-laundering center in Hong Kong, Shanghai has FTA, FTA heaven is money laundering. Shenzhen and Shanghai real estate used as collateral for financing, can creatively use domestic and foreign, legal and illegal channels, convert renminbi assets into dollar assets abroad......Shenzhen and Shanghai property market grow hotter, means the renminbi assets to be converted dollar assets abroad grows stronger, indicating that the future RMB exchange rate depreciation pressure will be greater. Black market rate is the dominant factor in the macro liquidity, other people will follow the trend, the problem is that once the black market money has basically completed its mission to transfer its assets abroad, then those following the trend [in real estate] will be left holding the bag.This argument adds a step to the one made last week by Haitong, covered in: The Secret to Soaring Home Prices in China. Haitong chief economist Jiang Chao laid out the case for money supply expansion driving real estate prices in first-tier cities. The above adds two steps: black market finance and its likely exit points in Shenzhen and Shanghai.
As far as real estate is concerned, the money supply thesis points to a peak in the housing market since the growth in deposits has already peaked. If the real estate market is also playing a role in currency outflows, a downturn in the real estate market will be accompanied by pain in the currency market. According to Wu Di's estimate, the real estate market will peak by June 2017 give or take a few months.
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