On Aug. 18, China’s stock market plummeted by a vertigo-inducing 6.2 percent in one day of trading, part of a months-long decline that’s erased over $3 trillion worth of market value from the country’s equity markets. That followed last week’s surprise decision to allow the value of the renminbi (RMB), China’s currency, to fall several percentage points against the U.S. dollar, which some view as a move intended to aid Chinese exports as the country’s economy flags. Global markets have appeared rattled, with major media outlets repeatedly invoking the specter of financial “contagion” from falling Chinese stocks and with major equity indices of the world’s biggest economies mostly retrenching in the days following the recent RMB devaluation.
How real is the threat of a global recession led by a deteriorating Chinese economy? Tea Leaf Nation asked several experts to respond to the recent hand-wringing. Stephen Roach, of the Yale School of Management, was previously Morgan Stanley’s chief economist; Patrick Chovanec is chief strategist and managing director at Silvercrest Asset Management and an adjunct professor at Columbia University’s School of International and Public Affairs; Derek Scissors is a resident scholar at the American Enterprise Institute; Daniel Rosen is partner and co-founder of the Rhodium Group, an advisory company, and an adjunct professor at Columbia University’s Graduate School of International and Public Affairs.
David Wertime: If and when a China-led recession happens, how might it differ in its particulars from previous global recessions — that is, what might a “recession with Chinese characteristics” look like?
Stephen Roach: The outpouring of concern over the likelihood of a Chinese recession is vastly overblown, in my view. Yes, China is struggling with a number of complex problems — the downside of a major equity bubble, excesses in its property market, deleveraging from a debt-intensive growth spurt in the aftermath of the Great Crisis of 2008-2009, and a decline in exports stemming mainly from sluggish growth in its major trading partners in the developed world.
For the rest of the world, this powerful shift in the basic structure of China’s growth model — from a focus on production to an emphasis on consumption — feels very much like a recession. It puts especially severe pressures on resource-based economies (such as Australia, Brazil, and Canada) as well as on producers of components and parts (largely in East Asia) that drive exports through China-centric supply chains. The sharp correction in global commodity prices is a direct outgrowth of the cumulative weakening in China’s old model of commodity-intensive economic activity.
Overlooked is this seemingly recession-like contraction in the Old China is the emergence of a new and increasingly powerful source of economic growth — a shift to services-led activity. In 2014, China’s services-based tertiary sector rose to 48.2 percent of Chinese GDP — up four percentage points from 2010 and well in excess of the 42.6 percent share in the manufacturing- and construction-led secondary sector. Chinese urban job growth has averaged slightly over 13 million in 2013-2014 — fully 30 percent faster than what the government had been targeting at 10 million; moreover, the data flow in early 2015 suggests that urban job creation is holding near the impressive pace of recent years.
Patrick Chovanec: A correction in China isn’t the event we’ve been dreading, it’s the event we’ve been waiting for. Worries about China’s economic downturn causing a global recession are based on the assumption that all growth is good growth, no matter where it happens or what it consists of, and that a downturn in China’s growth must be bad for everyone. In fact, a lot of the growth we’ve seen in China these past several years has been bad growth, or “growth” in quotation marks, that is harmful to the global economy, having created huge overcapacity and adding to a global glut of supply versus demand.
China’s over-investment boom inflated the price of inputs like copper, iron ore, and oil — but it deflated the price of all kinds of finished goods. The end of that boom is deflationary for inputs, which is clearly being felt by commodity producers, but by curbing overcapacity and shifting resources to the Chinese consumer, it will eventually help reflate other markets.
Derek Scissors: Weaker Chinese growth has already pounded commodities producers and unnerved asset markets but not triggered a global recession, since the ensuing lower prices simultaneously help commodities buyers. Financial contagion is unlikely since China is largely cut off from the rest of the world financially, due to its closed capital account.
The way China triggers a global GDP recession is to try to export [particular] problems. This is happening in steel, for example. If trade intervention occurred, it would expand China’s trade surplus further, cutting into rest-of-world GDP. It would also intensify the deflationary pressure China has exported for the past 15 years, which has been beneficial at some points but is harmful now.
A recession with Chinese characteristics thus looks like one we’ve feared off and on since the 1930s: deflation triggered by beggar-thy-neighbor behavior. It wouldn’t be as sharp as the Depression but would have multiple similarities: a major producer (United States then, China now) reacts to a bubble popping by trying to squeeze gains out of its trade partners. Seeing as they are already running large deficits with this large and suddenly irresponsible actor, the trade partners show no hesitation in retaliating. And off we go — though again, not in the same devastating fashion as the 1930’s.
Wertime: Is China better or worse equipped than the United States to safeguard against a recessionary event?
Roach: While it sounds very clever to call this a “recession with Chinese characteristics,” I think it misses the point of the powerful structural transformation that is now reshaping China’s economy.
China has not repealed the laws of the business cycle.The stiff headwinds it is now facing are certainly having an adverse impact on the industrial sector underpinnings of exports and investment. The recent shift in Chinese currency policy — from a decade of RMB appreciation to what I suspect will be a protracted depreciation — is a clear effort on the part of Chinese policymakers to cushion the blow. Targeted fiscal initiatives and recent accommodative shifts in monetary policy are also aimed at tempering the downside pressures.
Notwithstanding these initiatives, the most important thing that China can do to safeguard its economy is to stay the course of reform and rebalancing and provide ongoing support for the transformation to a new services-led, increasingly consumer-driven economy. If China were to backtrack on those efforts, then it would find itself quickly in the same box that the major developed economies are now trapped in — a quagmire of anemic growth with attendant pressures on jobs and social stability. The good news is that China has not succumbed to this temptation.
Daniel Rosen: China is a middle-income developing economy, several decades away from having the institutions and mechanisms advanced market economies use to safeguard against excess volatility — including on the downside — over economic cycles.
Chovanec: What the rest of the world should care about isn’t Chinese output (GDP) growth, but Chinese consumption growth. Even in the face of a downturn, Chinese consumer demand has the capacity to remain relatively resilient. People talk about China being a “global growth-driver” but in fact, by running chronic trade surpluses, it has been a growth-deriver. By propping up consumption in the face of an otherwise wrenching economic adjustment, China can become a source of much-needed demand and a true growth-driver for the world economy. The correction taking place in China is essential to making that happen.
Scissors: The question is not whether China is better equipped to safeguard against a recession compared to the United States now. That answer is easy: the United States is far, far better equipped. We have much richer consumers and an economy structured to serve them. We already run large trade deficits and can absorb even more in the way of foreign goods and services because we have the global reserve currency. China has none of these things. Its “successful” stimulus in the past has been production stimulus, exactly the opposite of what is needed.
China now would be a very bad joke as global economic leader.
Wertime: Might a China-led recession, perversely, mark its arrival as a great global power?
Roach: There is no shortcut to global power. For China, that can only come with a more sustainable approach to growth and development. The Chinese economy has come a long way in a very short period of time. But in many respects this was a powerful catch-up from the growth that was squandered in the quarter of a century under [Communist strongman] Mao Zedong’s leadership from 1949 to 1976. If anything, China stayed the course of the “catch-up model” for too long — resulting in what former Premier Wen Jiabao called an “unbalanced, unstable, uncoordinated, and unsustainable” economy. It was, in retrospect a recipe for trouble.
China’s stature as a global economic power can only come with a rebalanced and more sustainable economy. A recession in the old catch-up model is not sufficient to spark that ascendancy — unless it is accompanied by increased dynamism of the new — but it is likely to take years, if not decades, to reach the Promised Land. In the meantime, it is ludicrous to expect instant gratification from the current set of tough adjustments.
Rosen: Previous Chinese recessions came and went without marking the arrival of a new “great global power.” The extent of China’s global power is more dependent on other factors (such as confidence in the sustainability of its political systems, environmental stewardship, and ability to host basic capital markets) than it is on Beijing’s tolerance for business cycles.
Scissors: The extent of the damage the United States did to the world economy in the 1930s was due in part to the absence of a global economic leader. Britain had declined and Germany had aborted its own rise. Right now, the United States is still by far the dominant economic power. According to Credit Suisse, American national wealth is almost twice that of China and Japan combined; the average American makes 12 times as much annually as the average Chinese; China is even pegged to the U.S. dollar.
As long as the United States does not abandon its role, China cannot announce a larger presence on the world stage by causing a major downturn. It may well be that more bad economic choices make the United States in 2030 look like Britain in 1930 and open the door for China to be globally irresponsible. But it’s at least as possible that China in 2030 will be staggeringly deep in debt, demographically contracting, and the latest example of a statist failure.
Chovanec: The impact of China’s slowdown is not unlike the impact of Japan’s boom and bust. Like China, Japan was a chronic surplus country that derived growth from U.S. consumer demand. Japan did not drive U.S. growth in the 1980s — demand from America helped drive Japanese growth. When Japan faltered, and growth stagnated through the 1990s, it didn’t take the U.S. economy down with it, because it was never driving the U.S. economy in the first place.
I’m not saying this adjustment won’t be a bumpy path, or that the benefits will be immediately apparent. And anyone betting on the existing patterns of growth to continue is in for a rude surprise. But the net effect of China rebalancing will be positive for the global economy, and for the U.S. economy. None of this, by the way, depends on Chinese policymakers getting it right. This change is coming, whether they embrace it or not.
Text: China File by David Wertime 20-08-2015