TOKYO -- Market participants are rereading a year-old International Monetary Fund paper that took up the question of the global consequences of slower Chinese growth.
China's economic ties with the rest of Asia have deepened not only in terms of trade but also in finance, as Chinese foreign direct investment grows. This increased exposure to China requires "strengthening individual economies' resilience to shocks," the IMF wrote in its 2014 Spillover Report.
As anxiety over China buffets world markets like a summer squall, coming up with doomsday scenarios for the Chinese economy has become something of a cottage industry. The Daiwa Institute of Research put forward its own this month, albeit with the caveat that it sees only a limited possibility of a Chinese economic crisis in the near term.
Too much of everything
China's public spending binge to counter the effects of the 2008 financial crisis left it choking on excess capacity. It will take some time before the country's capital stock can be used productively. In the interim, banks have been saddled with debts that are unlikely to ever be repaid. This, in turn, encourages the banks to pull back, choking off the supply of credit to the economy.
In the "meltdown scenario," the most dire of the Daiwa Institute's what-ifs, China suffers a prolonged contraction that creates one of the biggest economic shocks in history.
"Derisking" is the word on everyone's lips. U.S. asset management heavyweight State Street observes two trends in institutional investors' recent stock trades. First, emerging markets are bleeding money the fastest. Second, defensive sectors, such as health care and utilities, are rallying worldwide. Both trends are textbook signs of a flight to safety.
The world has endured a string of financial crises over the past 25 years, from the Japanese bank failures of the 1990s to Europe's sovereign debt debacle this decade. But no global panic has ever originated in China. Although it is too soon to say such a crisis is upon us, the signs are sufficiently grave to create turmoil in global financial markets. China is, after all, the world's second-biggest economy, twice as large as the next biggest economy, Japan. The notion that the rest of the world can simply shrug off a sharp slowdown in China and let a resurgent U.S. take up the slack is not particularly credible.
When China sneezes
Asia relied on Chinese growth to pull it out of the economic rut it fell into following the collapse of U.S. investment bank Lehman Brothers. In 2009, Taiwan was the only major Asian economy to count China as its biggest market for high-value-added exports, according to a Mizuho Research Institute study published earlier in August. By 2011, Taiwan had been joined by South Korea, Indonesia and Malaysia.
The region is now suffering the side effects of its China dependency. A 0.7 percentage point decline in Chinese growth over two years will produce sharper slowdowns elsewhere in Asia, knocking 2.3 points off growth in Hong Kong, 2.1 points in Taiwan, 1.3 points in South Korea, and 1 point in Singapore, according to ratings agency Standard & Poor's.
S&P's estimates take into account only the direct effects of a China slowdown, such as falling exports to the country. But Asian economies would also suffer from secondary effects. Commodity prices are sinking as Chinese demand wanes. The Thomson Reuters Core Commodity CRB Index has dropped to its lowest level since 2002, down 40% from its June 2014 peak. But big crude oil importers like Japan cannot take unalloyed pleasure at the petroleum sell-off. Economic malaise in petrostates and rising bankruptcies in the U.S. shale oil industry will do no good for global growth.
Global financial markets have been waiting so intently for China to respond to the downturn. Fortunately, its relatively low ratio of debt to gross domestic product -- about 40% -- gives it some leeway to stimulate the economy further. "Our economists expect more fiscal measures," U.S. investment bank Goldman Sachs wrote in a memo to investors Aug. 24. Such steps could include handing out more money to local governments -- and twisting their arms to spend it -- and encouraging state-owned banks to extend more credit to companies.
China is beginning to respond. On Aug. 25, the central bank moved again to cut interest rates and lower lenders' reserve requirements.
China's bid for hegemony is at stake. China should foster a "prosperous neighborhood environment, and boost win-win cooperation and connectivity with our neighbors," President Xi Jinping told the Communist Party's top foreign policy body last November. His proposed "One Belt, One Road" economic corridors are an outgrowth of this diplomatic doctrine.
As of 2012, 124 countries counted China as their biggest trading partner, whereas only 76 did their largest share of trade with the U.S. Xi's vision of a "community of common destiny" sees Chinese economic prosperity enriching surrounding nations as well, earning China the world's respect and helping fulfill what Xi calls the "Chinese dream."
Whether that dream is fulfilled or goes sour, China shoulders a greater responsibility for global events than perhaps at any time in its history. Xi talks a lot about a "new normal." This is it.
Nikkei staff writer Ken Moriyasu in Tokyo contributed to this story.