Are we about to suffer another stock market crash similar to 2008 because of China?
China’s economic growth over the past three decades has astounded economists. Its GDP is the second largest in the world and many believe it could become the largest.
But as China’s role in the world grows so does its ability to affect global markets. There used to be saying “when the USA sneezes, the world catches a cold”. And with global financial markets intertwined, China could easily infect the world.
The uncertainty of the EU referendum, the possibility of Donald Trump becoming President and China’s faltering economy leaves many countries in a fragile state.
The FTSE 100 is down almost 13% since last year; the S&P 500 is down 9% since the start of 2016 and China’s growth has slowed from 7.9% to 6.7% over the last year.
With many countries in a vulnerable position, all it would take is another economic shock to set off a worldwide recession.
In recent months, we have seen the effects China can have on the global market, even in our own back yard.
China’s ability to produce products at such a cheap operating cost because of its cheap raw materials has caused UK steel markets to collapse.
It made so much steel that it even put itself out of business with supply vastly outweighing demand, causing thousands of job losses in in the steel industry worldwide.
China has been disturbing global markets as its totalitarian leaders try to prevent a stock bubble from bursting and a slowing economic growth from stalling.
But what can China do to prevent what many believe to be the shock that could set off another global recession?
The Chinese government imposes strict capital controls in order to keep its money within its borders. Therefore, the Chinese middle class, which has grown rapidly in recent years, has had little option but to invest in Chinese stock and property development.
This has caused a rapid spike in prices with the hallmarks of a bubble forming. This real estate boom has lead to over production as supply vastly outweighs demand leading to fears that the Chinese housing market is set to collapse.
China’s private and public debt stands at 280 per cent of its total GDP. While the size of the debt is worrying compared with other emerging markets, the rate at which it has grown is astounding.
Ha Jiming, Goldman Sachs chief investment strategist said: “Every major country with a rapid increase in debt has experienced either a financial crisis or a prolonged slowdown in GDP growth.”
Even if China slowed the increase of debt now it could risk a slowing of GDP only making the debt to GDP ratio worse.
The debt build-up must end sooner or later and when it does it will have a significant effect on the global economy.
China has also been experiencing vast amounts of capital flight taking place.
The Institute of International Finance measure capital outflows of about $735 billion from emerging markets with $676 billion coming out of China alone in 2015.
This comes at no surprise considering the grim state of faltering growth in China along with the capital controls put in place by the Chinese government and the continuing opacity of the markets making it incredibly difficult for investors.
No wonder investors wish to repatriate capital back to their own country.
However, some capital outflows are due to Chinese companies looking to pay offshore loans as the Renminbi continues to weaken, leaving them with healthier balance sheets.
The issue with these capital outflows is that they show no sign of slowing down due to the fragile state of the global economy.
This continuing capital flight can cause a lack of capital within China only impeding its economic growth further possibly leading to a hard landing if the Chinese government can’t control capital outflows.
If China was more transparent and open, it would improve investor confidence preventing the economy from stalling. Along with stable control of debt and house prices, it could pave the way for a more gradual decline in growth.
But with the European sovereign debt crisis, unemployment on the down and central banks already setting interests rates near zero there won’t be much in the way to stop an economic crisis in China spilling over to the rest of the world.
Josh McGurk is a third year economics student at Heriot Watt University