When $4 Trillion Is Too Much And $3 Trillion Is Not Enough

Swings in foreign exchange values also impact the dollar value of China's reserves. Many observers who discuss the decline in China's reserves tend to imply that it is purely a question of volumes. Yet changing prices cannot be ignored. The precise currency allocation ofChina's reserves are not known, but for the sake of this thought experiment, assume that in 2014, 20% of China's reserves were in euros.500 bln euros. Since then the euro has declined by more than 20% against the dollar since 2014.If nothing else changed, the dollar value of China's reserves would have fallen by more than $100 bln. For the record, the value of US currency reserves is not even $100 bln.  

The way many, if not most observers talk about the capital leaving China is that it is a form of capital flight. People are voting with their pocketbooks against the policies of the Chinese government. While there may be an element of that, we think that the situation is more complicated and less worrisome. There are two legitimate outflows which many observers do not even cite, let alone estimate:paying back foreign currency borrowing and direct investment outflows.

Many Chinese companies borrowed dollars. The yuan was steadily appreciating. This combined with regulations encouraged those companies to swap from dollars to yuan.That inflated reserves. Once the yuan is not a one-way appreciation bet, and US interest rates begin rising, pressure builds to repay the debt.That seemed to account for around 2/3 of the capital outflows in 2015.The calculations of 2016 are not complete, but the paying down foreign debt appears continued.Foreign directed investment outflows were averaging around $100 bln a year. 

And although of a smaller magnitude, note that there are around 330k Chinese students in the United States. Due to various changes, most cannot get student loans.If each takes the new maximum the equivalent of $50k a year out of China is about $16 bln.And some students report that families can "borrow" from a neighbor's quota which might not be otherwise used.   

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