The global economy is like a funfair rollercoaster. It has relentless ups and downs, frightening twists and turns, and it can even make some feel a little sick. If you picture the global economy as a complex mechanical ride, it consists of many moving parts, each made up of individual national economies. Some are much bigger than others and deserve special care and attention – particularly the United States and China. While potential downturns in other sizeable economies like Germany, the UK and Brazil might make the ride a little bumpy, dramas in China and the USA can take the whole thing out of service.
The problem investors have right now is that Germany is struggling and the UK economy is troubled, showing declining GDP in the second quarter (0.1% and 0.2% respectively), Brazil is part of a wider LatAm market under pressure, with neighbour Argentina in a big downturn. And to cap it all, there are increasing warning signals from the big two, China and the USA.
China has been a star of the show
On the face of it, the Chinese economy, second in the world only to the USA, is flying. You could look at the figures and see it’s been growing at an average of more than 6% over the last 30 years, an incredible performance. Buoyed by the spending of the State and powered by a wealth of natural resources, the manufacturing industries, in particular, built up an enormous head of steam and the export market exploded, so much that China is now the world’s largest exporter of goods.
As the country continued to modernise, in terms of its global relations, it joined the World Trade Organisation in 2001 and increasingly engaged in trade treaties all over, from New Zealand to Europe. But, as we shall see, it’s international trade that’s now threatening to derail the whole show.
With the economy heating up, investors looked to capitalise on Chinese business, and on its strong currency, the Chinese Yuan. Forex investors saw the price rising and backed it in its pairing with the USD and, over time, could almost trade automatically based on positive currency signals.
As you’ll see from the currency chart, since 2014, the Chinese Yuan has risen from 6.01 to a high of 7.13 this month. To put that into context the price hit rock bottom of 1.53 in 1981.
Why are there problems with China now?
If you refer to the graph once more, you can’t help but notice the sizeable blip, some might say severe downturn, in 2017, from which it has steadily recovered. What caused it? The United States, when President Donald Trump fired the opening salvos of what has become a dangerous trade war between the USA and China. The world’s two largest economies going toe-to-toe affects not just them, but the whole global economy. Remember, they are the key components that, if they go screwy, can shut down the whole rollercoaster ride.
Mr Trump had long complained about China’s trading arrangements, even before he took office. He believed the practices were holding back the USA, and after coming to power he ordered an investigation, resulting in the imposition of tariffs on billions of dollars worth of Chinese products. That, of course, put a big dent in China’s economic prospects, so it was no surprise when the country’s President Xi Jinping sanctioned retaliatory tariffs against the USA.
The path looked clear for a new deal between the two last December, but talks collapsed. Far from getting better, yet more tariffs were imposed on both sides. More recently, Mr Trump says he’ll continue the China trade war even if it plunges the US into recession.
It’s against the backdrop of this trade war that investors have become spooked about China’s economy.
China’s wobbles not all down to the US dispute
There’s no doubt the tariffs have hit China hard, but there are other factors at play that have further dented investors’ confidence. Three key indicators, in particular, are raising concerns. Firstly, the Chinese government relaxed its monetary policy to help fuel a credit boom, which is intended to shift the economy from an investment-based one to consumption-based. As a consequence, China’s debt leapt from 164% to 300% of GDP between 2008 and 2018. China tried to open the door wider to foreign investors to help stimulate more demand, which would help bring down debt. Latest data suggests those investors are not as interested in Chinese bonds as the Government might have hoped.
The second ongoing worry is that the Chinese Yuan is greatly overvalued. While the price has increased as the economy boomed, many believe the money supply is way too high to be sustainable. The People’s Bank of China (PBOC) has helped grow China’s total banking system assets to $39.9 trillion by 2017, a 200% rise over the previous seven years. With all that extra money sloshing about, the currency price could well be due a fall.
A third concern is that internally, Chinese investors have a penchant for investing large sums in real estate, as opposed to stocks. While this has created a booming real estate market, such as that in Beijing (above), it has not driven stock market investment, something the PBOC wants to encourage. And it has heated the real estate market to levels where a downturn would have serious implications. The Chinese must also consider more ways to support sustainable real estate.
Global investors left sitting on their hands
With these obstacles in the way of further Chinese economic growth, it’s clear to see why foreign investors have been hesitant to pile in with wide support for the currency and bonds. They have other economies they can turn to. The US economy is still strong, but it, too, has some warning signals. And, as we’ve seen, when the US and China hit economic trouble, the whole world feels the result. And that won’t be a funfair ride we’ll enjoy.