China grey capital

The Chinese Communist Party's news service, People's Daily (PD), reported on Friday that Chinese authorities had so far busted over 170 cases of money laundering and illegal fund transfers involving more than 800 billion yuan (117 billion euros, $125 billion) in a crackdown on illegal "grey capital" banks that was jointly launched in September 2014 by China's national police, foreign exchange regulator, and central bank (the People's Bank of China, PBOC).

The biggest such case to date involved transactions totalling 410 billion yuan, PD reported the Ministry of Public Security as saying on Thursday. Some 100 suspects from allied eight gangs, loosely united by a ringleader named Zhang, have been detailed in connection with the case.

In December 2014, arrest warrants had been issued for 56 suspects and more than 3,000 bank accounts were frozen. It has taken almost a year for police to sort through records of more than 1.3 million suspicious transactions.

Money laundering

The gangs offered clients ways to launder illegally obtained money or to avoid China's strict rules on foreign exchange transactions. Such rules are called "capital controls" in the jargon of finance. The rules were broken by means of complex transaction networks involving dozens of shell companies in Hong Kong.

The leader of one of the eight affiliated gangs, a man called Yang, told Xinhua news agency that the gang could earn over 50,000 yuan per day from clients for its services.

Unapproved financial institutions processing "grey capital" have been an increasing problem in China. They're used to launder money from corruption, online gambling and fraud. Those engaged in such illegal activities use underground banks to spirit money out of the country - selling yuan for dollars in the process.

Yuan hits the big time

A source told Reuters news agency on Wednesday that China is trying to improve the effectiveness of its capital controls in order to achieve better control of exchange rates and interest rates, in the run-up to China's currency being incorporated into the International Monetary Fund's (IMF) monetary reserve system, called "special drawing rights" (SDRs).

The main international reserve asset is the US dollar. However, there are problems associated with having a particular country's currency take the role of global reserve asset: Monetary policies designed to meet US contingencies can run against the interests of countries holding large dollar reserves.

For that reason, in 1969 the IMF created a synthetic reserve currency, the SDR, composed of a blend or "basket" of other major currencies, each weighted differently. At present, one SDR is composed of US dollars (41.9 percent), euro (37.4 percent), British pound (11.3 percent), and Japanese yen (9.4 percent).

The IMF will soon add the Chinese yuan to the SDR currency basket, recognizing the Chinese currency's growing importance to world trade and currency reserves - a reality reflected in recent deals establishing London and Frankfurt as financial centers for dealing in yuan-denominated financial assets.

Bancor

SDRs were originally meant to supplant the US dollar as the world's main reserve currency, inspired by famed British economist Lord Maynard Keynes' proposal for a synthetic reserve currency called a "bancor". However, the US didn't support the move because of the reduction in global demand for the dollar and the loss of hegemonic financial power that would have been entailed. SDRs never really caught on.

China, however, has been slowly but steadily working to weaken the US dollar's hegemony - not least because it wants to diversify its own government's reserve assets, currently denominated primarily in US dollars: the PBOC holds around $5 trillion in US dollar reserves in its account at the US Federal Reserve. If the US ever decided to play nasty with China, it could freeze that account.

The yuan's ascent to the Olympian heights of inclusion in the SDR basket, composed as it is of the world's most important currencies, is a further step in China's long-term plan to reduce its exposure to geopolitical risk by spreading China's currency reserves over a broader asset base.

Hence the crackdown on underground banks. Zhang and Yang, the money-launderers, had the ill luck to fall afoul of an important Chinese government policy priority - because effective capital controls are necessary for China to maintain control of the exchange value of its national currency.

nz / uhe (People's Daily, Reuters)