The Art of Capital Flight
CAMBRIDGE
– What impact will China’s slowdown have on the red-hot contemporary
art market? That might not seem like an obvious question, until one
considers that, for emerging-market investors, art has become a critical
tool for facilitating capital flight and hiding wealth. These investors
have become a major factor in the art market’s spectacular price bubble
of the last several years. So, with emerging market economies from
Russia to Brazil mired in recession, will the bubble burst?
Just five months ago, Larry Fink, Chairman and CEO of BlackRock, the world’s largest asset manager, told an audience in Singapore
that contemporary art has become one of the two most important stores
of wealth internationally, along with apartments in major cities such as
New York, London, and Vancouver. Forget gold as an inflation hedge; buy
paintings.
What
made Fink’s elevation of art to investment-grade status so surprising
is that no one of his stature had been brave enough to say it before. I
am certainly not celebrating the trend. I tend to agree with the philosopher Peter Singer that the obscene sums being spent on premier pieces of modern art are disquieting.
We can all agree that these sums are staggering. In May, Pablo Picasso’s “Women of Algiers” sold for $179 million
at a Christie’s auction in New York, up from $32 million in 1997. Okay,
it’s a Picasso. Yet it is not even the highest sale price paid this
year. A Swiss collector reportedly paid close to $300 million in a private sale for Paul Gauguin’s 1892 “When Will You Marry?”
Picasso
and Gauguin are deceased. The supply of their paintings is known and
limited. Nevertheless, the recent price frenzy extends to a significant
number of living artists, led by the American Jeff Koons and the German
Gerhard Richter, and extending well down the food chain.
For
economists, the art bubble raises many fascinating questions, but an
especially interesting one is exactly who would pay so much for high-end
art. The answer is hard to know, because the art world is extremely
opaque. Indeed, art is the last great unregulated investment
opportunity.
Much has been written about the painting collections of hedge fund managers and private equity art funds
(where one essentially buys shares in portfolios of art without
actually ever taking possession of anything). In fact, emerging-market
buyers, including Chinese, have become the swing buyers in many instances, often making purchases anonymously.
But
doesn’t China have a regime of strict capital controls that limits
citizens from taking more than $50,000 per year out of the country? Yes,
but there are many ways of moving money in and out of China, including
the time-honored method of “under and over invoicing.”
For
example, to get money out of China, a Chinese seller might report a
dollar value far below what she was actually paid by a cooperating
Western importer, with the difference being deposited into an overseas
bank account. It is extremely difficult to estimate capital flight, both
because the data are insufficient and because it is tough to
distinguish capital flight from normal diversification. As the late MIT
economist RĂ¼diger Dornbusch
liked to quip, identifying capital flight is akin to the old adage
about blind men touching an elephant: It is difficult to describe, but
you will recognize it when you see it.
Many estimates put capital flight from China at about $300 billion annually in recent years, with a marked increase in 2015 as the economy continues to weaken. The ever-vigilant Chinese authorities are cracking down on money laundering; but, given the huge incentives on the other side, this is like playing whack-a-mole.
Presumably,
the anonymous Chinese buyers at recent Sotheby’s and Christie’s
auctions had spirited their money out of the country before bidding, and
the paintings are just an investment vehicle that is particularly easy
to hold secretively. The art is not necessarily even displayed anywhere:
It may well be spirited off to a temperature- and humidity-controlled
storage vault in Switzerland or Luxembourg. Reportedly, some art sales
today result in paintings merely being moved from one section of a
storage vault to another, recalling how the New York Federal Reserve
registers gold sales between national central banks.
Clearly,
the incentives and motives of art investors who are engaged in capital
flight, or who want to hide or launder their money, are quite different
from those of ordinary investors. The Chinese hardly invented this game.
It was not so long ago that Latin America was the big driver in the art
market, owing to money escaping governance-challenged economies such as
Argentina and Venezuela, as well as drug cartels that used paintings to
launder their cash.
So
how, then, will the emerging-market slowdown radiating from China
affect contemporary art prices? In the short run, the answer is
ambiguous, because more money is leaking out of the country even as the
economy slows. In the long run, the outcome is pretty clear, especially
if one throws in the coming Fed interest-rate hikes. With core buyers
pulling back, and the opportunity cost rising, the end of the art bubble
will not be a pretty picture.
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