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China drops all COVID-19 restrictions and fully reopens for business
After maintaining a strict "Zero-COVID" policy for almost three years, China decided to end all restrictions in December 2022. This Is a complete reversal of the policy that had led to stringent lockdowns in many big cities, most notably the weeks-long shutdown of Shanghai that received global media coverage. With the flip of a switch, China Is suddenly back in business, and expectations are that the Chinese economy will roar back into 2023. How will this affect the global economy, and what are the implications for currencies?
What the markets are telling us:
- Raw materials prices are soaring: Commodity prices have increased sharply in anticipation of escalating demand from China. Prices for copper, iron ore, tin, and aluminum have increased since the end of "Zero-COVID." Higher commodity prices should be beneficial for the currencies of producers like Australia and Canada. Chinese oil consumption is forecast to hit a record this year, resulting in more demand and higher prices for crude oil globally.
- Economic activity is spiking in China's major trading partners, specifically Japan and Korea. The yen and the won have rebounded off multi-year lows against the dollar, and most analysts believe they will continue to appreciate over time.
- Other Asian countries are also experiencing benefits from China's re-opening. Thailand, Indonesia, Malaysia, and Vietnam have seen an influx of Chinese tourists and investments. This trend is expected to continue and could result in higher currency prices for these countries.
China has made several moves that could diminish the dollar's role in international transactions:
- China and India have become the primary customers of Russian oil. They have provided the demand to compensate for the loss of Western buyers who have imposed economic sanctions on Russia. Russia is accepting yuan and rupees for oil, again lessening the demand for dollars.
- China has been slowly rolling out testing of its Central Bank Digital Currency (CDBC). As of January 2023, China's central bank digital currency, known as the Digital Currency Electronic Payment (DCEP), is undergoing pilot tests and has been trialed in several cities, including Shenzhen, Suzhou, Chengdu, and others. This could result in a significantly lower demand for dollars as a means of exchange.
Takeaways:
- China is back. Estimates are that China's reopening will generate an additional $500 billion in total demand for goods and services over the next few months.
- Chinese demand could easily add fuel to global inflationary flames, driving rates higher, which could help lead to a global recession.
- Emerging economies may begin accepting payment in yuan instead of the traditional dollar. That could put significant downward pressure on the dollar over time.
- The dollar became wildly overvalued against most currencies in the 2022 runup. Even though it has since pulled back (about 10% from the highs), many economists argue that it will continue to drop as countries seek alternatives to the traditional dollar role in international transactions.
- Global demand for dollar-denominated debt will likely decrease. China and Japan have been reducing their holdings of US treasuries. A lack of buyers for US debt could lead to a long-term reduction in the value of the dollar.
The China reopening story and its implications for commodity prices and inflation will likely dominate the global economic narrative for 2023. Whether it turns out to be a story with a happy ending remains to be seen.