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TheEconomistUKedition
Chinaandtheworldeconomy
Takingatumble
StockmarketturmoilinChinaneednotspelleconomicdoom.Butitdoesraisequestionsfarbeyondthecountrysshores
THEabilitytomakestockmarketsboomerangisusuallyreservedforcentral
bankers.ButonAugust24th,hoursintoaglobalmarketroutthathadstarted
inAsiaandwassweepingitswaythroughEuropeandthenAmerica,Tim
Cook,thebossofApple,turnedhishandtoit.Icantellyouthatwehave
continuedtoexperiencestronggrowthforourbusinessinChinathroughJuly
andAugust,hewroteinanemailtoCNBC,afinancialnewschannel.I
continuetobelievethatChinarepresentsanunprecedentedopportunityover
thelongterm.
BythetimeMrCookfeltitnecessarytoopineonthestateoftheworlds
secondbiggesteconomy,plentyhadstartedtoquestionitsprospects.Followingweeksofwobbling,theShanghaistock
exchangehadjustcratered.Agovernmentoncecreditedwithnearmagicalpowerstobrowbeatitseconomyintogrowthlooked
tohavemisplaceditswand.Suspicionsaboundedthatadecadeslongeraofsuperlativeifrecentlysofteningeconomic
expansionmightbecomingtoanend.SothenewsthatChineseconsumerswerestillinthemoodfornewiPhonesandwhizzy
watchesdidmoretoassuagenervesthanreamsofofficialpronouncementsfromBeijingevercould.
Applesharesreclaimedthe$66billiontheyhadlosttheDowJonesbluechipindex,havingopeneddownacalamitous1,000
points,rebounded.Butthatwasaprecursorfordaysofvolatility.Manymarketsaroundtheworldcrossedthelineinto
correctionterritory,havingfallenmorethan10%fromrecentpeaks,thoughsomewererallyingasTheEconomistwentto
press.Shanghairemaineddownbysome40%,adrubbingtorivalthe2001dotcomcrash,ifnot(yet)the2008miasma.
Theeffecthasbeenfeltbeyondstockmarkets.Abasketofcommodities,includingeverythingfromsteeltowheat,hasfallento
itslowestlevelthiscenturyoilisatsixandahalfyearlows.Emergingmarketcurrencieshavebeenhammered.TheVIX
index,ameasureoffearinmarkets,jumpedthisweektoitshighestlevelsince2011.Theseesawinginstocksmayevenhave
putcracksinthearchitectureofmarkets:manyexchangetradedfunds,whichinvestorsusetobuybasketsofstocksorother
assets,decoupledfromtheirunderlyingcomponents,tradingatnervewrackingdiscounts.(Othersblamedthisonanilltimed
computerglitch.)
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InvestorsarenowtryingtodelvebeyondiPhoneshipmentsandgaugewhere
Chinaseconomyandsotheworldsstands.Intermsofglobalimpact,a
hardlandinginChinawouldnowrivalanAmericandepression.Countries
fromAustraliatoAngolahavegrownricherfromdiggingstuffoutofthe
groundandshippingittoChina.Industriesfromcarmakingtoluxurygoods
looktoChinafornewbusiness.Ithasbeenthemoststablecontributorto
worldeconomicgrowth.Willthatcontinue?
Certainly,therearereasonstothinkitisintrouble.Exportsarestumbling,
badloansrisingandtheindustrialsectoratitsweakestsincethedepthsofthe
globalfinancialcrisis.Neverentirelycredible,thegovernmentsclaimsthat
theeconomyischuggingalongat7%nowelicitderision.
Evenmorealarmingisthewaythesestressesappeartobeshowingthroughin
itsmarkets.OnAugust11ththecentralbankstunnedinvestorsbydevaluingtheyuan,whoserateitguidesthroughregular
interventions.Thecurrencymovedmoreinadaythanitdoesinmostmonths.Thedevaluationlookstohavebeenatechnical
changetothewaytheexchangerateismanaged.Butthankstopoorcommunication,manysawitasChinasfirstfusilladeina
globalcurrencywar.Marketsaroundtheworldhavebeenontenterhookseversince.CapitaloutflowsfromChinahaveshotup
asinvestorshavesouredontheeconomy.
Andthenthereisthedailycarnageinthestockmarket.Thegovernmenthasthrownatleast1trillionyuan($156billion)at
buyingsharesinordertostabilisethem,onlytoseepricesplungeevenmoreviolently.Thefearisthatallthismarketturmoil
speakstodeeperfracturesinthefoundationsoftheChineseeconomy,withtheentireedificeatriskoftopplingover.
SoisthisthehourofChinascrisis?Highlyunlikely.Thoughtheeconomyfacesgraveproblems,thefinancialtumultis
misleading.Chinasstockmarkethaslongbeenderidedasacasino,andforgoodreason.Thebourseissmallrelativetothe
economy,withatradablevalueofathirdofGDP,comparedwithmorethan100%indevelopedeconomies.Stocksand
economicfundamentalshavelittleincommon.WhensharepricesnearlytripledintheyeartoJune,theynomorereflecteda
stunningimprovementinChinasgrowthprospectsthantheircollapsesincethenhasforeshadowedasuddendeterioration.
LessthanafifthofChinashouseholdwealthisinvestedinsharestheirboomdidlittletoboostconsumptionandtheircrash
willdolittletoslowit.Puntersborrowedlotsofmoneytobuystocksingoodtimes,tobesure,andsomeofthatdebtwill
default.Butitamountstojust1%oftotalbankingassets,apotentialhitthat,althoughunpleasant,ishardlysystemic.
ThepropertymarketmattersfarmoreforChinaseconomythanequitiesdo.Housingandlandaccountforthevastmajorityof
collateralinthefinancialsystemandplayamuchbiggerroleinspurringongrowth.Yetthebarrageofbearishheadlinesabout
sharepriceshasobscurednewsofapropertyrebound.Housepriceshaveperkedupnationwideforthreestraightmonths.Two
monthsafterthestockmarketfirstcrashed,thisupturncontinues.
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Onthedownside,thereislittlechancethisreboundwilltranslateintoabigaccelerationinbuildingactivity,becauseChinese
developersstillhavetoworkthroughaglutofunsoldhomes,thelegacyoftheirbuildingfrenzyofrecentyears.Butthe
stabilisationofpricesreducestheriskofapropertymarketcrashaneventthatwouldbeforChinawhatastockmarketcrash
wouldbeinAmericaorJapan.
SomethinkChinahas,infact,alreadysufferedthehardlandingdreadedbyeconomists.Theypointtoweaknessacrossabroad
rangeofphysicalindicatorsusedasproxiesforChinesegrowthbecausethegovernmentsofficialdataareseenasiffy.Cargo
movedbyrailhasdeclined,electricityconsumptionisanaemicandproducerpricesaremiredindeflation.Additallup,the
scepticssay,andChinasannualgrowthlookstobejust23%.
Thisdownbeatassessmentoversimplifiestheeconomy.Heavyindustryis,withoutquestion,struggling.Thenortheasternrust
beltisonthebrinkofrecession.ButChinaisacontinentsizedeconomy,fuelledbymorethanjusttheconstructionofhomes
andrailways.Theservicesector,whichnowaccountsforabiggershareofnationaloutputthanindustry,isgrowingquickly.
Retailsalesremainstrong,asApplesMrCookwassokeentopointout.Economicgrowthisalmostcertainlylowerthanthe
ratereportedbythegovernment.Butitappearstobewithintherangeofasoftlanding.
Furtherturbulencewouldbemanageable.OnAugust25ththecentralbank
cutinterestratesandreducedtheportionofdepositsthatbanksmustlockup
asreserves.Evenwiththesecuts,thelatestinamonthslongeasingcycle,
benchmarkoneyearlendingratesstillsitat4.6%,whilerequiredreserve
ratiosare18%forbigbanks.Thecentralbanklookssettocontinuecutting
both,reducingfundingcostsforborrowersandfreeingupmoremoneyfor
bankstolend.ThesearethesortsofleversmostWesterneconomiesdonot
have.
Onthefiscalside,forallthetalkofministimulusmeasures,thegovernment
hasinfactexercisedremarkablerestraint.Itaimedforabudgetdeficitof
2.3%ofGDPthisyear,abitmorethaninpreviousyears.ButasofJulyitwas
stillinsurplus,havingraisedmoreintaxesthanithadspent.Thissuggestsit
stillhasplentyofpetrolinthetankifitwantstorevupgrowth.

Amesstomopup
EvenifChinaholdsupwellenoughnow,thereisstilltheworrythatasharper
slowdownliesahead.Thegovernmentfacesdauntingchallengesinmanagingtheeconomy.Itistryingtocleanupthedebt
messleftoverbythestimulusof2009,whenitunleashedamammothinvestmentspreetofightofftheglobalfinancialcrisis.
Debt,bysomecounts,hasreachedmorethan250%ofGDP,almostdoublingoverthepastsevenyears.Increasesofthat
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magnitudehavepresagedcrisesinothercountries,fromJapantoSpain.Atthesametimestructuraltrendsareturningagainst
China.Itsworkingagepopulationisnowshrinking.
ArangeofreformscouldhelpChinatapnewsourcesofgrowth:allowingprivatecompaniestocompeteproperlywithstate
firmsfosteringtheruleoflawtogiveentrepreneursmoreconfidencetoinvestandrelaxingresidencycontrolsthatstuntthe
freeflowofitspeople.Forthetimebeing,however,theserunagainsttheCommunistPartysreflexiveneedforcontrol.
Theturmoilofthepasttwomonthshassoweddoubtsaboutwhetherthegovernmenthaseithertheinclinationortheskillto
pushthroughreforms.ForalltheflawsofChinaspoliticalsystem,manyoutsidethecountryhadvieweditsleadersas
economicallyadroit,capableofbringingaboutrapidgrowthandsnuffingoutrisks.Nowtheyarenotsosure.
Thegovernmentsillfatedresponsetotumblingmarketshasseverelytarnishedthatauraofcompetence.Themarketsregulator
bannedshortsellingandhaltedIPOstradersandajournalistarebeingprobedforspreadingrumours.Stateownedcompanies
boughtbacktheirownshares.Thecentralbanklentcashtoanagencythatvowedtopushthemarketbackup.Statemedia
boastedthatthenationalteamwouldtriumph.Itdidnot.Themarketsanklower,erodingthegovernmentsreservesaswellas
itscredibility.
Chinasstockmarketshouldeventuallyfinditsfeetandthedevaluationdebaclemayrecedeintomemory,butthepolitical
damagewillbelasting.TheseepisodeshaveraisedunsettlingquestionsaboutthecommitmentofChinesepolicymakerstothe
marketreformsneededtoshoreupthelongtermhealthoftheeconomy.AnunusualeditorialinthePeoplesDaily,mouthpiece
oftheCommunistParty,saidlastweekthatXiJinping,Chinaspresident,wantedtomakedeepreformsbuthadencountered
resistancebeyondwhatcouldhavebeenimagined.SomeguessthatformerleadersarepushingbackagainstMrXi,whohas
ledananticorruptiondrivethathasmadehimChinasmostpowerfulleadersinceDengXiaoping.Otherssaythatcivil
servants,fearfulofthiscampaign,aresittingontheirhands,afraidofdoingmuchofanything.
Seniorgovernmentandpartyofficialshavesaidalmostnothingabouttheturmoil,whichhasfuelledspeculationofdivisionsat
thetop.Theprimeminister,LiKeqiang,whooversawthefailedattempttopropupthestockmarket,islikelytocomeinfor
particularcriticism.
ButMrXihimselfcanhardlyescapescrutiny.Unlikemostofhispredecessors,wholefttheeconomytotheirprimeministers,
thepresidenthasimmersedhimselfineconomicdecisions.Hechairsnewpolicymakingbodiesonreformandfinance.This
makesitharderforhimtoescapeblamewhenthingsgowrong.
IfChinadoes,afterabumblingfewmonths,pressonwithitsreformagenda,itcouldyetpullofftheamazingtrickofopening
upandmodernisingitseconomywithoutsufferingaseriouscrisis.Butevenifitsucceeds,therewillbenegativeconsequences
forothers.Theeconomyisrebalancing,albeitslowly,awayfrominvestmentandtowardsconsumption(seechart3).Chinastill
hasmanymorehomes,highwaysandairportstobuild,butthetrendawayfromthemisunmistakable.

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Rebalancingact
Asaresult,itsappetiteforcommoditieshasprobablypeaked.Thatisbad
newsforcompaniesandcountriesthatprosperedoverthepastdecadeby
sellingitmountainsofironore,copperandcoal.AdeclineinChinese
consumptionwouldbeofhugeconsequence:itabsorbsabouthalftheworlds
aluminium,nickelandsteel,andnearlyathirdofitscottonandrice.
ArguablyworseforsomeemergingeconomiesthantheprospectofaChinese
slowdownistherealityofresurgentAmericangrowth.Therichworlds
anaemicpostcrisisrecoveryhasensuredthatglobalinterestratesremainat
rockbottom.Themonetarystimulushasbeenboostedbyquantitative
easing(QE),bondbuyingdesignedtomakepolicyevenlooser.Withbond
yieldsdepressedinAmerica,investorspiledintoemergingmarketbondsin
thesearchfordecentreturns.
ThedaysofcheapAmericanmoneyappeartobenumbered.TheFederal
ReservesQEprogrammewaswounddownlastyearanditisnow
contemplatingraisinginterestratesforthefirsttimesince2006.Thatprospecthasdrivenupthedollar,whichhasrisenbya
weightedaverageof17%againstthecurrenciesofitstradingpartnersinthepasttwoyearsandbyconsiderablymorethanthat
againstemergingmarketcurrencies.
ThisisadramaticshiftgiventhatexpectationsoffutureraterisesinAmericaaremodest.Butmuchofthemoneythatflowed
intoemergingmarketswaspushedtherebythefallingyieldsonofferinAmericaandpulledbythelureofracierreturns.
Capitalhasalreadystartedtoflowoutofemergingmarkets.IfandwhentheFedincreasesrates,investorswillpromptly
repatriatemoremoneytoAmerica.
Whatsortoflandingfortheeconomy?
Thecountriesmostvulnerabletosuchareversalarethosewithbiggishcurrentaccountdeficitsinotherwordsthosethat
reliedonforeigncapitaltobridgethegapbetweenwhattheyspentandwhattheyearnedfromtrade.Thecountriesmost
exposedtoshiftsinChinaseconomy,meanwhile,arethecommodityexporterswhosupplytherawmaterialsforthesteel
girdersandcopperpipingthathaveunderpinnedtheconstructionboom.
Brazilsuffersonbothcounts.Itscurrency,thereal,hasfallenbymorethanathirdagainstthedollarinthepastyearandby
almosthalfsinceMay2013,whentheFedfirsthintedthatitsbondbuyingwouldtaperoffpromptingawobbleacross
emergingmarketsdubbedthetapertantrum.Brazilscentralbankhasraisedratesto14.25%totackletheinflationcausedby
therealsdive.Theeconomyisinrecession.Investmentinminingandinoffshoreoilhascollapsed.
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Thecurrenciesofothercommodityintensivecountriesnearby,suchas
ArgentinaandMexico,havealsofallenheavilyagainstthedollar.Among
emergingmarketcurrenciesonlytheRussianroubleslammedbythe
collapseinoilpricesandbysanctionsrelatedtoUkrainehasfaredworse
thanLatinAmericasminers.MalaysiaandIndonesia,thetwocommodity
exportersclosesttoChina,havealsobeencaughtupintheselloff.
Aftertwoyearsofpersistentselling,suchcurrencieshavebeguntolook
cheapwhensetagainstconventionalbenchmarks.Butthathasnotstopped
themfallingfurtherinrecentweeksasconcernsaboutChinaseconomyhave
intensified.TheColombianpeso,theMalaysianringgitandtheroublehave
beenamongthehardesthitcurrenciesinthepastweek.

Theunenviablethirdbucket
Despitebeingacommodityexporter,SouthAfricalargelymissedoutontheChinaledrawmaterialsboom,becauseof
weaknessesinitstransportandpowerindustries.ItbelongsmorereadilywithTurkeyinaseparatecategoryofemerging
marketsthathavesufferedbadlybecauseofanoverrelianceonhotmoneytofinancealargecurrentaccountdeficit.Both
economiesareinflationproneandhavelowdomesticsavings.Theyalsoshareatendencytodowellwhenglobalcapitalflows
freelyandtodobadlywhen,asnow,investorsarechoosieraboutwheretheyparktheirmoney.
Ironically,someofthemostresilientcountrieshavebeenthosewiththeclosesttradelinkstoChina,suchasSouthKorea,
SingaporeandTaiwan.Allhavesolidcurrentaccountsurplusesandhealthyforeignexchangereservesandsohavelittletofear
fromcapitalflightinresponsetorisinginterestratesinAmerica.Andasnetimportersofrawmaterials,theybenefitfrom
fallingcommodityprices.
Evenso,theircurrenciesfellinthewakeofChinasdevaluationinmidAugustandcrackshaverecentlystartedtoshowintheir
economies.GDPgrowthinSingaporehasdroppedbelow2%,thelowestrateforthreeyears.Surveysofpurchasingmanagers
pointtofallingmanufacturingoutputinTaiwanandSouthKorea.
FactorygatepricesarefallingacrossAsia,too,reflectingexcesscapacityinindustry.InChinatheyhavedeclinedfor41
consecutivemonthsinSouthKoreaandTaiwanfor35monthsandinSingaporefor31months,notesChetanAhyaofMorgan
Stanley.Fallingpricesmakeitharderforcompaniestoservicethedebtstheyrunuptopayfornewcapacityintheboomyears.
ProducerpricesarefallingevenininflationproneIndia,whichisoneoftherelativebrightspotsinemergingmarkets.Indiais
lesstiedtoChinathanothereconomiesinAsiaand,asanetoilimporter,benefitsfromlowcrudeprices(caused,mostly,by
abundantsupplyinSaudiArabiaandAmericaratherthanChinesewobbles).Itsjuniorfinanceministerevenspeaksoftaking
upthebatonoffastgrowthfromChina.Theworryisthatsuchboastsrevealcomplacencyaboutreformsthatareneededin
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Indiabuthaveneverthelessstalled.
Withlargechunksoftheemergingworldintrouble,parallelsarebeingdrawn
withtheAsiancrisisof199798.Yetmanyofthefactorsthatcontributedto
theintensityofthatdebacleandthebrutalityoftherecessioninemerging
Asiathatfollowedaremissingtoday.Thechiefabsenteeisexchangerate
pegs,whichwerecommoninthemid1990s.Theillusionofcurrencystability
thatsuchpegsfosteredledtoabuildupofdollardenominateddebtsin
emergingAsia.Whencapitalinflowsdriedup,thepegsbroke.Currencies
quicklyplungedinvalue,pushingupthecostofdollardebts.
Thesedaysfarmoreemergingmarketsallowtheircurrenciestofloat.By
contrastwithwhathappenedin1997,therecentfloodofcapitalfromtherichworldintoemergingmarketswentlargelyinto
localcurrencybonds.Foreignersownbetween25%and50%ofthestockofgovernmentbondsinBrazil,Turkey,SouthAfrica,
Indonesia,MalaysiaandMexico,accordingtoMorganStanley.Forawhilethemomentumbehindcapitalflowsmeantrich
worldinvestorsenjoyedavirtuouscircleofhigherbondpricesandstrongercurrencies.Nowthatcyclehasturnedviciousbutit
isthecurrency(andthusthelender,nottheborrower)thathasadjustedmost.Emergingmarketstypicallyhavefarlarger
arsenalsofforeignexchangereservesandhealthiercurrentaccountbalancesthantheydidinthe1990s.
Forthesereasonsthelatestemergingmarketdustuplackstheseverityofthe199798crisis.Butinatleastoneregarditis
moreworrying.TheweightofemergingmarketsinglobalGDPisnowmuchheavier,mostlybecauseofChinasgreatermass
(seechart4).Slowergrowththereisfeltmorekeenlyinrichcountries.Worryingly,worldtradesuffereditsbiggestfallsince
2009inthefirsthalfofthisyear.
Thereisoneothercontrastwiththelate1990s.Morerecentlythesearchfor
yieldinexoticplacestookrichworldpensionfundstothefarthestedgeofthe
investinguniverse:frontiermarkets,whicharetypicallypoorerandhave
lessdevelopedfinancialsystemsthanmostemergingmarkets.Resourcerich
Africawasoneofthebusiestpartsofthefrontier.Countriesthathadnotlong
agobeenfreedfrompunitivedebtburdensweresuddenlyabletoborrow
cheaply,albeitindollars.SixteencountriesinsubSaharanAfricahavenow
issuedsuchforeigncurrencybonds,saysStuartCulverhouseofExotix,a
broker.Withcommodityrevenuesfalling,repaymentcouldgettricky.Firms
thatborrowedindollarscouldfacesimilartroublesincludingsomeinChina
thathavedonesothroughopaqueoffshorearrangements.
QuitewhentheturmoilassociatedwiththeendofeasymoneycomestopasslargelydependsontheFed.Beforethetumult,
marketspricedthechanceofaSeptemberrateriseatover50%nowtheprobabilityiscloserto25%.GrandeessuchasLarry
Summers,aformertreasurysecretary,andBillDudley,headoftheNewYorkFed,haveexpressedscepticismaboutaraterise
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nextmonth.
YettheFedmayploughonregardless.AmericaseconomyiswellinsulatedfromtheChineseshock:just8%ofAmerican
exports,worth0.7%ofGDP,gotoChina.Whendiscussingthetimingofinterestraterises,JanetYellen,theFedschairman,
usuallyfocusesonthedomesticlabourmarketratherthanthefateofdistanteconomies.IfajobsreportonSeptember4thshows
strongemploymentgrowth,theFedcouldwellraiseratesdespitemarketvolatility.
Afterthetapertantrumof2013,arateriserumblewasalwaysapossibilityastheprospectofFedactionneared.Thathas
affectedallemergingmarketsincludingChina.ThecrashinShanghaiwasnotevidenceofaChineseeconomyonthebrink.
Nevertheless,policymakersinBeijinghavechosenabadtimetolosesomuchoftheircredibilityastheworldeconomyssafest
hands.
CopyrightTheEconomistNewspaperLimited2015.Allrightsreserved.Thisarticleisforyourpersonal,noncommercial
use.Youmaynotmodify,reproduce,transmitorcommerciallyexploitit.Visithttp://www.economist.comformoreglobal
news,views,andanalysisfromTheEconomist.

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