Good morning. It’s Fed week. I predict the Fed’s rhetoric will be very tough indeed, following the precedent set last month in Jackson Hole. I also predict the market will still not quite buy it. Have a different prediction? Email me: firstname.lastname@example.org.
How much should China’s slowdown matter to global investors?
The standard checklist of reasons to be bearish has, at present, three big items on it. One: to suffocate inflation, the Federal Reserve will tighten monetary policy until the US is in recession. Two: an energy shock will send Europe and the UK into recession, if it hasn’t already. Three: the zero-Covid policy and a slow-motion property crisis guarantee anaemic Chinese growth.
China’s woes cemented their place in the top three last week, when key economic data for August came out. While the headline figures were not as bad as the outright scary July numbers, the underlying picture has not gotten better — especially as regards domestic demand. China’s manufacture-and-export machine is still humming along, though weaker global demand is starting to show. But domestically, things are ugly:
The August retail sales number rose 5.4 per cent in August, a bounce from July’s 2.7 per cent. But analysts were quick to point out that the improvement was largely down to an easier comparison with last year and government subsidies for car purchases. Month-over-month and adjusted for seasonality, Capital Economics’ Julian Evans-Pritchard estimates that retail sales declined 0.8 per cent. His chart:
Youth unemployment remains close to 20 per cent, and rising.
For global exporters of iron ore, copper and other commodities used in construction, there is no sign of a recovery in the housing market, and fixed real estate investment continues to fall.
The government is pushing various forms of stimulus. Local government financing vehicles are borrowing to buy up land, supporting cities and provinces in the place of retreating real estate companies. The People’s Bank of China has cut a key lending rate. The government is encouraging banks to provide funds to restart stalled real estate projects. But given the scale of the problems, it looks like tinkering around the edges, with more rhetoric than substance. Here is Adam Wolfe of Absolute Strategy Research, writing last month:
The government has so far failed to deliver its rumoured stimulus measures. Media reports that local governments will be allowed to tap rmb1.5tn from next year’s bond [issuance] quotas have yet to be confirmed. And the bailout fund for stalled housing projects that the State Council supposedly approved hasn’t been announced. The Politburo’s quarterly economic review last week didn’t mention either, nor did this week’s PBoC and NDRC planning meetings for the second half of the year. That’s likely made firms even more cautious about investing since they’re not sure when, or if, additional government support will be forthcoming.
Monetary stimulus is ineffective because China is in a liquidity trap. “China’s private sector has little interest in further borrowing . . . ample funds exist for lending, but they are simply sitting in the banking system unused,” Craig Botham at Pantheon Macroeconomics sums up. So credit growth is slower than the growth in money supply. Here’s Botham’s chart (“M2” is the money supply, “ASF” stand for “all social financing” a broad measure of credit growth):
Not an encouraging picture. For investors who are not directly invested in China, though, should it be a major independent cause for worry?
An institutional investor in New York, London, Tokyo, or Singapore, with a reasonably standard portfolio of equities and bonds, will have loads of direct exposure to the US and European economies. Their direct exposure to China is likely to be much lower, for several reasons. China’s financial system is relatively closed, and foreign ownership of its financial assets is low (and, in the case of corporate bonds, falling fast). And while China has an immense role in meeting demand for goods outside of China, its role as a source of demand for goods and services for other nations is much more limited, and concentrated to a few areas — most notably commodities and semiconductors (the top ten holdings in MSCI’s World China Exposure Index consist of 5 semiconductor companies, 4 commodities groups, and an electronics component manufacturer).
But outside of huge commodities exporters such as Brazil and Australia, direct exposure to Chinese demand is not enormous:
Joerg Wuttke, president of the European Chamber of Commerce in China, pointed out to me that European exports to China (€112bn) are well less than those to the UK (€161bn) and not much greater than those to Switzerland (€91bn).
But while it is important not to exaggerate the contribution of China to global demand, it is equally important to acknowledge that the areas where China’s demand is most significant — commodities and semiconductors — are highly cyclical and visible. What China does contribute is highly volatile and could be both a leading indicator of global growth and a powerful driver of global sentiment. That helps to explain charts like this one, from Absolute Strategy Research, showing a significant if uneven correlation between Chinese economic and global stock performance:
I wonder if the correlation might be weaker this time around. Given that China’s two big problems (zero Covid and housing) are very much local, how much will China’s slowdown prove to be a global problem this cycle, outside of quite specific sectors like commodities? Will China lead the global economy — or just follow it?
One good read
Adam Tooze on the risks of coordinated global monetary tightening — a “Fed mistake” on a global scale.