Will China crash, dragging the global economy with it?

Will China crash, dragging the global economy with it? China over the last 40 years has made stellar advancements in its economy. It is on track to be the largest economy in the world, If not already. It has been the envy of the world. The question for some is, is it sustainable? There are dark storm clouds building. News Forecasters outlines the major issues facing China and what may likely happen in a very few short years. Whatever happens in China, it will have a major impact around the globe.

Like many countries, after they have passed an initial economic development stage, suffers from the demographic challenge. The one-child policy has left a legacy that is likely to seriously impede its ability to compete in the global innovation race – a rapid decline in birth rates. This, combined with life expectancy longer than ever before, has led China to suffer from an ailment that has been shown to be detrimental to innovation – an ageing population. It also becomes problematic for youth employment replacement and funding of old age pensions.

China’s economic growth rate has slumped to its lowest levels in 27 years. The country’s GDP grew at 6.2% in the quarter ended June, the slowest quarterly growth rate since 1992 and down from 6.4% in the previous quarter. China is about 22% of the global economy. At the current growth rate, this with mean China’s economy would again double in about 11 years (72 rule/6.2%). This will obviously not happen. It is easy to double economies when they are small, but not when they get so large you impact the overall global markets. The reality is that Chinese growth rates will have to drop to between 3 and 5%, similar to other mature economies in the world. This means massive Chinese economic contraction will occur. Recent PMIs (Purchase Manager’s Index – a measure of future economic activity – see inside chart) is stagnating and even trending lower.

The China debt and banking situation is of concern. Euromoney’s latest quarterly country risk survey shows China’s total risk score slipping, adding to a longer-term deteriorating trend. Down one place this year in the global risk rankings, China is now 43rd out of 186 countries, sandwiched between Italy and Peru, both of which have lower (triple-B) investment-grade credit ratings from Fitch and Standard & Poors. Liquidity and solvency issues are already dogging some of China’s smaller banks predominantly lending to small and medium-sized enterprises (SMEs), with the sector facing contagion issues after the bailout of Baoshang Bank and Bank of Jinzhou by the People’s Bank of China (central bank).

For years it has been common knowledge that China takes delight in cooking its economic books. Perhaps the most notorious example is the long-standing problem with the country’s GDP figures, where the combined provincial figures do not tally with the National Bureau Of Statistics’ national total (discussed recently in “Data Fraud At Chinese Province Suggests Local GDP Numbers As Much As 20% “Overcooked“).

President Trump’s escalating trade war against China threatens to inflict a powerful shock to the American economy that not even the Federal Reserve can fully absorb. The trade war will only add to the downturn in manufacturing spanning the globe. It will further dent shaky business confidence and could even puncture the optimism among consumers. There seems to be no end in sight.

We have already discussed the Chinese situation with Hong Kong. Another issue for China is its Muslim population. Top Chinese officials claimed that a majority of Muslims detained in internment camps have been released and “returned to society.” But they offered no evidence that this was true. Authorities in the Chinese capital ordered halal restaurants and food stalls to remove Arabic script and symbols associated with Islam from their signs, part of an expanding national effort to “Sinicize” its Muslim population. China continues to build up its military to challenge and supplant the U.S. as the preeminent power in the Indo-Pacific region. Remember, China is still essentially a dictatorship with President Xi as it’s president in perpetuity.

In summary, reasons to be concerned with China are mounting:

  • Demographics.
  • Inevitable declining GDP growth due to maturing size.
  • Potential debt and banking crisis.
  • Fraudulent accounting.
  • Current U.S. China trade war.
  • Political instability – Honk Kong as an example.
  • Geopolitical military stance – especially in the Pacific rim.

What would a China crash (or significantly slow down) look like? The worldwide economic and political ramifications would take years to unfold. China is the world’s largest importer of oil, gas, coal, uranium, iron ore, copper, nickel, cobalt and alumina, the second-largest buyer of gold and liquefied natural gas, and the third-largest importer of lithium. Minerals, metals, chemicals, and energy make up almost 40% of imports. The commodity impact would be devastating to producers shipping to China. America’s resurgent oil and LNG industry would also suffer severely, bringing recession to states such as Texas and North Dakota. The most likely fall in U.S. agriculture products to China would also be devastating to U.S. farmers. This would force a sharp drop in the value of the renminbi, and attempts by Chinese manufacturers to offload surplus stock would lead to a surge of exports of cheap products, forcing even more Trump anti-dumping tariffs.

China would turn inward, and President Xi’s signature “Belt and Road” initiative would likely be dropped, drying up investment in Central Asia and Pakistan. Important Asian trading partners, such as Japan, South Korea, Taiwan, and Vietnam, would also be badly hit. President Xi increasingly authoritarian, centralized rule would be discredited; he would be greatly weakened, or be replaced by another leader, likely after a factional power struggle. Like many other falling leaders, would President Xi use war as a diversion?

So will China crash, dragging the global economy with it? News Forecasters place this risk as likely (50% chance) by 2020 to 2022. Just in time or after the U.S. presidential elections (place your political spin here)? Remember the current U.S. business cycle has been the longest ever, we are due for a recession. It will depend on what you mean by crash – recessions seem to get worse each business cycle (a function of exponential fractional reserve lending). Get your helmets on.

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