China’s big ball of money has nowhere else to go

Least Resistance. China's investors are bumping up against the country's strict capital controls. Warnings from Beijing have managed to slow a rush into government bonds in recent months that was sparked by a lack of better options for parking cash. That has left a big ball of money with nowhere else to go.

Previously, when property prices sagged, households would buy stocks; when shares sold off, people would pile into real estate; when both looked shaky, more money would end up in bank accounts.

This year, lenders are offering low savings rates, stocks are moribund, and house prices are still falling. That has made Chinese government bonds an obvious refuge. But the pace of the pile-in has had some astounding consequences. In May, the price of a new debt issue spiked 25%. Two months later the People's Bank of China surprised with a rate cut, which fuelled another rally that threatened to push yields further below those of U.S. Treasuries. And in recent weeks the central bank strongly suggested lenders cool their "speculative" bond-buying jets.

Such warnings have had some success, with Chinese treasury futures selling off in recent weeks. Banks aren't the only buyers, though. Investment funds accounted for 53% of bond purchases in the first seven months of the year, Standard Chartered estimates. Some of that demand may have come from households spurning lacklustre deposit rates, as Goldman Sachs estimates cumulative excess savings in China fell about 100 billion yuan ($14 billion) in the second quarter, to 3.1 trillion yuan.

Letting Chinese financial institutions offer more investment products tied to overseas markets ought to be a logical next step. The demand is there: domestic lenders have been scrambling to increase their Beijing-mandated quota limits, Reuters reported this month.

This would have several beneficial effects, especially if as expected the U.S. Federal Reserve starts cutting rates: that would soften the dollar, making overseas investments even more appealing. Returns would probably be higher, which would help households better cope with the economic slowdown. And letting more money go abroad would help ward off excess appreciation of the renminbi.

When the economy does finally turn the corner, returns from investment abroad could be ploughed back into domestic markets. Chances are, though, that Beijing will not want to lift the restrictions enough to make a difference. That means the big ball of cash will, despite official opprobrium, soon find its way back into the domestic bond market, putting the central bank back on the defensive.

Context News

Prices for Chinese treasury futures, exchange-traded bond funds and bond-focused investment products have fallen in recent trading sessions as state media claimed official admonitions against speculating in the country’s debt market had begun to make an impact, Reuters reported on Aug. 16.