We’ve spent considerable time of late documenting the extent to which emerging market assets and, more generally, global growth are highly dependent on China.

This is of course a subject you could broach any time it struck your fancy. After all, it seems to be getting more important by the year.

But it’s especially important now because China has embarked on an effort to squeeze its interbank market on the way to curbing leverage in the financial system.

That has the potential to spill over in two ways:

1. curbing the credit impulse could impact the domestic and eventually, the global, economy
2. because there’s no way to tell, beforehand, where all the credit extended via shadow conduits ended up, squeezing those conduits risks popping bubbles that no one even knew existed which, in turn, can lead to unwinds in markets that are critically important to EM (witness the metals mayhem we got earlier this month)

If you’re in EM assets, I suppose it’s possible to say something like this: “well, so far the EM complex has shaken off a Fed tightening cycle and EM equities seem to have completely disconnected from commodities, so why not think the space can remain bulletproof?”

Of course you could also look at it the other way around. That is: “well, EM has been Teflon in the face of a Fed tightening cycle and has generally shaken off commodities jitters, so I’m not sure how many more bullets this priced-to-perfection asset class can dodge.”

However you choose to look at things, there is no question that China’s success or failure in walking a tightrope between curbing leverage/speculation and undercutting the economy by choking off credit growth will have implications not only for EM, but for the global economy more generally.

Via Citi

On ‘China-dependence’

‘China-dependence’ is not an EM-specific phenomenon, of course. The rise in the world economy’s dependence on China is captured in Figure 1, which shows the relative contributions to global growth that come from China and the US. China contributed 43% of global GDP growth last year; the US, 17%. It has been almost 20 years since the US had the same relative contribution GDP growth that China has today: in 1998-99, in the wake of the Asian crisis, the US’ contribution to global GDP growth was 45%, but has never regained that level in the years since then. And given all the attention that investors devote to China’s credit markets, it is worth highlighting that China’s contribution to global GDP growth is actually more substantial than China’s contribution to global credit extension to the non-financial sector (according to BIS data, Figure 2). So it’s not just EM that has a China-dependence problem, but the world...

The fastest-growing linkage between China and EM is through the commodities market. This point is neatly introduced in Figure 4, which shows the relationship between Citi’s MCI for China and deviation of global commodity prices from their 200 day moving average.