We wrote that the devaluation of the yuan had showed how desperate the Chinese government was over the state of the economy. What are the problems China is facing right now? How can they affect the global economy and the gold market?

For years, many analysts have been claiming that China has become another capitalist powerhouse. In reality, the country has been maintaining a “red capitalism”. According to Carl E. Walter and Fraser J.T. Howie, the authors of the Red Capitalism: The Fragile Financial Foundation of China's Extraordinary Rise, the Chinese economy is a patronage system with state-controlled oligopolies and a Soviet-inspired financial system. The country’s central planners (especially at the local-government level) have been doing their best to boost GDP growth and prevent unemployment, fueling one artificial boom after another. The first was the construction and housing bubble triggered by credit creation. The huge infrastructure development and fixed asset investment led to the belief that China would use every amount of raw materials, which contributed heavily to the 2000s commodity boom. The inevitable collapse of the housing and construction bubble (with ghost towns and excess manufacturing capacity as the best signs of the previous malinvestments) led Chinese investors to pump their money into the stock market, fueling the next bubble, which – what a surprise! – also burst.

There also other problems. The first is the private sector indebtedness. The private sector debt-to-GDP stands almost at 200 percent. This is 40 percent above the long-term trend and higher than it was in the U.S. at the peak of the housing bubble. Second, with a rising middle class looking for better wages and with the yuan pegged to the U.S. dollar, Chinese competitiveness has been shrinking. This is probably why the PBOC devalued the yuan: to make its goods cheaper for foreign parties. Third, China's economic slowdown, financial exuberance and reduced competitiveness have all contributed to the outflow of capital, which has escalated sharply in recent months.

To sum up, China’s economy is slowing down significantly. According to the official figures, GDP growth is still in line with 7 percent target, however, analysts who are studying data like electricity usage or freight volume believe that it will be closer to 4 percent. This weak performance could have far-reaching effects for the global economy, with the new wave of deflation being exported to the world. The precise long-term impact on the price of gold is not easy to predict, since it depends on many factors, including the measures taken by China’s government. Generally speaking, slow economic growth or recession with low real interest rates should be positive for the gold market, however, the rising U.S. dollar (due to safe-haven inflows) may put some downward pressure on the price of gold.

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Arkadiusz Sieron
Sunshine Profits‘ Gold News Monitor and Market Overview Editor

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