China’s Naturally Triangular Trade… and What China’s Bilateral Trade Data Is Telling Us Right Now

China’s trade is naturally triangular.

Set aside services (essentially a mix of “real” tourism and capital flight right now) for a moment, and focus on goods.*

China, in an equilibrium where its trade balances, would run surpluses with countries that have large markets for manufactures (the United States, the EU, India) and deficits with countries that have a lot of commodities (the oil exporters, Australia). China naturally exports manufactures and imports resources given its population and limited domestic supplies of energy (and arable land).

Global trade would balance, if it balanced, because the other big exporters of manufactures around the world would run surpluses with the commodity exporters.**

And so long as China’s electronics exports machine depends on imported semiconductors, China will “naturally” import chips from the Asian electronics supply chain (many U.S. semiconductor firms now either manufacture in Asia or contract to Asian “fabs”—so the bulk of China’s imported chips are sourced from Taiwan, Korea, or Malaysia. Intel manufactures the bulk of its chips in the United States but then ships many of its chips for “assembly and testing” in Asia as well. Visible exports of chips from the United States to China and Hong Kong are small relative to China's total imports).

As a result, China typically runs surpluses with the United States and Europe, and deficits with commodity exporters and the Asian electronics manufactures (Japan, Taiwan, Korea, etc).

And for global trade to balance, the United States and the EU consequently need to run surpluses both with the commodity exporters and the rest of the Asia. Of course, trade doesn’t balance—largely because the United States runs deficits with electronics giants (two of whom are also auto export powerhouses) and because, well, the United States just isn’t exporting that much, other than refined petrol, after the dollar appreciated in 2014.***

This framework is helpful for understanding the evolution of China’s overall goods surplus.

That surplus soared in 2014.

Commodity prices fell, and China’s balance with the commodity exporters swung—briefly—into surplus. And more recently commodity prices have increased, and China has moved back into a deficit with the commodity exporters.****

To keep life simple, I am treating Hong Kong as a distinct source of China’s surplus; in reality, it captures a fraction—about $75 billion I think—of China’s surplus to the United States and a portion of China’s exports to the emerging world.

This isn’t hard to understand—it maps to the swing in China’s overall deficit in commodities (“primary” products in the Chinese data).

The evolution of China’s balance with the advanced economies is in many ways more interesting.

The basic tendency since 2016 has been for both a bigger surplus with the United States and Europe (really with the United States now) and a bigger deficit with the electronics supply chain.

Exports to both the United States and EU have been up recently.

And the surplus with the United States is growing fast too. Trump’s stimulus, and the euro area’s absence of stimulus, has led to a divergence between China’s balance with the United States and the euro area (I used the U.S. and euro area data here, and added in trade with HK.)

Note here that there has been a divergence between China’s balance with the United States and China’s balance with the euro area after 2008. Before the crisis, if anything the surplus with Europe was growing more rapidly than the surplus with United States. The yuan was undervalued against everyone—but particularly undervalued vs. the euro after 2003, as the yuan followed the dollar down. Obviously, the euro has been weak the past few years vs. both the dollar and the yuan. And the euro area hasn’t generated a lot of demand post-crisis either…

There has been another important change recently too. China’s “deficit” with the electronics supply chain has been increasing.

That’s a change from 2010 to 2016, when the deficit was falling—as parts production shifted to China.

The most likely explanation? Semiconductor prices. Memory chip prices have soared, "The price-per-bit of DRAM chips rose 47 per cent in 2017". And with it China’s imports from Korea and Taiwan.  

China's deficit with the Asian electronics supply chain is up nearly $100 billion over the last two plus years.

So what’s the outlook?

Complicated.

Semiconductor prices are falling, which should help China’s balance.

Oil prices are now down (Brent is in the 60s, WTI is in the 50s), after previously being up significantly. If the recent fall in oil is sustained, China's petrol balance should stabilize.   

Import volume growth should slow a bit thanks to somewhat slower overall growth on the back of deleveraging/policy tightening, but perhaps only a bit. China is at a minimum backing away from tightening, and perhaps moving toward outright stimulus.

Trump’s tariffs haven’t had a major impact on China's overall exports so far, but they might in the future. The surveys of export orders point to a significant slowdown next year. On the other hand, there is also an argument that China’s currency could have another leg down, which would support exports and likely juice the manufacturing surplus (if semiconductor prices fall).

One last point: there isn’t yet much evidence the much discussed “front-loading” of China’s exports is having a major impact on China's export numbers, though it has impacted the data for some particular products.

A major distortion—like the over-invoicing of exports to Hong Kong back in 2013, or the soybean surge in q2 in the United States—usually shows up cleanly in the overall data, not just the data for particular products. I don't yet see that. Right now China's overall exports to the United States are growing at pretty much the same pace as they were earlier in the year, so the "pull forward" effect is only apparently relative to a counterfactual where Chinese exports to the United States would otherwise be falling.**** 

* I will take services trade a bit more seriously when it is measured a bit better, and a bit more consistently—and when the services data isn’t obviously distorted by global firms tax strategies! China’s tourism import surge all came, by the way, back in 2014, when China changed how it measured tourism imports (there was no real change in the pattern of actual growth in the number of tourists then). Actual tourism growth looks to have slowed a bit, but to see that, you really now need to look at the data on actual tourists. As much as a third of measured tourism imports could represent capital outflows.

** Consider another case of triangular trade. If the United Kingdom had a bit more North Sea oil, it wouldn’t import directly from the Gulf or Russia. But the euro area would. The United Kingdom would sell vacations (and financial services) to the Gulf and Russia, while the euro area paid for its imports of oil by selling manufactures to the United Kingdom and the Gulf/Russia (the oil exporters). I am simplifying a bit, but only a bit.

*** Here is a chart of U.S. manufacturing imports and exports, with refined petrol (a manufacture in the data) stripped out. I think it speaks for itself.

**** China’s exports to the United States in October were strong, even though the first big round of tariffs went into place in September. So the front-loading to beat the 10 percent tariff on $200 billion should now be out of the data. However, there is an argument that the impact of front-loading to beat the initial tariff is being masked by front-loading to beat the second round of tariffs, given that Trump has threatened to raise the tariff to 25 percent in January. One thing to watch: does a significant gap emerge between the pace of growth of China's exports to the United States and its exports to the EU. Right now they are growing at a very similar pace, which suggests the current distortion is modest in size