There is a lot going on in China because of the US trade war right now. So this post isn’t going to be all-encompassing. But the long and short of it is that China has decided to go all-in in its trade war with the US. And that means it has also been forced to add stimulus to its domestic economy to prevent economic growth from flagging.
China’s tariffs
The commerce ministry has said China would impose tariffs on $60 billion worth of US goods. Here’s the Wall Street Journal on the news:
In a statement issued late Friday, China’s cabinet said the government is preparing to impose duties at levels of 25%, 20%, 10% and 5% on some 5,207 American goods.
“The implementation date of the taxation measures will be subject to the actions of the U.S., and China reserves the right to continue to introduce other countermeasures,” the cabinet, known as the State Council, said. “Any unilateral threat or blackmail will only lead to intensification of conflicts and damage to the interests of all parties.”
This latest move by China makes clear that it’s not going to retreat (yet) in the bust-up with the US.
Earlier news outlets had been reporting that China was moving to stop the rapid depreciation of the Yuan. And this was seen as conciliatory since US President Trump had tweeted his view that the Chinese had turned to the currency as a weapon.
Trump’s view that China was manipulating its currency to hurt the US could cause him to harden his stance in trade negotiations with Beijing. But with the news of fresh tariffs on US goods, it’s clear that China does not want to look too acquiescent and wants to negotiate with the US from a position of perceived strength.
The currency weapon
Now, let’s be clear. We really don’t know what is driving the Chinese currency situation since it is a managed currency. So the Chinese could be using the currency as a weapon.
To give you an example of how this is being discussed, I’m going to highlight a German-language piece by Holger Zschäpitz over at German daily “Die Welt”. His headline yesterday: China setzt Yuan als Waffe im Handelskrieg ein. That translates as “China uses Yuan as a weapon in the trade war”.
He sees the train of events in this order:
- First, the US applied tariffs on $50 billion of Chinese goods.
- The result was a double-digit percentage loss in Chinese equities and a softening Chinese economy
- To combat the impact of the tariffs and a softening economy, the Chinese have begun to add stimulus.
- But since April, the Chinese have also been devaluing their currency. It’s lost 9% since then.
- This has angered Trump, who is now threatening tariffs on $200 billion more of Chinese goods.
- The Chinese have been caught out according to Zschäpitz . The economy is flagging and cannot withstand the tariff onslaught. Citi economist Li-Gang Liu estimates the new tariffs would cost the Chinese economy $100 billion or 0.83% of lost growth. Combined with the impact of the first round of tariffs, Liu sees the job impact as 4.4 million Chinese jobs.
- Deutsche Bank thinks this means more (market-dictated) currency weakness. They have set a year-end target on the Yuan at 6.95 to the US dollar. They could see the Yuan falling further to 7.40 in 2019. That would be another 10% fall on top of the fall already.
China peer-to-peer bankruptcies
Now, China’s economic growth was flagging irrespective of the toll the trade war is now playing. It may be that the government’s attempt to wring froth out of its equity and credit markets is having an impact. For example, in the less regulated peer-to-peer lending market, there has been a spate of bankruptcies. Here’s Bloomberg’s take:
At least 118 platforms have failed this month through early Friday, according to Shanghai-based Yingcan Group, whose tally for July stood at 57 just three days ago. The number of failures, which includes platforms that have halted operations or come under police investigation, is already the highest in two years with more than a week left in the month.
China’s clampdown on financial risk has weighed on P2P platforms for the past two years, but the pressure has intensified in recent months after the country’s credit markets tightened and the banking regulator issued an unusual warning to savers that they should be prepared to lose all their money in high-yield products. While that has triggered bouts of panic among users of smaller P2P platforms, there’s little evidence that the turmoil has spread to more systemically important parts of China’s financial sector.
Authorities are focused on weeding out bad actors in the P2P industry, one of the riskiest and least-regulated parts of China’s $10 trillion shadow-banking system, according to Chen Shujin, chief financial analyst at Huatai Securities Co. in Hong Kong.
How far this shakeout goes is unclear. But, however, you look at it, the shadow banking sector in China is large enough that a lack of credit supply there will dampen economic growth.
Speculation about an expansion in China’s monetary policy
So there is a lot of speculation that the Chinese will release the monetary taps. Here’s John Stepek at Money Week for instance:
..the sheer scale of Chinese malinvestment has been extraordinary. From 2008 to 2018, China’s gross debt rose from 171% of GDP to 299%.
“China’s credit boom is one of the largest and longest in history. Historical precedents of ’safe’ credit booms of such magnitude and speed are few and far from comforting”, note Sally Chen and Joong Shik Kang from the International Monetary Fund…
So for the last wee while, the Chinese government has been trying to have a bit of a clean up. It’s made it harder for companies to borrow money. It has allowed some corporate defaults, to make it clear that you can’t just lend money willy-nilly and expect it to be repaid.
Hence the rising profile of Chinese corporate defaults.
Why now? Well, as Jonathan Allum of SMBC Nikko points out, the Communist party had been hoping that strong global growth (which would boost export demand) would give it the opportunity to rein in financial risk. They could run the risk of tightening financial policy internally as long as the rest of the world was compensating.
Trouble is, they reckoned without Donald Trump.
As trade tension has ramped up with the US, this benign backdrop has changed dramatically. And now, the Chinese government is backing away from cleaning up its own backyard in order to focus on its external problems.
The speculation here then is that the Chinese will be forced to loosen so much that it will have a tremendously uplifting effect not just on China but on asset markets globally. It’s an interesting hypothesis. But I don’t have a read on it just yet
Final thoughts
My view here is that the trade war is dangerous for a world where central banks are both tightening and short of runway should the economy lapse into recession. I don’t see a recession around every corner; I actually think things are pretty good, especially in the US. But outside of the US, there are greater signs of flagging momentum, particularly in China. And a bilateral trade war will exacerbate those problems multilaterally.
I am still toying with John Stepek’s concept that China’s attempts to forestall a bad outcome will cause a blow-off top to a global asset bubble. What I did find interesting in the Zschäpitz piece is his quote of Douglas Irwin, an economics professor at my alma mater Dartmouth. Irwin notes that it was the creditor nation America that got killed in the trade wars of the Great Depression. And this go round, it is China that is the creditor nation. So they stand to lose the most if this thing escalates. I have long maintained that view as well. From an emerging markets perspective, that’s a quite negative tail risk.