How windy was it last week?
The Chinese have a curse ‘May you live in interesting times’. Last week’s devaluation of the renminbi (people’s money) or Yuan, the first since 1994, came as a shock to markets. Was it a victory for market reform, a precursor to helping the currency meet the conditions set by the International Monetary Fund (IMF) for the renminbi to join its prestigious basket of reserve currencies , or a cynical competitive devaluation designed to shore up flagging exports.
China’s economy grew at an annual rate of 7% during the first half of the year, amazingly exactly in line with the government’s full year target. Some western observers are more sceptical and believe growth to be much slower, around 5 – 6%. If this is so, further stimulus measures will be needed to prevent a further slowdown.
A 3% devaluation in isolation would not be enough to boost growth significantly. Other Asian currencies followed suit and devalued as well to counter the move. A threat of a wave of competitive devaluations spooked markets around the world. Western exporters to China, from Aero engine maker Rolls Royce to fashion house Burberry fell. Quoted luxury car makers in Europe were also under pressure.
Perceptions of China being the manufacturer and (cheap) exporter to the World is not backed by statistics. China has not pursued this policy over the past decade as net exports have subtracted 3% from annual growth in Chinese GDP on average over the period 2004 -14. It has been investment growth that has been the principal driver contributing 52% of growth each year. It was this tidal wave of investment that ensured that China did not fully participate in the post Lehman Bros meltdown experienced by western economies.
Fixed asset investment grew at its slowest pace in the first seven months of 2015, led by a collapse in property investment. This does not portend well for growth especially as there remains a huge overhang of unsold flats. It is easy to observe other evidence of the construction slowdown in China. Falling demand for basic materials from steel to cement and commodities in general have resulted in sharp price falls across the board.
The worry for Chinese leaders is that the slowing economy will feed through to a rise in unemployment. The implicit contact of the government has been a continuation of the authoritarian communist regime on the quid quo pro of increasing wealth for the population. Rising unemployment and discontent would be an unwelcomed development. It seems clear that the Chinese authorities will endeavour to keep Chinese growth in rude health, whether they can achieve this is more difficult to call. Global markets would not respond well to a melt down in the world’s second largest economy. Let’s hope that the ‘interesting times don’t last too long.’Disclaimers