Chinese financial
markets look precarious, with both
stock prices and the
yuan falling precipitously. Many blame the renewed yuan weakness on
trade tensions with the
United States. I am not so sure.
China’s total exports to the US account for 3.5 per cent of gross domestic product. In the highly unlikely event that these exports are halved by higher tariffs, the net impact on the Chinese economy would still be very manageable.
Therefore, the weakening financial markets in China must have been caused by other factors. The Chinese government has been trying to deleverage the
economy ever since growth started to accelerate in early 2016. While the
People’s Bank of China has tightened liquidity and credit supply aggressively, the central government has also actively cut back fiscal stimulus since early this year.
Furthermore, such policy tightening has taken place at a time when the Chinese currency has been strengthening substantially for the past 12 months. For example, prior to its recent fall, the yuan had risen more than 7 per cent in trade-weighted terms since mid-2017 and
11 per cent against the dollar since the beginning of 2018.
The combination of tight monetary and fiscal policy, together with a strong and expensive yuan, has quickly eroded China’s economic growth. Total social financing, the broadest measure of credit creation, has been contracting.
This has caused broad-based economic weakness: real fixed-asset investment, which is adjusted for inflation, has flirted with contraction for the past few months and retail sales growth has also fallen precipitously lately.
In fact, the Chinese government made similar policy mistakes in 2015, when authorities erroneously tightened credit supply and fiscal policy aggressively at a time of a very strong yuan but a weakening
global economy.
