OPINION
Global Markets Catch the Chinese Flu
The ill effects of Beijing’s borrowing and spending binge are rippling through the world economy.
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By Ruchir Sharma
Oct. 16, 2014 7:43 p.m. ET
17 COMMENTS
It has become almost politically correct to blame the latest global growth scare on the usual suspects, Japan and Europe, and to suggest that if only those skinflint Germans would spend more, all would be better. After all, the American economy is relatively resilient, so who else is there to blame? To the extent anyone brings up China, people seem to whisper its name politely, not mentioning how Beijing’s borrowing and spending binge threatens the world.
When the U.S. sneezes, the world catches a cold, an old saying goes. But now it’s China’s health that matters most. In 1998, when the world expected the Asian financial crisis to cause trouble world-wide, the trouble never came. Emerging Asia, including China, contributed little to global growth at the time, and the U.S. economy was accelerating. That was enough to prevent the Asian crisis from slowing global growth, which held steady at around 2.5% in 1998.
China has since replaced the U.S. as the main engine of the global economy. Its contribution has more than tripled to 34% of global growth this decade from 10% in the 1990s. The U.S. contribution has fallen to 17% from 32% in the 1990s, and the European contribution dropped to 8% from 23%. Europe may be a weak link in global growth, but that is beside the point, unless there is an outright crisis there. Europe’s contribution is roughly where China’s was in the 1990s, and it no longer matters as much.
China, however, is sending a deflationary chill around the world. Factory-gate prices in China have fallen every month for the last 31 months and GDP growth has slowed to 7% from 10% in 2010, according to official estimates. This is rippling across other emerging markets, which have seen their average growth fall to 4% from about 7% in 2010. Most of that decline can be attributed to the slowdown in China.
China is transmitting its cold through several channels. Over the past 15 years, China has become a critical trading partner for many nations, emerging and developed. So falling Chinese demand is now having a viral effect, driving down prices for basic commodities from steel to soybeans. The growth rate in Chinese demand for oil has plummeted to nearly zero this year, down from 12% in 2010. This is arguably the main reason why oil prices are down 20% from their summer peaks. The same is true for other commodities like steel and iron ore: Commodity economies like Brazil and Russia are already in or near recession.
China’s slowdown is also sharpening Europe’s polarized debate about how to revive growth that is no longer fully within European control. Indeed there are signs—including healthy retail sales—that domestic growth in Europe is not weakening much further. In the U.S., the biggest impact is on headline consumer-price inflation, which may drop to 1% by the end of this year, and inflation expectations are falling accordingly.
Many global markets are showing symptoms of China flu. The economies most exposed to China are also showing the sharpest fall in their currencies relative to the dollar. Global companies most dependent on sales in China are getting hit hard, which is why stocks in the energy and materials sector have seen some of the sharpest falls. On the other hand, among the best performing global stocks are those in defensive sectors like utilities or food, the kind of staples people still need in hard times.
It isn’t clear what comes next, but China looks likely to slow further. The market accepts the official estimate, which puts growth above 7%, but the official consensus has been well behind the China slowdown since it began four years ago. The sharp fall in Chinese demand for everything from oil to electric power, coupled with the recent end of the property market boom that drove growth in the last decade, suggests that the actual GDP growth may already be below 7%. Thanks to China’s rapid debt buildup, the next step is almost certainly another step down.
Since the global financial crisis, a lot of researchers have shown that rapid, sustained increases in debt make it very difficult to avoid a crisis, but my research adds a critical twist: Rapid debt increases make it virtually impossible to avoid a slowdown. Since 1960, the nations that indulged the 30 biggest credit binges all saw credit rise as a share of GDP by at least 40 percentage points over five years. Of those 30 cases, 70% ended in a crisis after the credit boom peaked, but 100% experienced a major economic slowdown within the next five years. On average, growth slowed by more than half, to 1.5% from 5%.
In China, now indulging in the worst credit binge ever, a slowdown by more than half could drop the country’s GDP growth to 5% or less in the coming years—another two percentage points off the already slow pace. It is ironic that while some criticize Europe for not spending enough, China is now paying the price for having stimulated too much since 2008.
What would a two-point slowdown in China mean for the world? Every one-point slowdown in China’s growth now takes about half a point off global growth, according to a recent J.P. Morgan analysis. So a two-point China slowdown could bring down global growth by nearly a point. With the world economy currently expanding at about 2.5%, a one-point drop would bring growth close to 1.5%. Any growth rate below 2% starts to feel like a recession.
The world thus faces something genuinely new, in that the next global recession will probably not be made in America. In the past 50 years, global GDP growth has dipped significantly below 2% only three times: in 1975, 1982 and 2009. Each time it hit bottom in the middle of a major U.S. recession. For now, though, the center of growth has shifted east, and the next global recession—whenever it comes—is likely to bear the label “Made in China.”
Mr. Sharma is head of emerging markets at Morgan Stanley Investment Management and author of “Breakout Nations: In Pursuit of the Next Economic Miracles” ( Norton, 2012).
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