Capital flight ‘black swan scenario” for China – Victor Shih

Europe might be looking at China as its financial savior, but China is really struggling to deal with its own debts, says financial analyst Victor Shih in Money Morning Australia. Capital flight is a serious risk, but only a worst-case scenario, he adds.

Money Morning:

Victor Shih, a political economics from Northwestern University in the US, estimates the Chinese banking system could handle half a trillion dollars due to capital flight.

But should it continue, Shih anticipates up to a trillion dollars could leave China’s grasp and see the government lower the RRR to 5% or 6% to combat the lack of cash left at the banks.

This means for now, China has a ‘cushion’ of roughly a trillion US dollars. That’s a lot of money. It’s the equivalent to 15% of China’s yearly gross domestic product.

However he predicts the real problem, is those who follow the ‘smart money’, China’s wealthiest 1%:

‘Sizeable outflows from the smart money would see the remaining 9% of top 10% of households follow the smart money.’

Meaning, if the rich see the super-rich moving their assets out of the country, they’ll quickly follow suit.

This exodus of cash could potentially cripple the Chinese banking system. Simply because the loans in Chinese banks don’t really have an end date. They’re either paid or not. So banks constantly ‘roll over’ bad debts. According to Shih:

‘A lot of loans in China are in reality non performing, they just get rolled over, time and time again, so they don’t ever get paid back. So you have a deposit base shrinking and on the asset side the loans are still there which means after a while you have illiquid banks.’

And should this happen, Shih reckons China’s authorities won’t be able to save China’s banks and recapitalise them. ‘China can’t liquidate its entire $3 trillion foreign exchange portfolio… some of it is already invested in Chinese banks and Chinese institutions.’

‘Chinese bank share prices would completely collapse if the Foreign exchange itself began to sell Chinese bank shares…’

But Shih is quick to point out that a capital flight of this level is more a black swan type of event. He says, ‘It’s a tail risk, but one investors should be aware of.’