There is only one way to square a record trade surplus with the sharp fall in reserve growth:

Hot money is now flowing out of China. Here is one way of thinking of it:

The trade surplus should have produced a $115 billion increase in China’s foreign assets. FDI inflows and interest income should combine to produce another $30-40 billion. The fall in the reserve requirement should have added another $50-55 billion (if not more) to China’s reserves. Sum it up and China’s reserves would have increased by about $200 billion in the absence of hot money flows. Instead they went up by about $50 billion. That implies that money is now flowing out of China as fast as it flowed in during the first part of 2008.

And in December, the outflows were absolutely brutal. December reserves were up by $20 billion or so after accounting for valuation changes – but the fall in the reserve requirement alone should have pushed reserves up by at least $25 billion. Throw in a close to $40 billion trade surplus and another $10 billion or so from FDI and interest income, and the small increases in reserves implies $70 billion plus in monthly hot only outflows … That’s huge. Annualized, it is well in excess of 10% of China’s GDP. Probably above 15%.

The mystery being, of course, who is doing the “hot money” transfers.  Chinese companies?  Investors from Taiwan or Hong Kong?  Investors from further abroad? Brad seems to suspect the second:

Over time, if hot money outflows subside, China’s reserve growth should converge to its current account surplus (plus net FDI inflows). That implies ongoing Treasury purchases – though not at the current pace – barring a shift back into “risk” assets. And if hot money outflows continue, watch for Hong Kong and Taiwan to buy more Treasuries. The money flowing out of China doesn’t just disappear … it has to go somewhere.