How Does the Chinese Economy Impact Forex Trading?

The Chinese economy has been struggling. Recent data points such as retail sales and output were lower than expected. Most of the attention has been focused on the property crisis despite the Chinese government recently cutting lending rates to enhance demand. The lackluster economic growth has created a higher potential for mortgage owners to hold off on paying their mortgages.

China is now facing a brutal combination of rising job losses, lockdowns from the zero Covid policy, and the spreading of mortgage payment strikes that might have severe consequences for their economy. The country’s debt property market is the most significant issue and has received the most attention. The collapse of property developer Evergrande in 2021 is slowly impacting every part of the Chinese economy. The question for investors is how the decline in Chinese output could impact the forex trading market.

Who Holds the Most External Debt?

The forex market is the largest and most liquid capital market worldwide. As of 2019, the daily volume of the forex market was approximately $6.6 trillion in notional value. The forex markets are driven by supply and demand. The forward markets are also constructed to be influential via interest rates. The forward rate consists of a spot rate and forward points. Forward points are built using the interest rate differential for each currency that makes up the currency pair that you are trading. Every transaction over two business days, considered a spot transaction, uses forward points to create the forward rate.
One of the influences that the Chinese economy might have on other economies is their willingness to continue to borrow their debt. China is the second largest holder of external debt worldwide, following the United States. With approximately 13 trillion of external debt, the Chinese economy is a powerhouse lender to many countries around the globe.

If you look at the Chinese economy as a massive lender to the world and the economy is starting to falter, you might assume that this lender will not be willing to lend as much money to other countries in the future. If China stops lending to different countries, there is also the chance that interest rates in the country they stop lending to will start to move higher because they need to find new lenders. The issue could be even more pronounced if this situation arises during a rising rate environment.

Who Holds the Most Foreign Currency Reserves?

Another issue the forex market might face with a struggling Chinese economy is the country’s foreign currency reserve reduction. China holds the most foreign currency reserves of any country worldwide. The country participates in forex trading, buying, purchasing, and selling its funds. Similar to the issues related to holding large amounts of debt of another currency, if China’s economy starts to falter, it might need to repatriate some of its currency, and could then need to reduce some of its foreign currency reserves, which would put downward pressure on the money they need to sell.

What is at the Heart of the Problem?

The meltdown is beginning to accelerate. The country holds $300 billion in debt that is in trouble due to the default of property developer Evergrande in 2021. While this one event did not create issues with mortgage debt, it started the ball rolling the wrong way. The tightening restrictions throughout China led to a group of homeowners that refused to make payments on mortgages, which left many developers in distress. The decline in mortgage payments and the ensuing reduction in GDP has reduced consumer sentiment, which is not good news for China’s rulers.

The government has decided to roll out a massive infrastructure project by which it will be spending its way out of trouble. China is planning a 75 billion infrastructure fund to help revive its struggling economy. The government tried as hard as it could to slow the collapse of Evergrande, but the economic environment and lockdowns due to Covid made the situation challenging.

Have We Seen This Before?

If you roll the clock back to 2008, you’d see this issue had already reared its ugly head. The mortgage rebellion in China shows that homeowners are desperate as they see an unfinished building falling in value and building developers struggling to stay afloat. Some statistics show that the property crisis currently impacts more than 100 residential properties and 50 cities in China.

In 2008, the U.S. property market started to struggle, and the mortgages offered to homeowners were abandoned. Homeowners just walked away from houses where the amount they owed on their home was worth more than the value of the house they lived in. Property owners were left with houses they did not want and eventually went bankrupt, putting the burden back on the banks that lent them money to build these homes. What made things even worse was that billions of dollars of mortgage securities were tied to the U.S. housing markets, which made the collapse catastrophic.

The Bottom Line

The issue with the decline in the Chinese economy and the collapse of the housing market is that banks could be at the heart of the problem. China is the second largest lender globally, and if the country has an economic problem, its issues could spill over to the rest of the world. Additionally, China holds the largest foreign currency reserves globally. If they need to convert their foreign reserves back to the Chinese currency to handle a run on a bank, these actions could impact the forex markets.

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