As was widely predicted, Chinese manufacturing PMI numbers dipped into negative territory at the end of May, compounding a turbulent few days for markets already reeling from the wider effects of the trade war between the USA and China.
Services and construction PMI numbers in China remained well above 50, and the composite figure thus held relatively firm at above 53. But even so, manufacturing has been the mainstay of China’s rise to global economic prominence and to see it performing so weekly in the face of the pressure being applied by Mr Trump must be giving the Chinese authorities serious pause.
If it is, though, they are playing their cards close to their chest. Publicly, the Chinese rhetoric instead stepped up a gear, accusing the US of economic terrorism and threatening to curtail the global supply of rare earths, of which China controls more than 70%.
That prompted significant buying interest in non-Chinese rare earths companies like Lynas Corporation (ASX:LYC) and Mkango Resources (LON:MKA), and caused several commentators to opine that the tension had reached new heights.
But China has threatened the world on rare earths before, and never really followed through. After all, even if China does have a commanding position in rare earths, it’s short of most other commodities and although these are scattered around the world in disparate locations and controlled by disparate entities, they nevertheless all broadly fall under the umbrella of the American trade system.
Exceptions are Iran and Russia, neither of which can be described as a significant economic player on the global stage, although Russia is well endowed with natural resources. But it’s not enough. China needs the American-backed global trading system for its ongoing economic growth, and both Mr Trump and the Chinese know this.
Hence, this week’s editorial in the South China Morning Post which argued that although China’s US$3.1tn in foreign currency reserves looks like a mighty stockpile, it might not actually be enough to enable the country to survive a full-blown trade war.
After all, China spent around US$1tn defending the yuan between 2014 and 2017, and that situation wasn’t half so hot as it’s likely to get in the event that negotiations between the US and China break down irrevocably.
The yuan itself is effectively backed by China’s foreign currency reserves, so if those reserves are deployed and start getting depleted the danger is that confidence in the yuan will drop further, capital will start to flow out of the country, and a downward spiral will begin.
We’re a long way from that happening, but it’s worth bearing that potential outcome in mind when considering the bellicosity of the Chinese state media and it’s talk of “economic terrorism” and “chauvinism”. In fact, the Chinese have been relatively cautious in terms of tangible responses to US pressure so far. Some tariffs on farming goods are in place, true, but the rare earths talk is just talk at the moment, and there is an apparent reluctance on the part of the Chinese to take the conflict to the next level. The reality is that for now, the Chinese need the Americans more than the Americans need the Chinese.
But there is one factor that may end up playing the Chinese way: Mr Trump himself. The Chinese, as the cliché has it, are very adept at playing the long game. Mr Trump is not without his own challenges domestically and across the US’s immediate borders.
Mr Trump’s oft-repeated rhetorical flourish that the Chinese are bearing the costs of his tariffs isn’t widely believed in the US, as it shouldn’t be. The import tariffs are paid by the US-based companies that are importing the US goods. US consumers know that they are likely to bear any knock-on effects in terms of pricing, which is why the US inflation figures are currently being watched more closely than normal.
And more than that, the US economy itself isn’t unassailable. Recent GDP numbers have been good, but treasury yields are at multi-year lows again, indicating that the market is much more cognisant of recession than it was this time last year. American PMI numbers aren’t stellar either, even if they are better than the Chinese.
And to cap it all, Mr Trump is about to put tariffs on Mexico in retaliation for Mexico’s failure to help with the immigration crisis at the US’s southern border.
No wonder markets tanked in May. Whether they will yet recover the ground lost by St Leger Day, as the saying has it, remains to be seen.