With much of the developed world still entangled in the balance sheet recession China has become an increasingly important economy. While discussing their biggest risks to 2011, UniCredit analysts explained why it is not the EMU that worries them in the future. It is China that most worries them. And not necessarily because they believe a hard landing is coming to China, but simply because China is becoming an increasingly important component of the European economy. The region’s largest economy is no exception:
In our view, the major downside risk to our rebalancing story is China – and not the European debt crisis. Although the odds for a broadening upswing are currently higher than in any constellation in the last ten years or so, the German economy is certainly not invincible. A hard landing in Emerging Asia would have enormous negative repercussions on German exports. This, in turn, would result in decreasing internal demand, and shock companies and consumers alike. For instance, further strongly rising consumer prices in China may lead to overly aggressive monetary tightening, weighing on the residential property market and on investment activity. Since the collapse of Lehman Brothers in autumn 2008, China has become more and more important for German companies. In the meantime, the export share (including HK) is 6% compared to less than 4% only two years ago. The figure for Emerging Asia plus Japan is a high 12%.”
In contrast, the European debt crisis is probably less relevant, as German export shares to Ireland (0.4%), Greece (0.6%) and Portugal (0.8%) are rather small. Even the impact of Spain (3.6%) seems to be comparatively modest. However, we acknowledge that there could still be adverse psychological effects, as had been the case at the beginning of the global financial crisis about two years ago. This is not only relevant for export-dependent companies but also for consumers. According to a recent survey, 60% of all Germans would like to keep the euro, whereas 36% are in favor of reintroducing the D-Mark. This ratio could quickly deteriorate further, thereby sewing consumers’ pockets shut.
The incredible growth in China is a welcome development for a western world whose problems would be far worse without it, but there are alarming facets in the Chinese growth story – particularly for one who calls him or herself a capitalist. China appears to have perfected this form of state run capitalism and it is working – at least for now. This incredible growth has led to an ever increasing reliance on China’s economy.
While it’s great to see citizens in China breaking free from the stranglehold of communism it’s also disconcerting that the global economy has become increasingly dependent on a nation that is insistent on running a flawed currency peg that contributes so severely to global imbalances. More importantly, it remains to be seen whether this form of state run capitalism can play out over the long-run without causing severe imbalances in the domestic economy.
At some point, paying construction workers in Beijing to build an unpopulated city in the desert has repercussions in the form of inflation. With their focus on managing foreign exports via a currency peg it will be interesting to see if China has the tools and fortitude to deal with the more important risk of rising domestic overcapacity. If they can’t properly contain these problems the repercussions will be felt not just in China, but all over the globe.
Disclosure: No position