Yesterday President Xi Jinping corroborated our long-held bias that that “the [Chinese] economy still faces relatively large downside pressures” – not that anyone needed Xi to confirm what we already knew. Growth in the volume of Chinese rail freight traffic and price trends across various key industrial commodities would seem to imply as much.
Looking across a variety of key high-frequency indicators, Chinese economic growth has stabilized insomuch that it is no longer “rolling down the hill” but policymakers are decidedly still “walking [the economy] down the steps”. This phenomenon is most recently highlighted by sequential slippage in the growth rates of industrial production, fixed assets investment, foreign direct investment, total social financing, as well as various measures of supply and demand in the Chinese property market.
Offsetting the aforementioned “downside pressures” is a sharp reversal of what has been a disastrous and well-documented trend of capital outflows that coincided with the IMF’s tacit decision to include the CNY in its vaunted SDR basket.
Moreover, Beijing has taken to capital controls to help it accomplish its goal of maintaining exchange rate stability. Specifically, the PBoC has recently stepped up verbal guidance to onshore banks to cull their offshore lending practices, which, in turn, has made it more expensive than ever to borrow and sell short the offshore yuan, or CNH.
While capital controls have rarely – if ever – been proven successful at staving off long-term currency depreciations, they can and will continue to be a short-seller’s worst nightmare from the perspective of consensus expectations for a material devaluation of the RMB. The “Bejing Put” remains the #1 reason we aren’t raging bears on China; Chinese officials can and will do what they have to do to ensure an orderly downshift in their economy – if there even is such a thing.
Will the aforementioned SDR labeling bring stability to the outlook for the exchange rate? Judging by the spread between the spot rate and PBOC’s reference rate since the mid-AUG devaluation, one could make the case that stability is in – for now at least.
As such, we feel comfortable reiterating the claim we staked in our 9/23 note titled, “When Will China Devalue Again?”: “…we think the Chinese are neither incentivized nor inclined to devalue the CNY again – certainly not in the near term. That said, however, we believe another round of euro debasement out of the ECB is likely the next catalyst for investors to begin pricing in this risk – rightly or wrongly.”
As a reminder, the ECB is scheduled to review its monetary policy on 12/3 and Draghi’s recent guidance has indeed been [appropriately] dovish, on the margin. From our 11/9 note titled, “What’s Driving Our Bearish Forecasts for Domestic and Global Growth?”:
“In terms of cratering a narrative around the aforementioned mathematical reality of steepening base effects in the Eurozone, industrial production, exports, consumer confidence, business confidence and PPI are all slowing on both a sequential and trending basis throughout the region. Its composite PMI is still slowing on a trending basis and household consumption growth is trending at an unsustainably elevated rate in the context of our outlook for ECB monetary policy and it’s likely [negative] impact on the EUR.”
All told, while we are comfortable reiterating our explicitly dour outlook for Chinese economic growth, it bears repeating that we continue to view the Chanos “economic collapse” view as misguided given that the “Beijing Put” continues to largely offset that outcome. China’s trending GDP growth deceleration just feels like a collapse to the rest of world given China’s outsized contribution to global growth.
That is especially true for those suppliers that are over-indexed to Chinese import demand. As the following charts highlight, the lower commodity prices go, the slower global business investment and corporate profit growth are likely to become.
It all comes back to the rising U.S. dollar. Consider the following dynamics:
- A significant portion of global demand growth in the pre and post-crisis eras was predicated on China’s “managed float” peg to the U.S. dollar.
- Why? Because China had been importing a substantial portion of our Greenspan/Bernanke bubble-blowing monetary policy for over a decade (the DXY declined -39.7% from its July 2001 top to its April 2011 low).
- Moreover, the country’s 2001 entry into the WTO opened up access to global export markets, which allowed it to generate the sizeable current account inflows needed to fuel gangbusters deposit growth throughout the onshore banking system (China’s “closed” capital account means every $ that enters the Chinese economy gets converted into RMB).
- The M1 growth associated with rapid current account inflows helped to perpetuate a domestic fixed assets investment bubble via asset/liability matching.
- INSERT insatiable demand for energy and raw materials HERE.
- The U.S. dollar bottoms in 2011 and goes on a multi-year bull run, up +35.9% from the aforementioned April 2011 low.
- Chinese export growth slows alongside a dramatic narrowing of its current account balance.
- Mainland deposit growth slows, followed by a secular slowdown in fixed assets investment growth.
- Growth in Chinese demand for incremental raw materials appropriately collapses… Meanwhile, every crude oil, copper and iron ore producer the world over is regretting having signed off of incremental exploration and production a few years back at the peak in Chinese economic growth.
CLICK HERE to review our deep dive analysis supporting these conclusions.
You can bet your bottom dollar that members of the PSC and broader CPC are well aware of these dynamics, which is largely why various officials have quite often used words like “messy” and “complicated” in describing Chinese economy over the past few years.
Moreover, this unspoken understanding is largely behind the stated drive to transform China into a services-oriented and consumption-led economy, which itself is a “complicated” task that will require a downshifting of GDP growth, a curbing of industrial overcapacity and a system-wide recognition of nonperforming loans – which have been both materially and serially underreported amid systemic “evergreening”.
Bigger picture, the aforementioned dynamics help explain a significant degree of the missing supply/demand link between the semi-perpetual (and often meaningful) inverse correlation between the U.S. dollar and commodity prices. As such, it’s not a coincidence that raw materials continue to crash in conjunction with the trending deceleration in global growth.
This linkage is largely behind why CAT’s management team can’t figure out why its order book continues to collapse.
More broadly, this linkage can explain a substantial portion of the current profit recession in the U.S.
Even more broadly, this linkage is largely behind why Brazil has been unable to escape recession and why many EM equity markets and currencies have crashed and/or continue to crash.
When the proverbial “dots” are connected, this linkage can even explain a portion of the BoJ’s shocking balance sheet expansion (now 75% of Japanese nominal GDP), which has perpetuated a peak-to-present crash of -38.3% in the JPY/USD cross and a +139.4% rally in the Nikkei 225 Index off its June 2012 lows.
“If you don’t do globally-interconnected macro, globally-interconnected macro will do you.”
As we’ve said at every turn since our 2008 inception, Global Macro starts and ends with the U.S. dollar – which itself is an extension of not just U.S., but rather global, monetary policy. In light of that, we think investors would do well to know exactly where the dollar is headed in 2016…
Feel free to email with questions or comments. As always, we encourage thoughtful debate.