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As China's economy slows, overreliant world exporters start to hurt

When world's second-largest economy slumps, its suppliers go along for the ride

TOKYO -- There is one fundamental cause behind the turmoil that has been shaking global markets since the beginning of the month: China. As growth in Asia's largest economy slows, the rest of the world finds itself in the throes of its first China-induced economic downturn.

And investors fear that matters will only worsen, judging by the swipes China and the U.S. are taking at each other in their trade war. These include: U.S. President Donald Trump's announcement of more retaliatory tariffs to be levied against China in September, the Chinese yuan being allowed to weaken into the 7 per dollar range, and Washington naming China a currency manipulator.

In Australia, investors have had their sentiment deflated by the cool down in China, which has been the largest buyer of Australian exports since 2009, accounting for more than 30% of the total. Thanks in part to this large, enthusiastic customer, Australia has experienced nonstop economic growth for more than 27 years.

But from the beginning of August to last week Australian stocks fell 6%, and the Australian dollar dropped to lows not seen in a decade. Long-term interest rates sagged below 1% for the first time in the country as the market priced in an economic slowdown. Even The Australian Financial Review, an economic paper known for its restrained tone, ran a dramatic headline across the top of the front page on Aug. 7: "Nation's prosperity in crossfire."

Australian market insiders were particularly alarmed by a sharp fall in the iron ore market. Iron ore is Australia's largest export, and China, a steelmaking powerhouse, is its top buyer. International iron ore prices at one point fell as much as 25% from where they were at the end of July. Market jitters ensued.

Iron ore exports are a key driver of Australia's economy, so weak prices directly affect the country's growth. Imagine if prices of cars, Japan's top-earning export, suddenly plummeted 25%. The impact on Japan's stock market would be swift.

Australian investor sentiment is a microcosm of the global mood, darkened by fear of an imminent disaster being triggered by China's slowdown.

The recent economic confusion has taught market players that the global economy has relied on China to a much larger extent than had been assumed.

China contributed 16% of the world's gross domestic product last year, trailing only the U.S.'s 24%. While some might think the impact from China's economic downturn will be limited, Australians would likely disagree.

So would the International Monetary Fund. According to IMF estimates, China last year was the biggest buyer of 34 countries' exports. In 2007, before the global financial crisis, China was 13 countries' top customer.

The U.S. was the biggest export destination for 36 countries last year.

After the near meltdown in 2008, and with the U.S. economy faltering, China increased its global economic sway by going on a massive economic stimulus spree. During the period, China displaced the U.S. as the top buyer of exports from Japan, Brazil and South Africa.

There is more. China is among the top three buyers of exports from about 70 countries. That makes it an important client for more than one-third of the world's 200 or so nations. It also ensures that an economic downturn in China will have a global impact.

In Germany, which is suffering a hangover from its indulgence on exports to China, investor sentiment further cooled after the government on Aug. 14 announced negative growth for the April-June quarter. "The largest single reason [behind Germany's economic downturn] is almost surely China," Jim O'Neill, chair of the Royal Institute of International Affairs, wrote in an email.

China is Germany's third largest trading partner, after the U.S. and France. This standing is a big jump from 2007, when China was Germany's 11th largest trading partner. The leap is largely thanks to Chinese drivers becoming smitten with German automobiles.

During the same period, China went from buying 3% of Germany's exports to 7%. But when China's economic growth slowed and Chinese drivers began putting off car purchases, Germany suffered, too.

The real pain is yet to come: The Chinese government is accelerating its campaign to replace traditional cars with electric one. According to U.S. consultancy AlixPartners, the percentage of electric vehicles in a broad sense among domestic sales will rise to 19% in 2025, up from the current 7%. This year alone, more than 50 Chinese electric vehicle makers will unveil over 100 models.

Germany, whose economy depends on automaking, was slow in moving to electric propulsion systems, mindful of how the heavy investment would pull down short-term earnings and necessitate job cuts.

But the real danger is that if Germany does not act, the country it has transferred technology to will poach its customers.

In other words, Germany might not recover from its current hangover if its auto industry finds itself at a competitive disadvantage to China Inc.

Japanese companies will also have to formulate business strategies that account for the world's second-largest economy. One bright spot: Diplomatic relations between the countries have improved. "Now the tulip is open," a Japanese diplomatic source said, likening China to a pachinko machine that is enticing Japanese companies to play.

But the tulip will eventually close. Australia and Germany have firsthand experience with this.

Corporate Japan can earn stable profits from China by making products that industries in other nations cannot. For example, take a look at South Korea, where many consumers are boycotting Japanese products but where chipmakers are nonetheless scrambling to secure Japanese materials.

A similar dynamic has even played out in China. After Japan in 2012 nationalized a group of East China Sea islets that are also claimed by China, large-scale anti-Japanese demonstrations broke out in that country. But Chinese consumers continued to buy high-quality baby bottles made by Japan's Pigeon.

Looking ahead, Japanese companies will have to get serious about innovating. Despite corporate Japan's historic levels of cash reserves, companies' digital investments have been much lower than those of their U.S. peers.

This is beginning to bite. Since the end of last year, many Japanese producers have posted worse-than-expected earnings as China's economy began to lose steam. Japanese stocks may soon be at the mercy of China's economy.

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