Welcome to all my new subscribers and thanks to my existing base for your engagement. We are entering a Chinese New Year, moving from the year of the Tiger to one of the Rabbit. What will this New Year bring and how will China affect the Global Economy. I’ve chosen to remain apolitical in this article and focus on the data to reach my conclusions as opposed to geopolitical factors.
Post the ashes of the GFC China led the Global Economy into a growth footing over a decade, what about the next decade or two?
What is driving China right now as I understand it?
The embargo on high end exports of Semiconductors from the US to China, leaves China vulnerable for their production for domestic consumption and exports. This has affected the Taiwanese / China One Policy of late. Lets not forget it leaves Huawei (the jewel in the Chinese corporate crown) more isolated. The Chinese tech crack down was potentially a control measure to focus private enterprise on CCP goals of Semi Conductor supply lines.
Restricted access to Capital Markets in New York, Frankfurt, London hence the previous crack downs by China in Hong Kong.
The CCP has actually committed to a reduction of Carbon Emissions. While China are the largest emitters of Carbon globally (Coal burning etc), ironically when a CCP Chairman says something is going to happen, it really happens as opposed to the Western politicians. This means that Chinese regions will reduce production particularly if their KPI’s are linked to lower emission data.
Control of its Energy supply and control of the South East China Sea. There is a 15 year program to roll out 150 nuclear power plants across China reducing reliance on Oil and LNG shipments (in due course). In a cruel twist of fate, the majority of renewable energy component parts in Wind Farms and Solar Panels come from China. Which means the West needs cheap energy and cheap wages in China to retain lower roll out costs of the West’s infrastructural strategy.
Common Prosperity Policy. The Chinese Household Consumption as a % of GDP is low at c.38% compared to Western Developed countries which an average have 60%. Wage inflation is not a problem for China, in fact it means that its citizens have more disposable income to spend as long as Inflation is curbed. (This is the important part). China needs household consumption to increase but with stagnant GDP this would mean that Business, Government and Foreign % of GDP would have to decline in order for the distribution of wealth directly to households to occur. This would mean that Corporate Values would shrink and there would be smaller Regional Government, you can see how this gets tricky as Turkeys seldom vote for Christmas. For distribution to households to occur China will need to dramatically drop its current account surplus, which is now at its highest level on record (since WTO membership 2001). Buying commodities in bulk seems to make sense in these circumstances.
The high level of Current Account surplus really suggests a pro-cyclical move in commodities will be upon us shortly.
De-leveraging has been a focus since 2017 which culminated in the demise Evergrande and other Chinese Construction Enterprises. The property market had created significant GDP growth over the years but the focus is now on increasing Household Consumption which is more productive GDP wise and less debt centric. Chinese people have a disproportionate amount of their wealth in real estate which is tricky for the CCP, collapsing property values destroys the “wealth effect”. You can see the downward tick in GDP Rate at 0.0% currently. Please note that the calculations of Chinese GDP and US GDP are different and as such not like for like comparisons.
How can China combat Inflation? If I learnt anything about inflation over the last 2 years it is that it is not driven by large amounts of QE, rather it was direct stimulus and forced lockdowns that caused product prices to surge as demand rose massively against reduced supply chains. China will need to distribute wealth directly to households leading to heightened inflationary risk. To offset this they have invested heavily in Central Bank Digital Currencies (CBDC’s) / a Digital Yuan. The effects of a CBDC are that you can direct consumer to spend in specific areas by increasing incentives so you could use this tool to mitigate inflation. Ironically China had higher inflation prior to Covid-19 lockdowns. The focus in China has always been on the supply side, the renewed focus will now be on the demand side.
Currency Wars - With China having a large Current Account Surplus and having stopped buying US Treasuries it has been investing globally in Resource Rich countries as well as increasing its Gold Reserves. One factor to consider with the Chinese re-opening post their lunar celebrations is that they will more than likely experience similar style inflation to the West, particularly on the services related sector. A strong Chinese Yuan helps China curb any potential out of control inflation but there are also other countries that now have a vested interest in a strong Chinese Yuan.
Russia has already started to use the Chinese Yuan as its forex reserve currency after the USD sanctions applied to it. More recently Russia has started to sell over $800m of Yuan to bridge the P&L (income statement) delta caused by the drop in Oil and Gas prices.
Reuters Link - Russia using Chinese Yuan as its FOREX Piggy Bank
The key message here is that they will build up Yuan reserves again in due course as their account hits a surplus. There is now international demand for the Yuan. In addition China is lobbying (successfully) Saudi Arabia to accept payment of Oil in Chinese Yuan, a subtle two fingers up to USD Reserve Currency Status
Food - China is the largest net importer of food in the world. This above all else will ultimately drive a pro-cyclical wave of food commodity price growth. The same pro-cyclical wave will also drive the need for domestic wage inflation, the higher the food cost, the more you need to earn. Revolutions were started by the inability of society to buy bread.
As it reduces its own food production (see decline consumption of Fertilizers in the chart above), China will increase its Food Importation need, this link to a possible reduction of its Current Account Surplus, need for Wage Inflation and muscling as the leading secondary Reserve Currency above the Euro.
Conclusion
With a Chinese reopening more likely to cause higher inflation than experienced to date, when we compare Western CPI rates, it will become increasingly obvious for China to strengthen the Yuan/RMB.
The knock on effect of the Yuan strength will be that the USD will strive to remain as strong as it was in the past. A strong USD is circular as Emerging Markets (and Europe) will come under increasing pressures to curb their own inflation.
In essence, the set up for me is that China will become a large consumer, to compete with the buying power of the USA in the next 10-15 years. To fund this inflated economy other countries currencies will have to underperform, so I will be Short EUR/USD. If this bears out over the next decade there will be a decent carry of Euro denominated cash invested into USD denominated assets.
From a pro-cyclical wave from the large Chinese Current Account, Commodities prices should increase, that should include Food and Metal. Most likely other Asian economies will benefit from Chinese spending and a strong Yuan as China fights to increase Household Consumption which will naturally reduce it Current Account Surplus while at the same time curbing inflation.
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NB: None of this is financial advice, please contact your own independent financial advisor before deploying any of your hard earned capital into these volatile markets.