VSChina has played a central role in the history of globalization over the past 30 years, but today it is in trouble. More than two years after the discovery of Covid-19 cases in Wuhan, the world’s most populous country has yet to bring the virus under control. Draconian lockdowns have been imposed because Chinese vaccines are less effective than those available in the West and immunity levels are also lower.
Growth is slowing, and not just because of tough restrictions imposed by President Xi Jinping. Flaws in the Chinese economic model coupled with a more hostile geopolitical climate mean that the days of explosive expansion are over.
Unlike the US, UK or the Eurozone, China does not face the inflationary problem that caused central banks to raise (or consider raising) interest rates. On the contrary, the People’s Bank of China is easing its policy to stimulate credit growth. Authorities will try to spend and export to get by.
China’s emergence as an economic superpower was finally recognized in the aftermath of the global financial crisis of 2007-2009. With its banks unable to operate normally, the United States was unable to carry out its traditional task of pulling the world economy out of recession. Instead, the driving force went to China, which gave its economy a double boost through public investment and credit expansion. China recorded double-digit growth, absorbing goods from Germany and Japan.
This policy had costs, one economic and one political. The economic cost was that China generated colossal debt, which fueled a housing boom. Non-financial debt as a share of the economy’s annual output (gross domestic product) has more than doubled from its pre-global financial crisis level of 290% of GDP. Real estate giant Evergrande’s troubles underscored the economy’s vulnerability to a debt crisis.
The political cost began as a matter of perception: the fear in the United States that China was a threat to American economic hegemony. Washington had worried in the 1980s about the threat posed by Japan, but China was an entirely different ballgame. Initially, the assumption in Washington was that as China grew wealthier, its political system would become more democratic. Xi’s hard-line approach to dissent has disillusioned American politicians with the notion. As a result, the process of globalization first stopped and then reversed. The United States has become protectionist under Trump and has encouraged companies to bring production home. Complaints about Chinese patent piracy and intellectual property theft have been on the rise. The United States has pressured its allies, including Britain, to ban Chinese foreign investment in specific sectors.
This trend was then amplified by the pandemic, which made the West even more wary of being exposed to long supply chains that start in China. And while China will eventually emerge from Covid-19 lockdowns, recent restrictions imposed in Shanghai and elsewhere have added to the jitters. In early 2017, when Xi showed up at the World Economic Forum in Davos as an advocate for globalization, that seemed a long way off.
The upshot of all this is that China’s growth rate is sure to slow down. Weaker growth and a zero-tolerance approach to Covid create the conditions for political dissent – and political repression. The economy’s underlying problems may worsen, especially if the authorities believe that unbalanced growth is better than no growth at all.
There will be many in the West, and the United States in particular, who will rejoice in China’s discomfort. Little unites Democrats and Republicans these days, but one of the things that results is hostility toward Beijing. Donald Trump’s trade war has led to a marked cooling of relations, but they have remained cold under Joe Biden.
Washington should be careful what it wishes for. China is a massive economy, and a real economic crash would be as damaging to the world as another subprime mortgage crisis in the United States or the breakup of the Euro.
There is, however, another reason for concern. As Charles Dumas notes in a report for TS Lombard, China’s full integration into the global economy since the early 1990s has been a key factor in the steady rise in stock prices on Wall Street.
Dumas says that the last 100 or so years can be divided into two parts: the period 1914-91 and the post-Cold War era. The first period included two world wars, the Great Depression of the 1930s and the high inflation of the 1970s, with an alternative to capitalism still offered by communism. The second period saw capitalism triumph over communism and Western businesses move to China, where labor costs were lower. Profits have gone up and the return demanded by investors to put their money at risk has gone down.
“The” danger in today’s markets is that Russia’s invasion of Ukraine, along with US-China divisions and de-globalization, herald insecurity for investors that demands a higher real return in what could s turn out to be a new cold war between the west and China/Russia (the former communist states, now totalitarian),” says Dumas.
There have been four stock market crashes in the past 100 years: the Wall Street crash of 1929, the bursting of the Japanese stock bubble in 1991, the dotcom implosion a decade later, and the global financial crisis.
Stock markets have fallen sharply in recent weeks, and the assumption – as always – is that they will rebound. The fact is, however, that the world is a riskier place than it was not so long ago, and China is one of the main reasons for that.