How Fragile is China?

Rhys Herbert, Senior Economist at Lloyds Bank Commercial Banking, looks at the changing trade picture in China and considers the implications for the UK, including the potential for rising exports – and interest rates.

There is no question that global trade tensions remain a key focus for markets and have been the source of plenty of volatility in recent weeks.

After the US announced it would be imposing tariffs on Chinese imports, China is finding itself in the spotlight.

Just rhetoric?

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President Trump undeniably upped the ante when he announced a 25 per cent tariff on $16bn worth of Chinese imports, with threats of much more to come.

In retaliation, China has named $60bn of US goods that could be subject to tariffs.

Some of this rhetoric is probably just part of the negotiations. It is certainly notable that, so far at least, the tariffs imposed only cover a small percentage of trade flows. Nevertheless, the threat persists and remains a key source of concern to markets.

Given this, it’s worth taking a more detailed look at Chinese trade.

Dissecting the data

China’s latest international trade in goods data showed another very substantial monthly trade surplus of US$28bn – albeit one that is down sharply from $42bn the month before.

The data reflects a combination of a robust export rise and even stronger import growth, which could be a sign that trade tensions are not yet impacting on trade flows, or perhaps that traders are moving stock before any tariffs kick in.

Rhys Herbert
Rhys Herbert

Keeping the balance

Over the longer-term, both China’s balance for trade in goods and its current account, which also takes into account trade in services and income flows across countries, have been coming down.

While China still has a substantial surplus in merchandise trade, the overall current account has moved into deficit this year. This reflects a number of economic developments which suggest that China’s trade surplus is likely to shrink further.

Productivity a priority

First, China is becoming a more expensive place to produce because labour costs are rising.

The Chinese are trying to combat this by boosting productivity and moving upmarket, but the signs are that lower-cost production is moving elsewhere in the world.

Secondly, China’s saving-to-spending imbalance seems to be changing.

One of the key factors that previously kept the current account so high was China’s reluctance to spend. That resulted in people prioritising saving their cash and so, among other things, meant there was little demand for imports.

Shrinking savings pot

The savings pot is now shrinking, in part because consumers are spending more, but primarily because regional governments are running up big deficits.

The result is less concern about China’s savings surplus and more talk of a growing debt problem.

These developments are having little impact on President Trump as he is very much focused on the bilateral trade links between the US and China.

Nevertheless, they may in time have important consequences for the global economy.

In particular, I would highlight three that suggest it is mixed news for the UK.

Implication for the UK

First, the Chinese economy is rebalancing and, as it does, it is likely to buy more of the things that the UK is good at producing.

This means services, such as UK holidays for richer Chinese consumers, more consumption of UK media and increased use of our financial and business services.

The use of the English language and historical links with Hong Kong should help give the UK a key foothold into the mainland Chinese market, helping us to capitalise these opportunities.

It is often said that we export far too little to China, but that could change in future.

In contrast, there is probably less realistic hope of restoring a significant amount of manufacturing output from China.

Confounding expectations?

Some people think that China’s shrinking competitive advantage in terms of labour costs will allow production to move back to the UK, but the signs so far are that it is primarily leading to a shift to other low-cost locations in Asia and beyond.

Finally, it could mean higher UK interest rates.

One factor often used to explain why real interest rates have been so much lower in recent years is that China’s savings excess has pushed interest rates down around the world.

So, if China is moving from being a net saver to a net debtor, will that also have implications for UK rates?

Interest rates in Britain have been very low for a long time. However, China’s move to being a more consumption-driven economy may mean UK rates eventually reach a much higher level than markets currently expect.

Whether President Trump’s current bullish stance proves to be pure rhetoric or not, the Chinese economy’s continued evolution will certainly have ramifications for the UK.

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