Trade War

This is why China urgently needs a trade deal with the US

5 Reasons Why China (Urgently) Needs a Trade Deal With the US

By | General, Special Reports, Trade War

Whether in trade or in politics, US President Donald Trump views this principle of negotiation as a constant: “Leverage: don’t make deals without it.”

Drawn from his book, The Art of the Deal, the aforementioned quote speaks to the source of his confidence in winning a tariff-fuelled trade war with China.

It’s simple, really. China exports more goods to the US than the US does to China, making the world’s second-largest economy more vulnerable to levies.

With both sides now locked in negotiations as the deadline for the 90-day truce closes in, the damage already inflicted on China’s economy might give the US the upper hand.

Here are five economic reasons why China needs to make a trade deal, and make one fast:

1) Consumption-Based Economy: The Dream Is Fading

Chinese President Xi Jinping once remarked, “We will improve systems and mechanisms for stimulating consumer spending, and leverage the fundamental role of consumption in promoting economic growth.”

Lately, his grand vision of making consumption the lifeblood of China’s economy has been dealt a heavy blow.

Between October and December last year, the nation’s consumer confidence index reading came in at 99.4, far lower than the 105.1 figure registered during the same period in 2017. A reading under 100 suggests consumer pessimism.

Not surprising, then, that sales in consumer discretionary categories, such as the auto sector, have faltered. Chinese automaker Geely recorded a 39 percent year-on-year fall in the number of cars sold in December 2018.

Geely-39% Drop in YoY Car Sales Volume-December 2018

2) RRR Cuts: Nothing But a Short-Term Solution

Say for instance, you’re a large bank required by the regulator to maintain a certain fixed capital ratio. Problem is, the rate at which you lend far outpaces your growth rate in deposits, exacerbated by the fact that you have facility loans coming due.

The nation’s economy is facing a slowdown, meaning lending is more critical than ever to stimulating growth. Left with little choice, the central bank lowers the required capital ratio to free up cash so banks like yours can repay the loans and continue lending.

The scenario described above neatly sums up the rationale underpinning The People’s Bank of China’s (PBoC) decision in January 2019 to lower the reserve requirement ratios (RRRs) by a full percentage point.

The move unleashed RMB 1.5 trillion (~US$219 billion) in bank capital across Chinese banks, with roughly half the amount allocated to repaying maturing medium-term loans. That left banks with a diminished lending chest of RMB 800 billion (~US$116 billion) to work with.

RMB800b-(_US$116b) Bank Capital Released from the PBoC’s RRR Cut for Lending-January 2019Is this solution effective? For a while, maybe.

Is it sustainable? Not if the strategy involves eating away at a bank’s finite capital base over the long run.

3) Ballooning Debt: Too Big to Fail

Speaking of stimulus, it’s creating a giant debt problem for China that now stands at more than 250 percent of GDP.

According to Smartkarma’s recent trade war report, “increasing financial leverage in China’s economy is also compromising its ability to withstand future tariff blows.”

More US tariffs will inevitably hurt Chinese manufacturing and consumer sentiment more than it already has, further imperiling economic growth, which could encourage still more stimulus to prop the economy.

Only by reaching a trade deal with the US can China begin to restore lost business and investor confidence. That could open the door to reverse this unsustainable debt spiral.

4) Manufacturing PMI: Under 50

Still unconvinced of China’s increasing economic weakness? Take a hard look at the supply side.

Data from the Official NBS Manufacturing PMI for December 2018 came in at 49.4 (under 50), the first contraction in factory activity since July 2016. Another well-respected gauge, the Caixin China General Manufacturing PMI, posted a 49.7 reading (also under 50).

Official NBS Manufacturing PMI-December 2018Caixin China General Manufacturing PMI-December 2018What happened? “External demand remained subdued due to the trade frictions between China and the US, while domestic demand weakened more notably,” CEBM Group’s Director of Macroeconomic Analysis Zhengsheng Zhong explained in a Reuters interview.

Should these PMI readings continue their downtrend, factory layoffs might ensue. And with it, the rise of possible social upheaval. Time is running out…

5) Property Woes: Too Many Homes, Too Few Buyers

In yet another reflection of growing Chinese economic pessimism, the homebuyers’ confidence index in October 2018 registered its lowest level in nearly two years.

November 2018 data from 67 key cities showed a 0.3 percent month-on-month dip in pre-owned home prices in China, said Diana Choyleva, who publishes on Smartkarma.

“Two of China’s top three leading property developers, Evergrande Real Estate Group and Country Garden Holdings, saw November sales plunges even after cutting prices by nearly a third at some housing projects,” she added.

Unfortunately, China can’t “export” real-estate overcapacity. It needs its economy back on a firm footing to revive consumer sentiment, which, in turn, would help spur fresh demand for property.

Closing Statement

We conclude with a statement drawn from Smartkarma’s special report on the trade war: “The stakes to even the trading field have never been higher.”

For China, that means inking a trade deal with the US as soon as possible so both sides can resume normal trade relations. And in so doing, hopefully lift disruptions to supply chains and export activity.

Get the full story of how this trade war began. Download Smartkarma’s special report: The End of Fair Trade

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