While experts debate whether the Chinese economy is slowing gradually or in real trouble of crashing, one factor that continues to cloud the debate is the lack of reliable data. Most people except that official numbers coming out of China are massaged, but without knowing the full extent it’s hard to form an opinion on what’s actually happening.
PMI drop precipitated official drop in Chinese exports
Earlier in the year analysts noticed that there was a distinct difference between PMI, which was definitely decelerating, and Chinese exports which were officially still growing. Many thought that the official figure of 10.6% year-on-year growth was at least directionally correct, if inflated, but that assumption was called into question when the Chinese export numbers showed an 18.1% drop in February.
“The drop reflected base-effects due to the surge in over-invoicing to Hong Kong that was most prevalent at the beginning of last year,” says the Omni Macro Fund March newsletter, a copy of which was reviewed by ValueWalk. “With these ‘false’ exports falling out of the series (important note: not reversed), headline export figures will be depressed, disguising better trends in ‘real’ exports.”
The Omni Partners newsletter points to the difference between Chinese exports to Hong Kong and Chinese imports into Hong Kong as proof that something is amiss. In theory these numbers should be the same since they are just reporting the same transactions from different vantage points, and they mostly are until 2010, when over-invoicing starts to skyrocket. The result is $290 billion in over-invoicing, $5 billion of which has now been reversed, being used by people in China to get USD in a carry trade.
Chinese exports: Copper also used to secure financing
Hong Kong probably isn’t the only place where such discrepancies exist, so $285 billion is the minimum size of the carry trade through over-invoicing, and that’s only from one method. Omni also points to the use of copper to get short-term financing. Another technique is to get a USD letter of credit for the purpose of buying commodities, sell those commodities in the local market, and then invest the proceeds into a wealth management product.
“[Standard Chartered] estimates that close to 80% of metal tied up in bonded warehouses in China is for financing and not industrial purposes,” writes Omni.
Raymond James chief investment strategist Jeffrey Saut has made similar comments, pointing out that “China’s currency (the renminbi) is not readily convertible into another currency. Therefore, if you want to get money into, or out of, China, it is done by ‘over or under invoicing’ various products.”
The result is that the recent drop in exports and the falling price in copper due to low Chinese demand might not tell us that much about actual Chinese exports and manufacturing. Instead, it could just be another sign that financing deals in China are starting to come apart.
For the month of March, Omni was up 2.39%, which is also the same exact YTD return.