China’s growth has stalled. Why? And is it indicative of a deeper malaise in the global economy?
Old hands at the investment game say you almost always get a crisis in August. Summer can often be an uncertain time in the stock market as experienced investment managers head off on holiday, often leaving their juniors in charge. The combination of thin markets and nervous traders makes for a volatile mix when something out of the ordinary happens. But however choppy August may be, things tend to settle down in September.
So far, however, the summer nervousness has continued into the early autumn, and should not be too lightly dismissed.
The difference is China. China is the world’s second largest economy and the biggest trading nation, so what happens there affects us all. Today China, as well as America, only has to sneeze for the rest of us to catch a cold. You can see this all too easily from an International Monetary Fund analysis in August 2015, which highlighted how Chinese growth has spurred the expansion of world trade since the financial crisis. In 2012 China drove 85% of the increase.
This dropped to 54% in 2013 as China’s economy slowed and the rest of the world recovered a bit and it dropped again to 36% last year. That means other regions are having to take up the slack as China’s share of global growth falls. But Europe is barely growing and, while the US is recovering, the pace is slow. The concern is that if China’s economy stays flat or deteriorates further, then the stimulus it delivers could drop as low as 20% for the rest of the decade. Investors are apprehensive because they have no idea what will pull the world forward if the Chinese locomotive is thus derailed.
The obvious answer is that the Americans will have to do it. But there is a further problem, which is that America and China are yoked together because the renminbi has long shadowed the US dollar. Unfortunately, this means that as the US recovers and the dollar becomes stronger on the foreign exchanges, it pulls the Chinese currency up with it. Chinese goods are already no longer the bargains they were and its exports are increasingly uncompetitive because of surging domestic inflation and rapid wage growth. So every time the dollar pulls the renminbi a notch higher, it increases the cost of Chinese exports and makes things worse.
And that is not the only point of pressure. Elsewhere in the world, use of quantitative easing to bring about devaluation in Japan and Europe – two of China’s biggest trading partners – has further underlined its plight because their weaker currencies make imports from China more expensive, putting further pressure on its economy.
This is why there is such concern about the prospect of an increase in US interest rates. The Federal Reserve may raise rates to stop the US expansion getting ahead of itself – a legitimate domestic concern. But the impact overseas could be profound if higher US rates lead – as is likely – to an even higher dollar and more pain for the Chinese.
This is the great paradox. Normally a growing US economy is good for the whole world. This time, however, because of these linkages to China, a growing US economy raises fears that it might make the global situation very much worse.
The obvious answer is for China to devalue – and it has taken a couple of steps in this direction. But this risks seriously damaging the already fractious relationship with the US. If China devalues as part of a move to become a normal open economy, where capital can flow in and out without restriction, then Washington would have few complaints. However, if the currency rate is cut without such reform, so that China can export at will while continuing to deny open access to its own markets, it could presage a major souring of relations at an already fragile time. At its worst it could trigger ‘beggar my neighbour’ competitive devaluations – as happened in the 1930s – in which nations pursue policies to the disadvantage of their rivals, rather than for mutual benefit. Then we really would be in trouble.
So there is much for the world to worry about, but things do not have to end in tears.
The declared Chinese ambition is to move its economy from reliance on exports to reliance on domestic consumption while normalising its trading relationships with the rest of the world. But this requires the
Chinese leadership to face down a lot of vested interests, to say nothing of all the other challenges embedded in such a huge shift. But thus far, and with only a few hiccups, it seems to be sticking to the task.
If the programme goes smoothly it could deliver enough Chinese growth to reassure the world’s investors that, once again, we will muddle through; but every time it seems to falter it could provoke more uncertainty and market turmoil. Either way, China will surely get there in the end; but that begs the question of how many times the rest of the world will catch cold on its journey.