Will China’s Economic Troubles Lead U.S. into Recession?
China’s stock market tumbled badly again over the last few days, and is now down over 40 percent since June 2015. The question I have been asked during this tumble is: Does China’s latest trouble mean that the U.S. is facing a recession?
I wrote about China’s impending economic calamity back in 2014 in my book, The Next Economic Disaster, and elaborated on this prediction in an article in The Democracy Journal in February 2015. The analysis was straightforward. Runaway private debt growth (roughly 20 percent of GDP or more in five years in high private debt countries) led to essentially all financial crisis—including the 2008 crisis in the U.S. and Europe, Japan’s 1991 crisis, the Crash of 1929, and a myriad of others.
Why? This runaway lending leads to so much overbuilding and overproduction that growth has to be severely curbed for demand to catch up, with far too many bad loans made in the process. And China’s private debt has grown by a massive $16.3 trillion since 2008, creating as much as $3 trillion in bad debt in the process. The result is a country littered with ghost cities and piles of commodities including iron and steel. The bust has begun.
But instead of curbing production and letting real, organic demand catch up with its oversupply—which is the unavoidable requirement to begin rectifying these problems—China is trying to stimulate more growth through the timeworn (and futile) trick of government intervention, and China’s lenders, builders and manufacturers are pushing even harder. This will all exacerbate the oversupply, insuring that the eventual reckoning will be all the more difficult.
What will this pain look like? It will be a decade of downward pressure on non-agricultural commodity prices, a deceleration of China’s growth rate to a level much nearer to zero, the near-failure of many lending institutions (though China has proved a master of propping up insolvent banks), and a potential acceleration of political unrest. If that isn’t enough, all will be accompanied by crisis or near-crisis throughout the Asia-Pacific region, Africa and South America.
So how will this impact Philadelphia and the United States? Well, the impact will be mixed, but will contribute to a softening of the U.S. and global economies. It’s hard to say whether we will actually dip into a period of negative GDP growth, which is the definition of a recession, but overall I think we are now due for a prolonged period of lackluster or “sideways” growth.
The things to note are the following:
On the positive side, the U.S. is relatively less dependent than other major countries on exports, muting the impact of overseas issues. U.S. exports to GDP are roughly 10 percent, while in most European countries and China it is closer to 25 percent, and in Germany it actually exceeds 50 percent. And U.S. lenders seem to be relatively less exposed to Chinese borrowers here than in prior situations—at least as far as any publicly available information shows.
On the negative side, even though lower non-agricultural commodity prices, such as those for oil and steel, are a benefit to some, certain sectors, especially the U.S. oil and gas industry, are being hit very hard and are suffering severely. This sector has depended heavily on debt, and the U.S. non-investment-grade bond market has been badly bruised, with energy defaults increasing and energy companies making up 15 percent of its aggregate face value. Even outside the energy sector, junk-bond spreads have increased by 240 basis points over the past 18 months, a measure of the heightened concern.
As for the stock market: Stocks are generally a symptom rather than a cause, and China’s Shanghai Composite Index, with a P/E ratio of 16, has a valuation that is no longer in the stratosphere. However, grave uncertainty about China’s economy and the fragility of China’s corporate earnings, nestled inside the shaky foundation of Chinese accounting standards, could keep China’s stock markets in a troubled mode for some time. This will continue to form a backdrop of concern for U.S. stocks that will be hard to ignore.
So, the U.S. will continue down its path of modest-to-low growth. China’s woes will likely have at least some moderating impact on U.S. job creation, which has recently been strong. The U.S. housing market has benefited significantly from low interest rates, and China’s issues will mean continued downward pressure on those rates. The U.S. will be the least impacted by China of all major countries, but China’s economy, now second largest in the world, is so large that we too will feel at least some level of impact.
The inevitable slowdown in China is made worse by the fact that there is no other major economy able to pick up the economic growth baton by expanding private debt. Together, the U.S., Europe, Japan and China add up to almost 65 percent of world GDP. Runaway private debt growth led to Japan’s economic miracle of the 1980s and crash in the 1990s, and it still has residual high private debt levels from this boom that are stultifying its growth rates to near-zero levels 25 years later. Runaway private debt growth led to booms and then busts in the U.S. and Europe in the 2000s, and the residual high private leverage now impedes their growth.
Now China has had its private debt binge as well, and is entering its bust phase. That means that all four of the world’s major drivers of global growth—the U.S., Europe, Japan and China—are now laden with private debt and are facing years of lackluster growth, insuring long-term downward pressure on commodity prices and interest rates.
It’s not a time to let down our guard.
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