Here's why global jitters about a China meltdown are probably overblown

China’s economic slowdown has wreaked havoc on commodity prices, helped push countries like Brazil into a severe recession and cast a pall over U.S. and other financial markets as investors grow increasingly worried about the health of the Asian giant.

American stocks bounced higher Thursday after getting walloped a day earlier and the Dow Jones Industrial Average edged close to a 10% decline from its recent high, the definition of a market correction.

The big question now is to what extent the slowdown in the world’s second-largest economy will have on the rest of the globe. It depends in large part on how much worse things get in China and whether growth continues to ease gradually, or falls precipitously, which is seen as less likely. Market anxieties could also prompt businesses and consumers to become more cautious, triggering a downward spiral.

For now, however, most economists agree that fears of meltdown in China triggering a sharp global downturn are overblown.

The latest upheaval in China’s stock and currency markets, which at year’s start spread gloom among investors and more recently helped push oil prices down further, doesn’t mean the Chinese economy has suddenly deteriorated. By most accounts, China is likely to remain the single biggest driver of global growth in 2016.

“Pessimism is feeding on itself,” said Sara Johnson, senior research director of global economics at consulting firm IHS, who sees the U.S. and global economies improving slightly from last year’s moderate growth pace to 2.7% and 2.8% this year, respectively.

China’s growth rate is expected to moderate to 6.3% this year from 6.9% last year, a significant decline but still more than twice the rate of the U.S. Johnson put the odds that China’s economy will slow to less than 5%, which she considers to be a “hard-landing,” at just 1 in 4.

If these projections hold up, China will remain the leading locomotive for the world economy, as it has been since the depths of the Great Recession in 2008. Last year China accounted for about one-third of the global economic growth, compared with about one-fourth for the U.S.

“Clearly markets are nervous because if China goes, the U.S. and the rest of the world isn’t going to compensate for that,” said Domenico Lombardi, a global economist at the Center for International Governance Innovation in Waterloo, Canada.

But he noted that nothing has changed in China’s growth prospects in the last two weeks of the stock market turbulence. “We have to look at the real economy, the fundamentals, the [government’s] reform agenda. So far, it doesn’t look like any pullback.”

China’s slowdown, after years of double-digit annual growth, reflects the nation’s attempt to create a more diversified and sustainable economy. And in some important ways, China is better positioned to make the difficult transition away from exports and investments and into a consumer-driven service economy than other Asian tiger economies that have attempted to do so.

In fact, China is further along in that adjustment than is generally known. The conventional thinking is that China’s economy remains dominated by an industrial sector focused on exports. It was a weakening of China’s manufacturing data early this year that largely set many global investors on edge.

But this ignores the relatively strong services sector, which has been the main engine of Chinese growth for the last three years and now accounts for more than half of the country’s economy, said Nicholas Lardy, a China expert at the Peterson Institute for International Economics. China’s opaque economic and political system makes it impossible to know for sure, but Lardy and other analysts are confident that Chinese private spending has continued to rise even as manufacturing has slowed.

“Our picture of China as a big export machine just isn’t accurate,” said Barry Bosworth, an Asia economic expert at the Brookings Institution. “What matters is that China is fundamentally a domestically based economy. It’s a great big domestic economy. And a threat of a collapse is very small. It’s just got too much wealth behind it.”

That’s not to say that China doesn’t have serious economic risks and challenges, among them huge debts from excessive investments in property, an oversupply of steel and other goods, inefficient state-owned firms and a rapid outflow of capital from China.

But even if those fault lines open, Beijing has the resources and will, at least for some time, to maintain satisfactory economic growth, which is crucial for its political legitimacy. With foreign reserves of about $3 trillion, if worse comes to worst, Chinese officials can be expected to throw money at the problem, as Beijing has repeatedly done by bailing out debt-laden banks and other vulnerable sectors of the economy.

Neither Japan nor South Korea had anywhere near that kind of cushion when each struggled in the 1990s, Japan with a real estate and banking crisis, and South Korea with speculative currency attacks that paralyzed its economy. And Beijing doesn’t have the intractable political warring found in the U.S. and other democracies that can stifle action. “Government control allows them to engage in stimulus,” said Clyde Prestowitz, an Asia expert and top trade negotiator in the Reagan administration.

China’s much-larger size, however, also means that the scale of its overcapacity in raw materials and enormous government debts pose bigger threats in the long run. And Beijing’s clumsy hand in steering the nation’s economy has only added to the nervousness about China’s future. Officials have taken herky-jerky steps to quell chaos in their stock markets and have mishandled their still tightly controlled currency. The result has been an abrupt fall in the yuan in recent weeks that has alarmed investors and further depressed commodity prices and other currencies, intensifying pressures on resource-dependent economies across the globe, including Brazil and South Africa.

China’s weakening currency will further pinch U.S. manufacturing as American goods will be a little more expensive in foreign markets. Concerns about Chinese growth, coupled with the strong U.S. dollar, have also sent oil prices tumbling, raising the specter of widespread bankruptcies for oil producers and related companies in the U.S.

Still, most economists figure the American economy, in its seventh year of recovery and expansion, can weather the weaker slowing activity in China and other emerging economies, including Russia, which remains mired in recession. U.S. domestic consumer spending has been solid, as has private-sector job growth. Exports to China account for less than 1% of the American economy. Banks and other corporations are coming off a string of record profits. Home-building is showing more strength.

“U.S. domestic demand is fundamentally strong,” Johnson said. One of her biggest concerns for the American economy, she said, is that falling oil and other commodity prices will intensify global deflationary pressures. If that happens, she worries that consumers and businesses will be more cautious about spending and investing.

“China is central to that risk,” she said. But at least for the moment, Johnson viewed it as a very low threat. After all, she said, “China’s government has ample financial resources to constrain any major slowdown.”

Twitter: @dleelatimes 

Copyright © 2016, Los Angeles Times

UPDATE

2:31 p.m.: The story was updated with additional background, quotes and analysis.

The story was originally published at 8:32 a.m.

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