Following the financial crisis of 2008, the global superpowers adopted near-zero interest rates and currency devaluation in hopes that these would rev up their economies. Lower interest rates boost investment and weaker currencies increase exports— like giving a little gas when attempting to jumpstart your car. As the value for one currency decreases, however, others will be relatively higher in comparison, resulting in competitive devaluation. And stimulus programs are only effective to an extent. Central banks can’t just throw money at the economy and expect it to rebound; they must encourage productive investment, or false impressions of productive growth can create bubbles and liquidity crunches.
Currency crises have been known to be fatal economic scourges (their effects continue to linger across parts of Africa and South America) and some currencies can be so hyper-inflated that bills in one thousand units of the currency can be worthless. Considering that the Chinese currency, Renminbi (RMB, also known as Yuan), is now part of the International Monetary Fund’s (IMF) currency basket, China’s currency devaluation strategies are facing increasing global scrutiny.
China has long been a country of manufacturers and exporters— dominating the twenty-first century economy with its ‘Made in China’ branding on nearly every product. With declining global demand, however, China seems to have had the wind taken out of its sails as it attempts to transition towards a more consumer-based economy. China GDP quarterly growth is down to just 6.7 per cent along with climbing debt and dwindling foreign exchange reserves. Concerns about the world’s second largest economy continue to fester as the RMB depreciates further, and quantitative easing stimulus packages (a measure that can be taken by a country’s central bank to increase the supply of money in circulation) prove less and less effective, with liquidity flooding its markets and stock prices bubbling. Various indicators continue to highlight the possibility of credit, debt, and currency crises as we approach the end of the third quarter of 2016.
To prop up investment in the stock market, China’s government began using ‘quantitative easing with Chinese characteristics’ over the summer of 2015, selling bonds worth trillions of renminbi to lower interest rates with the added benefit of devaluing their currency. While most quantitative easing traditionally starts with the central banks, China’s stimulus builds from the ground up, emanating from smaller banks. The China Development Bank (CDB) and the Agricultural Development Bank of China sell bonds, which are then bought by the Postal Savings Bank of China with cash supplied by the central bank. It all seems very convoluted, right? That’s because it is. This is a clear demonstration of how China has much to do in undertaking its transformation into an economy dependent more on internal demand. Without trustworthy financial intermediaries there to control primary markets, facilitating the distribution of all this wealth, and ensuring that these stimulus packages put money in the right hands, China’s lack of financial organisation could lead the country into a credit crisis. China’s stock market already saw a 20 per cent market correction going into the year 2016 after analysts speculated that China’s smaller capital stock prices were overinflated, factoring in quantitative easing injections that proved to be less effective than expected. With the country’s financial services industry still in its infancy, it will prove very hard to achieve the level of internal demand and financial organisation needed for China to resume a healthy growth pattern.
Many investors continue to hold bearish stances on China’s stock market despite its January 2016 market correction. Hedge fund managers like Kyle Bass highlight a few key economic reasons for their net short positions (an investment strategy where investors sell shares of borrowed stock, expecting the stock price to decrease over time when they will re-purchase them, making a profit) on the world’s second largest economy. Chiefly among them was China’s depleting foreign exchange reserves. The country’s inability to provide effective stimulus for GDP growth has inundated the market with cash, reducing demand for the RMB. At first this was intentional as weaker currencies promote more exports, and therefore, more growth. Only, if the RMB goes much lower China will risk hyperinflation, which would potentially make the currency worthless. In order to prevent this, the Peoples’ Central Bank of China (PBOC) sells their foreign exchange reserves, to decrease demand for the foreign currencies, thereby making their own currency stronger and more valuable. In 2015 China’s foreign exchange reserves had the steepest decline ever before seen, dropping by $512.66 billion. The country’s foreign exchange reserves now stand at just 29 per cent of GDP and are rapidly dropping. If percentage growth continues to disappoint, China will have no choice but to lower interest rates from their current 4.3 per cent bench mark to incentivise growth, further devaluing their currency, forcing them to use most, if not all, of their foreign exchange reserves. Upon losing its reserves, the PBOC will forfeit control over the value of the RMB.
Debt growth has also been on the rise in China. Relative to GDP, China’s debt now stands at 225 per cent, and continues to grow. In 2008, the debt to GDP ratio stood at just 150 per cent. As growth rates slow and debt soars, China may be sleep walking into an unsustainable debt crisis, piling on to concerns of market turmoil. This will further incentivise the PBOC to lower interest rates, as unsustainable debt growth patterns are often alleviated by grounding rates. Again, as lower interest rates also weaken the RMB, China will be stuck between a rock and a hard place to pick up where it left off before the financial crisis of 2008.
Ending the third quarter of 2016 in uncertainty, China’s economy needs to gather its bearings and set off on a different trajectory as stagnant growth, soaring debt and diminishing foreign exchange reserves are keeping the industrial superpower in the doldrums. Building a sound financial services industry along with some government policy changes could be the first step to a healthy and organised recovery. The record revenue of $14.3 billion posted for Alibaba on China’s Singles’ holiday (the anti-Valentine’s Day for China) encourages analysts that a transition to a more consumer dependent economy is practical while further indicating that China’s current economic quandary is certainly not irremediable.