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Shanghai is like a city on steroids and China is like a debt-addict on opioids.

Singapore, SINGAPORE – Ruby Wang is walking on 8th Avenue in New York City to her favorite Chinese restaurant which serves uncannily authentic Hunan cuisine from her hometown. In the bitter winter cold that is so typical of New York City this time of year, Wang is kept warm by the thousands of goose feathers in the lining and coyote fur-trimmed hood of her thousand-dollar Canada Goose parka. Wang enters the warmth of the restaurant, where steam bamboo baskets of all manner of delectable Chinese cuisine is being prepared. Taking off her parka, Wang reveals a several thousand-dollar Dior sweater, jeans and boots ensemble.

Slight in build, with alabaster skin, Wang is the privileged daughter of wealthy Chinese parents still holed up in the homeland and who dote on their only child by sending out barrels of money as she studies Economics at Columbia University. Dubbed the “fu-er dai” or second generation of wealthy Chinese, normally the children of party elites and businesspeople with deep connections in the Chinese mainland, China’s elite have long favored sending their children to exclusive colleges across the United States, for whom the dream of America doesn’t just represent opportunity, but freedom as well. But of late, Wang complains that she hasn’t been getting as much money back from home as usual, over a bowl of steaming hot mala noodles, Wang says (in mandarin),

“Daddy and Mummy told me that I don’t need a new Maserati this year, they say that I hardly drive the one they gave me two years ago. And lately they’ve been asking me to keep my expenses down.”

For Wang that means no more shopping trips to Milan and Paris over summer and less money on clothes and other luxury items. With slowing economic growth in China, it’s not just wealthy elites like Wang who have had to tighten their belts, back home for Wang’s countrymen, economic conditions are getting increasingly challenging.

China’s economic growth eased like an old man getting into a warm bath to 6.5% in the third quarter of last year. By any other convention measure, that is an astounding rate of growth, something that developed nations can only dream about. But despite all the ostensible displays of Chinese wealth in capital cities across the globe, China is not a developed country, not yet at least and at 6.5%, China’s economic growth is at its lowest in three decades which is significant because three decades ago was when China first started opening up its economy to more capitalist persuasions.

Red unfortunately, does not represent good fortune on the stock market.

But the Chinese didn’t need to wait for official data to know that things are slowing. Car purchases, long heralded as symbols of wealth and consumption, fell, for the first time in over two decades and the Shanghai stock market has been excoriated, plunging my over a quarter from 2018 highs. And while the looming threat of a trade war with the United States weighs heavily on a manufacturing and export reliant economy, the economic malaise in the Middle Kingdom is far more deep-rooted.

The issues with China’s economy today are unfortunately also some of the least visible. The Chinese have generally had a propensity for saving money. Given China’s tumultuous history, saving for a rainy day has long been a way of life, but that has since changed. Total Chinese debt relative to national output soared over the last decade since the financial crisis to 253% from 140%, according to data from the Bank of International Settlements. No developing economy in economic history has ever gone on a debt binge of this proportion and escaped some kind of financial reckoning at some stage, but then again, this is also the same country that landed on the dark side of the moon, so perhaps the Chinese may yet defy history. But perhaps the ability of Chinese mandarins to prevent an economic blowout are far more down to earth. Unlike a liberal economy, China has many levers of controls over banks, big corporations and importantly, capital flows. China limits the ability of its citizens to “offshore” wealth, ensuring that most of the money stays on the mainland. And the Chinese ability to quash capital outflows was on display in 2015, when a stock market bubble fueled by questionable lenders and bureaucratic bungling, burst. As the yuan stumbled, Chinese of every stripe starting draining money out of the Middle Kingdom faster than a hungry college student wolfs down a portion of General Chow’s chicken. But Beijing stemmed the outflow of cash, clamped down on capital outflows and bailed out the stock market. Crisis averted, back to your dumplings.

But while the 2015 Shanghai stock market crash was relatively easy (by Chinese standards) to manage, the debt tsunami on the horizon is an altogether different kettle of fish. Beijing is obsessed with social stability and it understands more than anyone else that an implosion of debt will necessarily unwind the trade-off which citizens have made with their rulers — limited personal freedoms for economic freedom. But like a cancer, that debt is poisoning the Chinese economy just as much as its factories are poisoning its water and skies. Already shaky Chinese banks were recently allowed by the People’s Bank of China, the central bank, to reduce their deposit to debt ratios. And even though official Chinese statistics put the non-performing loans at Chinese lenders at a paltry 2%, foremost experts such as Charlene Chu, a senior partner at Autonomous Research and estimates that as much as 24% of Chinese debt is dodgy, or approximately US$8.5 trillion worth of loans may already have gone bad. But the true extent is anybody’s guess. Last October, S&P Global Ratings noted that the amount of local government debt in China remains a mystery since so much of it is held off balance sheets, which they estimated to be somewhere in the ballpark of US$6 trillion. Adding to that problem is China’s shadow-banking sector, a US$10 trillion ecosystem of intermediaries that is impossible to fathom. Because Chinese economic growth depends on profligacy, especially by Beijing, local governments spread across the country have often had to step up in the spending of that cash on infrastructure and while growth-stimulating infrastructure may help growth, in many cases that infrastructure spending has been on white elephant projects which have contributed to China’s “ghost” cities.

Morning rush hour traffic in Ordos Kangbashi in China’s western region.

To make matters worse, Beijing has adopted a policy of min tui, guo jin for the economy, which literally translated means that citizens (and private enterprise) take a backseat while the government plays a more active role in the economy. The move has led to already-bloated state-owned enterprises encroaching on more and more areas where private enterprise once held sway, gorging on debt in the process.

Look up in the sky, it’s a bird, it’s a plane. No, it’s Capital Flight!

Proof that not everything which flies needs wings, capital has been also been taking to the air from China. But because money can’t gush out of China the way it would in any other country, Chinese have been looking at alternatives to route their capital away from the Middle Kingdom. China (as mentioned) has strict capital controls, which limits moving more than US$50,000 a year per citizen. But over the last three decades, the Chinese have circumvented these capital controls using a variety of measures, some more legal than others and for which cryptocurrencies such as Bitcoin were just one of many routes used to facilitate capital flight. The Chinese have topped the list of foreign buyers of U.S. residential real estate for the last six consecutive years, according to data from the National Association of Realtors and not all of those purchases have been funded with cash.

A mansion in Los Gatos, California. Made of brick and paid for in Bitcoin.

Last July, in an affluent, leafy suburb in Los Gatos, a 90-minute drive from San Francisco, Hongcai Guo, a Chinese national, was patiently tending to his chive plants in his 100,000 square foot mansion. A beef salesman and early Bitcoin adopted from China’s Shanxi province, Guo was one of many, freshly minted cryptocurrency millionaires funneling their wealth out of China by purchasing real estate aboard,

“It’s very normal to sell Bitcoin in the U.S. After selling Bitcoin, you can just buy anything you want.”

In the 12 months to end of March last year, Chinese nationals snapped up as much as US$30 billion worth of American homes. But there’s signs that real estate purchases by Chinese nationals is starting to slow. Anti-foreigner rhetoric emanating from the Trump White House is starting to cool demand for American real estate from Chinese nationals and the threat of increasing tension between Washington and Beijing means that Chinese nationals are starting to worry about the potential for anti-Chinese sentiment, with the memories of the internment of Japanese-Americans during the Second World War perhaps not far off from their minds.

And while Bitcoin may have come off its highs from late 2017 and early 2018, its relative (and I use this term loosely) stability has meant that for many Chinese who had hitherto not considering using digital assets to spirit their substantial wealth out of the country, cryptocurrencies are increasingly becoming a viable option. For now at least, supply of cryptocurrencies far outstrips demand, which is why in the short term, Bitcoin prices as well as those of other cryptocurrencies are unlikely to see any marked increases. But as Beijing increases its pressure to stem capital outflows and with Chinese investors having cooled on their own stock market and real estate investments, cryptocurrencies, with their ability to cross borders easily may yet come back in vogue.

Will the chickens come home to roost or roast?

It is an inevitability that China will eventually need to deal with its staggering debt. Like the opioid addict, China will eventually take on one dose of debt too many and OD. And when that time comes for China to deal with its debt habit, it will make the U.S. response to the last financial crisis — the US$700 billion Trouble Asset Relief Program — seem like pocket change. Going by past experiences in South Korea and Thailand, China’s bill for fixing its debt addiction could be as high as US$3.8 trillion, perhaps more. With a national output of US$13.487 trillion for 2018, based on World Bank estimates, the bill will be staggering.

Author of the Troubled Asset Relief Program and man telling you how big the one that got away was, former Treasury Secretary Henry Paulson.

And while Bitcoin was birthed in the aftermath of the last financial crisis, in response to the use of taxpayer monies to bailout private corporations, Beijing’s use of taxpayer monies to bailout its bloated state-owned enterprises may prove to be even more controversial and unpalatable to its people. Much of Chinese debt has fueled unnecessary factories, bridges to empty cities, highways to deserted communities and insolvent companies that are protected from competition and insolvency purely for the purpose of ensuring labor stays employed and away from the streets. But just like the opioid junkie whose subsequent highs are dulled through drug resistance, each attempt by Beijing to reflate its economy by piling on more debt will yield an increasingly smaller payoff. According to research firm Fathom Consulting’s study last October, China’s old economic model is already “exhibiting diminishing marginal returns.”

Even China’s banks appear to have given up on lending. Despite substantial pressure from the People’s Bank of China (the central bank), credit growth has not picked up steam. The move to slash reserve requirements has also not lead to a flurry of lending by Chinese commercial banks, much to the chagrin of Beijing’s mandarins. With worry over the economy dominating the Chinese psyche and the already staggering levels of debt, Beijing has less ability to use debt to goose growth. Which means that even if China has to roll out its own version of a Troubled Asset Relief Program, it may not work. Buying up its own toxic assets by increasing debt load will only devalue the yuan pushing more and more Chinese to send money offshore, by whatever means available, cryptocurrencies included.

The Case for Chinese Demand for Cryptocurrencies

For many in the West, China appears — especially for a visitor to one of its many shiny, modern cities — to be a functioning market-based and wealthy economy. But beneath the veneer of steel and concrete lies myriad problems which undermine the strength and resilience of that facade. If China had continued to push forward on reform, loosened capital controls and reduced government intervention in the economy, it would at least have had the potential to reverse course on some of its more questionable economic policy moves. A Chinese economic crisis, while painful, would at least give the free market an opportunity to do its job, to purge untenable enterprises, reallocate resources and improve productivity.

Chinese President and man who knows that five microphones make you sound five times bigger, Xi Jinping.

Unfortunately, the current Chinese President Xi Jinping has shown neither the appetite nor the tolerance for dealing with these economic realities. Instead of privatizing more enterprises, Beijing has increased its involvement in more areas of the economy. Already, Chinese businesspeople lament increasing state intervention in the market and have made contingency plans to expand their offshore business options. Xi’s top priority is not so much the economy, but imposing Communist Party control over everything, keeping the state-led, investment-heavy economic agenda that is the very raison d’etre for China’s current economic quagmire. Xi’s push into AI, robots, chip-making and electric cars, while making for good soundbites, may add to the existing mess — too many unnecessary factories built with too much debt and with too much waste.

For scores of Chinese, the last three decades have represented unbridled economic growth and opportunity, with many young Chinese living with the expectation that their lives would be better than those of their parents. But as economic growth slows and Beijing comes down harder on capital controls, pressure will build to find other means to spirit wealth outside of the country. For a generation which has only known an increase in property prices and a growing stock market, a Chinese financial crisis will be an entirely new experience and one from which the response is as yet uncertain.

And while Chinese nationals are not prohibited from investing overseas, capital controls makes it difficult to get the yuan out of China to fund those investments. To that end, Bitcoin and other cryptocurrencies have the potential to facilitate such transfers, which explains Beijing’s animosity towards Bitcoin from the very beginning. China’s private enterprises are also hamstrung in the way they can make overseas investments, with Beijing imposing strict rules for overseas investments since 2017. Against this backdrop, the Chinese will have to find other ways to spirit their funds out of China, at the very least as a hedge to a potential economic fallout in the Middle Kingdom.

Neo found that the Matrix looked a lot different after “blockchain” became a buzzword.

One albeit unlikely, but nevertheless helpful data points for China’s economic health could be derived from the blockchains of various major cryptocurrencies. While Bitcoin is the obvious example, Beijing has long monitored Bitcoin transactions and the Bitcoin blockchain as signs of over-the-counter Bitcoin transactions, which facilitate capital flight from China. The difficulty often arises when Chinese nationals want to use yuan to purchase cryptocurrencies, often the first step in getting capital out of the country. Watching the blockchains of various cryptocurrencies to monitor transaction volume, coupled with a close eye on any price movements in cryptocurrencies, may provide at least some indication as to whether or not Chinese nationals are again using cryptocurrencies for capital flight in larger numbers. The Chinese have used cryptocurrencies to get money out of China for awhile, but with the volatility and massive drop in value in 2018, cryptocurrencies lost their luster. Increasing capital controls by Beijing may change that. And because most of the transactions involving Chinese yuan or dollars held by Chinese for the purchase cryptocurrencies for sale overseas will not happen through major cryptocurrency exchanges, the price of cryptocurrencies is not likely to change. But given the pseudonymity of cryptocurrencies, such observations will depend on a combination of data and speculation — it’s simply not possible to know for sure if Chinese demand is fueling cryptocurrency transaction volumes, but given the waning interest in other parts of the world, a cogent argument could be made that it is.

As China dives deeper into debt and Beijing turns its back on liberalization and reform, scores of Chinese, from the needless to the needful will no doubt grow increasingly aware of their economic predicament. With slowing economic growth, Chinese will find a way to squirrel their wealth into other assets which the government will find hard to touch — decades of economic hardship and turmoil have prepared the Chinese for such occasions. Against this backdrop, cryptocurrencies may yet return to the fore as a viable option for the Chinese to protect their wealth.

The writer is Patrick Tan, Partner and General Counsel for cryptocurrency quant trading firm Compton Hughes.