Are China’s problems global problems?

good morning. It’s Fed week. I expect the Fed’s rhetoric to be very harsh indeed, following the precedent set last month at Jackson Hole. I also expect the market won’t buy it out completely. Do you have a different prediction? Email me: robert.armstrong@ft.com.

How important is China’s slowdown to global investors?

The standard checklist for reasons to be bearish, for now, has three big items. The first: to stifle inflation, the Federal Reserve will tighten monetary policy until the United States enters a recession. Second: the energy shock will push Europe and the UK into recession, if it hasn’t already. Third, the zero-Covid policy and sluggish real estate crisis ensure China’s meager growth.

China’s troubles cemented its place in the top three last week, when key economic data for August was released. While the headline numbers weren’t as bad as the downright scary July numbers, the underlying picture hasn’t improved – especially in terms of domestic demand. China’s manufacturing and exporting machine is still running constantly, although weak global demand is starting to show. But domestically, things are ugly:

  • The August retail sales figure rose 5.4 percent in August, a rebound from 2.7 percent in July. But analysts were quick to point out that the improvement is largely due to an easier comparison with last year and government support for car purchases. Month by month and adjusted for seasonality, Julian Evans-Pritchard of Capital Economics estimates retail sales fell 0.8 percent. his scheme:

  • Youth unemployment remains close to 20 percent, and it is rising.

  • For global exporters of iron ore, copper and other commodities used in construction, there is no sign of a recovery in the housing market, and investment in fixed property continues to decline.

  • The government pays various forms of stimulus. Borrow local government financing vehicles to buy land, supporting cities and counties in place of declining real estate companies. The People’s Bank of China lowered the key lending rate. The government encourages banks to provide funds to resume troubled real estate projects. But given the scale of the issues, it feels like tinkering around the edges, with more rhetoric than substance. Here is Adam Wolfe of Absolute Strategy Research, who wrote last month:

The government has so far failed to implement the rumored stimulus measures. Media reports said local governments will be allowed to tap into 1.5 trillion RMB of bonds next year [issuance] Quotas have not yet been confirmed. The rescue fund for distressed housing projects that the State Council is supposed to have approved has not been announced. The Politburo’s quarterly economic review last week said neither, nor did this week’s planning meetings of the People’s Bank of China and the National Defense Committee (NDRC) mention the second half of the year. This may have made companies more cautious about investing because they are not sure when or if additional government support will be available.

  • Monetary stimulus is ineffective because China is in a liquidity trap. The private sector in China is not interested in more borrowing. . . There is plenty of money to lend, but it is simply lying in the banking system unused,” summarizes Craig Bothham of Pantheon Macro Economics. So credit growth is slower than growth in the money supply. Below is Bothham’s chart (“M2” is the money supply, and “ASF” ‘All social finance’ stands for a broad measure of credit growth:

Not an encouraging picture. For investors who do not invest directly in China, should this be a major cause for concern?

An institutional investor in New York, London, Tokyo or Singapore, with a reasonable standard portfolio of stocks and bonds, will have a lot of direct exposure to the US and European economies. Their direct exposure to China is likely to be much lower, for several reasons. The Chinese financial system is relatively closed, and foreign ownership of its financial assets is low (and in the case of corporate bonds, declining rapidly). While China plays an enormous role in meeting the demand for goods outside of China, its role as a source of demand for goods and services for other countries is very limited, and concentrated in a few areas – most notably commodities and semiconductors (top) Ten holdings in MSCI’s China Global Exposure Index consist of 5 semiconductor companies, 4 commodity groups, and electronic component manufacturing company).

But outside of huge commodity exporters like Brazil and Australia, the direct exposure to Chinese demand isn’t huge:

Jörg Wootke, President of the European Chamber of Commerce in China, pointed out that European exports to China (112 billion euros) are much lower than those to the United Kingdom (161 billion euros) and not much larger than those to Switzerland (91 billion euros).

But while it is important not to overstate China’s contribution to global demand, it is equally important to recognize that the areas where China’s demand is most important – commodities and semiconductors – are cyclical and highly visible. What China contributes is highly volatile and could be a leading indicator of global growth and a powerful driver of global sentiment. It helps explain charts like this, from Absolute Strategy Research, that show an important, albeit uneven, correlation between the performance of Chinese economic and global stocks:

I wonder if the link might be weaker this time. Given that two of China’s big problems (zero-Covid and housing) are largely local, how far will China’s slowdown prove to be a global problem in this cycle, outside of specific sectors just like commodities? Will China lead the global economy – or just follow?

good reading

Adam Touse talks about the dangers of coordinated global monetary tightening – the ‘Fed’s Mistake’ on a global scale.

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