STARisk

The great wall of capital…

The great wall of capital controls surrounding China is falling apart. Yesterday a hole was knocked to allow Japanese capital into the country, after Japan became the first major developed country allowed to buy renminbi-denominated Chinese onshore bonds.

Already this year South Korea’s central bank has been given permission to buy Chinese securities and the China Development Bank has agreed in principle to lend in renminbi to Brazil, Russia, India and South Africa.

The capital controls are steadily being dismantled, with deep implications both for the world economy and investors.

For China, this means giving up control of its exchange rate and so stopping expansion of its $3.2tn of currency reserves.

Taken alone, that means it will one day have to stop buying Treasury bonds, and potentially start selling – a sort of reverse quantitative easing.

Offsetting that, the rest of the world’s economies should gain as China stops acting as a parasite – in diplomatic speak, global imbalances are reduced.

China’s current account surplus has already halved from its peak and in February it had the biggest trade deficit since at least 1989. Meanwhile Japan last week reported the largest monthly trade and current account deficits since at least 1985. Both were affected by seasonal factors and the weakness of Europe, but are part of a wider trend: the world is, slowly, rebalancing.

This is bad news for bondholders. Quite apart from lower demand from Chinese (or Japanese) reserve building, it means higher inflation.

China, as Ousmène Mandeng at UBS points out, has already stopped exporting disinflation and threatens to export inflation. Even in Germany, which has done far less to rebalance than China, workers are showing signs of wanting a bigger share of growth.

Even if this rebalancing goes smoothly, it will take at least three years. But anyone buying bonds maturing beyond 2015 should be wary.

FT China