March 19, 2014, by Tony Hong

China’s Complex Trade Deficit

By David Symington,

MA Student at Fudan University.

Well China recently posted a trade deficit – a rare event – and it has, predictably, spooked many commentators. The Wall Street Journal’s China Real Time blog wrote however, that there may be more to the trade figures than meets the eye. The blog wonders if the decline in export figures (which is measured by the volumes of capital inflows into China) was caused not so much by declines in exports but by capital outflows caused by the recent decline in the value of the RMB. In other words, foreign currency speculators are pulling out of the RMB not so much customers buying fewer Chinese goods. If this analysis is accurate, it means that there is nothing fundamentally wrong with Chinese exports and, furthermore, that we should start seeing modest increases as that declining RMB rate boosts competitiveness. The WSJ also remarks that not too much attention should be paid to that headline figure of 18% year-on-year decline because February 2013 happened to be an unusually booming month for exports.

Writing in Reuters’ Breaking Views column – John Foley comments that although there’s been a lot said about the expansion of credit in China and the scale of local government debt, the problem is not so much one of scale – or not yet, at least, – but one of complexity. As the financial sector has burgeoned in recent years so have levels of complexity in the sector. Middle-men, loans chopped up, repackaged, and sold on through “innovative” financial products and instruments abound. As Foley writes: “Money can wend an elaborate path. For example, a saver may put their money in a short-term fund sold by a bank. The fund buys a bond issued by an industrial company. That company makes a loan to a supplier, which in turn extends trade credit to its customers. If any one of those links is broken, the whole chain will feel the strain. Even if the government wants to help, it’s not obvious where assistance should go.” Part of the problem is that because the big banks tend not to lend to small, privately-owned businesses, these entities can only resort to the shadows to get their financing. The trouble with all of this is that the borrower and the lender end up being totally separated from each other so that no-one really knows why the money was borrowed in the first place and whether the loan was good or not. As Foley puts it, “Longer credit chains are dangerous because they make it harder for investors to price risk properly.” We all know what happened to those sub-prime loans in the US that got passed on along a seemingly endless chain. The person at the end of the chain barely knew what he was buying.

A small Shanghai Solar company, Chaori, achieved a national first – although don’t expect to hear the sound of popping champagne corks – they failed to pay investors interest owed on bonds before the deadline at 3pm on Friday 7 March thus making history as China’s first corporate bond default. Josh Noble writing in the FT last week, however, said that this is unlikely to spark off a chain reaction of other defaults – as some analysts had feared. So far bond markets have treated the incident as a non-event, with Chaori’s woes barely being registering any drop in the market. The surprise was not Chaori’s incapacity to pay but the fact that the Shanghai government did not choose to bail the company out to prevent the default – as had always been standard practice by local governments before. This was read correctly by the markets as not meaning that the Shanghai government did not have the ability to bail out Chaori but that they were sending a shot across the bows of the market to prevent “over capacity” and over-heating in some sectors. As Shuang Ding, an economist at Citi commented, the Shanghai government understands that bailing out is “not the right way to impose market discipline”

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