China’s credit impulse is not dead so far as commodity prices are concerned. But in terms of structural changes I agree with TSLombard that the US will be the engine and China the caboose in the cycle to come:
There was a time when China’s credit impulse was the most important piece of data in global macro. For almost a decade, the country has been locked in a stop-go policy pattern, with every oscillation in China’sdomestic monetary/fiscal stance eventually producing powerful swings in the broader global industrial cycle. To be precise, if China tightened, the world could expect a deflation scare, typically around8-10 months later. If the authorities eased, “reflation” would become the big theme. The problem with this correlation is that nobody understood why it had become so compelling–it seemed to go far beyond traditional trade links, including China’s role as a source of final demand. When we investigated this topic a few years back, we put it down to“indirect” linkages, including via investor sentiment, financial channels (e.g. global equity exposure) and capex. But perhaps there was a simpler story–with the developed economies suffering secular stagnation and central banks powerless to stimulate demand, China had become the world’s main source of “balance sheet”. By adding 30% of world GDP to the CCP balance sheet, the country had become the marginal source of demand for the entire global economy. But this leaves a problem–because China no longer wants to play this role.
Beijing has adjusted its economic objectives and is now less willing to engage in big credit stimulus. Central authorities understand that continued rapid debt build-up poses a risk not just to future growth, but social stability and national security as well. Since 2017, the Party has shifted focus from credit-fuelled expansion to an emphasis on slower sustainable development. Cracking down on shadow banking, tackling legacy debt burdens and removing explicit GDP targets. We don’t need to dig deep into CCP rhetoric to uncover the shift, actions speak louder than words. During the Trade War Beijing maintained a hawkish bias to monetary policy and a tight rein on government spending. In 2020, China covid stimulus was 3% of GDP (vs 13% in 2008), compared to 10% of GDP in the US, 16% in Germany and 14.5% in France. China’s stop-go policy cycle is still there, but the threshold for intervention is higher and the scale of stimulus is likely to be smaller.
In some ways, China has been having a“romance” with MMT-type thinking over the past decade. It has used a massive expansion in “state” credit, albeit assigned to various parts of the private sector (first “corporate (or quasi corporate)”, then increasingly “household”) to engineer an artificially high trend growth rate. It did this without ever fearing it would turn into Greece, or upset the bond vigilantes. In fact, it kept interest rates artificially low, through various forms of financial repression. But this is a romance with MMT that is either over, or has lost most its early intensity. While other countries talk about “running their economies hot” after the pandemic, China appears to want to run its economy cooler. And, ironically, climate change is the perfect excuse. Western governments appear to want to use “the war on climate change” as a reason to embrace a more interventionist approach, using big smart, green state investments to tilt the battle in their favour. But China is moving in the opposite direction. Beijing is using its green push to increase control over local government finances and investment. New centralized collection of emissions data (and by extension data on economic activity), in addition to environmental targets in local government performance indicators, are an attempt to rein in provincial officials’ addiction to rapid debt fuelled expansion.
What does this mean for global growth? Short-term, the world’s economic “cycle” (if you can even call it that) is dominated by COVID. The contractions and expansions associated with lockdowns and reopening comfortably dwarf any spillovers from Chinese policy, either direct or indirect. It is no wonder that investors are now paying less attention to China’s credit impulse. Whatever the Chinese state decides to do in the way of credit provision is unlikely to alter the eshape of the current global upswing, at least for the remainder of 2021, if not deep into 2022.
If China is truly falling out of love with State stimulus, the world is going to need an alternative source of demand if it is going to avoid an even more stagnant economy than before COVID-19. One possibility is that DM private-sector demand will take over. Maybe there will be a revival in productivity as we learn to use digital technologies more effectively, or perhaps a secular improvement in housing demand related to new hybrid working patterns and the“Race for Space”. Households in the US and across Europe might even re-leverage their balance sheets after a decade of excessive caution. But a spontaneous “Roaring 20s” narrative dependent on “you-only-live-once” (YOLO) consumer attitudes doesn’t seem particularly compelling (more hope than reality). This would leave it up to DM governments to replace the role China’s State balance sheet has played in the global expansion over the past decade. Only a new DM “romance” with MMT can replace what looks increasingly like a Chinese “divorce”.