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The stuttering stride of China creates global worries

02 September 2015 Jonathan Faurie
Jonathan Faurie, FAnews Journalist

Jonathan Faurie, FAnews Journalist

After being overlooked for so many years, the Chinese economy rose to prominence in 2007 with growth rates exceeding anything else the world had seen at the time. Like the former Soviet Union, it was now China’s time to build itself into a world economic superpower.

This was driven off the back of a significant infrastructure build programme where it seemed that the Chinese showed an insatiable appetite for commodities such as gold, platinum, coal and copper. However, it seems as if the bottomless pit of Chinese commodity consumption has been found as Chinese President Xi Jinping has indicated the presidency’s intention to move the Chinese economy from a commodity driven economy to a consumer spending based economy.

A world of trouble

The quandary that the rest of the world finds itself in is this: when China showed a significant appetite for commodities, the rest of the world jumped on the band wagon and dedicated significant resources into satisfying this hunger. But now, as China makes the move that it wants, the rest of the world is left stranded wondering what the next step will be.

Johann Els, Economist at Old Mutual Investment Group, points out that the biggest danger associated with China is probably related to sentiment. “China’s economy was already slowing and further policy easing was, and still is, expected as the Chinese government wants to reach its 7% real gross domestic product (GDP) growth target,” says Els.

He adds that the market meltdown came when China freed its currency thereby allowing it to depreciate. This led the market to believe that the Chinese economy is probably weaker than initially thought. Thus, Chinese authorities tried to stimulate exports through a weaker currency. However, Els feels this was a correction in markets, and not the start of a bear market.

The role of sentimentality

Chris Veegh, Head of Consulting at 10X Investments, agrees that the Chinese market is largely driven by sentiment and has given an example of how fickle this sentiment may be.

“Much of the price action since the Chinese slowdown was driven by speculation that Chinese A shares would join the MSCI Emerging Market index, and index trackers would be forced to buy the shares, whatever the price. The meltdown started when MSCI announced this would not happen for now,” says Veegh.

He adds that of bigger concern to investors has been the recent data releases out of China regarding falling Purchasing Managers' Index numbers which suggests declining trade figures. Other reports suggest that the Chinese economy is for all intents and purposes in recession, despite the published economic growth data, and the possible response of Chinese policy makers to this slow-down. “This has included trying to support the stock market, devaluing the currency, lowering interest rates and dropping banks’ required capital reserve ratios. These all suggest that policy makers are worried about the state of the economy.  This of course also impacts the international growth outlook, and may affect policy decisions elsewhere. The US Fed may well decide to postpone its first interest rate hike yet again,” says Veegh.    

Brittle and slow but moving forward

What does the Chinese meltdown mean for the world economy?

“The world economy remains slow, brittle and bumpy. But this market correction will probably mean easy economic policies for much longer than previously expected. Even expectations about the start of a US rate hiking cycle are being pushed out as it reinforces the slow pace of a US rate hiking cycle. However, the world should still gradually improve,” says Els.      

Veegh paints a different, yet not dissimilar picture. “The big knock-on effect, on the realisation that China may actually be in a recession, has impacted currencies, commodity prices, trade expectations and international share markets. A secondary issue is how Chinese policy decisions will impact foreign markets by way of possible further currency devaluations, or by lifting capital restrictions or by introducing some form of quantitative easing. This may mean more cheap money sloshing around the globe, looking for investment opportunities.”

Is there a light at the end of the tunnel?

This is the major concern that investors are wrestling with on a daily basis. Is the world so reliant on China that we are heading for dark times, or is there a light at the end of the tunnel?

“We don’t believe that the world has come to a dead end. There will always be innovation and opportunity and money will eventually flow in that direction. But there is a general acceptance that the world economy will not grow as fast as it has done in the first few years of this century, and the fact that China is not immune to that global slow-down will probably set expectations lower still,” says Veegh.

Els agrees with this pointing out that the troubles in China means that there will be easy policies for longer, as seen in the US.  “A lot of this holds for South Africa as well; slow growth and lower inflation means we have revised our interest rate forecast. There should be no more rate hikes in this cycle,” says Els.

Editor’s Thoughts:
Perhaps the major beneficiary of the Chinese turmoil is the man on the street. Yes the Rand has depreciated to record lows against the Dollar and the Pound, but if we are able to shelve the international holidays, our bond and car repayments may be a little easier. Please comment below, interact with us on Twitter at @fanews_online or email me your thoughts jonathan@fanews.co.za.

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