China’s importance still underplayed
The turmoil in China is both less serious and more serious than generally assumed.
It is less serious in the sense that the connection between financial volatility and economic weakness is far from straightforward. In China’s case it could be argued that the ups and downs of the GDP growth rate are, to some degree, reflected in a hugely magnified form in the movements of the Shanghai Composite stock market index. But that is insufficient to prove the Chinese economy is suffering from underlying structural problems.
Comprehensive research suggests that there is no simple link between economic growth and stock market performance. ‘Triumph of the Optimists’, a 2002 study of long-term equity returns in a broad cross-section of countries, reached the startling conclusion that, if anything, they are negatively correlated to GDP growth per head. Sadly, many market experts have failed to appreciate the importance of this conclusion. It is common to hear equity returns and economic growth discussed as if they are closely tied.
But the lack of a general pattern does not rule out the possibility of fundamental Chinese economic weakness this time around. If that is the case, and it is a subject that demands in-depth investigation, it would be a serious matter not only for China but for the global economy.
The world is far more dependent on Chinese economic dynamism than generally appreciated. Astute observers recognise that China has contributed over a third of global growth since 2008-09. But even in the earlier years of that decade China was the predominant force driving the world economy forward.
China’s importance in the earlier period is generally missed because observers were too fixated with US demand. The common refrain from the late 1990s was that the world economy was ‘flying on one engine’ with the American consumer as the driving force.
This orthodoxy missed the way that Chinese production underpinned US consumption. American demand was, in effect, buoyed by cheap credit from China as the emerging Asian giant used some of the proceeds of its growth to buy US Treasuries.
Without a dynamic China, the plight of the world economy in recent years would have been far worse. China’s forward momentum muted the effect of the recession that followed the global financial crisis and softened the euro-zone’s troubles.
From this perspective it should be clear that if China is suffering more than a measured slowdown it could have serious consequences for all. Despite all the talk of recovery, the advanced economies are just limping along. Without huge inputs of credit from central banks their stagnation would be all too apparent.
If China also succumbed to economic atrophy it would no doubt benefit a few. Most bond investors would probably prefer sluggish global growth over rapid expansion with the attendant risk of inflation. The bulk of the population would no doubt take a different view.