The One Chart That Really Matters: China’s Current Account Balance (3 min read)
Bull markets always properly end when money (liquidity) gets too tight. And tight money is one of the necessary conditions for a US and therefore global recession. The reason for this is simple. Tight money brings stress into the global economy and into global financial markets.
In a world which over the past two decades has become increasingly characterised by financialisation, unconventional monetary policy, and what we term ‘Alice in Wonderland’ economics, tight money typically bursts the serial bubbles that have been, and are, inflated by that monetary backdrop. The deflation of those bubbles then adds to stress, impacting revenue and cash generation and feeding back into the economy. For those reasons, monitoring the build-up of imbalances and excess across the globe is critical for assessing the outlook for key asset classes.
Given this week’s G20 meeting, one imbalance of particular concern is the Chinese structural bubble. Why? That bubble is closely intertwined with the Chinese current account balance. And that balance is about to enter a much anticipated and imminent move deficit. This is potentially accelerated by the current trade war, and deserves watching closely.
Current account dynamics look poor
In 2018 the Chinese current account balance was in surplus by 0.4% of GDP. Back as recently as 2007, just ahead of the global financial crisis, that surplus was just shy of 10% (Figure 1). As the chart shows, the IMF is forecasting a modest continued surplus through to 2021, before the projecting that the balance will move into deficit in 2022.
More realistically, though, a deficit is likely as soon as this year considering that the underlying dynamics of the Chinese economy continue to deteriorate. That deterioration is down to several factors:
- A reordering of global supply chains away from China in large part the result of increasing tension between China and the US
- A continued leveraging up of the household balance sheet as China continues to lean on consumption to drive its growth
In particular, given a broadly fixed exchange rate and its reduced reliance on investment to drive growth, China is likely only to be able to achieve its GDP growth targets with more credit fuelled consumption, that is, a continuation of the recent trend shown (Figure 2). Added to which, with a shrinking population at working age and similarly shrinking employment, coupled with low productivity growth, households will need to further increase their leverage to drive strong consumption growth. Debt fuelled consumption is a well-trodden path to current account deficits.
Crunch time coming soon
While there’s much agreement on the level of excess in China’s economy, the bulls’ argument has always been that the debt is internally owned and hence not an issue for the rest of the world.1 Once China moves into current account deficit, that argument, of course, falls flat as China then becomes dependent on the 'kindness of strangers'. It’s at that stage that China’s vulnerability becomes heightened and it becomes a key risk factor. Tightening Fed policy, when it returns (perhaps in late 2020), is then likely to expose China’s structural weaknesses and excesses. Ahead of that we continue to monitor China for signs of stress in its own financial system.
Chart 1: Chinese current account balance as a share of GDP (%)
Source: Longview Economics, Macrobond
Chart 2: Contribution of consumption to GDP growth vs household debt ratio
Source: Longview Economics, Macrobond
1 And whilst that’s an interesting argument, it’s worth noting that Japan also ran a current account surplus in the late 1980s (i.e. in the run-up to its crisis) yet still entered into a challenging economic environment for more than twenty years.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)
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