Much More Than Covid in China's Slowdown

Daniel Lacalle — Mon, 09 May 2022 15:12:00 +0000

The latest macroeconomic data suggest that China's slowdown is far worse than projected, and that it is not solely due to the covid-19 lockdowns.

Lockdowns have a significant influence. Twenty-six of China's mainland provinces are experiencing an increase in covid cases, raising fears of a Shanghai-style lockdown. According to information from Shanghai, these draconian curfews cause significant harm to the populace. Millions of people without food or medicine, as well as an increase in suicides, have demonstrated that the famed "zero covid" policy often conceals enormous population control and persecution.

It would be easy to blame the Chinese economy's weakness on the Covid-19 lockdowns, but it would be a poor simplification. The issue is very serious.

China is experiencing a severe recession as a result of the massive real estate bubble burst and the government's crackdown on the private sector, which has resulted in a drop in investment growth.

According to Nomura Research, China is experiencing its worst slowdown since the covid epidemic in 2020, and the rest of the globe should be concerned about a further decline as long as the obstacles remain. Official GDP estimates may be manipulated to meet the government's aim, while all other macroeconomic indicators indicate to significantly slower development.

It's important to remember that the Chinese government "boosts" real GDP in two ways: by presenting low inflation and GDP deflator figures and by ramping up credit and infrastructure spending. Those two, however, cannot deny the significance of China's economic weakness, which is now fundamental.

The main issue is the implosion of the real estate bubble. According to Kenneth Rogoff and Yuanchen Yang's research, China's real estate sector contributes for roughly 29% of the country's GDP. The Chinese government will be unable to balance the impact of such a large segment of the economy with other high-growth industries. Furthermore, the impact of real estate on the job market is difficult to replicate. The impact of the real estate crisis, according to economist George Magnus, will continue for years.

To make matters worse, the government's attack on the private sector has made it even more difficult to spur growth in other industries and firms. Fear of ongoing political meddling is causing a significant slowdown in foreign direct investment growth, as well as apprehension about investing capital and taking risks in the Chinese economy only to face severe penalties from the authorities once benefits are realized.

The severity of the Chinese economy's decline can be seen in recent leading indicators. In March 2022, the Caixin China General Manufacturing Purchasing Managers' Index (PMI) fell to a two-year low of 48.1, indicating contraction. In March, the Caixin Services PMI fell to 42.0 from 50.2 in February, falling below the line that distinguishes growth from contraction. This reading is the sharpest drop in activity since February 2020.

According to numerous media sources, political meddling in the technology sector, which is one of China's main job generators, has raised fears of frozen headcounts and layoffs. According to JP Morgan, the central bank's decision to lower reserve requirements for banks did not prevent a major drop in lending growth.

To this, we must add a currency, the yuan, which, according to Reuters, is used in fewer than 3% of worldwide transactions due to the central bank's strict capital controls and exchange rate regulation. Due to the excessive interference on the currency market, which prevents China from having a truly worldwide means of payment, confidence in the local currency is poor.

China's massive debt is another issue. According to the Institute of International Finance, total debt exceeds 300 percent of GDP. China's debt-to-GDP ratio for the entire private sector is currently over 250 percent, according to the European Central Bank (ECB), with the corporate component of this debt being the largest in the world. The ECB also mentions the risk posed by the fact that "a major share of finance is supplied to the corporate sector by non-bank financial firms," which leads to increased risk taking and a shadow banking system with large inefficiencies and solvency issues.

The forceful and erroneous lockdowns are harming supply chains and activity, but the underlying issues of rising currency and industry interference, as well as a deeply indebted economy, are likely to weigh on genuine growth and jobs for a long time.

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Why Saudi Arabia Will Not Abandon the Dollar in Favor of the Yuan

Daniel Lacalle — Wed, 30 Mar 2022 09:47:00 +0000

Numerous articles have speculated that Saudi Arabia may use the yuan, China's local currency, to finance its oil exports.

Saudi Arabia exports how much to China? According to the Organization for Economic Cooperation and Development, the kingdom's primary export destinations were China ($45.8 billion), India ($25.1 billion), Japan ($24.5 billion), South Korea ($19.5 billion), and the United States ($12.2 billion). Crude oil exports totaled $145 billion.

Saudi Arabia is the world's top oil exporter, with $145 billion in revenue, while China is the world's largest importer, with $204 billion in revenue in 2019.

Saudi Arabia's public finances are impeccable. The kingdom plans to achieve a surplus in 2022, from a deficit of 4.8 percent, and its public debt to GDP (gross domestic product) ratio is 30.8 percent, one of the lowest in the world.

Is it necessary for Saudi Arabia to use the yuan at all? No. Despite the pandemic-induced decline in exports and oil demand, the country's foreign currency reserves, including gold, stood at $472.8 billion in 2020. Is there any pressure on it to change its currency? Even more so. Its reserves comfortably cover its foreign debt, allowing it to maintain an exceptional level of stability in comparison to other OPEC (Organization of the Petroleum Exporting Countries) members with substantial trade and fiscal deficits.

What benefit might Saudi Arabia derive from the yuan's use? Not an increase in shipments to China. China requires oil imports far more than Saudi Arabia requires Chinese dollars. There is no evidence that Saudi Arabia's exports to China would decline if it continued to utilize the US currency.

Yuan usage in international transactions is extremely limited. According to Bloomberg, based on data from the Society for Worldwide Interbank Financial Telecommunications, "activity in the renminbi, as the currency is often known, increased to its second-highest level ever in 2021." This still amounts to a persistently tiny 2.7 percent of the market, compared to the dollar's 41 percent, which has held the top spot for decades. The euro accounts for 36.6 percent of worldwide transactions, the British pound accounts for 5.9 percent—more than double the yuan's share despite the UK's far smaller economy—and the Japanese yen accounts for the same amount as the yuan at 2.6 percent.

More crucially, despite the Chinese economy's dramatic rise in global importance, the yuan's currency status has barely improved since 2015, when it reached the fourth rank.

Why is the yuan utilized in only 2.7% of global commerce but accounting for 14% of global GDP, and what changed in 2015?

The yuan is the only currency issued by a major global economic power that is subject to capital controls and has a fixed exchange rate. As a result, each holder of the Chinese money is constantly threatened with an unexpected devaluation and the inability to make payments in the currency.

And this is precisely what occurred in 2015. China's central bank has announced a sharp devaluation.

The yuan is not a viable alternative to the US currency because to capital controls, fixed pricing, and, worse, the People's Bank of China's monetary policy is much more aggressive than the Federal Reserve's. For two decades, China's money supply expansion has been multiple times that of the US, despite substantially lower worldwide demand for the yuan.

It's also worth mentioning that even the largest Chinese oil corporations prefer to conduct worldwide business in US dollars. By examining the open interest in the Shanghai Commodity Index, or the so-called petroyuan index, we can observe that the yuan is used in very few worldwide oil transactions.

China's ostensibly substantial gold reserves amount to less than 0.3 percent of its money supply (M2), while its unquestionably substantial US dollar reserves of $3.35 trillion barely cover its foreign currency commitments.

If other countries' oil and commodity producers, particularly in Latin America, have previously accepted China's currency, it was due to the massive debt obligations they incurred with the Asian superpower, not for practical reserve currency–use reasons.

Any commodities producer who takes the yuan in lieu of the US currency must understand that capital controls and price fixing are significant dangers, and there is no indication that the People's Bank of China will alter either.

The reality is that the yuan possesses all of the negative characteristics of fiat currencies—massive printing, a lack of real support, and a central bank incentive to erode purchasing power—but none of the positive characteristics of the dollar, euro, or pound—free-floating pricing, legal and investor protection, and an open financial system.

While Saudi Arabia may use some yuan in its oil exports, the reality is that no fiat currency subject to capital controls is a viable alternative to other fiat currencies, and the arrival of central bank digital currencies accentuates this distinction. Central bank digital currencies are surveillance disguised as money, with significantly greater risks of enormous printing, degradation of purchasing power, and transaction control than with traditional currencies.

Saudi Arabia may seek refuge in gold or cryptocurrency in order to circumvent the money-printing machine. However, it will be difficult to replace the US dollar, a heavily printed but open and secure fiat currency, with a closed and less secure one.

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Much More Than Covid in China's Slowdown

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