China, its troublesome credit system and its shaky relationship with the West dominated global markets for years. Then it gave the world the coronavirus. And now, somehow it has slipped from attention, dropping down investors' lists of concerns. This is strange because something important is afoot. Chinese stock markets have far outperformed the rest of emerging markets this year, almost closing a gap that has persisted for decades. China has hosted economic growth, but its equity markets have not logged the returns seen elsewhere — until now:
The last week has seen the domestic Chinese stock market's strongest five-day performance in more than five years, and one of the strongest on record:
China has also, contrary to all expectations earlier this year, seen a noticeable appreciation in the currency, a hot spot in the country's relationship with the West. Last August, Chinese authorities allowed the yuan to weaken and exceed the level of 7 to the dollar, in what appeared to be a retaliation for US threats of added tariffs. Then earlier this year, after a trade ceasefire of sorts had been negotiated, it again broke above 7, this time because of concerns about the damage that the coronavirus would wreak. Now, in a development that suggests a degree of strength in China, and also may remove some heat from its trans-Pacific relationship with the US, the yuan has almost returned to the 7 level:
While currency valuations are important, the most significant market "tell" of Chinese economic strength comes from industrial metals prices. At the margin, China has been setting prices for industrial metals for years as it has gone through its growth spurt. And so the 20% rally in Bloomberg's industrial metals index (combined with a gain of more than 30% for iron ore on China's Dalian exchange since April) suggest that China is getting its act together again:
This is a remarkable turnaround, only six months from the beginning of the pandemic. How has it been achieved?
The best guess is that China has pressed the pedal on expanding credit once more, but not by using orthodox monetary policy and not in a way that weakens the currency. The following chart, from CrossBorder Capital LLC of London tells the story of the remarkable expansion of Chinese credit over the last quarter of a century as well as anything:
The stimulus applied by Shanghai's big equity bubble in 2007, and then by the huge extra spending and credit easing that started in late 2008 to deal with the last global financial crisis, was on a different scale from the stimulus that is now being applied. Much of that was achieved via shadow banks, shown by the yellow line, whose opaque structures led to concerns that China could stage its own repeat of the Lehman crisis. The People's Bank of China has spent the last few years in an explicit attempt to avert this risk, and now appears to have shadow banking under control. That has allowed them to unleash a 20% increase in liquidity, through traditional banks and through the bond and equity markets.
For the short term, this can only be positive. Questions will rightly continue about whether the Chinese regime, attempting to use a communist command structure to regulate a capitalist economy, can possibly endure. It is only a few months since the Communist Party's inadequate response to the early stages of the pandemic appeared to be heralding major change. But for the short term, China appears to have been able to right its ship, and to find the money to keep its economy nicely afloat.
This could be a vital precondition for a cyclical upturn in the emerging markets. They also need to contain the economic damage done by the pandemic, and this is far from certain in major countries such as India and Brazil. And they would be greatly helped by a further weakening of the dollar. Emerging currencies have picked up a little in the last month, but would be helped by much more dollar weakness.
If these preconditions can be met, however, the world is beginning to show the symptoms of previous periods when China was in the ascendant. Along with strong industrial metals, we also have a gold price that is as high as it was the last time that China was stimulating with full force at the beginning of the last decade. Nobody knows how long it can last, but it looks like the Chinese economic machine might be able to drive one more economic cycle.
John Authers is a senior editor for markets. Before Bloomberg, he spent 29 years with the Financial Times, where he was head of the Lex Column and chief markets commentator. He is the author of "The Fearful Rise of Markets" and other books.
Disclaimer: This article first appeared on Bloomberg.com, and is published by special syndication arrangement.