Recently, two little-noticed things happened in Britain.The first is surely the more important. The Financial Times notes:
“Britain and China took fresh steps to improve their economic relationship on Thursday, agreeing to boost Chinese infrastructure investment in the UK and London’s role as an offshore trading centre for the renminbi. . . [China has given] formal backing to moves by UK banks and financial institutions to develop the UK as an offshore financial centre for renminbi trading.”
This is big news.
Two years ago, China started allowing ‘offshore’ trade in renminbi in Hong Kong to settle Chinese trade. This follows moves back in 2004 to let Hong Kong residents open limited renminbi bank accounts. China’s aim is to maintain strict capital controls – which Chinese leaders will tell you are a key ingredient in China’s growth miracle – and yet also allow the currency to trade freely, offshore, insulated from the mainland economy. To have its cake and eat it.
The ultimate end goal of all this is to see the renminbi attain global reserve currency status.
This is a little like what the United States did from the 1960s and 1970s: it was rather tolerant of the offshore London-centred Eurodollar markets, despite all the disruption they were causing, because it helped keep the U.S. dollar as a highly liquid global currency, an essential pre-requisite for its status as the global reserve currency of choice. Having a reserve currency gives a country an ‘exorbitant privilege‘ allowing it to, in essence, print unlimited money at home to pay for foreign escapades. In America’s case, the Vietnam War was a key issue to pay for at the time (read all about it in Treasure Islands). (Trading in your own currency also helps you sidestep currency risk.) In China’s case today there is no big war to pay for – but it’s going to be a highly useful tool generally in future. With London’s help, China hopes it can allow renminbi to be traded ‘offshore’ – now in Hong Kong and London – and yet hold onto those tight capital controls.
This is a major milestone in a gigantic story that has only just begun.
All this will have powerful impacts inside China (see this thought-provoking piece, for instance, for some ideas of what may be happening.) In the case of the U.S. the policy of tolerance of the offshore Eurodollar worked in the short term – but as Treasure Islands explains – it rebounded on the United States in unexpected and unpleasant ways, notably (but not only) in massively boosting the powers of Wall Street and its ability to capture the policy-making apparatus in Washington. It’s not beyond the realms of imagination that something similar might happening in China in future.
And there’s another thing. Offshore renminbi trade is, presumably, going to be massive. According to the Hong Kong Monetary Authority, the percentage of Chinese trade settled in Renminbi (via Hong Kong) rose from 0.7 percent in the first half of 2010 to seven percent in the first half of 2011. What a leap. Zhou Xiaochuan, governor of the People’s Bank of China, said that said that the offshore renminbi market was “developing faster than what we had imagined.” Indeed – just like the Eurodollar market, and offshore markets more generally. Give them an inch, and they will soon take over everything. You can’t really control ’em. That’s the whole point about offshore, really: they are about escaping from control.
Feral finance, some might call it.
If the City of London can make itself the dominant international platform for this – as it did for the gigantic Eurodollar market (and a prospect about which City bankers are licking their caviare- and champagne-spattered lips right now) this will cement the City’s power and make it even more difficult for British people to curb the stranglehold and excesses of our own offshore financial centre.
This spells real, real trouble for ordinary British people. And probably for ordinary Chinese people too.
Now having got all that off my chest, there’s this second thing that has almost entirely slipped beneath the radar.
A new UK-China tax treaty.
Tax treaties generally dictate what happens when a multinational, say, from one country invests in another: which country gets to tax which bits of the resulting income and dividends and so on, and at what rate. They can also contain other things such as provisions on information exchange.
The always excellent In the City column of the latest edition of Private Eye has more on the new UK-China treaty. UK-registered companies that own a stake of over 25 percent of a company in China will pay only a five percent withholding tax on any dividends remitted to Britain, after payment of Chinese tax. Now I try to resist quoting at length from Private Eye, but I think there’s a strong enough public-interest argument to do so here.
“The previous rate was 10 percent and enables the UK to compete with Hong Kong and undercut some more obvious havens such as Cyprus. Tax on interest and royalties is now 10 percent but that is still as good as other tax havens (or a big saving on them) when the rate can be as high as 20 percent.
Once remitted to the UK, money from dividends, interest or royalties can then be transferred onwards to those bad offshore tax havens with no further tax deduction. The UK does not operate a withholding tax, eespecially if the owners are non-resident. So money can disappear into secret bank accounts in more opaque centres far from prying Chinese eyes.
. . .
How long before Chinese tax evaders or others outside Britain will be using this as a loophole to add to the billions annually corruptly flooding out of China? After all, registering a British company costs a few hundred pounds, takes as many minutes, and beneficial ownership can be disguised long enough to take care of business.
. . .
No doubt HMG would not want to see Britain rivalling the BVI as the home for thousands of special purpose vehicles established for single deals, many of them corrupt, in China. Or maybe it would!”
(In fact, I think Private Eye overstated the royalty payments, the treaty in Article 12 suggests some royalties will be effectively charged at 60 percent of the 10 percent rate, or six percent.) So it’s an even darker move than they suggest.
In summary: this sets the stage for the UK to muscle in on the business of those exceedingly dirty jurisdictions that serve as a conduit for illicit money and illegally round-tripped money back into China.
The dirty money gravy train rattles on.
Are these two developments linked? I actually don’t know.