Should we be worried about China?

Once again the economic news has been dominated by stock market turmoil in China and its knock-on effect around the world.  At the same time, the US has posted some very positive figures across a number of economic indicators and we are therefore faced with a plethora of seemingly contradictory data on the state of the global economy.

These conflicting trends take place against a backdrop of global political volatility which is taking the attention of many of the world’s leading power brokers away from day-to-day economic considerations.  So should we all be worrying more about the state of the Chinese economy or focus hard, for example, on the type of local unrest stimulated by the refugee crisis in countries such as Germany and Sweden?

The obvious answer is that, as the second largest global market, what happens to the Chinese economy affects us all one way or another – but that those repercussions may be felt more in some parts of the world than others.

Here are a few observations:

• Chinese Markets: The falls in the markets in China represent their sharpest drop in 20 years – the markets fell more than 12% on one day alone.  This collapse seems to have been precipitated by the publication of very weak manufacturing data (the sector has fallen for 10 months in a row) and this bad news was then compounded by the fact that the government decided to further devalue the Yuan – adding to a feeling of impending gloom.
• Chinese Debt Levels: Chinese debt levels are huge across a range of sectors – local government, SOE (state-owned enterprises), the real estate market and corporate.  Nothing unusual about that – the same could be said about any number of countries.  However Chinese debt levels seem to have been racked up during the boom times of 10%+ growth rates but they will need to be repaid at a time when the economy is growing at only 5 - 6% at best.  Troubles lie ahead unless the economy starts to improve.
• The Role of the State: As has often been cited, there is a paradox at the heart of the Chinese economy which is fundamental to how the Chinese future pans out.  The Government wants an apparently ‘free’ market economy with all the undoubted benefits that are associated with that (and which have aided the ‘economic miracle’ of the last 20 years) but at the same time the authorities don’t seem able to accept the inherent volatility and uncertainty which comes with a ‘free’ market economy.  Hence the type meddling by the authorities into the stock market, currency levels etc. which we have seen over the last six months.

So what does this mean for the rest of the world and who will be most affected?

• Global Commodities: As China currently accounts for just under 50% of all globally traded commodities, this means that when China goes into recession any country which relies on commodity trade is going to be severely affected.  We don’t need to look much beyond Brazil, Australia and Canada to see the impact being felt already – and things are set to get worse.
• Emerging Markets: China is the largest provider of FDI to a number of emerging market countries – most noticeably across Africa.  If a recession starts to bite at home it is likely that these levels of FDI will decrease and the poorest countries stand to be the hardest hit.  (This impact could possibly be ameliorated by an expansionist Chinese government determined to extend China’s political influence around the world.)
• Chinese Structural Change: The first great shift saw China move from an almost exclusively agrarian economy to a manufacturing-led economy and we are now seeing the country go through its next big shift from manufacturing to service driven.  This realignment will prove painful but will ultimately bring huge benefits.  This enormous structural change promises potential for those foreign investors who excel in the service domain and whose knowledge and experience will be at a premium.  Countries such as the US and the UK should benefit from this in both the short and the long term.

So back to my original question – should we be worried about China?  I suppose the answer is, ‘it depends’!  It depends on whether or not you are commodity producing country and it depends on what sector your country excels in.  But most of all it depends on what the Chinese authorities do next – and predicting that is virtually impossible.

I’d be interested to hear other people’s views on this matter.