The coronavirus makes China’s economic balancing act even harder

2020 should be the year when China straightens out its heavily indebted economy. But the coronavirus could throw a spanner in that plan, says John Stepek.

Markets now see the coronavirus as a buying opportunity. Even by the normal standards of these things, that was pretty quick. Is there no natural hazard, no geopolitical threat, no economic crisis, that the promise of endless liquidity cannot contain?

The US and China shake hands, for now

China and the US are getting to work on putting “phase one” of their trade agreement into practice. Both sides will be halving tariffs on some goods on Valentine’s Day (how sweet).

The move helped to cheer markets. (The fact that Donald Trump’s impeachment trial ended with the US president being acquitted might have helped, although it was pretty much expected.) Investors had been a little concerned that the coronavirus outbreak would make the deal a lot trickier.

China has pledged to buy an extra $200bn in goods and services from the US over the next two years. Even if you agree that the basic idea of fixing a term of trade like this is a good idea (which I don’t – what happened to free markets?), this was always seen as a tall order. It’ll be a lot harder if China’s growth has been hit (which it clearly has, whatever the official data ends up saying) by the measures to contain the coronavirus outbreak.

So the fact that the two are going ahead on what seem to be pretty good terms with one another has helped to ease concerns that we’d have another trade drama. I imagine we might have one after the US election is over this year, but markets are probably right in thinking that Trump won’t want to stir up this hornets’ nest before November again. But what about the longer run?

Why coronavirus could bring China’s economic “endgame” closer

Diana Choyleva of Enodo Economics had a good piece in the Financial Times yesterday, on the future for the US and China’s relationship.

Choyleva has long talked about the “great decoupling”. Her basic point is that China and the US have fundamentally different approaches, and that these can’t be reconciled.

The two nations are competitors – the incumbent versus the rising power – and it means that the “free trade” benefits that we took for granted in the olden days of globalisation can no longer be relied upon. Decisions on where to manufacture goods (particularly technology, as we see from the debate over Huawei) and who to purchase them from will be made based on political factors, not on economic ones. So the efficiency gains created by specialisation and comparative advantage (the idea that we all focus on what we’re best at, and trade with each other for everything else) will be eliminated. “Meanwhile, deepening mutual mistrust will slow scientific and technological co-operation.”

It also points to higher prices. Not just from tariffs, but also from this diminished efficiency. And it’ll get worse if flow of capital around the globe is also impeded in the longer run – if funding costs go up, so will prices. The key takeaway for me from Choyleva’s points is that the coronavirus just exacerbates all this.

In another report from Enodo, she points out that China will almost certainly have to embark on more stimulus in order to prop up its economy after the hit from the coronavirus.

Trouble is, to cut a long story short, the Chinese economy is already so indebted that it’s hard to get a lot of bang for its buck. As Choyleva notes, 2020 had looked as though it would “be a critical year for the clean-up of bad debts”. However, that’ll now have to be delayed. And that means the debt issue will deteriorate even further. And cleaning that up in a managed way (ie, letting companies go bust but avoiding systemic problems) means that China will have to be in a position to tolerate weaker growth for several years to come.

The risk, notes Choyleva in the FT, is that “Beijing fails to lift productivity growth substantially through sweeping structural changes.” If that’s the case, then the only other option could be a significant devaluation for the renminbi, with the Chinese government allowing the currency to weaken sharply. That would be very disruptive, creating a deflationary shock around the world.

None of this is going to happen tomorrow. And I suspect that markets will have a melt-up before the scarier scenarios come to pass. But it’s probably fair to say that the coronavirus outbreak brings this China “endgame” somewhat closer than it was before.

What should investors do? No need to panic, as ever. Just make sure you have a bit of gold (for emergencies), a diversified portfolio of equities, bonds and cash according to taste, age and requirements – and keep an eye on the key economic data and on the Chinese exchange rate (both of which we monitor every Saturday in Money Morning).


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