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China's Massive Trade Surplus: Is it Real?

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China is finally losing steam after a decade of rapid economic expansion. GDP growth slowed to 7.7 percent in the first quarter, a considerable drop from the past decade of double-digit annual growth. Although the recent positive trade data seems to point towards a gradual recovery, the higher-than-expected surplus is simply too good to be true.

Data released by the Chinese government stated that China's trade surplus was $18.2 billion, and that exports increased by 14.7 percent from last year. This data seems fishy, given that there was a deficit of $884 million only a month before.

The abnormally large trade surplus is also unlikely since external demand for Chinese goods was not as strong as what export figures represented. The growth of container throughput for foreign trade in China's top eight ports was very weak, and economic growth in the U.S. and Eurozone was slow. The export data showed mismatches: export data to Hong Kong was higher than Hong Kong's import data.

A May 10 report from Bank of America Merrill Lynch finds that the trade data distortion is partially due to the widening differential between onshore and offshore exchange rates for the yuan. The report speculates that the abnormal increase in the movement of gold between the mainland and Hong Kong were used by arbitragers who exploited the exchange rate discrepancy. High unit value goods such as gold are ideal for arbitragers since transportation costs are cheap and unit values are easy to manipulate.

The interest rate differential between the mainland and Hong Kong is another opportunity for arbitragers: profit seekers could borrow Hong Kong currency at low rates, convert HK currency to mainland currency, and deposit the mainland currency at higher rates.

The actual trade surplus is much more realistic. According to Bloomberg Businessweek, after factoring out irregularities in the trade data, analysts from the Royal Bank of Scotland estimated that China's exports rose by approximately 5.7 percent in April, nearly 9 percentage points lower than the reported level.

China's trade surplus figures were undoubtedly over-inflated by "hot money" flowing into the country to profit from exchange and interest rate differentials. The sluggish growth in China is not matched by its large trade surplus. Future Chinese trade data should be viewed with a dash of skepticism: if the numbers are too good to be true, then they probably are.