China's economy is too fragile to just open up to global trade
In an article for Bloomberg, our friend and regular contributor to the Expert Series Chris Balding argues that the US should take the weakness of China’s economy into account when ‘negotiating a better deal’. The US demands that China either opens up and allows more foreign competition or agrees on hard targets for boosting imports, but Chris thinks the US needs to recognize the Chinese economy is still very fragile.
From the outside, the Chinese economy appear stable, with official GDP data coming in strong quarter after quarter. As we know, Chris is an expert in digging into the Chinese numbers, and he finds that underneath the headline data, there is plenty to worry about;
The 2017 expansion wasn’t driven by a change in the structure of industry as much as by a reversion to old drivers. Through a combination of fiat and the encouragement of flows from wealth-management products into commodity trading, regulators successfully pushed up base input prices in 2016 and 2017.
This had a spillover impact across the economy. Mining and processing of ferrous and non-ferrous metals accounted for more than 72 percent of the growth in industrial profits last year. Back out those commodity industries, which enjoyed almost triple-digit price increases, and the remainder of Chinese industry saw profits grow by only 2.8 percent.
Banks’ nonperforming-loan ratios flattened as the most indebted and risky sectors boosted profits. The jump in nominal GDP from the commodity boom put a brake on the widely watched debt-to-GDP ratio.
While the headline numbers look better, the reality is that Beijing faces many of the old problems and has less room to maneuver. Key financial metrics remain stressed or are deteriorating. Debt-to-equity ratios of heavy industrial firms, even after the boom in profits, have barely changed. The People’s Bank of China lowered reserve ratios to allow banks to repay money they borrowed from the central bank. With the ratio of new loans to new deposits now consistently above 100 percent, and reserves to assets continuing to decline, banks are showing signs of stress as nonperforming loans, or NPLs, have ticked back up.
Chris goes on to remark that Beijing is well aware of these issues, and therefore are very concerned about simply opening up the economy. He thinks it only makes sense that the one industry the Chinese leaders want to open up is finance. The government hopes that in giving foreign banks access to Chinese markets, they will also rid the system of some of the NPLs. Overseas banks however seem to be looking, but are not moving in, cautioned by the risks that come with owning a Chinese bank.
Chris posits China is stuck between a rock and a hard place;
Apart from inviting foreign banks to bail out Chinese institutions, Beijing has shown no interest in liberalizing the economy. Trump officials can talk about not wanting to change China’s economic structure, but the reality is that’s what they are demanding – and they’re demanding it of a weakened economy.
Chris concludes that Washington has to mindful of which concessions China can and cannot do, or the mission could fail;
Given the seeming evolution of a deal focused on observable metrics, like Chinese imports of U.S. goods, Washington will fail if it comes away without concessions on market access. However, another way to fail is pushing too hard for market-opening measures that present excessive risk or that Beijing cannot or will not implement.
Trump is right to confront protectionism and to push for verifiable steps in any agreement. But China’s economy is weaker than the U.S. recognizes, and progress toward a pact will need to take account of that reality.