The news sent the index of Hong Kong-listed shares in mainland companies up by 8.74%, their biggest one-day rise since May 2000. This should also go a long way in easing speculative pressure on the Shanghai A-share market.

This is probably the most important financial development in China since their entry into the World Trade Organization in 2001. So you all were a little surprised the announcement was delegated to page six in the Financial Times.

Once again, the cover story focused on the U.S. liquidity crunch. If you’re looking for liquidity, there’s arguably no better place to turn than China.

China had accumulated foreign exchange reserves in excess of $1.33 trillion at the end of June. Total national household savings in China are estimated to be roughly $2.2 trillion.

With regards to the “bigger picture,” releasing capital account control is the next step towards the eventual flotation of the RMB. This move should allow many on Capitol Hill to take a deep breath.

China took the first step towards currency liberalization in December 1996, when it made the renminbi convertible for current account transactions, removing both quantitative and regulatory restrictions on the use of foreign exchange for current account transactions. China’s WTO accession in 2001 has also been seen as a catalyst for capital account liberalization and currency convertibility.

For lack of a better description, the current account is the difference between a nation’s total exports of goods, services and transfers to its total imports of the same. Relaxing the current account has allowed Chinese manufacturers to feed American consumers. Thus far, this has been primary fuel feeding the Chinese economy.

A current account deficit occurs when a country’s total imports of goods and services are greater than the country’s total exports. This situation makes a country a net debtor to the rest of the world.

See the U.S.

A current account surplus is just the opposite. Exports of goods, services and transfers are greater than imports.

See China.

The next natural step in liberalization is the capital account. Once again, for lack of a better description, the capital account is the net result of public and private international investments flowing into and out of a country.

Allowing mainland Chinese citizens to invest in the Hong Kong stock market signifies the most significant move to date by Beijing officials to liberalize the country’s capital account. This policy will allow the roughly $2.2 trillion conveniently stashed underneath one billion or so mattresses to find a better home with a better return.

But don’t go expecting the Chinese to float the RMB anytime soon. They are firm believers in gradualism. It’s taken more than 10 years to get from current account liberalization to this point. I would suspect it’s going to take many more before we reach full floatation.

But let’s forget the currency issue for a moment. The real winner here is undoubtedly the Hong Kong market, especially H-share companies that don’t have either a Shanghai or Shenzhen listing.

As Zhao Xiao, a professor of Beijing’s University of Science and Technology, said: “Remember, if all Chinese money can go to Hong Kong, then many global firms will favor listing in Hong Kong.”

According to our friends at CNBC, an official at Bank of China in Tianjin said the scheme was due to be up and running by September.

Less than two weeks and counting… The time is now.

Until Next Time,
Christopher Hancock
August 24, 2007

P.S.: I’ve been watching these Chinese-related trends very closely for years now, and it still amazes me that the mainstream media is still incredibly slow in covering it. But then again, it does give my readers a huge advantage over Wall Street.

In fact, staying with this theme, here’s a look at what I’ve been calling the “World’s Greatest Retirement Stock.” Wall Street hasn’t quite figured this one out yet, but when they do… Watch out!

Investing in China was originally featured in the Penny Sleuth.