Trade Trends: Lower yuan can’t fix China’s problems

   Global markets began the New Year with an unfortunate hangover, and it’s been difficult to find many bullish signals outside the United States.

   The main concern is China, whose markets began the year with a steep slide that reverberated throughout the world. Domestically, healthcare, education, and e-commerce are all relatively bright economic sectors for China. These are the good signs that suggest China’s long-term aspiration to move from an export-oriented economy to a consumption-oriented one, as we’ve outlined before in American Shipper, is realistic.

   But, according to government figures, China’s GDP experienced its slowest growth period since the 2008 financial crisis. The culprit is exports, which initial estimates pegged as being down 3.7 percent on the year.

   While China’s policymakers do have some remedial ingredients, the cupboard is looking increasingly bare. Neither monetary nor fiscal policy alone can eliminate the directional problem with China’s downtrodden economy in general, or its sputtering export volume in particular.

   The yuan, which was approved as a reserve currency by the International Monetary Fund late in 2015, saw a 4.9 percent drop in value in 2015, and many observers expect similar levels of depreciation in 2016.

   It is a mistake, however, to believe the declining yuan will fix China’s problems.

   A weaker yuan does stimulate exports in that it effectively makes Chinese goods cheaper. But it erodes growth at home, the very quality that China’s economic transition depends on, as goods become more expensive when the currency devalues. There’s also concern that further devaluation of the RMB by the Chinese government could kick off trade disputes and create new competition with other countries.

   It does not seem likely that the Chinese government will be able to spend its way out of its current economic slump like it did after the 2008 financial crisis. The asset management company BlackRock estimates that China’s debt —government, financial, non-financial, and household debt—was 282 percent of GDP in 2014, having risen from 121 percent in 2000 and 158 percent in 2007. The BlackRock report notes that there have been four credit booms of similar magnitude during the past 50 years, and all four led to fairly immediate banking crises.

   The fact is that China’s slowdown is not being driven by a lack of competitiveness. It’s being driven by weak demand— at home and in destination markets. Since China is already the undisputed world leader in manufacturing, and a highly efficient one at that, it has relatively little scope to gain global market share through lower currency alone. Appreciation of the dollar against a broad basket of currencies also means that most other manufacturing economies share the same benefit of cheaper currency in the strongest export destination, the United States.

   China’s economy has had two primary engines for growth in recent decades: capital investments into domestic infrastructure which keep property markets strong, and export-oriented manufacturing. Both have slowed down significantly and this has had trickle-down effects into the rest of the economy. China’s steel industry, for example, lost $11 billion last year. They are overproducing steel as domestic demand has slumped. This is partially because of a slowing of big infrastructure projects, such as the building of roads and bridges. However, the bigger reason is the slowdown in the property market, the economic sector that has historically churned the greatest demand for steel in China. An oversupply in housing has grounded demand for new housing starts to a halt.

   China’s National Bureau of Statistics producer price index was down 5.9 percent in 2015, with 45 consecutive months of decline. This suggests alarmingly weak domestic demand, especially considering the role that the property market and housing sector plays in stimulating the rest of the country’s domestic economy.

   Consumers who are dependent on employment in these two-engine sectors are spending less, holding back commerce as well as service-based employment at local and regional levels. Domestic demand is thus becoming a significant obstacle.

   The slowdown of world trade was unexpected and caught policymakers by surprise. The Chinese economy needs global demand for manufactured goods, such as that spurred by the holiday season in North America, South America, and Europe, to trend upward. Stimulative effects from a depreciating yuan against the U.S. dollar can of course complement this trend, but it cannot replace it.

   There is reason for cautious optimism. Though economic forecasts for South America’s largest countries are rough, the U.S. economy is on solid footing and a strong U.S. dollar favors imports. There are also signs of a slow, albeit still fragile, economic recovery in the European Union after years of slow or negative growth. If these trends continue, they have the potential to generate solid demand for Chinese exports.

   Because China is a longer-term question mark for a lot of multinationals, these trade patterns are all worth monitoring in the early half of 2016.

   Taneli Ruda heads Thomson Reuters’ global trade management business, ONESOURCE Global Trade. He can be reached by email at taneli.ruda@thomsonreuters.com.