We all pay for China’s pain

The move by China to devalue its currency is a worrying trend.

The biggest Chinese devaluation since 1994 knocked the stuffing out of global markets over the past week, sparking a debate on the underlying strength of China’s economy as it transitions from an industrial to a consumer-led society.

The move by China on its currency was justified  by many as no different to United States, Japan and more recently European initiatives to stimulate their economies by releasing more money into their trading systems.

They flooded their markets with liquidity thus forcing currency markets to devalue their currencies.

But the Chinese move appears to be a little more serious and hides the fact that the Chinese economy, upon which Australia is so reliant, is doing worse than most observers have expected at this stage of the downturn. Many don’t think they will reached their underlyng target of 7 per cent growth this year.

The Australia Financial Review’s Alan Mitchell concurred, “A larger depreciation of the yuan would provide a shot in the arm for the Chinese economy which, according to the official data, has slowed to its lowest growth rate in six years as it works through a major housing market correction. (Some economists who distrust the official data think China already has fallen into recession.)”

Whatever the reason the Australian share market fell into official correction territory with the benchmark S&P/ASX 200 index falling more than 10 per cent below its April high and by Friday that trend was being compounded by disappointing local annual profit results.

The yuan devaluation also had the knock-on effect of sending so-called ‘fragile’ currencies lower as most of those emerging nations count China as their biggest customer. A lower yuan helps China’s exporters undercut their competitors – and in turn stimulates the economy – but also means that China’s imports become dearer and less affordable. This impacts on Australia as well.

But a spluttering global recovery also means China will find it difficult to just rely on exports to drive expansion and other policy initiatives will be required.

This is a long way from the Chinese Government’s plan of a few years back to move away from an export-led economy and move to a domestic consumption economy as wealth spread to the aspiring middle classes.

The trend back to pushing exports, if successful, will have to unwanted effect of redirecting investment away from internal stimulation including much-needed infrastructure and environmental projects.

Mitchell points out, “A lower real exchange rate would boost profits of the big state-owned manufacturers and divert investment capital away from the new service industries: the very opposite of the fundamental structural change needed to put China on a more sustainable growth path.

But you can’t say China isn’t trying. Over the past three months China has dropped lending and deposit rates in an attempt to get more investment going even it is in the more speculative areas of the economy. The government is also addressing the issue of bad debts in the banking system and acknowledges that the taxation system will have to be reformed to help pay for increased social programs.

And just like Australia the Chinese do have some massive infrastructure projects on the drawing board.

The economists at CommSec believe the Chinese economy is still  transitioning from it over-commitment to exports, though they believe that any move that shores up China’s growth will eventually flow through to other markets.

Let’s hope it doesn’t take too long because what China is really exporting at the moment is pain to most of the world’s equity, currency and commodity markets.

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