“It has been said for decades that ‘when America sneezes, the rest of the world gets a cold’,” says Ian Harwood of Evolution Securities. “Recently, however, world markets have begun to behave as if the same is true of China.” Last week global equities were unnerved by unexpectedly strong Chinese growth figures and an inflation rate still above target.
This raised fears that “policymakers are behind the curve”, said Diana Choyleva of Lombard Street Research. The government “will be slamming on the brakes” to cool the overheating economy. But will it slam too hard, burst the credit and housing bubble and cause a nasty collapse? With China expected to provide a third of global growth this year, the worry is that a sharp slowdown there could derail the global recovery, says Merrill Lynch Wealth Management.
GDP growth and inflation are too strong
Growth hit 9.8% year-on-year in the fourth quarter, up from 9.6% in the previous three months. Chinese statistics are notoriously unreliable, but three gauges of growth that are harder to fudge also depict an economy “pretty much at full throttle”, says Lex in the FT. Electricity consumption rose almost 15% last year, compared to 7% in 2009. Rail-freight traffic’s 10% rise in the first 11 months of 2010 was double the five-year average. Bank lending is still ten times the level of December 2007. And this is an economy that the authorities have been trying to slow down.
As for inflation, it retreated to an annual 4.6% in December from 5.1% the previous month. But month-on-month it is still climbing, as are producer prices for raw materials and manufactured goods, says Lex. Nor is food inflation, up 10% in the past year, going away. Grain and vegetable prices have rebounded of late. Note too that migrant workers’ wages rose 18.7% year-on-year during the first nine months of last year, says Bank of America Merrill Lynch.
How will a sharp slowdown affect the world?
A Chinese slowdown might have far less of an impact on the world than many expect, says Michael Pettis of Peking University’s Guanghua School of Management. People are wrong to assume that China drives global growth. “Arithmetically, China is the largest component of global growth, but that doesn’t make it the locomotive.”
This is because China has a huge trade surplus. That means it is a net exporter that relies on foreign demand; it is “a net drag on growth elsewhere”, as Capital Economics puts it. So the key to how China affects the world is what happens to its trade surplus, says Pettis. If it falls as the economy slows, this drag will go into reverse, providing a boost to global demand and helping to shore up growth elsewhere.
Japan’s experience illustrates this point, says Pettis. Before it collapsed in 1990, it was a key driver of global growth statistics. But its slump didn’t stop the global economy flourishing in the 1990s. Japan had been growing fast but because of its massive trade surplus, its growth had not been stimulating demand and growth elsewhere. When its trade surplus fell as growth slowed, the rest of the world got a fillip.
The FTSE is vulnerable
However, even if the world is not dependent on China’s economy, markets won’t be able to shrug off a slowdown. Commodity markets and commodity producers will be especially vulnerable, given that China is a key source of demand. That bodes ill for the FTSE 100 in particular, where raw materials companies comprise a third of the index, says Neil Hume in the FT. But given China’s perceived importance, all equity markets would be rattled, at least in the short term. Yet there is an upside. A China slide should temper global inflation by lowering commodity prices and thus keep interest rates low, in turn underpinning world growth.