Events in China and their apparent impact on global markets may have people coming back from their summer break wondering what just happened. One part is not complicated: China’s economy has been weakening for years, and this remains only a minor threat to the American economy. But new instability in Beijing’s policy choices means they need to be watched.
China faces serious economic problems. The seeds of Chinese stagnation were sown no less than 12 years ago, when the government initiated an investment boom that unbalanced the economy.
{mosads}The government’s chief measure of investment grew 12 percent in 2001, but climbed at least 24 percent annually from 2003 through 2012. This was not sustainable, and the latest growth figure is 11 percent. Perceived weakening starts with the unavoidable cresting of the 2003 investment wave.
China’s then-acclaimed 2008-9 stimulus was an even bigger mistake. Whatever positive it might have accomplished, it is far more important that the fastest debt-run up in history ensued.
In 2007, Chinese debt was not worth mentioning as a global risk. By 2014, some previously optimistic observers were finding a $20 trillion rise in Chinese debt in just seven years. More conservative estimates still run to an increase of more than $13 trillion (to put it in context, this is twice the size of cumulative U.S. fiscal deficits over the same period).
Debt is a productivity killer. Combined with the aging of the country’s workforce, it is no surprise at all if China’s economy weakens. It should not be a surprise if it eventually stagnates entirely.
China’s problems did not suddenly intensify in June. The economy did not get stronger in July 2014 when the Shanghai stock market began rising; quite the contrary. Nor did it get weaker when the market began falling. Chinese stocks do not reflect corporate profits or any other fundamental indicator, but rather perceptions of the government’s stance on share prices.
Share prices are still about 50 percent higher than 15 months ago. The 20 million late-coming and now angry Chinese retail investors are a political issue for the Communist Party, but they are not a global financial threat.
China’s problems are not a major threat to the U.S. economy. A decade ago, China was strongly contributing to our economy by keeping prices down when growth and monetary policy would have otherwise pushed them higher. In the current environment of durably low growth and inflation, Chinese production is no longer nearly as helpful and may even be unnecessary.
Some may be concerned that China will chose or be forced to sell U.S. Treasury bonds, sending interest rates higher. After rising $800 billion from mid-2006 to mid-2010, Chinese holdings of long-term American debt did not budge from mid-2010 to mid-2014, even as our borrowing surged. Yet interest rates remained low and our economy certainly did not start to weaken in mid-2010.
American exports to China did fall in the first half of this year over the first half of last year. But the decline was less than $3 billion, a rounding error in light of U.S. household net worth of $85 trillion at the end of the first quarter. Certain American companies are highly exposed to now suspect Chinese demand. That is a major challenge for them, not for the economy as a whole.
Chinese policymaking is disturbing and should be watched. The most likely way China’s long-term economic difficulty triggered a sudden global disruption was the small devaluation Beijing announced Aug. 10. At 1.9 percent, the devaluation was less than one-tenth the size of the yuan’s run-up against the yen and euro over the previous year and was, in that light, harmless.
But while China’s stock market sees a boom-bust cycle every seven to eight years, it has not devalued since 1994. It did not devalue during the global financial crisis or the Asia’s regional financial crisis before that. Perhaps most alarming, the devaluation announcement was a surprise.
The prospect of a further, meaningful devaluation terrifies China’s currency-conscious trade competitors. It adds to global worries about oversupply and deflation, which already had China at the center.
The main question, therefore, is whether more policy surprises are coming. Beijing can again intervene in stocks and it is merely a spectacle — Thai stocks are more strongly correlated with the Standard & Poor’s 500 index than Chinese. But more Chinese production subsidies that lead to more dumping on American and global markets, for instance, can cause serious harm.
Party General Secretary Xi Jinping visits the U.S. in two weeks. Normally, this is time for American demands that achieve little. This particular visit should be a time for questions: What else is coming our way? China’s economy continues on its slow downward course; this is not a serious risk. Unstable Chinese policy could be.
Scissors is a resident scholar at the American Enterprise Institute (AEI), where he studies Asian economic issues and trends.