China turning

Can you spot the difference? While the formerly big and pompous G7 had their summit in Canada, only to be stomped into the ground by one Donald Trump, the real action guiding the world of tomorrow happened in Qingdao, China. At the SCO meeting, more of the Eurasian plate was shaped. And while EM currencies are plummeting against the dollar across the globe, the pundits are breaking their heads over why the Renminbi has at the same time be so strong. Wasn’t China meant to be an emerging market?

Food for thought… On Friday, the PBoC reported China’s foreign reserves for the month of May. And interestingly, the number has turned down again. Reserves drifted by 14.2 billion dollars, and the new total accounts for 3.11 trillion. After that breathtaking 1 trillion dollar slump from 2014 through 2016 and the total dropping from 4 trillion to briefly breaking the 3 trillion threshold on the down, reserves had gradually recovered to 3.16 trillion in January this year. Ever since we have been declining again.

The monthly changes have been too marginal to make out a new trend as yet, but the Cassandras are already on alert. Could this mean we are entering another wave of capital flight, finally breaking the camel’s back and prove all the China-bears right? Well, I don’t think so. There are no reasons for anyone to consider moving assets out of the country for a fear factor. The economic course is pretty much prescribed, and there have not been any surprises, nor are any expected any time soon.

Instead, it could mean one of two things. One, it is hard for outsiders in Europe or America to fathom how rapidly China has been modernising. I am always amazed how eye-opening it is for people coming over and seeing for themselves. Just watch the extent of growth in infrastructure, built to the highest standards for generations to come. Just look at China’s urbanisation and its society’s progressive development. Just consider how fast advancing AI- and e-commerce-related industries have become. And you will get a sense.

The May trade numbers, also released on Friday, gave us a little more evidence of this thesis. Export volumes increased in a healthy fashion, by +12.6% year-on-year, to a total of 212.9 billion dollars, but the number was sharply lower from 40.5 billion in the same month a year earlier and missed the market consensus of 31.9 billion by quite a margin. Imports, on the other hand, climbed markedly, by a record +26%, to 188 billion. The trade balance was in surplus by just a fraction shy of 25 billion.

This is essential. In the first 5 months of this year, the total trade surplus substantially narrowed to 102.8 billion, from 141.9 billion in the same period of 2017. It demonstrates the extent that the economy and society have been transforming. China is clearly no longer the export-driven, emerging market, growth model that is once was. Quite the contrary, it is increasingly based on its growing domestic consumption which is reflected in that boost in imports.

As contended numerous times before in this space, such an economy is simply in no need of carrying 4 trillion dollars in reserves, nor 3 trillion, nor 2, nor maybe even 1. Even if the PBoC had to defend its currency against an outflow of funds at times before, the means applied constitute a drop in the ocean in light of such firepower. In effect, Beijing can be utterly relaxed about the volatility in its reserve holdings and may even be inclined to carefully orchestrate a managed reduction from here.

The second reason I can think of lies in the recent trade spat with Washington. The only blemish in the numbers is that China’s global surplus in May is basically its surplus with America, at 24.6 billion. In the first 5 months of this year, it jumped by +12.9% to 104.9 billion, in absolute numbers more than its surplus with all trading partners combined. If you exclude the US from the statistics, you will find that China runs a slight trade deficit with the rest of the world.

There must be a reason why China is reducing its surpluses with all other countries but not with America, and the reason might well be the lack of competitiveness of US products and services and not necessarily unfair trade practices as alleged by Donald Trump. Beijing will of course make every effort to compromise, but it may still not be enough for Washington. If negotiations failed and Trump provoked a trade war, there wouldn’t be any good arguments for China to continue providing vendor financing.

It is conceivable that the PBoC as the largest foreign creditor to America has commenced to limit purchases of US Treasuries or even trim the total balance held. China’s holdings had risen to a 5-month high of 1.2 trillion dollars in March, the latest published reading. As you will remember, TIC data are being released with a 2-month delay, so we will only find out in coming 2-3 months whether this suspicion holds.

In any case, China is by now a far cry from a traditional emerging market and rather growing into an economic supertanker, which is slowly turning to reflect its fast modernising country and its new confidence in the world including its assertiveness with America. Likely by 2030 China will command the largest GDP in the world. As such, Beijing has slowly begun to take leadership, in the Asian region but also globally. The obstinate accumulation of foreign reserves may from here be less important than it was in China’s emerging past.