Disappointing news out of Beijing yesterday as Chinese economic data all point to trouble ahead. Growth in retail sales, industrial production, and fixed asset investment all disappointed, missing estimates economists had predicted. Data that covered the month of April and a slow-down, even before the renewed trade war had started up again, don't bode well for the world's second largest economy. Should U.S. President Trump continue to push a hard line on trade with China and insist on increasing tariffs even further, the damage won't be isolated to China alone, but may very well spread like contagion throughout financial markets.
Of the data that missed analysts expectations, perhaps the most worrisome concerns Chinese domestic sales. Chinese consumers spent 7.2 percent more in retailers around China than they had in 2018; however, sales were projected to increase by 8.6 percent. While industrial production also missed substantially, it is Chinese domestic spending that is the most important factor for me. If China is able to generate enough domestic demand so that its economy is dominated by consumer consumption, as are the economies of countries like Turkey and the United States, then foreign tariffs on Chinese exports are not as important. This has been the goal that the Chinese have long sought and are very close to achieving but alas, have not yet completed. With China's dependence on exports, the key component of its economy, China will have to take drastic measures to shore up its markets.
The Chinese Yuan is kept on a tight leash by the People's Bank of China (PBOC) and has depreciated significantly against the U.S. dollar, down 10 percent in the last year. Unlike free-floating currencies, the PBOC has the reins when it comes to currencies moves and has the foreign reserves to back up its stance, being the largest holder of U.S. debt globally. In other words, if the PBOC wanted, it could manipulate its currency any way it sees fit and in this current political climate it chooses to depreciate the currency in hopes of softening the blow of the Trump trade war. Will this step be successful?
In and of itself, I'm not convinced this step will address the concerns of markets. A protracted trade war between the U.S. and China will ultimately force China to sell U.S. debt to the tune of over a trillion dollars. This will send shockwaves throughout the global economy and cause rates to rise as debt prices decline. Moreover, should Trump continue to squeeze Beijing, the Chinese will be forced to plan ahead for a global economy that isn't necessarily dollar-centric. This will lead to continuing political battles that may see the U.S. respond with increased support for Taiwan and other measures it sees as punishing China. Continued uncertainty and trade wars will ultimately begin to unravel China-U.S. economic cooperation, which will be disastrous for both countries. Is Trump prepared to take such a major gamble to win points with his domestic base? It appears he is.
Should the U.S. continue to push China, look for the Chinese to respond. If the response is in kind, the world will experience a multiyear recession until trade resumes between the two countries. If the response is measured, perhaps the relationship can continue where it left off after Trump's election to a second term. In the interim, best to sit on the sidelines and divest from the securities most impacted by this increasingly messy debacle.
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