Big Bad China: Should Their Economic Risks Matter To Us?

by Shane Obata

It seems like every day we are inundated with news out of China. Investors are already concerned. The offshore renminbi (CNH) is more international than the onshore one (CNY), which is tightly managed by the government. As such, Source: @vikramreuters

In the following sections we will attempt to analyze China’s markets and determine the biggest risks facing its economy. Lastly, we will try to answer the following question: does it matter to us?

As the first week of trading in 2016 came to an end, the Chinese markets had already been halted confusing …

That said, the volatility is not surprising considering how Source: Bloomberg Brief

Along the same lines, individuals account for at least 80% of trading on the mainland exchanges. In other words, there are many speculators and few investors. China’s markets are undeveloped and relatively unimportant. Nonetheless, they may offer some clues into consumer sentiment and the government’s ability (or inability) to control the economy.

China remains an indispensable part of the global economy. In nominal terms, Source: The Economist

With regard to trade, Source: McKinsey

The rate of debt growth is also a concern. Non-financial corporate debt, increased from 72% to 125% of GDP from 2007 to 2Q14, a 73.6% increase.

China’s debt load is a global risk because of how tightly managed its economy is. The government Source: Gordon T. Long

That is more than twice as high as it is in both the US and the European Union.

The PBOC has been very active trying to support the economy. It has cut rates 6 times since November of 2014. Likewise, it has been lowering its Reserve Requirement Ratio and selling its foreign reserves in an attempt to prevent excessive devaluation of the yuan (CNY). They are down more than $400 billion (from a peak of ~$4 trillion) since mid-2014:

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FX is also a risk because China has a great deal of USD-denominated debt. In mid-2015, non-bank borrowers held ~$1.2 trillion worth of it. This debt becomes more expensive as USDCNY rises, which is exactly what the markets expect to happen.

China’s have been disappearing while others are being investigated. Moreover, securities regulators have been cracking down on market manipulators, “ensnaring some of the nation’s most high-profile money managers and announcing more than 2 billion yuan of fines and confiscated gains” (source: BBG Brief). Critics of the campaign suggest that it may deter business while failing to address the corruption that exists within the ruling party.

As investors, we should be concerned because China is one of the biggest economies and the world’s leading trader. Therefore, if it slows down, so will global growth:

China is also important because it is a massive source of demand for many commodities. Thus, its weakness is spreading to the amount of debt they have accumulated since the financial crisis.

In the US, credit is already tightening . If borrowing costs rise for the emerging markets, especially China, then we may see a wave of defaults with untold consequences.

Written By: Sober Look