Could China's Meltdown Derail The U.S. Economy?

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by: Motif Investing

Summary

With 2016 off to a rough start, there are fears that China's 40 percent stock market declines from recent highs could spell trouble for the global economy.

Fears of a Chinese housing bubble collapse, social unrest, and declining demand for imports trouble investors.

The resilience of the U.S. economy in comparison to Japan's after its bubble burst in 1989 may imply that China's slowdown may not have as big of an impact as many fear.

A decline in China's growth could lower Chinese buyer demand of U.S. property.

There's a funny saying that when China sneezes the world catches a cold. With China's Shenzhen and Shanghai stock markets down over 40 percent from its recent highs, fears are growing that China's slowdown will derail the global economy. Already, we've seen the worst 10-day decline in the S&P 500's history in 2016.1

In 1990, China produced less than 3 percent of global manufacturing output by value. Now its share is close to 25 percent.2 China produces most of the world's air-conditioners, phones and shoes. From Apple's ubiquitous iPhones to Nike's $190 Air Jordans, so much of what the world consumes comes out of China thanks to its competitive wages and operational efficiencies.

Slowdown Stirs Up Fear

Despite the production dominance China exhibits, not all is well. There is a glut of property that raises fears of a housing bubble collapse like the one we saw in the United States. Local governments have accumulated alarming debt levels that may prove difficult to repay.3

Meanwhile, the dependable 7 percent+ annual GDP growth figure China has experienced for decades is no longer a given, causing Beijing nightmares about increasing social unrest between the haves and the have-nots. Fast growth is necessary to create enough urban jobs to help raise the standard of living for the lower middle class.

With the Chinese domestic economy slowing down, one of the greatest fears is that there will be a commensurate slowdown in Chinese import demand. China is the world's number two importer of goods with roughly $2 trillion in demand, second only to the United States with roughly $2.4 trillion in demand.

Given financial markets and business cycles are so much more synchronized today than in the past, fears of a knock-on effect abound.

It's too soon to tell whether China's slowdown could really cripple the world. However, one can look to the past to make educated guesses about the future.

Source: Statista

Looking Back At Japan's Struggles

According to HSBC's economist, Frederic Neumann, Japan's contribution to global gross domestic product was about the same in the late 1980s as China's is today. Despite the bursting of Japan's bubble on Dec 1, 1989 when the Nikkei 225 index topped out at 38,916 there wasn't a global meltdown in the 1990s.

After Japan's bubble burst in 1989, the Nikkei continued to struggle but the world's economies went on. Neumann further commented on Japan in a report saying, "At the time, its share of global U.S. GDP was a touch above 15 percent. The subsequent slowdown, however, didn't push the world to the brink."4

Looking at the graph below, since December 1, 1989 the Nikkei is down about 54 percent as of January 15, 2016. However, the S&P 500 has risen close to 471 percent during the same time period.

Click to enlarge

Source: Yahoo Finance

It's also interesting to note that the portion of retained merchandise imports amongst China's GDP is lower than Japan's today even though China's imports have grown significantly in recent years. Roughly 30 percent of China's imports are used in the production of its exports. Thus, China's impact on driving global growth may not be as large as some people think.

Why China's Slowdown Could Have Different Results than Japan's

Although it is comforting to see that the U.S. economy kept marching higher despite Japan's collapse, our countries and business cycles are inextricably more linked today than they were in the 1980s.

The more China artificially restricts their markets to find the natural clearing price, the more investors will worry. Further, if China continues to aggressively devalue the Yuan, they might do well to help their manufacturers. But a weak Yuan would tend to have an adverse effect on non-Chinese exporters who depend on Chinese demand.

Despite the negatives of a slowing Chinese economy, there are also several positives. Given China is also a major consumer of commodities, a slowdown should help suppress prices in gold, wood, and oil which are key input costs for many manufacturers and consumers.

Possible Impacts On U.S. Real Estate

For investors looking to purchase property in major cities such as San Francisco, Los Angeles, Las Vegas, New York, and Miami, it's possible that declining wealth in China may lead to a marginal decline in Chinese buyers of U.S. property.

Chinese investment in U.S. residential real estate has grown from a measly $50 million in 2000 to an eye-popping $28.6 billion in the year ending in March 2015. That is up 72 percent from a year earlier and double the amount spent a year earlier.

Chinese buyers surpass all other foreign buyers and represent 16 percent of international buyers according to RealtyTrac.5 Canadians made up 14 percent of overseas buyers. Mexican buyers ranked third, accounting for 9 percent of foreign buyers.

After a Chinese stock market rout in the winter of 2015, there is evidence that Chinese buyer demand has declined. Perhaps further slowdowns in China's economic growth could continue to lessen Chinese interest in U.S. real estate.6

Click to enlarge

Source: The Wall Street Journal

The World Keeps On Turning

Volatile and slowing markets domestically and abroad are not a recent phenomenon. Take some time to reassess your financial goals, analyze your existing holdings, rebalance if needed, and deploy capital.

  1. Domm, Patti, "These Are Risks For Markets In Week Ahead," CNBC, January 15, 2016.
  2. The Economist staff, "Made In China?" The Economist, March 14, 2015.
  3. Tejada, Carlos, "China Places Cap On Local Government Debt," The Wall Street Journal, August 30, 2015.
  4. Tan, Huileng, Katy Barnato, "Why A China Slowdown Will Not Hurt That Much," CNBC, January 15, 2016.
  5. Nuiry, Octavio, "International Buyers Flow Into U.S. Housing Market, China Tops List," RealtyTrac, August 28, 2015.
  6. Kusisto, Laura, Alyssa Abkowitz, "Chinese Pull Back From U.S. Property Investments," The Wall Street Journal, November 27, 2015.