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The vanishing illusion of China's financial might

China's current-account surplus is shrinking amid a growing dollar shortage

China's current-account surplus is expected to fall into deficit in the coming years as its services trade deficit grows. (Photo by Akira Kodaka)

TOKYO -- Frustrated by what he has described as China's backtracking on key trade commitments, U.S. President Donald Trump has taken his trade fight with Beijing to the next level. He has raised U.S. tariffs on $200 billion in Chinese exports to 25% from 10% and directed the U.S. Trade Representative to prepare more tariff hikes on Chinese products.

The source of Trump’s ire is China’s huge trade surplus with the U.S. In 2018, China exported $539.5 billion worth of goods to the U.S., 4.5 times more than the U.S.’s $120.3 billion worth of shipments to China. That leaves the U.S. with a staggering $419.2 billion trade deficit with China.

But China’s current-account balance paints a different picture.

In addition to a country's imports and exports of goods, the current account also measures its trade of services and international transfers of capital.

China's current-account surplus has been shrinking rapidly, to less than $50 billion in 2018 from more than $300 billion in 2015. It is expected to continue trending downward.

After rising to nearly $60 billion in 2019, it will fall to about $40 billion in 2020, and drop to about $20 billion in 2021, according to forecasts by the International Monetary Fund. China is projected to post a current-account deficit of over $6 billion in 2022 and keep bleeding red ink in the following years.

The country has been running growing deficits in services trade. While its goods trade surplus is around $400 billion, its trade deficit in services has grown to roughly $300 billion.

One big factor behind this trend is shopping sprees by Chinese tourists in other countries. Their spending at stores abroad is counted as Chinese imports.

Another notable factor concerning China's balance of payments data is "errors and omissions," which indicates funds unaccounted for. These figures tend to fluctuate, but China's annual net errors and omissions have been oddly stable at around $200 billion since 2015.

One possible explanation is that China is suffering losses on investments of its foreign-exchange reserves. About 60% of China's foreign reserves are invested in stable foreign assets like U.S., European and Japanese government bonds. But it is not known where the rest is parked.

The funds may have been invested in assets in emerging and resource-rich countries through special-purpose companies. The Chinese government does not offer detailed information about its loans to and investments in emerging countries.

But Johns Hopkins University's China-Africa Research Initiative has compiled a detailed database of China's loans and investments involving Africa by using data disclosed separately by lenders and borrowers.

China lent a total of $143 billion to African countries between 2000 and 2017, according to the database. Additionally, Boston University estimates that China has extended $140 billion in loans to Latin American and Caribbean countries since 2005.

In other words, China has loaned more than $280 billion to these two regions alone in the past two decades.

In April, China hosted a summit to promote the Belt and Road infrastructure investment initiative, one of President Xi Jinping's signature policies.

While boasting about $64 billion worth of new deals struck by companies participating in the initiative, Xi stressed the importance of the projects’ sustainability. The remarks reflect Beijing's growing concern about the possibility that unsustainable projects could leave it with a mountain of bad assets.

There are also signs that Chinese banks are facing problems financing overseas loans.

Bank of China, a leading state-owned commercial bank that focuses on international operations, had $70 billion more dollar-denominated liabilities than dollar assets at the end of 2018.

The reason is clear, according to the Wall Street Journal. While the government wants to make China a major supplier of funds overseas, there is little appetite among potential borrowers for loans in yuan.

Most of the development projects in the Belt and Road initiative have been financed in dollars. If Chinese banks run short of dollars, the government has no choice but finance the projects with money from its foreign reserves.

China's current situation is reminiscent of Japan in the 1990s, when wildly inflated asset bubbles were in the process of collapsing.

During the bubble years, Japanese direct investment in overseas assets, most notably real estate in the U.S. and other countries, skyrocketed. But a large portion of these investments eventually went sour.

Japanese banks suffered from credit rating downgrades and found it difficult to raise funds overseas after enormous loans at home turned into non-performing assets.

China's all-powerful financial machine, which has made much of the world uneasy, may prove to be a paper tiger.

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