by John Rubino
Being huge, consequential and technologically advanced, China isn’t normally lumped into the “emerging” category with Brazil and Argentina. To most observers they’ve already left the kids table and are now seated with the developed-world adults.
But that might be premature. A big part of China’s economic ascendance was purchased with borrowed money – including a lot of US dollars – and came at the perceived expense of US well-being. And the US now wants to redress what it sees as unfair terms of trade in the most abrupt way possible.
This leaves China with huge debts to service and – possibly – a declining trade surplus with which to do it. Here’s how today’s Wall Street Journal summarizes the situation:
Chinese markets are in trouble once again.
China’s currency is down nearly 1% from Friday’s close, wiping out the yuan’s gains for the year, after the People’s Bank of China cut reserve requirements for banks over the weekend. Slowing growth and rising trade tensions are pummeling Chinese shares, with the Shanghai Composite entering a bear market Tuesday. And rising defaults are testing the country’s gargantuan debt market.
To investors with a long memory, this may sound uncomfortably familiar. The last big yuan selloff, beginning in mid-2015, was heralded by a historic stock-market collapse, a rash of corporate bond defaults and Chinese monetary easing.
As in 2015, the U.S. and Chinese central banks are moving in opposite directions, making yuan assets less attractive. Investors owning Chinese rather than U.S. 10-year government bonds pocketed a measly 0.6 percentage-point yield premium in May, the smallest since late 2016.
China is now gradually easing monetary policy, while the Federal Reserve is tightening. Trade tensions are rising, and China posted its first current-account deficit since 2001 in the first quarter. Growth will probably slow further in the second half.
Panic or no panic, a weaker Chinese currency in the months ahead still seems likely.
It’s logical for China to respond to US trade sanctions by weakening its currency, allowing its export industries to cut prices to offset the higher tariffs. And a lot of people seem to expect an explicit devaluation as the dance progresses. From CNBC a few days ago:
China’s currency has slipped markedly in the last week, to the point where it’s trading at December lows against the dollar, and that’s prompting speculation that China would be willing to use a weakened currency to fight U.S. tariffs and trade threats.
China has often been accused by the U.S. government of intentionally keeping its currency depressed to cheapen its goods in the world market, making them more attractive than those from countries with stronger currencies. The Trump administration this year stopped short of calling China a ‘currency manipulator,’ and China’s currency has actually been fairly steady for most of the year.
“It looked like they were impeding the dollar’s rise against the remnimbi, in line with what you normally expect given the general strength of the dollar. That caught up last week,” said Robert Sinche, the chief global strategist at Amherst Pierpont. “They weren’t letting the currency weaken as much as it should have, so the trade-weighted remnimbi was actually rising in that environment. I think they might have said, ‘The U.S. is not going to play nice, we’ll let the remnimbi trade as it should.’”
Nonetheless, rumors circulated that China could go further and actually become aggressive in forcing a decline in the remnimbi, also known as the yuan.
“The yuan is controlled. They allow it to trade in a band. In order to make sure they don’t have a runaway trade. What you’re seeing is the [speculators] took it by the upper limit of its band,” said Boris Schlossberg, managing director at BK Asset Management. “I think the market is anticipating something, or they feel it’s going to be a natural policy response if this keeps up.”
But there’s another side – the emerging market side – to a Chinese devaluation: All those dollars that Chinese companies and local governments have borrowed would – with a rising dollar – become a lot harder to pay off. The following chart illustrates the magnitude of China’s dollar obligations relative to other emerging countries. $100 billion isn’t unmanageable for a several-trillion-dollar economy, but it’s definitely a problem in a world of many other problems.
To sum up, a Chinese devaluation helps with trade but hurts with debt repayment. And it’s not clear which side of that equation outweighs the other – or whether this kind of currency war escalation might get out of hand.