Almost seven years after the 2008 financial crisis, many global economies have returned to a condition of modest stability and growth. In fact, the U.S. Federal Reserve and other leading economies had anticipated by the end of 2015 raising interest rates and abandoning quantitative easing. Apart from Greece, even areas of the Eurozone have begun to exhibit strong growth spurts. However, what many expected to be a fruitful economic climate may be coming to a halt, because growth in China, the second-biggest economy in the world, has fallen to its lowest level since 2009.
After a plunge in July on what was called “Black Friday” in China, pundits have begun to examine how China's economic turbulence could impact the U.S. and global economies. (For more, see: Is Now the Time For Chinese Stocks?) The relationship between the U.S. and China has been built on extensive trade, and following the 2008 crisis, China has financed a majority of U.S. debt. It's too soon to tell whether China’s troubles will spark a new global downturn. However if things persist, there could be significant ramifications for foreign trade, financial markets and economic growth in the U.S. and around the world.
Is China Collapsing?
For the past 30 years, China has grown at a rate of 10% per year, with annual peaks of 13%. A large part of China’s rapid growth is owed to its 1970s economic reform. In 1978, after years of state control of all productive assets, China started introducing market principles to stimulate its economy. Over the following three decades, China encouraged the formation of rural enterprises and private businesses, liberalized foreign trade and investment and invested heavily in production. Although capital assets and accumulation have heavily influenced the nation’s growth, China also has sustained a high level of productivity and worker efficiency, which continues to be the driving force of its economic success. As a result, per capita income in China has quadrupled over the past 15 years.
However, it seems that even China's rapid growth couldn't last forever. Over the past five years, its growth has slowed to 7%. Still, to put this in perspective, the U.S. economy grew 3.7% in second-quarter 2015 while the IMF projects global growth at 3.1% over the course of 2015. Even having a slower rate of growth than prior years, China still outpaces a majority of countries, including many advanced economies.
Regardless, it has become a growing belief among some market analysts that China is showing signs of a possible economic collapse, pointing to recent events to substantiate their point. Over the course of 2015, China has suffered from sinking oil prices, a shrinking manufacturing sector, a devalued currency and a plummeting stock market. For the latter, over August 2015, the Nikkei 225 (N225) index declined almost 12%, with a near 9% dive posted on a single day. The pain extends beyond the stock markets, however. Oil prices, which have been declining for months, reached a six-year low in August, which has had an impact on the Chinese stock exchange. In turn, losses in the Chinese stock market triggered global sell-offs and prompted China to devaluate the yuan. (For more, read: What China Devaluating Its Currency Means to Investors.) Chinese demand for oil is further decelerating, which, to close the circle, is one of many pressures keeping global oil prices low. Adding to the slowdown, Chinese manufacturing has declined to its lowest level in three years. The official purchasing manager’s index for August fell to 49.7, implying a contraction.
This chain of events is becoming a source of alarm for some global economists. Worries of a continued freefall in China have raised concerns whether a spillover effect could hit the U.S. and the global markets.
The U.S. Dependency on China
While the United States and China haven't always seen eye to eye on diplomatic issues, particularly human rights and cyber security, the two counties have built a strong economic relationship, with significant trade, foreign direct investment and debt financing. Two-way trade between China and the United States has grown from $33 billion in 1992 to $590 billion in 2014. After Mexico and Canada, China is the third-largest export market for U.S. goods, accounting for $123 billion in U.S. exports. As for imports, the U.S. imported $466 billion in Chinese goods in 2014, primarily consisting of machinery, furniture, toys and footwear. As a result, the United States is China’s largest export market.
Alongside an extensive amount of foreign trade, China has been a popular destination for U.S. foreign direct investments. The stock of foreign investment from the U.S. into China exceeded $60 billion in 2013, primarily in the manufacturing sector.
That being said, the U.S. has a significant trade deficit with China due to U.S. Treasury bonds. Currently, China is one of the largest holders of U.S. debt, amounting to $1.2 trillion. For China, Treasuries are a safe and stable way to maintain an export-led economy and creditworthiness in the global economy. As long as China continues to hold a massive amount of forex reserves and U.S. debt, some market observers believe the U.S. economy could be essentially at the mercy of China.
Various Scenarios
Given that the China's current turmoil has been followed by a downturn in U.S. and global stock markets, a pessimistic reader might wonder if much more chaos should be expected if China's economy continues to deteriorate. With China holding a great deal of Treasury debt, one worst-case scenario would be for China to dump their Treasury holdings, which could have fearsome implications for the U.S. dollar.
That said, while this makes for an intriguing doomsday scenario, there's little actual evidence of any such forthcoming catastrophe. After all China, who's no longer the largest holder of U.S. debt, has already been selling Treasuries, in a bid to prevent the yuan from weakening beyond the level that the Chinese government wants. At China's current rate of Treasury selling, we haven’t seen any pressure being exerted on the U.S. economy. In fact, even if China really wanted to dump all of its U.S. debt, the move could easily backfire: they would find it extremely difficult to find any alternative asset as stable or liquid as Treasuries.
The Bottom Line
Recent happenings in China suggest that the Chinese economy, lauded for its rapid expansion over the past 30 years, is no longer what it used to be. With slower-than-expected growth for the next coming years, the world's second-biggest economy could become more subject to pressures that other advanced economies have long had to contend with. As China continues to transition into having more aspects of a market economy, it may be more exposed to the ups and down of the normal business cycle. And though the world is becoming more financially intertwined, turmoil in one of the world's biggest economies may have short-term spillover effects but still not pose any real threat to the economy’s long-term prospects.
