I’ve never actually seen Groundhog Day — the 1993 film about a Pittsburgh TV weatherman who finds himself trapped reliving the same day over and over again — but Bill Murray is a legend, and if you have to opportunity use him to explain what’s going on in the global economy, then you should.
So I will.
China’s economy has been stuck in its own Groundhog Day since 2015, and August’s weak economic data showed that we’re likely to continue the loop into 2018.
Here’s what the loop looks like.
In the beginning of the year, reeling from a year-end Federal Reserve rate hike, the Chinese economy starts to falter. The economists, politicians and intelligentsia at the World Economic Forum in Davos all click their tongues in dismay. Someone from the World Bank or the International Monetary fund reminds everyone that the country is, yes, still a massive debt bubble and yes, its banking system is still churning out credit at a mind-bending rate.
And everyone completely freaks out.
- That freak out prompts the Chinese government to intervene. Whether that means loosening up credit or shoring up the stock market depends on the situation at hand. Going into 2017, for example, the problem was currency outflows. China does whatever it can to make it go away.
- The economy stabilizes for a few months, the intervention subsides, and the economy starts to show signs of weakening again. Then in December the Federal Reserve hikes rates again.
Nothing really changes — not the country’s debt position or credit creation. And the loop resets.
Setting the loop
This loop was set in 2015. That’s when, during a few terrifying months, Chinese stock markets crashed twice and then in August, the country devalued its currency, the yuan. The government intervened, and the country sputtered through to the end of the year.
In December, the Fed hiked. In January 2016, the yuan started to slide.
“It’s serious,” legendary investor George Soros told a crowd in Davos that year, referring to China’s debt problem. “And the Chinese left it too long to address the changeover in the growth model that they have to adopt from — investment and export-led to domestic-led. So a hard landing is practically unavoidable.”
He wasn’t the only one worried, of course.
“I think the Chinese situation with the currency is very important. Very important. If there is significant currency weakness for the yuan that will mean more imported deflation and it will make things more difficult,” said Ray Dalio, founder of massive investment fund Bridgewater Associates during an interview in Davos.
(We should note that Dalio likely believes the loop will hold, as his firm is reportedly raising money for a Chinese onshore fund.)
Forgetting the loop
This 2016 panic was short lived. The Chinese government stabilised the economy by turning on the credit spigots again. And everything was great for a few months. Then not so great.
Then the Fed hiked rates in December 2016. Since the hike was expected, money started leaving China toward the end of that year. In December China experienced $US82 billion worth of outflows, the continuing a troubling trend that has been pushing the value of the yuan, the country’s currency, down.
So when 2017 hit people were nervous, and — again — the government intervened. Star China analyst Charlene Chu of Autonomous Research wrote a note telling clients not to breathe easy, though, and to watch out for the second half of the year.
Specifically, she said [emphasis ours]:
“China’s authorities have chosen to pursue harsher measures against capital outflows over a large change in the exchange rate to address the country’s outflow problem, at least for now. This could work for a few quarters, but we think closing the gates is not feasible over the long run for the largest trading nation in the world with a USD33trn banking sector. We expect growth to begin decelerating in 2Q17, as a weaker credit impulse passes through, but this is of secondary importance to outflows and the currency.”
The government didn’t just intervene to stop outflows either. It also made money easier, meaning debt concerns would have to take a backseat for the moment.
“Everyone thinks the Q1 performance was done despite the fact that credit tightening,” Lee Miller, founder of China Beige Book, a private firm that collects Chinese economic data, told Business Insider in an interview back in June. “What we actually showed in our data… was that it was done because of some of the loosest conditions we’ve seen.”
Loving the loop
China’s August data showed that the deceleration Chu called for has begun. Here’s the breakdown of the country’s main August data points from Bloomberg Economist, Tom Orlik.
- Industrial output growth slumped to 6% year on year, down from 6.4% in July and missing expectations of 6.6%.
- Production doesn’t appear to have picked up following the weather and flooding related slowdown in July. A higher base for comparison after growth accelerated in August last year was likely one contributing factor.
- Retail sales slowed to 10.1% growth, down from 10.4% in July, and below expectations of 10.5%.
- Fixed-asset investment slowed to 7.8% year on year in the first eight months of 2017, down from 8.3% in the first seven months and missing expectations of 8.2%.
- Real estate sales and new construction continued edging down, slowing to 10.3% and 11.6%, respectively, in the first eight months, from 11.5% and 11.9% in the first seven months.
Now, the Chinese government could look at this data and decide to intervene again. There’s a big Chinese Communist Party meeting in October that will determine leadership, and President Xi Jinping may want things nice and stable then.
But of course, the market expects the Fed to hike rates again at the end of the year. So then we’re back in Groundhog Day. We’re back in loop.
“The way the rest of the world gets impacted by a big China slowdown or a disorderly unwind of its debt problems is through the currency,” Chu told Business Insider last month. “A substantial weakening of the yuan would unleash a wave of deflation globally.”
The question is what would do that? A strong dollar? A trade war? A sudden (and unlikely) jump in inflation?
“If we start to get an inflation constraint in China that would be a very new development,” Chu said. “Inflation is not our base case, but it is worth thinking about with a 57 trillion yuan in new credit in 2016-17e and many commodity prices back on the rise. And it matters because it says to the authorities that we cannot keep pulling the credit lever as aggressively as we have in the past, and then there will be serious questions about growth.”
When you think about that, Groundhog Day sounds amazing, frankly.
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