How capital controls are not effective when it comes to movement of goods across borders
When interest rates differ from country to country, speculators who want to make profits have a strong incentive to borrow money at lower interest rates and lend money at higher interest rates.
For example, if banks in the United States made loans at 1%, while banks in China paid depositors an interest rate of 3%, investors would borrow from American banks and allow Chinese banks to make a decent profit. Will lend This trade is popularly known as carry trade. Such a flow of capital across borders in search of higher returns will continue until the interest rate differential between the two countries disappears, taking into account the various transaction costs. However, the flow of capital across borders is not always desired by central banks.
For example, when capital flows into a country with high interest rates, it can lead to an appreciation of the country’s currency and affect the size of the country’s overall exports. Therefore central banks often impose capital controls that limit the movement of capital across borders.
Despite strict capital controls, there is still an economic incentive for speculators to engage in carry trades. Therefore, speculators look for ways to circumvent capital controls. “Currency Carry Trade by Trucks: The Curious Case of China’s Massive Imports from Italy” by Xuepeng Liu, Heiwei Tang, Xie Wang and Shang-Jin Wei looks at how speculators engage in indirect carry trade across Chinese borders for goods. You can use.
Economists first note that controls on the movement of goods across borders are not as strict as those imposed on the movement of financial capital. For example, a speculator may not be able to transfer a large amount of US dollars directly into China through banking channels due to capital controls. But he can still transfer money to China through the current account route. A speculator can convert his US dollars into Chinese yuan on the pretext of importing cars from a friendly Chinese company into Hong Kong.
The Chinese company can then invest the yuan in a Chinese bank to earn a higher interest rate. Eventually, when the speculator wants to convert his investment in yuan back to US dollars, the friendly Chinese company can withdraw the money from the bank and re-import (or buy) the car, thus returning the investment proceeds to the speculator. can do
Economists note that it is difficult to come up with concrete data on how much capital is illegally moved across China’s borders via the current account channel. But they see other proxies that actually suggest that, despite capital controls, the size of illegal carry trades increases with an increase in potential returns from engaging in such carry trades.
To assess potential returns from carry trades, economists track changes in the US and Chinese money supplies as these affect interest rates. And to assess the size of the illegal carrying trade, they look at the value of goods moving across borders and compare them by their own weight. It should be noted that high value goods with low weight are more likely to be used for the purpose of illegal carry trades because their transportation and storage costs are low. The paper also looks at whether state-controlled enterprises in China are more likely than private enterprises to carry out illegal carry trades.
It comes to the conclusion that state-controlled enterprises are actually more likely to engage in illegal carry trades that bypass capital controls. Economists speculate that this may be because, unlike private businesses, state-controlled enterprises have more friendly relations with the government and may thus believe they can evade crime.
(Liu, Xuepeng & Tang, Heiwai & Wang, Zi & Wei, Shang-Jin, Currency Carry Trade by Trucks: The Curious Case of China’s Massive Imports from (January 2022). NBER Working Paper No. w29633, Available at SSRN: https://ssrn.com/abstract=4004846)
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