China's Economy Continues To Wobble

Investors need to pay more attention to what is really happening in China rather than the stir up over Trump's recent trip to Europe. Other distractions have a way of allowing us to see the "forest from the trees" such as footage released from a  CNBC interview that was released just after 6 a.m. ET on Friday morning. In the piece, President Trump said he's "ready to go to 500 billion and slap tariffs on every single Chinese-made product entering the U.S." Showing a bit of impatience with the current process of dealing with China he stated, "I’m not doing this for politics. I’m doing this to do the right thing for our country." With so much of China's economic success coming as a result of a massive trade surplus with America it is not difficult to make a case that the economy of China is often given far too much credit for stability.

Rapid Growth Slowing - Now What?  (Click To Enlarge)

Rapid growth over the years has created an illusion of strength that discounts its total dependence upon exports to fuel malinvestment driven by corruption and poor judgment. The financial missteps in China have continued and it will only be when their economy falters that we will learn to what extent or hear more stories about how they have masked their problems. The largest indication of problems ahead come from data recently released pointing to the slowest investment growth in over 22 years. This is a clear indication that regulatory crackdowns in the banking sector are starting to filter through to the broader economy.

While the Chinese have made progress in diversifying their economy, the country still relies heavily on making and exporting toys, clothes, car parts and other goods to the United States and elsewhere. Within months the United States trade conflict could escalate as another $200 billion in Chinese goods get targeted with tariffs. The IMF has warned that growing trade tensions between America and the rest of the world could shave as much as 0.5% off growth by 2020, costing the global economy 430 billion dollars. While the Washington based organization made a concerted effort to spin this off as a rebuke of President Trump by saying the U.S. would find itself particularly vulnerable "as the focus of global retaliation" and could suffer most as a relatively higher share of its exports are taxes in global markets many economists see China taking the brunt of the pain.

Shadow Banking Is In Collapse

The topic of a trade war is so sensitive in China that several sources working for Chinese media report that China’s censors are scrambling to control the trade war narrative by giving the media a list of dos and don't when reporting on the topic. Those briefed on these internal instructions told the South China Morning Post that they were told not to “over-report” the trade war with the U.S. and be extremely careful about linking the trade war to stock market falls, the depreciation of the yuan or economic weakness to avoid spreading panic. “When you report a fall in the stock market index or a weakening in the yuan’s exchange rate, you can’t use ‘trade war’ in your headline,” one source with an official Chinese media outlet stated. Concern over the impact is so high that China has gone to a full court press approaching the EU to join them in pushing back against tariffs.

Still of greater concern than just tariffs the figures we are seeing warn of problems in many areas of China's economy and indicate that massive debt is taking a toll on growth as money is siphoned away from investment to service past obligations. Chinese stocks are in bear market territory and the currency is weakening. The answer to Chin's problems will most likely not come from the World Trade Organization where Beijing has filed a complaint about a batch of levies by America in response to alleged violations of intellectual property or a new round of money flooding into its banking system. The fear is more credit while juicing growth and ramping up spending on big projects like highways and airports but could undermine efforts to break the country’s addiction to borrowing.

The latest news is that the Yuan is again sliding and in offshore trading has reached the lowest level since July 12, 2017. This was in response to the PBOC weakening its fix on the onshore yuan below 6.7 for the first time since the the start of the yuan drop in June and Beijing launching a quasi-QE, in which the central bank announced the introduction of incentives that will boost the liquidity of commercial banks, helping them to expand lending and increase investment in bonds issued by corporate and other entities. It will do so by using monetary policy instruments such as its medium-term loan facility (MLF). Many currency traders view this as an indication China is comfortable with a gradual depreciation of the yuan going forward. It must be noted that the yuan has fallen more than 4% in the past month making it the worst performer among 31 major currencies.

This somewhat sneaky way of adding liquidity into the system through the banks rather than directly by the central follows a record collapse or decline in shadow banking. The fact is that for years growth in China has been fueled by its government expanding the money supply and debt. This has distorted markets across the world. It is even responsible for causing housing prices to soar in many parts of Canada. This is why it is so baffling that many economists have chosen to ignore or given a pass to the ramifications of China's policies as they affect the big picture. This has accelerated since the global financial crisis of 2008, China's local governments and state-owned companies borrowed heavily to build cities and roads, invest in businesses and bolster financial markets. The spending spree resulted in a domestic debt hangover, particularly among some of the country's bloated and inefficient state-owned companies. This has created an unstable situation that continues to fester.