Resurgent Dollar Threatens China's Economy

The Telegraph's Jeremy Warner warns:

...  Weakening demand elsewhere in the world, particularly in emerging markets, is depressing commodity and energy prices. This is unhelpful to further development of US shale, but it makes American consumers better off. The greenback will need to go a lot higher before US policymakers hit the panic button. 

For others, however, the panic may be more immediate. At Fathom Consulting, Danny Gabay reckons that Chinese growth may already have dipped to less than 5pc on an annualised basis. It’s a view shared by Diana Choyleva, of Lombard Street Research. 

And it’s hard to argue with their prognosis. Even the Chinese premier, Li Keqiang, has said he finds the official Chinese GDP figures unreliable. Using his preferred measures of electricity consumption, rail freight volumes and credit growth, you get a much lower number than the officially targeted 7.5pc rate. 

If these more pessimistic estimates for the Chinese economy are even halfway true, then any significant strengthening in the US dollar would virtually guarantee a hard landing. Chinese policy makers don’t like to do anything in a hurry, but a strengthening dollar is a major headache for an economy already at risk from a deflating credit bubble, and could therefore significantly speed up the process of capital liberalisation. 

Whether China is quite ready for such a revolution is an interesting question. Quite apart from any other considerations, the Chinese corporate and financial sectors have some big dollar debts. These are made bigger still by dollar appreciation, threatening multiple bankruptcies. 

Even so, the Chinese authorities have already quietly ceased attempting to support the renminbi/dollar peg with asset purchases. Just a few years back, Chinese reserve accumulation used to be characterised as barely legal currency manipulation. There was outrage on Capitol Hill, and repeated calls for tariffs on Chinese goods. Back then, the Chinese policy goal was to stop the renminbi appreciating against the dollar, so that Chinese exports could remain competitive. 

The irony is that if the peg was abandoned today, it wouldn’t be renminbi strength the Chinese would have to worry about, but the reverse – rapid depreciation. Decoupling would be a huge step for a country that has built its economic success in lockstep with the dollar. However, in a world where demand is increasingly hard to find, it may yet come to that.

In other words, because China has pegged its currency to the dollar, as the dollar appreciates in value, the cost of Chinese goods will also increase. Combined with declining demand from Europe, and currency devaluations being pursued by Korea and Japan, this may result in a significant decline in demand for Chinese goods. On the other hand, because many Chinese companies have debt that is denominated in dollars, if the Chinese government unhooked its currency from the dollar, that debt (including interest payments) would rise relative to those companies' value/income causing defaults and bankruptcy. Somewhat of a Catch-22.