China’s weak economic figures increasingly contrast with recovering growth in the US. The danger is increasing that this contrast will cause the drop of the Chinese renminbi to turn into a free fall.
One year ago, China suddenly slackened the coupling of the yuan and the dollar considerably. In one week, the currency fell by three per cent. Financial markets saw this as a signal that the Chinese economy was in even worse shape than was already feared. A worldwide recession seemed to get one step closer because of this. The recovery in the US was very brittle, and the economic motor in Europe had by that time as good as stopped. The S&P 500 Index went down by over ten per cent within two weeks.
Since then, the financial world has got used to bad news about the Chinese economy. On Monday, it was announced that export in July was 4.8 per cent lower than in the previous year. It was the twelfth time in thirteen months that export decreased. Import even decreased by 12.5 per cent. Both figures were slightly lower than what economists predicted. Furthermore, the PMI (purchasing managers index) reached negative numbers for the first time in six months. That indicator is a good predictor for the direction the economy is headed.
Wider range for renminbi
The unexpected fall that the renminbi made last year, was the start of a larger drop. Since that first hit of a year ago, the renminbi dropped a further four per cent. Moreover, price developments are a lot jerkier than in recent years. During those years, the government made sure the exchange ratio between the renminbi and the dollar moved in a narrow range.
Traders have to get used to that volatility. Just as they have to get used to the negative signals about the Chinese economy. In recent months, the financial markets hardly paid attention to the jerky relapse of the renminbi. Most of the attention is going towards news about the Brexit, the American presidential election, and the Federal Reserve’s next step. However, it is only a matter of time before there is more clarity on these issues. Attention will then shift back to China’s economic challenges.
Magical growth formula worn off
The country is headed for an economic growth of 6.3 per cent this year according to the IMF. Estimates for 2017 show that number to be 6.0 per cent.That is the slowest speed in over 25 years. Moreover, this is significantly lower than the official aim of at least 6.5 per cent. The shift from an export economy to an economy driven by the consumption of the domestic population is going less well than the government had hoped for.
In the past the growth speed was easily raised by increasing government spending, but that formula has worn off now. All the important road, rail and industry projects are finished by now. New investments therefore have far less effect than those from the past. Moreover, the Chinese indebtedness is starting to become a problem. National debt amounts to slightly more than 40 per cent of GDP. That is much lower than in Europe or the US. But the total value of the debt of business increased to 164 per cent of GDP last year. Especially state enterprises are struggling with high indebtedness.
Drop threatens to turn into free fall
The weakening economic growth makes it less interesting for foreign parties to invest in China. This causes demand for the renminbi to decrease. Chinese currency is losing ground extra quickly regarding the dollar, because signals about the US economy are becoming increasingly favourable. During the second quarter, consumer expenses increased by 4.2 per cent. Stocks decreased and the Federal Reserve already noticed that the risks for the American economy decreased on the short term.
The successful economy increases the likelihood that interest rates in the US will be increased soon. That would make the dollar an even more attractive destination for wealthy Chinese, who in view of the slowing growth in their own country increasingly prefer to keep their money abroad. For now, there is no end in sight for the drop of the Chinese currency and its erratic price movements. For peace on the financial markets we can only hope that this drop does not turn into a free fall.