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Rethinking China's role as the world's growth engine

In recent years, investors have gotten used to the notion that economic growth in China will translate into a tailwind for the global economy. But as China recalibrates its policies and channels more efforts into prioritizing domestic growth, does the assumption still hold?

In the years prior to the COVID-19 pandemic, a strong and increasing credit impulse—the change in new credit issued expressed as a percentage of GDP—resulted in excess domestic demand in China, which was then exported to the rest of the world. This was often instrumental in cushioning global growth and led to high correlations between Chinese macro data and global macro data.¹

However, since 2018, China has tilted toward a growth model that emphasizes self-sufficiency and growing the country’s net exports at a faster pace than net imports. In essence, China’s growth and stimulus efforts are increasingly staying within its own economy as opposed to supporting global growth through trade. 

The recent spike in Chinese credit might not contribute much to global growth if it’s trapped domestically

Chart of China's credit growth from 2005 to December 10, 2020. The chart shows that credit growth, which has been supporting economic expansion in China, has been growing since mid 2018.
Source: Bloomberg, Macrobond, as of December 10, 2020.

This has important implications for investors because it means China is importing net demand from the rest of the world instead of exporting net demand. As such, the consensus view, which extrapolates China’s rapidly rising credit impulse this year to stronger global demand over the next 12 months, is flawed. China’s global demand impulse has in fact grown increasingly negative over the past year and the United States is the most important source of global demand.¹

For example, a rising Chinese Purchasing Managers’ Index or the introduction of additional Chinese stimulus won’t be enough to propel global growth higher and it would be a mistake to believe that prior positive correlations between China’s credit impulse and global growth will hold in the current and future environment. 

In contrast to previous cycles, China’s demand for global goods and services is no longer net positive  

Bar chart highlighting the China's demand impulse to the rest of the world from 2005 to December 10, 2020. The chart shows that unlike previous economic cycles where China’s appetite for imports helped to support world economy in its periods of weakness, Chinese demand for global goods and services has slipped into the negative territory in the past few months.
Source: General Administration of Customs of the People’s Republic of China, U.S. Census Bureau, National Bureau of Statistics of China, U.S. Federal Reserve, Macrobond, Manulife Investment Management, as of December 10, 2020. Gray areas represent recession. China’s global demand impulse refers to China’s annual imports net of exports.

Here’s a simple bilateral example of how the China versus global growth model is shifting.

Due to insufficient domestic demand and its own form of income inequality, China is producing more goods and services than it can consume domestically and needs to export its excess supply to country A in exchange for claims on overseas financial assets. However, if China experiences domestic demand deficiency, it will translate into reduced demand for goods produced in country A which, by extension, contributes to higher unemployment, higher debt, and income inequality in country A. 

"As such, the consensus view, which extrapolates China’s rapidly rising credit impulse this year to stronger global demand over the next 12 months, is flawed."

Staying with the example, but expanding it further—in the globalized reality, multiple adjustments are being made across multiple economies simultaneously to balance global trade and financial flows that originate from the domestic demand imbalances of surplus economies.

Since the U.S. dollar is the world’s reserve currency, there will always be excess foreign demand for claims on U.S. assets, resulting in a capital account surplus, and, by extension, a current account deficit in the United States. As the net marginal consumer and net marginal provider of financial capital to the world, it stands to reason that the United States remains the world’s most important marginal global growth impulse. 

In contrast to previous cycles, U.S. demand for global goods and services is net positive

Bar chart highlighting the United States' demand impulse to the rest of the world from 2005 to December 10, 2020. The chart shows that unlike previous economic cycles where U.S. appetite for imports waned as it entered a recession, U.S. demand for global goods and services has returned in the past few months, becoming net positive.
Source: U.S. Census Bureau, Macrobond, Manulife Investment Management, as of December 10, 2020. Gray areas represent recession. The United States’ global demand impulse refers to the United States’ annual imports net of exports.

Growth implications

As China’s economy continues to expand, the influence it yields over the world economy will no doubt grow. As China accelerates its efforts to become self-sufficient, and as the United States evolves its relationship with China, there will be important implications for the world economy. In the short term, however, we’re concerned that market participants are overestimating the global impulse from China. In the same way, should the United States take an even more aggressive approach to ensure that its domestic stimulus efforts will only benefit its own economy, it will mark an acceleration in the U.S.-China decoupling process and deglobalization trends, which we believe will ultimately lead to a painful period of stagflation, all else being equal.

From a longer-term perspective, we believe investors have underappreciated the risk that widening income gaps can pose to the global economy. While it’s important to monitor how key economies are approaching trade and fiscal imbalance, how policymakers address income inequality could also have an important bearing on growth. In the absence of appropriate means to redistribute wealth back to consumers to boost aggregate demand in a sustained manner, any global growth recovery risks being shallow and short-lived. 

 

1 Macrobond, Bloomberg, as of December 6, 2020.

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Sue Trinh

Sue Trinh, 

Former Co-Head, Global Macro Strategy, Multi-Asset Solutions

Manulife Investment Management

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