In mid-October, China fleshed out the details of its plan to stimulate growth in the world’s second largest economy:
- 2.3 trillion yuan of support for local governments, equivalent to 1.8% of GDP.
- 1.0 trillion yuan of new borrowing authorization for local governments to consolidate property developers’ debts into local balance sheets, equivalent to 0.8% of GDP.
- 1.0 trillion yuan recapitalization of the nation’s largest banks, equivalent to 0.8% of GDP.
- Lifting of restrictions on buying investment properties across most Chinese cities, and easing of requirements for first-time purchasers.
These measures come on top of the People’s Bank of China’s (PBOC) recent reduction in interest rates. If China succeeds in boosting growth, it could have profound consequences for commodity markets including crude oil, aluminum, copper, corn, soybeans and wheat. Over the past 20 years, many of these commodities have followed the path of Chinese growth, often with a lag of about one year.
For example, using the Li Keqiang Index – which tracks bank loans, electricity consumption and rail freight volume -- as a proxy for the Chinese economy, growth rates peaked in 2007, 2010, 2017 and 2021. WTI crude prices peaked just about one year later in each case (2008, 2011, 2018 and 2022) (Figure 1). The Li Keqiang Index has a strong correlation to the state of China's industrial economy and to prices of many natural resources.
Figure 1: WTI tends to track growth in China but with a lag of 12 months
It’s a similar story for aluminum and for copper, although these two industrial metals sometimes respond to changes in the pace of Chinese growth more quickly than crude oil (Figures 2 and 3). Thus far in the 2020s, copper prices have diverged somewhat from the pace of growth in China owing to strong demand for the red metal stemming from the energy transition, and limited supply growth. By contrast, the price of aluminum appears to adhere closely to what’s been happening in China.
Figures 2 and 3: Aluminum, copper prices also tend to follow changes in the pace of China’s growth
It’s a similar story for the agricultural markets. Corn and wheat, for example, also tend to follow what’s happening in China but with slightly longer lags of 12-18 months (Figures 4 and 5).
Figures 4 and 5: Corn and wheat prices have followed Chinese growth with a lag of slightly over 1 year
The same can be said of soybeans and soybean oil (Figures 6 and 7):
Figures 6 and 7: Soybean & soybean oil futures often follow the pace of growth in China
Most famously, China’s 2009 stimulus generated a powerful bull market that peaked in late 2011 for oil and industrial metals, and in 2012 for the agricultural products. Oil prices rose from below $40 per barrel to above $110. Copper prices rose from $1.30 per lb to over $4.60. The prices of most agricultural goods roughly doubled.
The 2009 stimulus differed in key aspects from the current one. First, it was much larger as a share of GDP. Between 2009 and 2010, non-financial corporate debt rose by 35% of GDP as the government encouraged a massive infrastructure building program (Figure 8). Thus far, the announced stimulus measures amount to about 3.6% of GDP, making it about one-tenth the size of the 2009-10 effort relative to the size of the economy.
Figure 8: China’s 2009 stimulus was large and occurred in a relatively low-debt environment
Second, the 2009-10 stimulus was meant to deal with the global financial crisis, which was exogenous to China. By contrast, the current stimulus is meant to deal with the endogenous problems of falling real estate prices, reduced consumer confidence and spending, weak finances on the part of local governments and property developers, and undercapitalized lenders. In fact, China’s lenders have total balance sheets that add up to nearly 200% of GDP (Figure 9), far higher than bank leverage ratios elsewhere.
Figure 9: China’s banks are exceptionally highly leveraged relative to the economy
Third, higher debt ratios in the non-financial sector may also limit the effect of the stimulus measures. When the 2009-10 stimulus measures came into effect, the overall debt ratio was close to 140% of Chinese GDP – much lower than in Europe or the U.S. Today, China’s non-financial (or non-bank) leverage ratio is close to 300% of GDP, higher than in Europe or the U.S. (Figure 10). When debt ratios are low, additional borrowing can quickly add to the investment and spending components of GDP. By contrast, when debt ratios are high, additional borrowing often serves to refinance the existing stock of debt rather than add to the investment or spending components of GDP. Indeed, that seems very much the case with the existing stimulus proposals: allowing local governments to issue bonds to consolidate the debt of property developers onto their books and adding to the national public debt to boost the capital of the nation’s largest banks. This closely resembles what countries like the U.S., Ireland and Spain did in the 2008-2010 period. While such measures halted the economic downturn, they didn’t produce a particularly strong economic recovery.
Figure 10: China’s non-financial (non-bank) sector is highly leveraged
Finally, there is the issue of interest rates. While it is true that the PBOC has been cutting interest rates, it’s equally true that China’s core inflation rate has been falling. In fact, the gap between the PBOC’s policy rate and core inflation, which has been relatively stable over the past few years, is wider than it was at times in the past (Figure 11). This suggests that real rates in China have not in fact fallen and that monetary policy is China is not particularly easy for the moment. Giving a larger boost through monetary policy might require rates to move much closer to zero, but near-zero rates in China might also create pressures for capital flight and a weaker yuan which might make the PBOC reluctant to ease policy too much too soon. A sharply weaker yuan could fuel a protectionist backlash against China.
Figure 11: PBOC policy rates remain high relative to core inflation
A large part of the reason why commodity prices have been depressed despite conflicts in the Middle East and war between Russia and Ukraine is the weakness of Chinese demand growth. If China manages to halt or reverse the slowdown in its growth rate, the world could wind up with higher commodity prices. That said, the jury is still out on the degree to which China’s latest stimulus will boost growth.
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All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.
