China has been central to the story of globalisation over the past 30 years, but now it is struggling. More than two years after Covid-19 cases were discovered in Wuhan, the world’s most populous country has yet to get on top of the virus. Draconian lockdowns have been imposed because China’s vaccines are less effective than those available in the west, and immunity levels are lower as well.
Growth is slowing, and not just because of the tough restrictions insisted upon by President Xi Jinping. Flaws in China’s economic model coupled with a more hostile geopolitical climate mean the days of explosive expansion are over.
Unlike the US, the UK or the euro area, China is not facing the inflationary problem that has prompted central banks to raise (or think about raising) interest rates. On the contrary, the People’s Bank of China is easing policy to stimulate credit growth. The authorities will try to spend and export their way out of trouble.
China’s emergence as an economic superpower was finally recognised in the aftermath of the global financial crisis of 2007-09. With its banks unable to function normally, the US was incapable of assuming its traditional task of hauling the global economy out of recession. Instead, the locomotive role went to China, which provided a twin boost to its economy through public investment and credit expansion. China grew at double-digit rates, sucking in goods from Germany and Japan.
There were costs to this policy, one economic and one political. The economic cost was that China generated a colossal amount of debt, which fuelled a property boom. Non-financial debt as a share of the economy’s annual output (gross domestic product) has more than doubled since its pre-global financial crisis levels to 290% of GDP. The problems of the property giant Evergrande emphasised the vulnerability of the economy to a debt crisis.
The political cost started off being a matter of perception: fear in the US that China was a threat to American economic hegemony. Washington had been concerned in the 1980s about the threat posed by Japan, but China was a whole different ball game. Initially, the assumption in Washington was that as China became richer, so its political system would become more democratic. Xi’s hardline approach to dissent has disabused US politicians of this notion. As a result, the globalisation process first stalled and then went into reverse. The US turned protectionist under Trump and encouraged firms to bring their production back home. Complaints about Chinese patent piracy and the theft of intellectual property grew louder. The US put pressure on its allies, Britain included, to ban Chinese inward investment in specific sectors.
This trend was then amplified by the pandemic, which made the west even warier of being exposed to long supply chains that begin in China. And while China will eventually emerge from Covid-19 lockdowns, the recent restrictions imposed in Shanghai and elsewhere have added to the nervousness. Early 2017, when Xi turned up at the World Economic Forum in Davos as the defender of globalisation, seems an awfully long time ago.
The upshot of all this is that China’s growth rate looks certain to slow. Weaker growth and a zero-tolerance approach to Covid create the conditions for political dissent – and political crackdowns. The underlying problems of the economy may get worse, especially if the authorities take the view that unbalanced growth is better than no growth at all.
There will be many in the west, and in the US in particular, who will take delight in China’s discomfort. Not much unites Democrats and Republicans these days, but one of the things that does is hostility towards Beijing. Donald Trump’s trade war led to a marked cooling of relations, but they have remained chilly under Joe Biden.
Washington should be careful what it wishes for. China is a massive economy, and a full-blown economic crash would be as damaging to the world as another subprime mortgage crisis in the US or the breakup of the euro.
There is, though, another reason to be concerned. As Charles Dumas notes in a report for TS Lombard, China’s full integration into the global economy since the early 1990s has been a key factor behind the steady rise in share prices on Wall Street.
Dumas says the past 100 years or so can be divided into two parts: the period 1914-91 and the post-cold war era. The first period included two world wars, the Great Depression of the 1930s and the high inflation of the 1970s, with an alternative to capitalism always on offer from communism. The second period saw capitalism triumph over communism and western firms move to China, where labour costs were lower. Profits went up, and the yield demanded by investors for putting their money at risk went down.
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“The” danger in current markets is that the invasion by Russia of Ukraine, together with US-China divisions and de-globalisation, heralds insecurity for investors that requires a greater real-earnings yield in what could prove to become a new cold war between the west and China/Russia (the former communist, now totalitarian states),” Dumas says.
There have been four stock market busts in the past 100 years: the Wall Street crash of 1929, the bursting of the Japanese equity bubble in 1991, the dotcom implosion 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 bounce back. The fact is, though, the world is a riskier place than it was not long ago, and China is one big reason for that.
