By Nick Cunningham
China’s stock market fell sharply on Thursday, dragged down by a range of concerns that should offer a warning to the broader global economy.
The Shanghai Composite Index fell nearly 3 percent on Thursday, falling to its lowest point in nearly four years. The problems in China are dragging down markets across Asia, including in Japan and South Korea.
The Shanghai Composite is now down more than 25 percent since the start of the year, and is down more than 10 percent in the last three weeks alone. Viewed another way, the Chinese stock market has lost more than $3 trillion in the last six months.
Shanghai Composite Index, last 12 months
The troubling thing about the recent declines is that the factors driving the losses are multiple. The trade war with the United States, mountains of debt held by local governments within China, a broader slowdown in growth, a weakening yuan and high oil prices are all creating headwinds for the Chinese economy.
China’s central bank said that it still has plenty of tools that it could use defend against the trade war. Looser reserve requirements took effect a few days ago, a move the central bank made to inject money into the economy.
The IMF says that China’s GDP growth could slow from 6.6 percent this year to just 6.2 percent in 2019, although the risks are skewed to the downside because of the trade war. The Fund said that a worst-case scenario in which the U.S. slaps stiff tariffs on nearly all imports from China would shave off 1.6 percentage points from Chinese growth.
China won’t see any relief from the U.S. Federal Reserve. Minutes of the Fed’s last meeting in late September were released on Wednesday, and they reveal a determination on the part of the central bank to continue to tighten interest rates.
The Trump administration offered a very modest bit of relief this past week when it decided to hold its fire in its latest report on foreign-exchange policies. The Treasury Department maintained that China was a source of “particular concern,” and that China’s “lack of currency transparency and the recent weakness in its currency” would continue to pose “major challenges in achieving a fairer and more balance trade,” but the department refrained from using the “currency manipulator” designation. The move was widely expected, but it also shows a bit of restraint from the Trump administration, deciding not to go all-out in its economic battle against China.
But that is belied by the trade war that Trump is waging against China, which could still escalate in the coming months to new levels. Tariffs on $200 billion of Chinese imports will jump from 10 percent to 25 percent at the beginning of 2019. Trump is also weighing tariffs on an additional $267 billion of Chinese goods.
The campaign is taking a toll. “Current indicators of Chinese economic activity are weakening,” the International Energy Agency said in its recent Oil Market Report. “China’s Caixin Manufacturing PMI fell to a 16 month low of 50 in September: the output component pointed to slower growth, new orders remained unchanged and exports fell the most since early 2016.”
The cracks in the Chinese economy are a headwind for the oil market. China’s gasoline demand was up 180,000 bpd year-on-year in China in August, but that came after a second quarter in which demand was lower than a year earlier. Car sales in July and August actually declined compared to the same period in 2017. The IEA laid out the numbers: “Total vehicle sales declined to 1.59 million in July, a 15.2% m-o-m decline and a 5.3% y-o-y decline. Vehicle sales reached 2.103 million units in August, down 3.8% y-o-y. Passenger car sales, in particular, dropped by 4.5%.”
For now, though, the impact on oil demand remains unclear. The IEA still thinks that total oil demand in China will rise by 525,000 bpd in 2018, a 4.2 percent increase compared to last year. That will slow, but not overly so, to 465,000 bpd in 2019.
In other words, as it currently stands, China still represents a major source of demand growth. China and India together account for 60 percent of total global oil demand growth. The cracks in the Chinese economy will translate into a deceleration in demand growth, but it will take a stronger slowdown to really put a major dent in consumption levels. The thing is, for China, and for the oil market, a more serious downturn cannot be ruled out.
By Nick Cunningham