China Beige Book started collecting data in 2010. For the entire time since then, the Chinese economy has been in what Leland calls “stable deceleration.” Slowing down, but in an orderly way that has generally avoided anything resembling crisis. As any emerging market becomes larger, its growth invariably slows down. This is a normal trajectory of developing economies. What is impressive is that China’s has been a stable deceleration. That is an unusual outcome that I can’t really remember occurring anywhere else. It is why so many observers keep expecting a “hard landing.”
It was Leland, by the way, who gave me the title idea for last summer’s “When China Stopped Acting Chinese” letter. China Beige Book noticed in mid-2014 that Chinese businesses had changed their behavior. Instead of responding to slower growth by doubling down and building more capacity, they did the rational thing (at least from a Western point of view): they curbed capital investment and hoarded cash. With Beijing still injecting cash that businesses refused to spend, the liquidity that flowed into Chinese stocks produced the massive rally that peaked in mid-2015. It also allowed money to begin to flow offshore in larger amounts. I mean really massively larger amounts.
Leland said at the time that the stock rally had little to do with China’s actual economy, which his data showed to be on the mend. That’s no longer the case.
Dealing With A Different China
China Beige Book’s fourth-quarter report revealed a rude interruption to the positive “stable deceleration” trend. Their observers in cities all over that vast country reported weakness in every sector of the economy. Capital expenditures dropped sharply; there were signs of price deflation and labor market weakness; and both manufacturing and service activity slowed markedly.
That last point deserves some comment. China experts everywhere tell us the country is transitioning from manufacturing for export to supplying consumer-driven services. So if both manufacturing and service activity are slowing, is that transition still happening?
The answer might be “yes” if manufacturing were decelerating faster than services. For this purpose, relative growth is what counts. Unfortunately, manufacturing is slowing while service activity is not picking up all the slack. That’s not the combination we want to see.
Something else China Beige Book noticed last quarter: both business and consumer loan volume did not grow in response to lower interest rates. That’s an important change, and probably not a good one. It means monetary stimulus from Beijing can’t save the day this time. Leland thinks fiscal stimulus isn’t likely to help, either. Like other governments and their central banks, China is running out of economic ammunition.
One quarter doesn’t constitute a trend. Possibly some transitory factors depressed the Chinese economy the last few months, and it will soon resume its “stable deceleration” course. It is hard to imagine what those factors might have been, though. The data is so uniformly negative that it sure looks like something big must have changed.
What does this economic weakness say for Chinese stocks? Probably nothing. It should be clear to all that the Chinese stock market is completely unrelated to the Chinese economy. They don’t move together, nor do they move opposite each other. They have no consistent connection at all – or at least not one we can use to invest confidently. I went to Macau when I was in Hong Kong a few weeks ago, just to observe the fabled fervor with which the Chinese gamble. The place did indeed have a different “feel” than Las Vegas does. I’m not the only one to think that the Chinese stock market is just an outpost of Macau, but one in which leverage and monetary stimulus can overload the system.
Let me say that there are real companies with real value in China. But the rules on the ground, not to mention the accounting, make it a particularly treacherous market to invest more than your own “gambling money.”
China’s currency is another story – and a much deeper one.
Yuan Flew Over The Cuckoo’s Nest
Recent Chinese stock market volatility has had more to do with China’s currency than its stocks. Donald Trump and other politicians (yes, he is one) often assail Beijing for devaluing its currency and acquiring an unfair advantage.
First, the Chinese have actually been manipulating their currency upwards. While countries in the rest of the world have been letting their currencies devalue against the dollar, China has maintained an effective dollar peg until very recently. And then the “move” that seems to have everybody in a dither was only about 4%. To be fair, what really had the markets worried was that this move might presage an effective devaluation. And considering that China has watched the euro, the yen, and nearly every emerging-market currency drop anywhere from 30 to 50% against the yuan – a rather painful experience for its export sector – the Chinese have been quite patient.
I find it fascinating that we can be singularly focused on China and its currency, which has moved only slightly, and not pick on those countries that are openly and aggressively manipulating their currencies down. Seriously, if you want to have an intellectually consistent argument, why not talk about what those evil people in Europe are doing to lower their currencies against the dollar? Or Mexico? Or almost any other country in the world? If you are truly against the strong dollar, then why not just say so and promote a policy of further massive quantitative easing and competitive currency devaluation? That is the only logical conclusion to the Chinese currency-bashing polemics. I guess all the loose talk is just another misguided attempt to Make America Great Again™.
In a normal world, nations with trade deficits naturally see their currencies weaken. No one needs to intervene or manipulate markets. When you bring stuff in, you send cash out. When you send stuff out, you bring cash in. It’s as effortless as breathing. And if your cash is useful only for buying things in your local country, when too much of your money is offshore, your currency is going to weaken.
Then why has the dollar gotten stronger even as we continue to run massive trade deficits? Because the dollar, being the world’s reserve currency as well as the currency for international trade, is in demand. In fact, it is in such demand that if we closed the trade-deficit gap (as we have been starting to do), the dollar would get even stronger, because the world needs dollars to facilitate global trade. We do indeed enjoy a special privilege. Which is why I want to think at my conference about the consequences of the world’s leading trading currency going to negative interest rates.
It is true that politicians everywhere try to pervert the trade process and gain short-term advantages by cheapening their currencies. Most are smart enough not to equate their currency valuations with national pride. I wonder if Trump, et al., have thought through the consequences of their seeming desire to see the dollar weaken. Hopefully someone will enlighten them soon.
Back to our story: does Beijing think it can boost exports by manipulating its currency lower? I don’t think so. Remember how their business model works. Unlike, say, Saudi Arabia, China doesn’t simply extract resources from the ground and export them. China imports raw materials, transforms them into finished goods in its factories, and then exports those goods. Their gain lies in the value added in the manufacturing process.