It’s noticeable how China has been hitting the headlines with greater frequency in recent weeks. There was the money market crisis towards the end of June, together with reports earlier this week of growing concerns regarding the rise in government borrowing. Furthermore, the much talked about slowdown (which is in many ways welcome and needed) is starting to bite. But how does this manifest itself in the FX market?
What is going on in China right now is relevant for several reasons. In the early days, China (and less so the other major emerging economies) were able to act as a decent counter-weight to developments the US and beyond. Not being reliant on external financing meant that China was able to push ahead, helped by internal credit growth. Overall credit growth has moved from 120% of the economy to nearer 200% over the past 5 years. So whilst the major economies in aggregate contracted during the 2008-2010 period, the BRIC economies (Brazil, Russia, India, China) grew by over 20%. This ability to act as a counter-weight to weaker growth elsewhere is now much diminished. China (and the other BRICs to varying degrees) just does not have the capacity to do so anymore.
Despite the fact that the Yuan is far from a freely floating currency, the impact of events in China manifest themselves in the FX market in many different ways. Before the global financial crisis, it was via the impact of excess savings in the US bond market, with Chinese official purchases of US government bonds keeping yields low, even when the central bank was raising rates. This helped keep the dollar falling, when in theory it should have been rising along with US official interest rates as they moved from 1% to 5%.
The Aussie has also been strongly interlinked to the China story, which can be easily seen in prior correlation with global commodity prices and the size of coal/iron ore exports to China in recent years. Iron ore exports have quadrupled over the past 5 years, coal even more so. That story has also broken down, as reflected in the recent collapse in the Aussie and likely further rate cut from the RBA in August.
Compared to the Aussie, the impact on the yen is less perceptible, but still noteworthy. Japan’s exports to China have doubled over the past ten years, but China is the largest exporter to Japan (nearly 20% of Japan’s imports), so we’ve seen a trend deterioration in the trade balance (more negative) between the two over the past 3 years. China has further undermined Japan’s competitive position within Asia, which has ultimately proved yen positive (but negative for the growth and the escape from deflation).
So whilst we may fear the consequences of slower growth in China and its impact, there are upsides. The huge savings surpluses of before and investment fuelled booms in commodities demand meant an over-reliance on China. Overall, it was to keep the global economy going during rough times. In the US, to keep Treasury yields low (and that was not a bonus) and in Australia to power the commodities boom. It may be tough short-term (especially on the Aussie), but moving to a world less reliant on China should ultimately prove a good thing.