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What would happen to global growth if China collapsed

, July 23, 2013, 0 Comments

A serious slowdown in China would affect the global economy tremendously . It should not be taken seriously by those who only put forward the benefits in the medium and long term. First of all it depends on these scenario that would hold : a gradual deceleration (soft landing) or a sudden financial crisis which can not be ruled out in view of recent indicators from the Chinese central bank itself.

In the second case, one would observe contagion in financial markets around the world that transits through a new financial crisis in Asia as a whole, and contagion across other markets. There are too many financial products today that are dependent on the health of the Chinese economy, including Europe.

If it is in the scenario where China’s growth falls to 4 or 5% per year as we begin to fear, and I do not mean the official figures but estimates of experts of the Chinese market, there are two effects:

A real negative for very large commercial balance of the planet short term effect :
there are indeed few substitutes for a variety of products exported by China, and it will continue to export. And even in larger quantities because Chinese exporters will then seek to export at all costs to maintain their level of production. In contrast, China will greatly reduce its imports of equipment and raw materials as domestic demand decreases. So that the overall imbalance vis-à-vis China, already high, may increase as opposed to what we think. This will put in very difficult situations in countries that are already in deficit. Developed countries will not be affected first. Emerging countries such as Brazil and India are at the forefront. Besides Africa, which exports its natural resources heavily in China. As a result, the trade will be contagion through emerging and then rebound in developed countries, especially in Europe, because it is more exposed to emerging markets as the U.S. economy, including all Middle  Europa Northern Europe. And then the backlash from France course.

The second short-term effect for financial markets :
if there is a downward pressure on the yuan, or at least stop the movement of revaluation of the yuan started in recent years, there is a risk of exacerbation the currency war that began more than a year. If the yuan goes down, all currencies with which its competing will align and this will increase the recessionary pressure, particularly in Europe, which still does not manage its exchange rate according to the requirements of competitiveness, but simply inflation . In short, the real exchange rate of the euro will appreciate, and it’s not good at all for the job.

A second phenomenon will occur in the financial markets through scholarships. A large part of the profits of Western societies, whether European or American, are actually achieved by the emerging markets, especially China through low production costs and strong sales growth in recent years. What you think of the German luxury car which China has become the first foreign market. If the profits of these companies are strongly affected by the Chinese slowdown that will affect the budget. These could then fall by 20 to 25% and this would be reflected by ripple effect on the real economy, through lower investment, not to mention a decrease in funds and bank profits.

A sharp slowdown in Chinese growth would have serious short-term effects. The significant figure is obviously the GDP of China, the world’s GDP today, but its weight in world trade.  

Total exports and Chinese imports, accounting for about 20% of world trade today which itself perhaps accounts for a third of global GDP. It would therefore mechanically shock from 6% to 10% of the global GDP. It is not far from what was observed during the subprime crisis in 2008.

What will be the countries most affected by this shock?
First Asian countries who are in a relationship with China, such as Japan, Korea or Taiwan “integrated circuit”. Then they would drop their component sales to China and their economies can only slow sharply due to their current dependence on the Chinese market, whether the export or the domestic market essential for companies like Samsung, LG and Toyota.

Second group of affected countries: countries that export raw materials to China. These are countries that take part in today’s global growth: Africa, the Middle East and some countries in Latin America.

But in the medium term, is that the decline in Chinese growth could result in a re balancing of trade balances in western countries vis-à-vis China?
A medium-term effect, a slowdown in Chinese growth could lead to an acceleration of the relocation of activities that made in china triumphant had swallowed three decades if growth slows, China attracts fewer firms, particularly those had taken the habit of relocating their production units. This movement should benefit the entire world, including Europe and emerging countries that have experienced strong competition from China in the past 20 years.

In reality, this effect of medium term is already underway. Past five or six years a slow return of the China-based activities to other countries are observed; emerging markets such as Vietnam and Bangladesh, but also in Europe as seen in France same. The real question is whether the world is moving towards a soft output of “Made in China” on a decade, or to an abrupt exit. The world economy has no interest in a sudden release of a system that Western countries have themselves contributed to engage in the mid-eighties. It should never rejoice at the misfortune of others in such a globalized world!

Should we fear a credit crunch in China? What would be the consequences?
Liquidity is currently undergoing stress with short-term rates that are mounted to nearly 25%. This is clearly a sign of great difficulty of the PBOC (People’s Bank of China) to manage the required deceleration of credit demand without causing a major credit crunch. Panic on this point could trigger a major financial crisis because even in China, the financial markets are volatile and natural herd . But judging by its massive liquidity injections, I have the feeling that the Chinese central bank will behave more like the U.S. FED post-Lehman Brothers and as the ECB. This means that it will issue all the necessary liquidity. Still, it also needs to stop the bleeding credit in recent months and especially from smaller institutions or suspicious financial institutions like many municipalities.

What are the adverse effects of undervaluation of the yuan?
To export it goes without saying: the competition is unfair as it continues to say. But more important is the impact on Chinese domestic demand. The fact that the yuan is undervalued has a depressive effect on the Chinese domestic consumption, particularly with respect to imported products that are too expensive and we have certainly no interest in a crisis that would stop the yuan revaluation. We instead need a stronger yuan to stimulate the domestic market and restore the competitiveness of Europe

About author
Jean-Joseph Boillot is co-chairman EIEBG (Euro-India Group) and a doctorate in economics. Jean specialize and focus on emerging Asia particuarly India & China since 1980s and was an advisor to the Ministry of Finance on most major emerging regions in the 1990s. ...more ...more