During 2018 Chinese financial markets have been on the move. 10yr bond yields rose from all-time lows throughout 2017 but have since declined: –

Source: Trading Economics, PRC Ministry of Finance

Despite this easing of monetary conditions the negative impact US tariffs, continues to weigh on the Chinese stock market: –

Source: Trading Economics, OTC, CFD

Despite being a leader in frontier technologies such as e-commerce (China has 733mln internet users compared with 391mln in India, 413mln in the EU and a mere 246mln in the US) the recent decline in tech giants Alibaba (BABA) and Tencent (TCEHY) have added to financial market woes. However, as the chart above shows, Chinese stocks have been in a bear-market since 2015. Some of its Asian neighbors have followed a similar trajectory as their economies have slowed in response to a US$ strength and US trade policy.

The notionally pegged Chinese currency has also weakened against the US$, testing it lowest levels in almost a decade: –

Source: Trading Economics

Meanwhile, President Xi has now announced plans to rebalance China’s economy towards consumption, turning it into an importing superpower. Surely something has to give.

The IMF expects Chinese GDP to grow at 6.6% in 2018. They continue to point to signs of economic progress: –

The country now accounts for one-third of global growth. Over 800 million people have been lifted out of poverty and the country has achieved upper middle-income status. China’s per capita GDP continues to converge to that of the United States, albeit at a more moderate pace in the last few years.

The authors go on to predict that the country may become the world’s largest economy by 2030. However, there are headwinds: –

Despite the sharp rebound in nominal GDP and industrial profits, total nonfinancial sector debt still rose significantly faster than nominal GDP growth in 2017. While the corporate debt to GDP ratio has stabilized, government and especially household debt is rising, driven by continued strong off-budget investment spending and a rapid increase in mortgage and consumer loans.

It is debt that concerns Carnegie Endowment’s Michael Pettis – Beijing’s Three Options: Unemployment, Debt, or Wealth Transfers – as the title suggests he envisages three paths to adjustment.

Raise investment. Beijing can engineer an increase in public-sector investment. In theory, private-sector investment can also be expanded, but in practice Chinese private-sector actors have been reluctant to increase investment, and it is hard to imagine that they would do so now in response to a forced contraction in China’s current account surplus.

Reduce savings by letting unemployment rise. Given that the contraction in China’s current account surplus is likely to be driven by a drop in exports, Beijing can allow unemployment to rise, which would automatically reduce the country’s savings rate.

Reduce savings by allowing debt to rise. Beijing can increase consumption by engineering a surge in consumer debt. A rising consumption share, of course, would mean a declining savings share.

Reduce savings by boosting Chinese household consumption. Beijing can boost the consumption share by increasing the share of GDP retained by ordinary Chinese households, those most likely to consume a large share of their increased income. Obviously, this would mean reducing the share of some low-consuming group—the rich, private businesses, state-owned enterprises (SOEs), or central or local governments.