China: Looking at growth past the trade war

March 13, 2019 10:40
The joint challenges of a rapidly aging population and actual declines in the working-age population could potentially hit China's real GDP hard. Photo: China Daily

Despite decelerating growth, high debt and a trade war with the United States, China's economy is holding up and growth could accelerate in 2019 in response to aggressive monetary easing. However, the same monetary easing is piling on risks for the 2020s as well. Our analysis of China’s economy highlights the interplay of long-term demographic trends, the declining effectiveness of traditional policy tools and the impact of the current policy environment.

How China fares in the short and long term will go a long way towards determining how various markets perform, especially commodities and the currencies of commodity-exporting nations as they show strong correlations to Chinese growth.


Demographic trends suggest slower growth is in store for China in the 2020s as the economy copes with and adapts to low birth rates, an aging population and little to no growth in the working age population.

In 1990, the percent of the population over 65 years of age in China was 5.5 percent. Today, it stands at 11.3 percent, and by 2030 it will have risen to 17 percent, which means the younger generations have a greater burden of support.

In addition, the growth of the working age group cohort, defined by the US Census as 15-64 years of age, is of huge importance to potential economic growth. If one thinks of growth potential as the sum of labor force growth and productivity growth, when labor force growth slows, it sets the same trend for real GDP growth subject to the variations in productivity.

From 1990 to 2018, the population of those aged 15 to 64 increased cumulatively by just over 30 percent and US Census Bureau projections for 2018 to 2030 suggest that China may see a -4.66 percent cumulative decline in the population of this age group.

Population demographics suggest a deceleration of economic potential that will be beyond the ability of traditional policy measures to reverse. China’s dramatic rural-to-urban population shift has effectively masked the impact of aging because the highly productive urban labor force has still been growing at 3 percent-plus per year.

As migration diminishes over the next decade, the joint challenges of a rapidly aging population and actual declines in the working-age population could potentially hit real GDP hard. If China can manage average real GDP growth in the 3 to 4 percent range in the 2020s, it will have done an exceptional job of adapting to its demographic challenges.

Debt trap: a looming risk

The main policy that falls into China’s camp of policies to increase real GDP is the extensive use of debt, both in the government and private sector. According to the Bank for International Settlements (BIS), China’s total credit to the non-financial sector is 253 percent of GDP for the second quarter of 2018, while that for the United States is 249 percent of GDP.

When the US and the eurozone reached 250 percent debt-to-GDP ratio, they experienced severe debt crises due to high debt levels coupled with central bank tightening. Between June 2004 and June 2006, the US Federal Reserve Board hiked rates 17 times, raising its policy rate from 1 percent to 5.25 percent. Between 2005 and 2008, the European Central Bank raised rates from 2 percent to 4.25 percent. This tightening of monetary policy slowed growth and made the debt burden unsustainable.

For the moment, China is taking the opposite approach. The Peoples Bank of China (PBoC) cut rates five times in 2014 and 2015 and has since been slashing its reserve requirement ratio – essentially attempting to solve a debt problem with more debt. For the moment, with Chinese inflation quiescent, the PBoC can ease policy without too much trouble. When they eventually begin to tighten policy, however, China’s economy could face significant risks.

Adding more debt may no longer grow the economy at a faster rate as additional lending may only serve to finance the existing debt rather than adding growth through spending and investment.

Trade war takes its toll

The US-initiated trade war has slowed China’s growth. From May 1, 2018 through Jan. 25, 2019, the Shanghai Composite was down 16 percent. And as per the latest data from December 2018, China has seen a 4 percent year-over-year decline in exports, compared to 11 percent growth for April 2018 over April 2017.

Our research has indicated that the initial direct effects of the trade war were relatively small but as the trade war takes a toll, indirect effects have kicked in and made the picture a little worse.

Equity markets may not behave well if progress to ease trade war tensions does not come to pass. Other markets, such as soybeans and copper, may also be negatively affected if trade talks break down.

Policy tools limited

China’s challenge is that if the trade war were to intensify, it would not be able to cushion its impact as well as it did in 2018.

That said, the yield curve is showing signs of life. China’s yield curve went flat in mid-2017, heralding a coming slowdown in growth. It recently steepened again. As such, it is possible that PBoC’s extreme monetary easing may show results one more time: stabilizing and even increasing China’s growth rate in 2019 but at the expense of rising financial fragility and greater risk of a financial crisis in the 2020s.

Commodity investors who might take heart in improved economic growth should also be warned: China’s easing monetary policy to stoke growth might bring forward economic benefits in 2019, but potentially at great expense during the next decade.

Bottom line

The US-China trade war is damaging, but demographic trends and debt levels constitute a far more critical threat to China’s economic wellbeing during the 2020s. The risks are growing and stronger short-term growth followed by much slower economic progress in the 2020s could send commodity prices and the currencies of commodity exporters on a wild ride.

Erik Norland, Senior Economist at CME Group, is a co-author of the article.

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Chief Economist of CME Group