China’s attempt to crack down on commodities speculation, cryptocurrencies, grain purchases and property bubbles and its efforts to slow capital inflows and the appreciation of its currency are indicators of stresses and conflicting challenges within its economy.
It has been notable in recent weeks that China’s authorities have been very active on a wide range of issues and there is a sense of urgency in their response to the surge in commodity prices, a flood of capital inflows and financial and currency markets risks.
The obvious conclusion to draw is that they are concerned about imbalances and bubbles, or potential imbalances and bubbles, within their economy and are acting to try to prevent them from destabilising the economy and/or forcing them to take more dramatic steps.
The attempt to reduce speculative activity in commodities – China’s metals industry executives were threatened with punishment last weekend if they engaged in excessive speculation, hoarding or price-fixing – is, along with a squeeze on grain imports, clearly related to concerns about inflation and competitiveness.
The rebound in China’s economy, indeed the global economy, from their pandemic-induced depths last year has seen prices for all commodities, hard and soft, soar as demand has returned more quickly and strongly than anticipated.
Supply chain disruptions and the continuing impact of the pandemic on developing economy producers like Brazil or South Africa have contributed to the extent of the price rises.
Inflated commodity prices are feeding into higher input costs for Chinese companies. Last month China’s factory gate prices rose by their most in three years. There are reports of manufacturing industry production shutdowns and job losses because of the resulting loss of competitiveness and profitability.
China’s industrial base has powered its strong recovery from its pandemic nadir, so the rising costs of raw materials threatens to slow its overall growth rate.
Domestic consumer and services sectors haven’t recovered at the same rate and the prospect of an outbreak of inflation as manufacturers pass their higher costs into the domestic market would jeopardise China’s ability to broaden the base of the recovery even as the authorities try to withdraw some of the fiscal and monetary stimulus they injected last year.
The appreciation of the yuan – it’s at its highest level against the US dollar for nearly three years – isn’t helping.
It also undermines the competitiveness of China’s exports, albeit that it makes commodities, generally denominated in US dollars, cheaper and therefore helps on the inflation front.
China has a tightly-managed “float” of its currency, which is pegged daily within a two per cent plus-or-minus range against the US dollar. That hasn’t, however, prevented the yuan from strengthening markedly in recent months. Neither has some modest loosening of China’s tight controls on capital outflows.
A challenge for the authorities is that the yuan’s strength is being driven as much by US dollar weakness as it is by China’s superior economic outcomes.
The erratic Trump era, the mishandling of that administration’s response to the pandemic, the scale of the US fiscal and monetary responses and the Biden’s administration’s proposed ambitious and very expensive social spending programs have weakened the dollar against other major currencies.
The unprecedented build-up in US debt and deficits and the scale of the debt issuance required to fund maturing and new debt will weigh on the dollar’s value and provide a floor under the yuan for the foreseeable future.
The authorities are worried about the risk of further inflating bubbles in their financial and property markets if there is too much liquidity sloshing around the system.
When coupled with the higher rates available from China’s debt securities, the stronger yuan sucks in capital in a self-reinforcing cycle, flooding the financial system with liquidity even as the authorities are trying to remove it to reduce speculative activity and deleverage and lower the risks within the financial system.
The crackdown on cryptocurrencies’ trading and mining is related to those efforts to reduce speculative activity. The authorities are worried about the risk of further inflating bubbles in their financial and property markets if there is too much liquidity sloshing around the system and/or inflation gets out of control.
(The extreme carbon-intensity of crypto mining also, of course, conflicts with China’s efforts to reduce its carbon emissions).
The authorities could take more macro actions to address the threat of bubbles in their economy – the People’s Bank of China could remove more liquidity or hike interest rates – although that would slow growth, strengthen the yuan further and undermine exporters even more, which perhaps explains why they’ve initially resorted to using jaw-boning, coercion and some tinkering with export and import controls.
China’s problems aren’t only China’s problem. It remains the world’s manufacturing base and rising costs within that base threaten to reverse what has been the norm for decades – China exporting deflation to the rest of the world – and result in China exporting inflation even as there are signs that inflation in the West, dormant for decades, is stirring.
China’s exports are running nearly a third higher than they were a year ago and materially higher than their rate before the pandemic hit. Without readily available alternatives sources of supply for a lot of what China produces, the prospect of China adding to those emerging inflationary pressures elsewhere is quite realistic.
What’s apparent from their recent actions is that China’s authorities have recognised that they have a range of challenges and risks to deal with, some related to China’s domestic settings and some – like commodity prices – that they can’t influence in any substantive way.
An unbalanced recovery from the pandemic and both global and domestic inflationary and competitiveness-threatening choke points are overlaying longer term structural issues like excessive leverage, asset bubbles, the poor productivity of state-owned entities and China’s over-reliance on fossil fuels even as some decoupling of Western economies from China’s gets underway.
China’s leadership presents an image of total control over the levers of its economy. That control, however, is more tenuous than the imagery might suggest.