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Bull in a China Shop? | 6th May 2014

China’s status as the world’s largest economy is no reason for hubris  |  China’s status as the world’s largest trading nation and, during 2014, as the world’s largest economy should be treated with caution by markets. It is still an emerging economy, faces manifest problems in terms of structural reform and has a difficult year ahead of it in terms of trade and economic growth. Observers would do well to treat the news about its size with the ambivalence it deserves: over-reaction, which is admittedly absent at present, could add further challenges to China as it seeks to impose major structural reforms without causing a sovereign debt crisis. It is no longer growing, either in trade or GDP terms at the rate that it was pre-crisis. This is a fact, and one that should concern markets more than the size of the Chinese economy, which does little more than beg the question, “so what?”

In October 2011, Delta Economics predicted that China would become the world’s largest goods trader by 2014. In January 2014, China officially became the world’s largest goods trader (1) in the world accounting for over 13% of world trade according to our estimations. Last week the World Bank (2) announced that China would also become the world’s biggest economy, in 2014, a fact which surprised many economists who had forecast that this would not happen until 2019; it also frustrated the Chinese government. There is some scepticism about the materiality of the numbers themselves because of the way in which they are calculated but, as Martin Wolf (3) points out, it is a reasonable, even an unsurprising conclusion and does not mean that China is the world’s most powerful economy.

The Delta Economics view is that China should indeed be regarded as an emerging economy. This means that analysts should be looking for evidence that its economic fundamentals are catching up with those of the developed world to justify investment decisions.

First, there is no better place to start than in a closer examination of the structure of its trade. China is not catching up quickly with either Germany or the United States in terms of the goods it imports and exports and, indeed its trade is becoming more concentrated in its top ten exported and imported products rather than less. In import terms, this means that it is still importing predominantly commodities and intermediate manufactured goods while in export terms, its exports are heavily concentrated in computers and intermediate machinery. As Figures 1a and 1b show, the fact that the “rest” component of the top 30 sectors has fallen so sharply, suggests that the reliance on these sectors in export and import terms has increased.


Bull in a China Shop  |  Figure 01a

 Figure 1a  |  Share of China’s top 10 export products as a percentage of its top 30 export products, 2014

Source  |  DeltaMetrics 2014

Bull in a China Shop  |  Figure 01b

 Figure 1b  |  Share of China’s top 10 import products as a percentage of its top 30 import products, 2014

Source  |  DeltaMetrics 2014

Figure 2 compares the structure of China’s trade with Brazil, India, Russia, Germany and the US in 2001 and 2014 using the Finger-Kreinin Index, which measures the similarity of the structure of exports between countries. Effectively it is a measure of how a country is catching up/competing with another in terms of its exports. The closer the value is to zero, the less similar the structure of exports is – in other words, the country comparator as few export sectors in common.


Bull in a China Shop  |  Figure 02


Figure 2  |  Finger-Kreinin Index for China’s export similarities with selected countries

Source  |  DeltaMetrics 2014

What the figure quite clearly shows is how different China’s structure of exports is to other countries, whether developed or emerging. It is more like a developed world economy that Brazil, India or Russia since electronic goods and intermediate goods dominate its exports as compared to the dominance of commodities in the other countries. Only India shows any sign of a major shift towards export similarity, but as the value is still low, at 0.13, the change does not suggest that India is competing directly with China.

Of more interest is the fact that neither Germany nor the US are similar in terms of their exports either. China has become more like the US over time, although it is still very different and Germany became mildly more similar immediately pre-crisis with slightly higher values (0.12) which is arguably because of a shift in German manufacturing out to China at that time which has since performer5 coupon code reversed. Similarly the biggest shift in the similarity of US export structure to Chinese was in the same period and has not yet reversed.

But the fact remains that neither selected emerging economies or the two other, largest, trading nations, are at all like China.

Second, while Barclays Capital, argues that China’s trade is not growing fast enough to keep investors happy, the effects of Hong Kong are dampening prospects for growth. Strip the effects of Hong Kong out, and export growth last year was 6.8%. This is very close to the Delta Economics similar estimate of Chinese export growth of 6.9% in 2013 suggesting that the Hong Kong factor is an important one to consider.

It is necessary to exercise caution when looking at the relationship between Hong Kong and China in trade terms. Because Hong Kong is a semi-autonomous region, it counts as part of China for some import and some export purposes. Thus, re-imports into China (which are the proportion of imports from, say, Hong Kong or China Macao that originate in China) grew from 4.5% of the share of top 30 importers into China to nearly 10% now.


Bull in a China Shop  |  Figure 03


Figure 3  |  Chinese exports to key port nations, USDm, June 2001 – January2016

Source  |  DeltaMetrics 2014

The figure shows Chinese exports to key port hub nations. Clearly it exports more to Hong Kong than it does to other port nations but this figure suggests two things: first, the volatility of China’s trade with Hong Kong has increased since 2009 and follows a regular pattern and second, that trade with Singapore and the Netherlands grew faster year-on-year in the first quarter of 2014 that exports to Hong Kong.

Third, the volatility in particular suggests that Chinese trade inflows and outflows themselves do not necessarily reflect the trade fundamentals, which have remained very similar since 2001. And yet, the Hang Seng index and Chinese exports are extremely highly correlated, with a value of 0.81 suggesting that this volatility may even be helping investors to predict where that market might go in the future, as illustrated in Figure 4.


Bull in a China Shop | Figure 04

Figure 4  |  Chinese exports versus Hang Seng, Last Price Monthly, June 2001 – March 2014

Source  |  DeltaMetrics 2014 and Bloomberg

It is this last point that is the most important. The correlation between markets and Chinese trade is strong, but much stronger for emerging markets than it is for developed world markets, even regional ones like the ASX 200 or the Nikkei (Figure 5) and, as shown in Figure 6, the relationship between the S&P 500 and Chinese exports is negative from the end of Q1 2013.

Bull in a China Shop | Figure 05

Figure 5  |  Correlation of Chinese exports with key regional markets and the S&P 500

Source  |  Delta Economics own analysis

Bull in a China Shop | Figure 06

Figure 6  |  Chinese exports (USDm, June 2001 – Dec 2014) vs S&P 500, Last Price Monthly, June 2001 – March 2014

Source  |  DeltaMetrics 2014 and Bloomberg

All of this illustrates the importance of China’s exports to emerging equity markets. These watch China’s economic indicators and react accordingly, perhaps because the emerging countries in the Asia-Pacific region are so dependent on China’s economic health. Interestingly there is a relatively weak correlation with the ASX 200 and one that turned negative in early 2010.

There are lessons for investors in both emerging markets and developed markets in this. For emerging markets the case is clear: China’s businesses are key to the growth of their own markets (whether in the real economy or money markets) and this drives capital inflows and outflows. Delta Economics has downgraded its forecast for Chinese trade in 2014 from 6.1% growth at the end of last year to 5.3% now suggesting a tough year for these markets.

For the developed world, the apparent bullishness is still not pricing in the risks in emerging markets. These risks are manifesting themselves through trade in the first instance but have the capacity to spill over into debt markets as well as disinflationary pressures and the potential for defaults become more evident. It might well be that these bulls could do themselves a lot of damage if they don’t look more closely at the Chinese shop.


(1) Anderlini, Jamil and Hornby, Lucy (January 10th 2014) | ‘China overtakes US as world’s largest goods trader‘ Financial Times

(2) Giles, Chris (April 30th 2014) | ‘China poised to pass US as world’s leading economic power this year‘ Financial Times

(3) Wolf, Martin (May 2nd 2014) | ‘China: On top of the world‘ Financial Times