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ECONOMY: China Economy Report September 2015
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Economy Monthly Report

By Andrew Smith

There have been so many economic developments over the last month that it is hard to know where to start. Yet again it has been made blindingly obvious by official statistics that the Chinese economy, following in line with a general weakening of output across the globe, is continuing to slide. Mark Porubcansky of the Minn Post quite rightly pointed out that, “Every winning streakcomes to an end. China has become an economic powerhouse during decades of breakneck growth, but suddenly it is looking a bit wobbly. The question this summer as the country has lurched from stock-market meltdown to currency devaluation is whether the run is finally nearing an end.”

Official statistics show that China’s exports, which have been in a steep decline in growth for several months now, fell by around 8% last month from the year before. The trend hardly comes as a surprise given the intrinsic weakness of key export markets in Europe and North America but it is clearly a major problem for the Chinese, as, despite efforts by policymakers to move towards a more balanced model, the economy is still highly reliant on export-led growth. As Russell Jones and Bimal Dharmasena of Llewellyn Consulting note, “The export-led model has run its course. In many ways, it sowed the seeds of its own destruction, the emphasis on exchange rate competitiveness and foreign exchange reserve accumulation morphing into undue monetary laxity, excessive credit growth, asset price inflation, income inequalities, and malign financial imbalances similar to those built up in the advanced economies pre-2007.”
Unfortunately the problems don’t stop there. This week, in a working paper for the National Bureau of Economic Research, Feng Shuaizhang of the Shangai University of Finance and Economics and Hu Yingyao and Robert Moffitt of Johns Hopkins University concluded that the real rate of unemployment in China is far from the 4% rate that official statistics are indicating. Instead, they argue that unemployment rates in the world’s second largest economy have been much closer to 8-10%. Whatever the true number is, the fact remains that key industries – particularly the hard hit manufacturing sector – is laying off staff in order to reduce costs in an increasingly uncertain economic environment.

That is why we saw a dramatic intervention by the central authorities in Beijing to bring about a substantial devaluation of the yuan. On the week of August 17th the central bank made one of the most telling moves so far this year when they went about devaluing the Chinese currency for several days in a row. According to the Chinese authorities, the move was a ‘one off intervention’. Speaking earlier this week, PBoC assistant governor Zhang Xiaohui said the central bank could directly intervene in the market, after reports it bought yuan to prop up the unit. She said, “Currently there is no basis for the renminbi exchange rate to continue to depreciate, the central bank has the ability to keep the renminbi basically stable at a reasonable and balanced level.” She also emphasised that, “The central bank, if necessary, is fully capable of stabilising the exchange rate through direct intervention in the foreign exchange market.” The devaluation is the latest attempt to stimulate growth. It follows on from a series of interest rate cuts that were designed to spur growth in key sectors that had suffered during the recent liquidity dry up.

Analysts are divided over whether the recent devaluation measures will be positive for the wider economy. Stephen King from HSBC caused quite a stir when he suggested that the devaluation of the yuan may eventually bring down the, “last wall of defence for global growth.” He pointed out that, “over the last decade China has acted as a shock absorber for the global economy, a punch bag seemingly able to soak up the recessionary blows that would otherwise have totally derailed global growth.” This trend, he says, is well and truly over as the interest rate cuts and now the dramatic devaluation drive signals that the Chinese themselves are worried about the prospects of their economy going forward.

In a recent article in The Guardian newspaper Larry Elliot summed up the split when he said that, “The optimists argue that China is adroitly easing its way to slower but more sustainable growth, that the fall in commodity prices has been caused by over-supply rather than a shortage of demand, and that the rest of the world has had plenty of opportunity to prepare itself for an
increase in interest rates from the Federal Reserve later this year.” On the other hand, “The pessimists would say that China’s hard landing is being disguised by dodgy official figures, that oil and metals prices are falling because demand is faltering and that the $1tn of capital that has flowed out of emerging markets in the past year is evidence of a sharp drop in investor confidence.” The one thing everyone can agree on however is the fact that economic conditions across the board are looking shaky and that is having an impact on everything from commodity prices to equity valuations.

Although the currency markets look set to remain volatile for some time to come, equity markets have taken a much bigger hit as a consequence of slowing Chinese growth and general concerns about the health of the global economy. In August, the mainland stock indexes and Hong Kong’s Hang Seng yet again resembled a rollercoaster ride from hell. Some days they recovered from the recent string of huge losses, while on others they fell by up to 6% as previously optimistic traders started to panic and decided to sell off their holdings. Perhaps for the first time in recent history the perceived weakness in the Chinese economy has also started having a profound effect on Western investor sentiment. With the world’s second largest economy seen to be in serious trouble, equity investors all around the globe have been engaging in a sell off that has basically thrown key indexes like the S&P 500 and the FTSE 100 into bear market territory. It is clear now that everyone in the financial world has their eyes firmly set on what is going on in China.

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