Continuing with Thursday’s China theme, SocGen’s Albert Edwards has been looking at the emergence of a trade deficit in the People’s Republic and the implications.
The backstory here is the recent, surprise announcement from Premier Wen Jiabao and Commerce Minister Chen Deming that China would record a trade deficit in March – the first since April 2004.
The deficit, of course, is one result of the massive Chinese stimulus package focused on infrastructure, which has sucked in massive amounts of commodities.
And obviously Edwards thinks this is going to have serious ramifications.
One of the key changes over the last year is the rate at which Chinese import growth now outstrips export growth (see left hand chart below). It is clear much of this is down to the rapid pace of commodity imports, associated with a step-up in infrastructure projects due to the fiscal stimulus programme, but also with stockbuilding. Hence we see total imports handsomely outstripping imports from countries that are not big commodity producers, such as the US and Europe [see charts below].
Now, Edwards believes the trend toward a sustained trade deficit in China is very real, as much because of infrastructure projects as the stock piling of dollar denominated assets.
Now there are a couple of things I have been mulling over in my mind about these developments. It is well known that China has been buying commodities in excess of its needs for final consumption and stockpiling them. This seems sensible.
If you have a pegged exchange rate and have to buy dollar assets, why just pile up mountains of US Treasuries when you can pile up mountains of copper and iron ore that can be usefully consumed at some point in the future?
This change in policy also has the added advantage of engaging in FX intervention on the trade account rather than the capital account, thereby relieving intensifying political pressure for a yuan revaluation. Indeed I would suggest that the pre-announcement of the March trade deficit is the latest salvo in the ongoing war of words.
China can quite reasonably point at its trade deficit and respond to the US that its criticism that the yuan should be revalued is totally invalid if it is running a trade deficit. Some might argue that instead of ‘manipulating’ its currency, it is trying to head off pressure to revalue by manipulating its trade balance.
All of which means, China will be buying a lot fewer Treasuries. Although that does not necessarily mean higher bond yields, says Edwards.
To the extent that China’s trade surplus is ’shifted’ elsewhere (e.g. Canada), these countries may be larger consumers of US goods and hence the US may see a quicker reduction of its own trade deficit. If that is the case, the US could become more like Japan, funding purchases of Treasuries out of domestic savings. Or to the extent the commodity nations see larger trade surpluses and do not peg their currencies in the same way as China, they will see intensifying upward pressure on their own currencies, helping to clear recent extreme global imbalances which were at the heart of the recent credit crisis.
Ultimately though, Edwards thinks there is a bigger issue than US Treasuries yields. And it is this:
I still make the very simple point I made back in November; a collapse of the current recovery seems extremely plausible in both the US and China in the not too distant future. This will only intensify the mutual belligerence seen in both nations. And despite the recent downturn last year, the yuan has strengthened decisively over the last four years.
I think the emergence of a persistent Chinese trade deficit would fundamentally change the political dynamics between the US and China. If political tensions continue to mount and the US begins to erect trade barriers after naming China as a ‘currency manipulator’, at some point China may indeed do exactly as the US authorities wish and stop ‘manipulating’ its currency. And if it is running large trade deficits, investors should consider the very realistic outcome that China does indeed devalue the yuan.
Yikes.
Related links:
Now, China is bashing the euro – FT Alphaville
Down the drain in China – FT Alphaville
Is China blowing bubbles? – FT Alphaville
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