What Happens in China Doesn’t Stay in China. This Could Be a Last Warning.

This article is a bit technical but still of the utmost importance. Let’s begin our analysis with a brief recap of the Chinese economic narrative that Wall Street has been pushing since November 2022.

Prior to that date, China had been subject to a severe anti-COVID policy called Zero Covid. The goal was to stop the spread of the virus, but the means used were beyond draconian.

Cities with 30 million or more residents, such as Shanghai and Beijing, were repeatedly shut down. Schools and factories were closed. People were confined to their homes. Travel to other cities was banned. Concentration camps were set up for those who tested positive so they could be separated from their friends and families to stop the spread.

None of this worked and never would work. COVID is a respiratory disease spread by an airborne virus that goes through masks and goes where it wants. However, the drag on the Chinese economy from these extreme lockdowns was obvious.

Then, last November, Chinese dictator Xi Jinping turned 180-degrees, ended the lockdowns, and just let the virus rip through China. One million people died (about the number expected based on results in other countries). The Chinese population soon achieved herd immunity and new cases dropped radically, also as expected. This gave rise to the “reopening” narrative that Chinese growth would explode and carry the rest of the world out of the recessionary trough now emerging.

As always, the bottom line on this Wall Street narrative was, “buy stocks!” But China’s economic problems always ran deeper than COVID. They had to do with adverse demographics, slowing growth around the world, declining world trade, tariffs, and reduced foreign direct investment by the West. The reopening was a flop, and China’s economy is now struggling along with Europe and the U.S.

This stagnating growth is exacerbated by a global dollar shortage and contracting bank balance sheets. The headline that Chinese banks are selling dollars to buy yuan and prop up the exchange value of the yen is true but misleading.

The Wall Street interpretation is that China is “dumping dollars” and supporting the yuan. The reality is that China’s companies are desperately short of dollars and the banks are supplying them on orders from the central bank so that the central bank itself does not have to deplete its dollar reserves.

Whether the dollars are supplied by the central bank or the commercial banks on orders from the central banks is irrelevant. What matters is that China is short of dollars and the banks are running low.

Investors should expect further declines in yuan (as the dollars run out) and a crash in Chinese stocks (as companies start to default on dollar loans).

This is not a case of a strong yuan and weak dollar. This is a case of an imploding China that will soon run out of dollars. The impact of that disaster will most certainly not be confined to China.

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