By Valentin Schmid
The good news first. The slowdown in the Chinese economy and lower commodity prices mean more money for the consumer in the West.
"What happens to the overall world economy depends on whether the boost to income and spending of the consumer will outweigh the hit to the income and spending of the producers," says Diana Choyleva, chief economist of Lombard Street Research.
U.S. disposable income has gotten a boost from low commodity prices (St. Louis Fed)
But while consumers in the European Union have spent most of it, according to Choyleva, consumers in the United States are staying put because a big chunk of their savings is tied up in the stock market.
"The longer financial market volatility continues, the more likely it is that the American consumer will continue saving the real income gains and not spend them," says Choyleva.
Good for China
The same is true for China. Take money away from the producers and put it in the consumer's pocket. A devaluation of the currency could help this process, says Choyleva.
"An open capital account and weaker currency will produce higher domestic interest rates. It's exactly what China needs in order to move toward higher consumption," she says. Because most of Chinese household savings are in interest bearing deposit accounts within the banking system, higher rates mean higher income and thus higher consumption.
Lower Chinese investment by producers and the government, on the other hand, would enable Western businesses to pick up the slack and increase business investment.
As for higher import prices because of a weaker currency, Mrs. Choyleva says this is nothing to worry about because China doesn't actually import a lot of consumer goods but rather commodities needed for investment.
Bad for China
However, it looks like Western central banks aren't letting China get away with this strategy. "It would have been much better for them to let the currency go in a one-off fashion. But of course, that would be like a red rag to the bull; whether it's the Japanese bull or the American bull," says Choyleva.
The Bank of Japan has recently reiterated its aggressive stance on monetary easing and even told China to implement stricter capital controls to stem capital outflows and prevent a depreciation.
"We are in the midst of a currency war. It's quite clear that if every major central bank in the world tries to devalue its way out of trouble, no one will succeed, unless of course, we find life on Mars," says Choyleva.
Evan Lorenz of Grant's Interest Rate Observer thinks a sharp Chinese devaluation would definitely make in onto the U.S. election agenda in 2016.
"It would be a political catastrophe right now. We're in the middle of a U.S. election right now. China has already become an election issue. I have to imagine that the Republican front-runner Donald Trump is going to make China headline news until the election in November should they devalue 10-15 percent. That may lead to trade sanctions or some problems for China down the line," he says.
Ugly for China
Evan Lorenz has a more pessimistic view on the whole China rebalancing story. "It does seem like China's overinvestment bubble is starting to pop with bad repercussions for China and the rest of the world," he says.
He says China has a massive debt problem (240 percent of GDP officially), which is impossible to solve without dramatically slower growth. The regime has recently set a target of 6.5 percent to 7 percent, but Lorenz thinks this won't be achievable.
"It's unclear whether it's going to be 0, 1, 2, or even -1 percent but I do expect lower growth," he says. The real problem, however, would be for China to inflate another bubble to counter slow growth.
"If the authorities throw money at the problem, forget reform, maybe we will have a short-term relief rally. Given the alarming pace of increase in debt in China, given the investment excesses of the past, given the lack of structural reform in places like Japan and the Euro-area, then it's very unlikely that this will be a healthy and long-term improvement. On the contrary, the fallout from that sort of policy would be much worse," says Mrs. Choyleva.
"It has in the past, when it's run into these hurdles, tried to go through one last, great surge of lending and we saw that around the transition of CCP Chairman Xi Jinping in the last Congress of 2012," says Lorenz.
It seems China is following this "great surge" policy in 2016 as well, as it has created more than $1 trillion in total debt financing until the end of February, a new record.
This will not end well, according to Mrs. Choyleva: "China doesn't have another ten years to be blowing up bubbles and kicking the can down the road. Given where debt-to-GDP is at the moment, it actually has at most one or two years to do the wrong thing before it blows up. The positive take on this is that it still has the funds to clean up the excesses now if it does the right thing." If it does the right thing.