China has been at the heart of globalization for the past 30 years, but is now struggling. More than two years after the discovery of Covid-19 cases in Wuhan, the world’s most populous country has yet to deal with the virus. Draconian blockades 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 the strict restrictions demanded by President Xi Jinping. The shortcomings in China’s economic model, combined with a more hostile geopolitical climate, mean that the days of explosive expansion are over.
Unlike the United States, the United Kingdom or the eurozone, China is not facing the inflation problem that has forced central banks to raise (or think about raising) interest rates. On the contrary, the People’s Bank of China is easing its policy of stimulating credit growth. Authorities will try to spend and get out of trouble.
China’s emergence as an economic superpower was finally recognized after the global financial crisis of 2007-2009. As their banks could not function properly, the United States was unable to take on its traditional task of pulling the world economy out of recession. Instead, the role of locomotive went to China, which provided a double boost to its economy through public investment and credit expansion. China is growing at double-digit rates, sucking goods from Germany and Japan.
This policy had costs, one economic and one political. The economic cost was that China was generating a colossal amount of debt, fueling a property boom. Non-financial debt as a share of the economy’s annual output (gross domestic product) has more than doubled since pre-global levels to 290% of GDP. The problems of the property giant Evergrande highlighted the vulnerability of the economy to the debt crisis.
The political cost began to be a matter of perception: the fear in the United States that China was a threat to American economic hegemony. Washington was concerned in the 1980s about the threat from Japan, but China was a very different ball game. The initial assumption in Washington was that as China became richer, its political system would become more democratic. Xi’s firm approach to disagreement has disappointed American politicians. As a result, the process of globalization first stopped and then reversed. The United States became a protectionist under Trump and encouraged companies to bring production back home. Complaints about Chinese patent piracy and theft of intellectual property are growing. The United States has put pressure on its allies, including Britain, to ban Chinese investment in certain sectors.
This trend was then exacerbated by the pandemic, which made the West even more cautious about exposing long supply chains ending in China. And while China will eventually come out of blocking Covid-19, recent restrictions imposed in Shanghai and elsewhere have added to the nervousness. The time, in early 2017, when Xi appeared at the World Economic Forum in Davos as a defender of globalization, seems a long time ago.
The result of all this is that China’s growth rate will certainly slow down. Weaker growth and a zero-tolerance approach to Covid create conditions for political dissent – and political repression. The main problems of the economy may worsen, especially if the authorities accept that unbalanced growth is better than no growth at all.
There will be many in the west, and in the United States in particular, who will enjoy China’s discomfort. It doesn’t unite Democrats and Republicans much these days, but one of the things they do is hostility to Beijing. Donald Trump’s trade war led to a significant cooling of relations, but they remained cool under Joe Biden.
Washington must be careful what it wants. China is a huge economy and a complete economic collapse would be as disastrous for the world as another US mortgage crisis or the collapse of the euro.
However, there is another cause for concern. As Charles Dumas noted in a report for TS Lombard, China’s full integration into the world economy since the early 1990s has been a key factor behind the steady rise in Wall Street stock prices.
Dumas says the last 100 years can be divided into two parts: the period 1914-91 and the post-Cold War era since then. The first period includes two world wars, the Great Depression of the 1930s and the high inflation of the 1970s, with an alternative to capitalism always offered by communism. In the second period, capitalism triumphed over communism and Western companies moved to China, where labor costs were lower. Profits rose and the yield required by investors to put their money at risk declined.
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The “danger” of current markets is that Russia’s invasion of Ukraine, along with the split between the United States and China and globalization, portends uncertainty for investors, which requires greater real profits in what could turn into a new Cold War between the West and China / Russia (former communist, now totalitarian states), ”says Dumas.
There have been four stock market crashes in the last 100 years: the Wall Street crash of 1929, the bursting of the Japanese stock bubble in 1991, the impetus of a dotcom 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 return. The fact is, however, that the world is a riskier place than it was a long time ago, and China is a big reason for that.
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