Watch These Two Chinese Economic Indicators

Amongst all the panic and hand-wringing over what the volatility of the past week means, we haven’t heard much about China.

Which is kind of crucial, especially for Australia. Put simply (and accurately) if China holds up, Australia will be fine.

So, is China holding up?

There are a number of things we can look at to answer that question as accurately as we can.

The shorty answer is, yes it is. But that should not come as a surprise. After all, it’s not as if the US economy is slowing sharply and putting pressure on China.

And even if the US economy were to slow later this year (as it probably will, given its recent strong growth rates) that doesn’t mean China will take a big hit.

China is not as dependent on the US as it was back in 2008. Its economy is much larger and more diverse these days. Importantly, Chinese domestic consumption represents a larger slice of the economy than it did 10 years ago.

Having said that, The US just reported a trade deficit with China of US$375 billion for 2017. That represents a significant inflow of dollars that must be offset by printing yuan to keep the exchange rate stable. This in turn represents an important source of liquidity for the Chinese economy.

If the US economy remains healthy, what other signs can we look at to gauge the health of the Chinese economy?

The Aussie dollar would be my go to indicator

Australia has a net foreign debt position of over $1 trillion. That means global markets keep a very close eye on us. They know we are a derivative of China. When China is doing OK, investors are sanguine about Australia’s prospects.

But if China runs into problems, it means Australia suffers. It threatens our ability to service our rather large debts.

When these problems hit, it shows up in the exchange rate very quickly. When it became apparent that problems in the US housing market in 2008 were deeply impacting the banking system, which would in turn impact the demand for credit and consumption, the market quickly realised China’s export-dependent economy would take a hit.

Although this may be hard to believe now, on July 15, 2008, the Australian dollar hit a multi-decade high of 98.5 US cents. But from there it started to fall rather quickly. It was telling you that something wasn’t right.

Exactly two months later, Lehman Brothers collapsed and by 27 October, the dollar had fallen to 60.1 US cents as the global economy plunged into a deep recession.

In fact, if I’m remembering this correctly, the US economy was actually in recession in late 2007, not long after the US equity markets had peaked in October of that year. So much for equity markets moving ahead of the economy…

Anyway, in response China engaged in massive stimulus. The Aussie dollar recovered along with the global economy. But thanks to China’s stimulus, commodities took off again and the dollar rallied to a new high of US$1.108 in July 2011. It was around this time that most commodities peaked too.

So what’s the dollar doing now? 

Thanks to US dollar strength across the board, it’s pulled back slightly. But if you look at the chart below, you’ll see that the trend higher since early 2016 is still intact.

While the Aussie has been pretty volatile, a series of higher lows as marked by the green lines tells you it’s been trending higher. Unless that trend breaks down, you have to conclude that the Chinese and global economies are still doing well.

While the Aussie (AUD) has been pretty volatile, a series of higher lows as marked by the green lines tells you it’s been trending higher. 13-02-2018

Source: Optuma
[Click to enlarge]

The Aussie dollar is a good time currency. When the world economy is in good shape, the Aussie is in a good mood. But when things turn, it doesn’t want a bar of it…it will turn very quickly too.

While the upward trend is still intact, a fall below 75 US cents would be a worry. So that is a level to keep an eye on.

The oil story

The other asset to keep your eye on is oil. China is now the largest importer of crude oil in the world. Oil price strength in the second half of 2017 is due in part to China’s ongoing strong demand.

And a look at the chart of Brent crude tells a similar story to the Aussie dollar chart. That is, while it’s had a sharp pullback over the past week or so, the trend remains bullish.

Brent rallied from US$44.40 per barrel in June 2017 to around US$71 per barrel in January this year. That’s a 60% rise in just over six months. Most rallies of this size give back some of those gains in a correction, and oil is no different.

Brent rallied from US$44.40 per barrel in June 2017 to around US$71per barrel in January this year. 13-02-2018

Source: Optuma
[Click to enlarge]

Based on these two measures — the Aussie dollar and crude oil — I don’t see any early signs of a Chinese economic slowdown. That doesn’t mean it won’t happen, but there’s no point jumping at shadows.

As I mentioned yesterday, we now look to be at the start of a global equity market rebound. How that unfolds will gives us important clues as to the future of this bull market.

Greg Canavan,
Editor, Crisis & Opportunity

Greg Canavan is a Feature Editor at Money Morning and Head of Research at Fat Tail Investment Research.

He likes to promote a seemingly weird investment philosophy based on the old adage that ‘ignorance is bliss’.

That is, investing in the Information Age means you have all the information you need at your fingertips. But how useful is this information? Much of it is noise and serves to confuse, rather than inform, investors.

And, through the process of confirmation bias, you tend to read what you already agree with. As a result, you often only think you know that you know what is going on. But, the fact is, you really don’t know. No one does. The world is far too complex to understand.

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