The turbulence in Chinese markets continues to fray many nerves globally, and rightly so as China is the world’s second-largest economy. The Chinese growth engine is sputtering and not helping to pull along growth for the rest of the world. The catalyst for the financial market turmoil that started early this year was China’s plunging stock market, caused by its questionable financial policies. Markets experienced a similar episode last summer. While this appears scary and a major slump would be profound, it is important to understand the cause of the slowdown in the Chinese economy and the need to put it into perspective relative to the U.S. economy.
The Chinese philosopher Lao Tzu wrote that “A journey of a thousand miles begins with a single step.” The Chinese government is attempting to re-engineer its economy to rely less on investment spending and transition itself away from manufacturing and heavy industry toward more internal consumption. This is no surprise, as the strategy had already been long communicated when I visited policymakers in Beijing in 2007. This transition has meant cutting the double-digit pace of Chinese economic activity nearly in half. The former pace of growth was dependent on capital spending required to build factories, rail networks and roads — significant expenditures and far larger than spending focused on consumer-driven needs for household consumption. Making this pivot for an economy that steers more like an ocean liner than a speed boat is a difficult thing to achieve. Other reforms were needed, including moving from a command-and-control model toward a market-based economy including developing their debt and equity capital markets. The transition is a process that will take many decades and the deceleration will be drawn out with fits and starts.
Economic factors from deflationary prices and weather conditions to reduced foreign tourism and shifting consumer preferences came together in 2015 to create an interesting and challenging environment for retailers. Looking at the year ahead, NRF Chief Economist Jack Kleinhenz believes the economy remains on solid footing and the probability of a major slowdown is relatively low. Download the January 2016 report.
The recent volatility in the Chinese stock markets and elsewhere reflects the challenges in rebalancing the economy. There have been setbacks and consequently there are heightened concerns about the current strength of the economy to withstand these changes. Equally important is whether central government authorities are able to manage and navigate China’s currency markets and equity markets in this new environment. In my view, the government has the financial resources and flexibility to respond its challenges and will attempt to steer the ship to safety.
The direct effects and the exposure of the U.S. economy to China are rather limited. This is quite evident by looking at trade ties as the United States imports nearly four times the amount of goods from China as it exports to China. The value of U.S. exports to China are less than 1 percent of U.S. gross domestic product. On the other hand, the value of imports from China are worth about 10 to 12 percent of all goods consumed by U.S. households.
Of course, financial linkages of U.S. companies and banks need to be considered in the event of a collapse associated with the loss of U.S. exports to China and U.S. investments there. While these risks should not be minimized, these finances are not very extensive. Looking forward I do not currently believe that Chinese economic activity will entirely collapse into recession. It is not hyperbole to state that the U.S. consumer is keeping China and the world economy afloat. As long as the world’s largest economy driven by consumer spending remains on solid footing, it will provide ballast for China to navigate the choppy waters of transition.
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