How we seem to forget the past :
Looking at the news over the past day or two you might be forgiven for thinking that this is nothing new after all much of the news since the crash of 08-09 has been about the slow and painful recovery of Europe, the very real risk of deflation and a unhealthy and economically illiterate fetish for deficit reduction, at any cost. This however might be a new beginning to bad news rather than a close, the question is, is China capable of stopping this spiraling out of control and are the rest of us ready if it does?
Across Europe countries such as Greece, Spain and Italy have paid far higher prices than most, but only now are the structural problems of the US, the UK and others really starting to look frail. The anaemic recovery in the UK finally seemed to be getting real wind behind it. The growth is being followed up by a boost in consumer and investor confidence, government bond yield are averaging around 2% and investment is cheap. Other than anaemic inflation the blame for which has been pegged on weak foreign demand for exports and the ever present fluctuations of the oil markets. At least most of the key indicators such and unemployment where heading in the right direction.
Then hit China’s currency manipulation, suddenly the warnings in the UK and US about raising the base rate of interest suddenly seemed small in comparison. The administration in China decided without consultation or warning to attempt to fix their waning level of growth which is down from an unnaturally debt fuelled 10%PA to a mere 7%PA.
The Chinese government debt ballooned from the financial crisis as they began following the neo-liberal trick of liberalising the credit markets in response to the US, EU and UK credit crunch of 08-09. Though the easing of credit seemed to fend off the worst of the credit crunch for China, it also led to speculative bubbles in housing, investment and overvalued share prices. It is this shift away from a debt fuelled speculative boom in China that now risks rocking the boat across the world. This balloon even with the best handling of the Chinese authorities will certainly cause some problems for the rest of Asia and the UK which are heavily exposed to Chinese debt though loans.
The Chinese model of never ending investment and export led growth was always bound to slow and cause serious issues in the medium run after decades of growing the emerging middle income group become less competitive and investment will dry up from outside China as middle income Chinese labourers decide to focus on consuming and the domestic consumer market. With China so heavily fixed into an export and investment led growth model this transition was always going to be a hard one. The question is if this is not managed well and contained could the second biggest economy in the world pull down Asia, a fragile Europe an upbeat UK and a tentative but positive USA.
Putting aside what this does to confidence and worldwide share prices which while damaging, can be overcome. If confidence in China does not return soon then the falling prices are likely to continue their knock on effect on other markets. This matters because some of this capital taking flight is used for investment purposes and can sap the life out of many companies that provide key services and employment.
There seems to be two possibilities and both carry risks. The first possibility is that China find it too hard to transition without causing a recession domestically, which in turn will take down many financial markets, test to the limit many new regulations and many really stretch both active and less active central banks which are already running low on options. This is the one that brings down markets like the finical crisis of 08-09 struggled to do so.
The other far less gloomy is that China manages to convince markets that with its giant reserves that it can transition with a small amount of pain and start growing its consumers domestically. If it can pull this off and start gearing itself away from the over reliance on investment and exports and towards a more sustainable path of a mixed economy with a strong and thriving consumer economy as well as investment. If this goes to plan then the world will live until another such day in an economy teetering on the edge of financial meltdown but with hope that lessons can be learned before anything hits the fan.